“To Buy or Not to Buy”

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buy vs rentBuy vs Rent? – Life Lessons

Buy vs rent? For the majority of my life, I was convinced that buying was the only way to go. The downfalls of renting were always so clear to me. But, why weren’t the downfalls of buying clear? It’s likely because the necessity of buying a home was deeply engrained in me throughout my entire life.

For the first 15 years, I had only one source for financial education, my family. Sure, I learned the basics in Math class, but for some reason, no one thinks it’s necessary to give real-world examples in school. My father was my primary frame of reference and he owned a home since before I was born. My parents started off in an apartment, but once their second baby was on the way (me) they decided it was time to buy a house.

I can remember periods of my childhood when money was a serious struggle for my parents, but they kept us in the same home for 14 years. As soon as they got to the point where expenses weren’t an issue, it was on to the next, bigger house. And with that, it was back to the same old story of money problems. Although that always stuck out to me as something I would never want to do, I never thought once about the possibility of renting. That first home is the backdrop of all my best memories. My brother and I have this attachment that will never fully disappear, no matter how many times we move. There is definitely a benefit to giving your children something to call home and having that stability that renting can’t always provide.

Buying a Home – Investment

In early adulthood, owning a home was the only form of investment I could grasp. It’s a physical entity that under the right climate increases in value. People always need a place to live, and my parent’s home sold for 500% more than it initially cost. How could that be anything but a great investment? Fortunately, the housing bubble happened before I bought a home, so I did end up learning that buying a house isn’t a guaranteed profit. It is still an asset that I can easily grasp how the value is affected:

  • Neighborhood: You are investing in the neighborhood just as much as you are investing in the home.
  • Schools: Traditionally in America, the starter home is the first step to starting a family. It’s one of those boxes that most traditional parents check off their life goal list. So, homes in a good school district tend to hold their value.
  • Infrastructure: The ease of getting to and from your home something all home buyers should consider. If you live in a town that most people are trying to commute to the city, having public transportation nearby will add value to the buyer.
  • Value: Getting the right value for your money is very important. If you buy the best house on the block, there is less room for it to appreciate. Conversely, if you buy a fixer-upper in a good neighborhood, the money you sink into the home for improvements will add value.
  • Structure: How the building was built is arguably the most important part of the home. The interior can always be altered and upgraded, people see those upgrades and if done right, will pay extra for them. If you need to make a serious structural repair, nobody will know when you go to sell your house.
  • Property: A large portion of the cost of your home is the dirt it stands on. If you have an undersized house on an oversized property, there is room for growth.

All of the items listed above are tangible and easy to conceive. That is what made buying a home the only investment I was comfortable with.

Buy vs. Rent – Expenses

This is where everything gets a little hazy. On face value, a rental is an expense, and a home is an asset. So, buying a home is a no brainer, right? Wrong. Let me start by listing everything that I learned was bad about renting throughout my childhood.

  • When you rent an apartment or a house, you are paying someone else money to support their investment. You are paying for the expenses of the house, but not gaining any of the equity.
  • You will never see a return on the money you put towards your rent.
  • Any improvements you make to the home is equivalent to giving money to the landlord.

That first item is partially true, but not so black and white. There is nothing saying that your rent is covering 100% of the expenses of the home. The neighborhood will dictate fair market value for rent, not the owner’s expenses.

The second and third item is essentially the same thing and both true. However, there is a chance you would be spending just as much money as a homeowner. What isn’t so obvious to people when they make the comparison of buy vs rent, is how much money is spent monthly that doesn’t go towards the principal of the house. A homeowner is covering the interest on the money, the taxes, and all the utility bills. The utility bills include the normal electric and gas, which you may or may not have to pay when renting, but also includes; water, sewer, garbage and I’m sure some others that I may be forgetting. There is a good chance that you aren’t paying for all of those bills when renting.

Obviously, it depends on the specific property if it’s worth it to buy, so I figured why not analyze my latest sale to see how I did.

The Case Study – (Owning a Home)

If I were to tell you that my condo appreciated $80,000 in 5 years, would you assume I made the right choice to buy rather then rent? I’m not so sure if I did or not, so let’s dig in.

