Buy or rent?

questionman                                          

Like most real estate questions, the answer to “buy or rent” is “it depends”.  I’ll look at the pros and cons of renting and buying, and at why some people are more likely to buy than others.

What follows is a screening tool, not a sales pitch on the virtues of homeownership.  Those virtues are real, and I mention them because they make a compelling case for homeownership.  But this article won’t turn a confirmed renter into a motivated buyer.  In fact, I’m hoping for the opposite result:  the confirmed renter will realize that he or she is a confirmed renter.  Life is too short to be looking at houses you’ll never buy.  But if you’re already predisposed to buying, you may find yourself thinking yeah, I kinda thought that.

 Renting has its place, offering more mobility, requiring less commitment.  Renting may be better if you’re here only for a short time, since it eliminates the risk of buying during a market peak and selling during a market low.  Your landlord takes care of the maintenance—or at least that’s what the lease says.  Renting lets you spend more on the symbols of achievement:  trips, restaurants, cars, toys.  Buying, however, is a genuine achievement, a rigorous rite of passage in a market that goes out of its way to punish buyers.  Renting lets you enjoy a neighborhood a notch or two above what you could buy.  And maybe you just can’t afford to buy, or can’t afford what you want; that’s true of many in this area, where less than one-fifth of us make enough to buy the median-priced home.

 But while renting has its benefits, they don’t include long-term wealth accumulation, except for your landlord.  Home equity (the difference between the value of a house and its loan balance) is a very powerful thing.  Equity accounts for about one-third of a homeowner’s net worth by retirement age, according to the April 2004 issue of Money, and the proportion may be an even higher in this area.  I’ve seen long-time homeowners pull hundreds of thousands of dollars out of their home, money that lets them maintain their lifestyle while either downsizing here or relocating to a less-expensive area.  Refinancing homeowners used their equity to keep themselves and the economy afloat during the recent recession.  Home equity is a good thing.

 How about putting your money in the stock market instead of real estate?  From January 1994 to December 2012 the NYSE composite, the NASDAQ and most local home prices have appreciated in the 10-12 percent range annually.  (Local condos and the low end haven’t appreciated as well.)  So their historical rate of return is quite similar—or is it?  A study reported in the September 2004 issue of Money suggests that the past return on stocks is more like 2.4 percent annually “after factoring in the effects of inflation, brokerage charges, investors’ tendency to buy high and sell low, and taxes”.  According to another study quoted in the same issue, “NASDAQ investors, as a whole, darted in and out so much that they would have done just as well keeping all their money in T-Bills”.

 All this confirms my theory as to why home equity plays such a powerful role in wealth accumulation.  It’s easy—way too easy—to move into and out of the stock market based on whims, hunches and wishful thinking.  But a home is an “illiquid asset”, more difficult and expensive to buy and sell than most other assets.  This forces homeowners into the “buy and hold” investment style that investment pros tell you pays off far better over the long run than frequent buying and selling.  Homeownership also has its hidden costs, of course, but it offers tax benefits, and home prices have traditionally stayed just ahead of inflation as demand exceeds supply (especially in this area).  And it gives you a place to live, something you’d probably need anyway.

 Some self-defeating rationales for renting.

     Remember, I’ve said that there’s a place for renting.  But I sometimes run across rationales for renting that don’t stand the light of day.  If buying is eventually your goal, these misconceptions will really put you behind the eight ball.  If, however, your goal is to indefinitely postpone the day you walk out of a title office with a thirty-year mortgage, a “honey-do list” and all the other accoutrements of serious commitment, these rationalizations will certainly postpone that awful day of reckoning.

 One is the idea that renting helps you avoid the “inflated prices” of local real estate.  But unless you’re living in your parents’ spare bedroom or under a bridge, you pay a premium to live here whether you rent or own.  Renting isn’t how you beat the high cost of housing, it’s just another form of it.  Yes, renting is cheaper in the short run, but in the long run you’re giving up a big chunk of your retirement nest egg.  And no, that wouldn’t have fazed me either when I was younger—”there’s plenty of time”—but it means something to me now, especially since I’ve seen home equity bail out retirees after the stock market let them down.

“I won’t buy unless I know I won’t lose money.”  Then you’ll always rent, because you’ll never get that guarantee.  In fact, it’s entirely possible, even probable, that you’ll lose money if you buy in an up cycle and sell in a down cycle.  Real estate in this area pays off handsomely, sometimes in as little as a few months, but usually only over a period of years.  And since when did the stock market guarantee you won’t lose money there?    

