Source: Keeping Current MattersArticle by Founder, Steve Harney
Posted: 06 May 2014 04:00 AM PDT
I have been a subscriber to the Wall Street Journal
(WSJ) for as long as I can remember. In my opinion, it is the single
greatest source of financial information and insights available. I don’t
always agree with their analysis but I always respect their position.
However, in an article this past weekend, The New Math of Renting vs. Buying,
they flat out got it wrong. Below are a few excerpts from the article
and the reason why I believe the analysis to be incorrect.
The Cost of Renting is Lower than the Cost of Owning
In the article, they discuss that homeownership is more expensive than renting in many large metropolitan areas.
"The monthly cost of renting was lower than buying in 20 large
metropolitan areas at the end of last year, the most recent period for
which data are available, according to figures provided exclusively to
The Wall Street Journal by Deutsche Bank. That is up from 15 large
metropolitan areas a year earlier.”
The challenge is that more recent data from two very reliable sources
has shown that not to be the case. Among the 35 largest metro areas analyzed by Zillow in the first quarter, every metro showed it would be cheaper to buy than rent if you plan to live in the home for at least 4.2 years.
According to a study by Trulia:
“Homeownership remains cheaper than renting nationally and in all of the 100 largest metro areas.
Rising mortgage rates and home prices have narrowed the gap over the
past year, though rates have recently dropped and price gains are
slowing. Now, at a 30-year fixed rate of 4.5%, buying is 38% cheaper
than renting nationally.” (emphasis added)
Renters Don’t Have All the Expenses of Homeowners
The article goes on to explain that as a renter you have many less expenses than you would have as a homeowner:
"Renters, for example, don't pay property taxes, homeowner's
insurance and, in most cases, maintenance costs. These expenses can cost
homeowners about 3% of the price of their home annually, experts say.
While those costs can be folded into monthly rent, apartment
renters often pay a smaller share as landlords spread the costs among
many tenants, says Stijn Van Nieuwerburgh, director of the Center for
Real Estate Finance Research at New York University. If a window breaks
or the toilet plugs up, your landlord—not you—pays for the repairs."
Don’t kid yourself – the landlord does not pay the taxes nor pay for repairs.
The tenant does. It is incorporated in the rent. It is true, if it is
an apartment building, that the property taxes are shared by all
tenants. However, realize that the amount of property taxes for an
apartment building with “many tenants” will be far greater than a single
family residence.
We think this situation is best explained by Eric Belsky, Managing Director of the Joint Center of Housing Studies at Harvard University, in his paper on homeownership - The Dream Lives On: the Future of Homeownership in America:
“Households must consume housing whether they own or rent. Not
even accounting for more favorable tax treatment of owning, homeowners
pay debt service to pay down their own principal while households that
rent pay down the principal of a landlord plus a rate of return. That’s yet another reason owning often does—as Americans intuit—end up making more financial sense than renting.” (emphasis is mine)
Investing the Difference in Payments Will Net a Renter More Money
The WSJ article claims that, if a renter invests the difference
between their rent payment and a potential mortgage payment had they
purchased, they would be better off financially in the long run.
"Renters don't end up with a valuable asset, as buyers do when
they pay off a mortgage. But renters might be able to make more money by
investing the monthly savings, as well as the cash they would otherwise
use for a down payment, he says."
They go on to explain their reasoning as follows:
"The value of the average single-family home increased by 3.6% a
year in the three decades through 2013, compounded annually, according
to mortgage giant Freddie Mac. By contrast, the compound annual return
on the S&P 500 over that period was 11.1%, according to
Chicago-based investment-research firm Morningstar."
As to the idea that the return on investment would be greater by
investing in the stock market rather than purchase a home, I think the
article in the WSJ forgot that housing is a leveraged investment.
Belsky, in his paper, explains:
“Few households are interested in borrowing money to buy stocks
and bonds and few lenders are willing to lend them the money. As a
result, homeownership allows households to amplify any appreciation on
the value of their homes by a leverage factor. Even a hefty 20 percent
down payment results in a leverage factor of five so that every
percentage point rise in the value of the home is a 5 percent return on
their equity. With many buyers putting 10 percent or less down, their
leverage factor is 10 or more.”
That 3.6% average annual appreciation is really an 18% return on cash to a home buyer putting down 20%.
They also assume the renter will save any difference in housing
expense. However, that does not happen in reality. In their ongoing
research for their paper, Beer and Cookies Impact on Homeowners’ Wealth Accumulation, Eli Beracha and Ken H. Johnson reveal that homeownership creates a ‘forced savings’ plan:
“It appears that homeownership creates extra wealth mainly
through its ability to force owners to save rather than through property
appreciation. Thus, homeownership appears to be a self-imposed savings
plan, which through time leads to greater wealth accumulation as
compared to comparable renters. In short, buying a home makes Americans
save.”
And Belsky from Harvard agrees:
“Since many people have trouble saving and have to make a housing
payment one way or the other, owning a home can overcome people’s
tendency to defer savings to another day.”
To further make this point, we can look at a study by the Federal Reserve which showed that the net worth of a homeowner ($174,500) is 30 times greater than that of renter ($5,100).
Bottom Line
Looking at financial advantages of homeownership from every angle
still reveals that it is a much better investment than renting.
----
After reading this article, I contacted my son, a journalist who lives in NYC, and asked his opinion on the article. Here is his reply...
I can't speak to the disparity between the figures in the WSJ article and the ones that this guy uses...
But
I will say that, as a renter, I'm not hit with surprise expenses --
like replacing an AC unit or other wear and tear costs. Those are built
into my rent. I'd say renting is also a hedge against having to leave
unexpectedly. It's hard to know what your needs will be or other
circumstances that cause you to change cities.
If
you're not highly confident that you will be okay staying in the place
for five or six years, I think renting is probably more prudent.
I
do agree with his point that home ownership is a leverages
investment... So if the value of your home goes up by rates that they
have historically, you can be a bigger winner than you would be
investing in the market.
Bottom line, I
think there are too many variables, and individual circumstances, to say
that renting is better than buying. But if you're sure you're staying
put for at least six years, and you've got the money, buying could be
the better way to go. It's the longer horizons where it really pays off
to buy. Or so it seems to me.
On May 5, 1862, General John A. Logan, leader of an organization for
Northern Civil War veterans, called for a nationwide day of remembrance
later that month. “The 30th of May, 1868, is designated for the purpose
of strewing with flowers, or otherwise decorating the graves of comrades
who died in defense of their country during the late rebellion, and
whose bodies now lie in almost every city, village and hamlet churchyard
in the land,” he proclaimed. The date of Decoration Day, as he called
it, was chosen because it wasn’t the anniversary of any particular
battle.
For decades, Memorial Day continued to be observed on May 30, the
date Logan had selected for the first Decoration Day. But in 1968
Congress passed the Uniform Monday Holiday Act, which established
Memorial Day as the last Monday in May in order to create a three-day
weekend for federal employees; the change went into effect in 1971. The
same law also declared Memorial Day a federal holiday.
