Is it Better to Rent or Buy? That is The Question.
May 28, 2008
Rent or Buy? Buy or Rent? What’s the smart thing for me to do?
I started thinking about this today because I just read a great article by David Leonhardt on NYTimes.com about this topic. And I’m sure that a lot of you are thinking about it too, considering that there are a lot of pros and cons on both sides. Especially now, in this crazy Real Estate market.
Now, I know that owning real estate is a cornerstone of building wealth. But, does that mean that whatever Real Estate I purchase will help me build wealth? I’ll need to do a lot more research to find the answer to this.
But back to the Rent or Buy question. Let me tell you about why I started thinking about it. I live in New York City where an average 1-bedroom apartment in a good neighborhood costs around $500,000. Yes, that’s 500 Grand! For a 1-bedroom! That’s crazy. But then, this is the greatest city in the world.
Let’s say I buy a condo for $500K. That means that I would have to put down at least 10% or $50,000. If I buy a co-op, I would have to put down 25%. For this calculation, we’ll stick with buying a condo.
So, now I’m left with a $450,000 mortgage. At 7% Annual Interest Rate over 15 Years, I’ll have a monthly mortgage payment of $4,044.73. This doesn’t include the Monthly Maintenance on the apartment (which varies greatly based on the condition of the building.) It also doesn’t include closing costs, mortgage points, insurance, attorney fees, etc. On the plus side, I would be building equity and would get tax benefits for owning a home.
Currently, I rent a 1-bedroom apartment for a lot less than half of the above monthly mortgage payment. Sure, I’m not building equity and I’m not getting any tax benefits, but I also have more than $25K extra at the end of the year than I would have if I had bought an apartment.
That’s my dilemma: Should I continue renting or should I buy a place?
According to the New York Times article, there are more things to consider than just the info I gave above. There’s something called a Rent Ratio, which seems to be an important thing to consider. It’s a way to compare the costs of renting and owning. To do this, you find 2 similar houses/apartments, one for sale and the other one that’s a rental. Then you divide the sale price by the annual rent. The result is the Rent Ratio.
The article states that throughout the 1970s, ’80s and ’90s, the average Rent Ratio nationwide was between 10 and 14. In the last few years, it almost hit 19. In New York, it topped 25.
The author states that a Rent Ratio above 20 means that the monthly cost of ownership greatly exceeds the cost of renting. He gives an example of a $500,000 house that would have monthly expenses of about $3,000 (this takes into account the taxes, repairs, typical down payment and mortgage deduction). As a rental, the house rents for $2,000 a month or $24,000 a year. This would give it a Rent Ratio of about 20.
He goes on to say that there are some problems with buying a house in this situation. The first is that you’re paying an extra $1,000 a month for owning. The second is that a Rent Ratio of above 20 is a good indication of a Real Estate bubble.
So, what should I do? Well, right now, I need to seriously consider all of my options. Luckily, the article also has a great multimedia calculator that will help me compare the costs of renting and buying equivalent homes.
Check out the article and the calculator. And let us know what you think.
Hey Billy, Great piece!! It’s a really interesting subject. I rented for years and finally bought my own home 10 years ago. It was a buyers market then…it turned into a sellers market for awhile and the price of our house greatly appreciated….and you know what it’s like now. I’ve heard that real estate is the best thing you can invest in and that it will always increase in value over time–do you agree? The point you made about your rent being so much less than your mortgage payment would be is a good one….but what if you took out a 30 year mortgage? Yes, you would pay more in interest in the end (a lot more) but your payments would be substantially less and you could always pre-pay to cut down on the interest. Since your interests lie in not only financial but also emotional and spiritual wealth, I have to tell you that owning my home is one of the nicest pleasures in my life. I feel completely different about the way I garden, clean the house and even do little things like feed the birds. I always did all those things but there is a different feeling that goes with it now–I can’t explain it. Well, as for you…. I picture you renting in the city and buying a beach house anyway–so there!!
[...] chips and salsa of the bunch goes to Bill D. at The Wealth Hunter with, “Is it Better to Rent or Buy? That is The Question.” It’s a good take on the age-old question, and employs a “rent ratio” to [...]
If you are not planning on moving in less than 5 years (and you can afford it) it’s better to buy. But make sure you buy in a neighborhood that will be desirable to the largest number of buyers.
http://idealinvestment.blogspot.com/
It’s funny that you trust the same mainstream media that completely ignored the onset of the credit crises.
Alt-A mortgages have yet to really begin to reset (a problem that is just about as big as subprime that doesn’t start until next year - and banks have barely begun to admit the true losses that have occurred from subprime, neither admitting the true value of mortgage backed securities they still hold or clearing any of their massive bank owned properties), housing inventories are still sky high, housing prices are still way above what they would be based on the average rate of appreciation over the last 100+ years.
Do yourself a favor, and save the difference between rent and a housing payment for at least several more years. Then, when everyone is screaming that real estate is the ‘worst investment ever’, go looking for a real auction (not one where the minimums are already set) where the bank is looking to unload for pennies on the dollar.
Don’t wait too long, though, hyperinflation may be lurking around the corner what with the enormous $50-60 trillion in projected unfunded entitlements ‘owed’ by our government, and you’ll need an inflation hedge.
Good luck, and don’t trust everything you read in newspapers, nor platitudes of ‘buying always builds equity’, ‘real estate always goes up’ or ‘if you’re not planing on moving for 5 years, buying is always best’.