 “I’m saving money for a bigger down payment.”  Local real estate prices have gone up about 10 percent annually on average since 1992, and that includes several years when home values either went down or barely budged.  Since late 1999 I’ve sometimes seen prices go up 10 percent in a month.  This means you’d have to increase your savings rate for a down payment by 10 percent just to stay even with home prices.  And unless you can exceed that rate—or unless you expect your income to jump much higher in the short term—you’re fighting a losing battle.  

 Then there’s the “I’m not getting sucked into that middle-class mortgage trap thing” rationale.  Far be it from me to question someone’s lifestyle, especially if they understand its consequences.  If they’re eschewing homeownership to save a small corner of the world, then they have my admiration.  If they’re eschewing homeownership solely to live like they belong in the next higher tax bracket, then they’ve traded an imagined trap for a real one.  

 And finally, there’s that old standby:  “I’m waiting for prices to go down.”  This magically transforms do-nothing inertia into shrewd market timing.  “I’m paralyzed” becomes “I have a plan and I’m sticking to it.”  The downside is that market timing is a lousy investment strategy.  None of us can accurately predict the random events that make markets go up or down.  Just as important, market timing ignores the reality that home prices go down only when most people (including market timers) are too scared to buy.  Market timers should ask themselves this:  would I buy when everyone at work is talking about the next layoff, or when a terrorist attack or an imminent war sends the economy deeper into recession?  Because that’s when home prices have gone down over the past seven years.  Sound like a risky time to buy?  You bet, and that’s the irony of “I’m waiting for prices to go down” as a risk-avoidance strategy.  It trades one risk, the risk of paying too much in an overheated market, for the risk of buying when home prices are spiraling downward with no end in sight.  So as local real estate has careened from boom to bust since 1999, the risk-averse have stood on the sidelines, waiting, waiting, waiting for the perfect moment, the perfect house and the perfect deal that somehow never shows up because there is no perfect moment, no perfect house and only fair deals.  If bad news drives down home prices 10 percent, market timers wait for prices to go down even more.  When prices finally bottom, market timers know they’ve bottomed only when prices suddenly shoot back up and yesterday’s buyer’s market is today’s seller’s market.  The seller’s markets of late 1999, late 2000, early 2002 and 2004 and 2012 all came out of nowhere, with multiple offers and skyrocketing prices, and suddenly it was hard to buy a house.  Hit a few open houses and you’ll realize why our market turns so quickly:  there’s huge pent-up demand for homes here.  Any sort of green light to buyerslow interest rates, a booming economy or rising consumer confidencequickly overwhelms our limited supply of homes.                

 Why buy a home? 

You probably know the financial benefits:  building equity over the long term and deducting your mortgage interest and property tax payments.  But I wonder how important the financial aspect is to most buyers, aside from the obvious:  money gets you into the market, lack of money keeps you out.  It’s telling that no one has ever said to me, “I’ll buy if you can prove that home ownership makes sense financially”.  Maybe they’ve already done the math, but I have a feeling that the decision to buy or rent comes mostly from the heart, not the head.  You’re ready, emotionally, or you’re not.

 So if you have the money to be in the market, what determines whether you buy or watch from the sidelines?  What separates a buyer from a bystander?  I think it’s identity, commitment and tolerance for risk and uncertainty.

 At some point buyers decide that home is so important to their identity and lifestyle that they want more control over it.  Bystanders, on the other hand, are comfortable borrowing someone else’s house even if their use is restricted and temporary.  Renters are limited as to how much they can make the house their home.  And without a lease, they could be out in thirty days.

 At some point buyers decide that they like it here enough to put down deeper roots.  Buying is the ultimate commitment to an area.  Bystanders aren’t ready to commit.  There might be something better on the other side of the hill.

 At some point buyers decide that the benefits of owning outweigh the risks.  Buying is much like marrying, having a child or coming to a new area for career opportunities:  it’s a calculated risk taken in the hope of gaining a potential reward, either emotional, financial or both.  Buyers accept the idea that home ownership has no guarantees, but that the long-term trend in local home values has been upward.  Buyers may have seen that for many long-term owners, the equity in their house is their major asset, one that enhances their lifestyle and supports them in old age.  For buyers, the emotional rewards of owning their own home more than offset the financial risk.  Bystanders  focus on the potential downside of home ownership.  For them the glass is always half empty.

 When home prices are high and the competition fierce, many are called and few are chosen.  So ask yourself these critical questions before you get into the market and, just as important, answer them honestly.  Are you genuinely excited by the idea of owning your home, or is everyone I know has bought a house pushing you into the market?  Are you ready to pursue the dream aggressively, perhaps more aggressively than you’ve ever pursued anything?

 Are you happy with what you can afford?  Are you willing to make the sacrifices?  Are you able to conquer your fears?

 If the answers are yes, contact me at jfyten@cbnorcal.com.

copyright © John Fyten 2004-2014

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