There's a lot of debate on whether it's better to rent or own. If you are a renter, I'm sorry to say the return on rent is always negative 100%. You get a place to stay for your rent. But there is no potential financial return on rent as opposed to owning.
After years of renting, you will have nothing to show for your money. Whereas if you own, at least you have a chance of growing your net worth through greater home equity. And based on the history of real estate appreciation, your chances are really high you will build wealth owning.
One of my most important recommendations to build wealth is to at least own your primary residence. This way, you get neutral real estate and inflation. Just like it's not a good idea to short the S&P 500 long term, it's also not a good idea to short the real estate market long term by renting.
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Buying My First Property
I remember when I bought my first 2/2 condo in 2003. I felt a sense of relief that I no longer had to pay ever-rising rents. Even though the $2,300/month mortgage payment was about 15% higher than my previous rent after a 25% down payment, it felt good knowing my costs were generally fixed.
What I've recently realized is that many homeowners over the years have not had to pay a single penny for housing costs. In essence, they've lived for free! Not only have the lived for free, thanks to tremendous home price appreciation, homeowners have also made a tremendous amount of money as well.
Let me show you how homeowners have lived for free with an example. It doesn't involve mooching off your parents as an adult child.
How To Live For Free In An Expensive City
Here's the profile of a 3/2 home that was purchased for $1.3 million in 2011 and sold for $2.2 million in early 2019. He put down 20% and took out a $1,040,000 mortgage at 3.5%. Below are some approximate numbers to highlight the power of homeownership.
Financial Positives Of Homeownership
- Monthly rent avoided for eight years: $5,500
- Total rent avoided after eight years: $528,000
- Net proceeds after fees, principal pay down, all taxes from selling house: $1,100,000
Financial Negatives Of Homeownership
- Opportunity cost of not investing $260,000 (down payment) in the stock market from 2011 – beginning of 2019 = $286,000 (110% appreciation to $568,000)
- Net mortgage interest cost after eight years = $203,000
- Net property taxes after eight years = $90,000
- Maintenance cost after eight years = $20,000
- Principal pay down over eight years = $100,000
Net cost of living = ($528,000 + $1,100,000) – ($286,000 – $203,000 – $90,000 – $20,000 – $100,000) = $929,000.
Based on this simple math, not only was my friend's family housing free for eight years but he was also paid $929,000 to live in San Francisco. That's pretty good value for just living.
Obviously, experiencing a 69% appreciation in his property was a big factor in this equation, but so was not having to pay $528,000 in rent during this time period. Further, one can debate whether paying down $100,000 in principal is truly a negative.
Even if the property only appreciated by 3% a year, my friend would still have been paid over $480,000 to live in San Francisco for eight years.
This example is probably similar to hundreds of thousands of homeowners over the years. Now compare the return on rent. There is no comparison.
Related: Reinvestment Ideas After Selling A House
How Much You'll Spend On Rent In Your Lifetime
Check out this chart about how much money you'll spend on rent for a median-priced home in various major cities. The calculate is based of about 10 years, 20 years, 30 years, and 40 years of renting. The figures clearly show the return on rent is always negative.
It's kind of crazy to see that a San Francisco resident would pay $2,468,000 in rent for a median-priced property by the time he or she turns 60. If you see this figure and live in San Francisco, your goal should be to buy your primary residence as soon as you can based on my 30/30/3 home buying rule.
Is your city on the list? If not, add up how much you'll end up spending on rent for your desired property if you never buy. I don't think you'll like the results.
With such massive amounts paid in rent over one's lifetime, is it no wonder why the desire to buy property is so strong? Yes, renters also benefitted during the pandemic due to higher utilization rates by staying inside more. However, the inability to make a profit long term is difficult.
I'd love for property prices to decline by 20% so I can snap up another Golden Gate Heights panoramic view property in San Francisco. Alas, unless I get really lucky, another investment property is not in my cards.
I've reached my limit to the number of rental properties I can manage of four. My remaining cash flow is going toward private real estate funds for 100% passive investing.
Takeaways On Living For Free Through Homeownership
It is amazing that many homeowners have been able to live for free all these years. With the housing market heating up because mortgage rates have plummeted and so many people working from home, housing has become an extremely attractive asset.
Here are some takeaways from this post:
1) The return on rent is always negative 100%.
Yes, you get a place to live, but if you buy, you also get a place to live. Once this variable is canceled out, what's left is the owner's optionality to sell the asset. Who said high school algebra was a useless course.
2) It's easier to invest in real estate than stocks.
Although buying a home is making a concentrated bet with leverage, buying a home may ironically be easier than investing the same amount of money in the stock market. This is because you're buying a tangible asset that may improve the quality of your life. With stocks, there is no utility. Further, prices could decline out of the blue.
Given real estate is less risky than stocks, you can ironically make much more from real estate than you can from stocks.
3) Real estate helps with financial discipline.
