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Rent or Buy?

Friday, November 18, 2016 1:09
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Tim Duy:

Rent or buy? Often I am asked this question, and I find I lack a satisfactory answer. I realize that people who ask me this question are typically in transitional phases in their lives – moving from young adulthood to real adulthood. The answer is perhaps more obvious on either side of that inflection point, less so in the middle of it.

From my experience, these are the pros and the cons:

Pros

  • You earn the untaxed imputed rent (you pay yourself rent) and receive a tax deduction on your mortgage interest. Double subsidy.
  • Assuming a fixed rate mortgage, you no longer face the prospects of future rent hikes.
  • Owner-occupied housing provides you both the service of shelter and an investment asset.
  • It is a leveraged asset, which improves returns in a rising market.
  • Mortgage rates are historically low. That won’t last if policymakers do their jobs.
  • Housing is a hedge against inflation.
  • You receive psychological benefits.

Cons

  • It doesn’t provide cash flow. Instead, it requires cash flow. Mortgage payments, property taxes, insurance, repairs, etc.
  • Most buyers do not recognize/plan for depreciation costs. I have heard that you should expect annual depreciation of 2% of the cost of your home. This seems consistent with my experience.
  • Maintenance and upkeep are time consuming, particularly for single-family housing. Anyone want to come over and rake leaves with me this weekend?
  • Depending on the market, it can be an illiquid asset. This can be a problem if you plan/need to move. This is especially the case if you buy in a region that is struggling economically.
  • It is a leveraged asset, which is brutal in a falling market.

I am guessing that commenters will add additional pros and cons.

My standard advice is that property should be a part of your portfolio, but not your entire portfolio. If buying a home leaves you cash poor or unable to save in your firm’s retirement plan, it probably isn’t a good option for you. If you plan to move soon, it probably isn’t a good option. If you are too busy with your career to deal with upkeep, it probably isn’t a good option. Recognize the risk that comes with the reward. If you aren’t ready to accept the risk, it probably isn’t a good option.

I don’t think you should let the recent housing bust play too heavily in your decision. I tend to think that was a fairly unique event. If you are waiting for another housing bust on a similar order of magnitude before you buy, you might be waiting forever.

I have heard the advice that you should buy the most expensive house you can because the burden will fall as your earnings rise. Bad advice, in my opinion. Following this advice will leave you cash poor and unable to meet other financial goals or prepare for a life change or emergency. My advice is to leave substantial margin for error. And buy for the neighborhood, not the house.

My experience as a homeowner has been generally positive, but I would say that my circumstances are somewhat unique. Partly through accident, and then later through design when we recognized the benefits, Mrs. FedWatch and I have always purchased housing that we could afford on just one of our incomes. As a result, we have had to make some housing sacrifices. Not really me so much, mostly for her. She complained the last house was “killing her soul.” That doesn't sound pleasant. And the current house needs some work. But on the upside, however, when Mrs. FedWatch wanted to take time off work, we did not face a financial hardship.

Good luck with whatever decision you make.

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