First of all, my wife (girlfriend at the time) and I bought our condo in 2012. The market was starting to make a comeback following the recession, but it was far from fully recovered. Also, interest rates were extremely favorable at the time so it seemed like the perfect time to buy. We found a condo in an up and coming neighborhood a half hour bus ride from the city. The total housing costs for 5 years were:

  • Purchase Price – $341,000
  • Closing Costs – $9,000
  • Year 1 Total Condo Dues – $5,750
  • Year 2 Total Condo Dues – $5,750
  • Year 3 Total Condo Dues – $5,750
  • Year 4 Total Condo Dues – $5,900
  • Year 5 Total Condo Dues – $5,900
  • Year 1 Property Taxes & HOI – $6,575
  • Year 2 Property Taxes & HOI – $6,575
  • Year 3 Property Taxes & HOI – $6,575
  • Year 4 Property Taxes & HOI – $6,575
  • Year 5 Property Taxes & HOI – $6,575
  • Year 1 Total Interest Payment – $10,675
  • Year 2 Total Interest Payment – $10,600
  • Year 3 Total Interest Payment – $10,525
  • Year 4 Total Interest Payment – $10,450
  • Year 5 Total Interest Payment – $10,375
  • Year 1 Other Insurance – $540
  • Year 2 Other Insurance – $540
  • Year 3 Other Insurance – $540
  • Year 4 Other Insurance – $540
  • Year 5 Other Insurance – $540

Over the course of 5 years, we spent $126,250 on housing including closing costs. That is an average of approximately $2,100 per month. I did not include utility bills, since there is a chance that you are paying a portion of them when renting as well. Also, you may notice I broke up my mortgage payment into individual categories and left out my principal payment. Considering the value of the home increased, all that money essentially went to savings.

Now let’s look at the sale of the home, 5 years later.

  • Value of Sale – $420,000
  • Closing Expenses – $26,000

The true profit made on the home is equal to the $420,000 sale less the original buying price:

  • Sale Price + $420,000
  • Buy Price – $340,000
  • Buying Closing Costs – $9,000
  • Selling Closing Costs – $26,000
  • Total: $45,000

Now that sale that on face value profited $80,000 over 5 years, truly was only a profit of $45,000. With our original down payment of $35,000, we made 130% on our money in 5 years.

That is an 18% annual return on the initial down payment.

The Case Study – (Renting an Apartment)

Now let’s take a look at the flip side of that.

The cost of renting a similar apartment at that time was approximately $2,000 a month.

5 years x 12 months = 60 months x $2,000 = $120,000.

The total housing expense for 5 years would have been approximately $120,000.

On a month by month basis, I would only have been able to save approximately $100 more each month in housing costs. So, after 5 years the costs of owning a home and renting basically ended up being a wash.

The Kicker

Now let’s look back at that (not so) little item that I left out of the expenses of owning a home,
the principal.

  • Year 1 Total Principal – $6,575
  • Year 2 Total Principal – $6,650
  • Year 3 Total Principal – $6,725
  • Year 4 Total Principal – $6,775
  • Year 5 Total Principal – $6,875

That “savings” that I talked about was a total of $33,600 over the course of 5 years, or $560 a month. If I hadn’t bought the home, in theory, the initial down payment, plus the $560 monthly contribution and the $100 per month savings would have been available for other investments. To make a fair comparison I will do a simple compounding interest calculation with the following factors:

  • Initial Investment $35,000
  • Monthly Contribution (60 Months) $660
  • Rate of Return 4%
  • Total: $86,250

After 5 years, our total assets would have totaled $86,250. That is a total profit of $51,250.

Conclusion: Buy vs Rent

Factoring in the $560 a month savings to the sale of our home, our total assets after 5 years were approximately $115,000.

  • Down Payment $35,000
  • Profit from sale $660
  • Total Principal (60 months) $560 x 60 = $33,600
  • Total: $115,000

So, I am learning just as you are, it looks like we made the right decision to buy all those years ago. I’m sure some of the readers will say the 4% return rate is too conservative, I would argue, maybe it’s not conservative enough. 5 years is a very short time span, that money could have easily depreciated over that time. In order for the renting option to have made sense, the rate of return would have needed to be 12%.

  • Initial Investment $35,000
  • Monthly Contribution (60 Months) $660
  • Rate of Return 12%
  • Total: $115,000

I think it’s fair to say, buying a home definitely has a place in the investment world. As long as you take the time to find the right home, in the right area, it will pay a substantial profit in the end.

-M-

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