Renting and investing the difference in the stock market and other assets is a great idea. Unfortunately, most people often fail to do so due to a lack of financial discipline. Without a proper automatic invest strategy in place, chances are high the saved difference gets spent.
Regularly paying a mortgage is one of the easiest ways to save and build wealth. It is called forced savings. Over time, this forced savings adds up.
4) Time is your friend when it comes to owning a property.
Over time, the cost to rent rises to barf-inducing levels. Meanwhile, the appreciation of a property also sometimes rises to unbelievable levels. The only way you can survive as a renter is if rents stay flat or go down. Unfortunately, inflation tends to always push rents higher.
Rising rents and rising property prices will crush your financial progress. Therefore, it's important to at least get neutral real estate by owning your primary residence. You can also relocate to a lower cost of living area.
Large rent increases won't last forever. However, homeowners should hold onto their rental properties to benefit from rising rents.
5) To live for free, you've got to take risk.
Staying in a rent-controlled apartment is somewhat akin to working at a safe day job with no upward mobility. You'll likely never starve, but you'll likely never get rich either given the return on rent is -100%.
If you take some risk by buying real estate, you might do very well just like if you decided to start your own business or hop to a different employer. Alternatively, you might go bankrupt if you buy inappropriately. At the end of the day, no risk no reward.
6) Living for free strengthens the real estate market further.
Living for free is another phrase for rising home equity. The more home equity there is, the larger the buffer in case of a recession. Given lenders have significantly tightened their lending standards since the 2009 financial crisis, only the most credit worthy borrowers have bought homes.
When you combine high credit worthiness with record high home equity and lower mortgage rates, it's hard to see another crash in home prices again. The best we can hope for is a 10% – 15% decline window before another recovery.
Arbitraging To Live For Free
Once you own your primary residence, you won't truly know until after you've sold your property whether you lived for free all those years or not. In the meantime, you can make educated estimates every year about whether buying or renting made more sense.
If you really want to live for free in the present, you've got to figure out a way to make investments that will produce income. Once you've got enough passive income to cover all your housing expenses, you are living for free.
The concept of Buy Utility, Rent Luxury (BURL) is one logical strategy. You basically rent in a high cost of living area and invest in real estate in a low cost of living area with a higher rental yield to cover your rent. This can be done through a speciality REIT or through real estate crowdfunding, where I've got 18 different commercial real estate investments.
Aggressively saving money on the short end of an inverted yield curve to cover your longer duration borrowing costs is another strategy, especially when the yield curve is inverted.
But the easiest strategy is to simply not rent for life. If you rent for life, you are going to look back 30 years from now with regret. Your kids will also likely hate you for not buying so long ago.
If you're not willing to build assets for yourself, at least do it for your children. Just make sure the numbers make sense and you can withstand downturns.
Real Estate Recommendations
Now that you know the return on rent is always negative 100 percent, I suggest you buy rental properties. The value of rental income has gone way up. Low interest rates mean more capital is required to generate the same amount of income.
I've bought another rental property during the pandemic because I found a good deal. I'm also building a real estate portfolio for my kids to manage, just in case they can't find gainful employment.
In addition to buying rental properties, you can invest in real estate crowdfunding through Fundrise. Instead of needing to come up with a big down payment, you can get started investing with as little as $10 into a diversified real estate fund. Real estate exposure provides the opportunity to generate passive income and diversify your investment exposure. For most people, investing in a diversified fund with Fundrise is the smart way to go.
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I've personally invested $954,000 in real estate crowdfunding across 18 properties to earn income 100% passively. To build wealth, you must invest. Otherwise, inflation will eat away your purchasing power. Both platforms are long-time sponsors of Financial Samurai.
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Sam, if your rent is <15% of your income – does it actually matter in this case? I understand if it's reaching 50% of your income that it may make more sense. I am an expat (not in US) and buying property in a foreign country is not appealing though I have been here for a few years (<5)
Not a big expense provided you are saving and investing the difference.
These numbers seem high to me, at least for my city. If one rented from age 22 to 30, it would mean an average rent of $1074 a month. I don’t know anyone here who was paying that much in rent a month let alone that age group- most people in that age group get a room, pay $5 to 700? Totally possible to pay similar for a studio if you look around. I paid between $400-550 for a room or small studio in the 2010s. In 2017-18 paid $650/month for a small 1 bedroom (jr 1 bed) in Chinatown, $400 for a room in NoLibs in 2019, $575/mo for a TINY studio in Fishtown in 2020. There are parts of the city you could rent a whole house for that much.
The other thing to think about is rental arbitrage. When I had the Chinatown studio I regularly rented it out on AirBnB because it was close to the convention center and a couple larger music gigs. I would occasionally crash at a friend’s (or be travelling myself) but usually stayed in a cheaper airbnb somewhere. Made like $10k that year. Would have done it in Fishtown last year but, covid.
Anyway some thoughts.
The Return on Rent isn’t always zero.
The return on rent is the difference between a mortgage and the rent cost, invested in your favourite investment, essentially dollar coast averaging (DCA). For me, this is DeFi, where I expect minimum 20% per year on cash equivalents.
The comparison is against whether than is better than the capital gain you will receive on a house that you live in minus it’s financial drag (interest payments, maintenance, rates etc).
The house you live in it is not an investment unless you have tenants. You can not compare renting to an investment property, because you still have to live somewhere. Mortgage repayments are just forced savings that you can’t invest.
In most circumstances, this DCA strategy grows quicker than the equity in the house that you live in.
Bob, you can tell yourself this, but you would only be lying to yourself. You gain ZERO equity/wealth when you rent. There is no guarantee building wealth owning either. However, at least there is a chance.
Just like shorting the S&P 500 long term isn’t a good idea, shorting the housing market by renting long-term isn’t a good idea as well.
You’re neutral real estate if you own your primary residence and that’s it. If you want to go long real estate, you need to buy rental properties, REITs, and or private eREITS.
“3/2 home that was purchased for $1.3 million in 2011 and sold for $2.2 million in early 2019.”
“Net proceeds after fees, principal pay down, all taxes from selling house: $1,100,000”
Something got distorted in edits of this article, or your simple math was too simple, or the way you adjusted the figures is confusing.
2.2 – 1.3 = 900k. Subtract another 100 in selling costs. 800k in gains is 300k in taxable income if he’s married, and 550k if he’s single for more than 3 of the last 5 years. The bill on that is at least 25% in CA.
20k in maintenance costs for 8 years on an San Fran 3/2 is not realistic. Maybe if it were new construction, but at 1.3 that would likely make it a condo, with HOA fees that terrify. You also gave a healthy tax deduction for the mortgage interest and property taxes. Applicable to the time, but non existent in the current tax laws where SALT is limited to 10k and the personal exemption got absorbed into the standard deduction.
Last, 2011-2019 was a near best case scenario. i did the same, buying at 800 in late 2012 and selling for 1425 in early 2019. Net gain was just under the 500k exclusion, so zero tax bill to me, and quite a profit considering my PITI was less than the combined rents of myself and my now wife.
The long term history of SF suggests market rents increase at 5%/year, or double inflation. In the decade+ picture, your thesis is well maintained, esp with the lower interest rates of this century. If you can swing the down payment and you want to stay here long term, you’re pretty damn happy after the first decade. Your costs have barely moved. The market renter downtown saw rents go up more than 100%. A renter in a rent controlled apartment also like his rent after 10 years, but only if he’s still happy in the quality of the apartment. There aren’t rent controlled SFHs, and newer apartments are also subject to market rate increases. Just as owning has opportunity costs, so do the tin handcuffs of an apartment. And should the owner ever Ellis Act you, or there is a fire or other disaster, suddenly your cost of living might triple or more. You better be banking that cash flow.
Sorry that it is not more clear. Please re-read the section again given the use of a mortgage and paying down principal over the eight years of ownership. Those are the big items you are missing from your calculation.
However, you are free to calculate the returns however you want as there are no set variables.
Don’t completely agree with this if you are young, live in a large city and want to retain flexibility to move to other cities for your career.
Take NYC for example. If you factor in taxes, insurance and the very high maintenance fees, the math does not work out unless you assume the property appreciates in value. Cap rates are so low in these cities that it makes more sense just to rent.
That said, if you can buy in downturns like 2001/2002 and 2009/2010, then it absolutely makes sense to buy.
Yikes, that table with the list of rental costs in each city for each age is frightening! That’s far more money than I was thinking in my head. I see your point about finding a way to buy property as soon as possible! I’ll have to look for a property or get a realtor to help.
To quote Uncle Lou* – “Its amazing what a little time will do”. He meant this regarding investing in the stock market and in a positive way, but the same could be said about the down side of paying rent.
* Louis Rukeyser – the host of Wall Street Week on PBS every Friday night in the ’90’s.
Buy a property in the city then have it rented out while you move to the suburbs and pay a lower rent.
I apologize if this question has already been covered in the comments (I confess I skimmed the bottom half of them). The market seems very hot for sellers in Newark, DE where my boyfriend and I are looking. Currently renting in an odd house (kitchen in the basement?) with the rent reflecting the unique layout of the house. At this point I would like to buy because I want to have a dog and it seems very difficult without lying to have a dog in a lower cost rental. This is a college town and I understand the perceived fear of irresponsible college aged students with large dogs causing property damage or problems with neighbors. I’m concerned the housing market will turn soon, in less than five years, and leave us underwater on a mortgage. We could have the 20% down payment in a year but it would drain the majority of our savings (not including my retirement funds). I also have concerns about the real estate management company raising rent.
What would you recommend in my situation? Start looking for a house? Start looking for a different pet friendly rental? Keep saving coins and wait for a change in the market? Or all of the above?
Liz,
I was in the same situation that you are now, 3 years ago. After renting for 15+ years in different countries we (myself and my husband) decided that we needed to make a change. At that time we were living in a new 120m2 loft.
Unfortunately, despite of another reader’s reaction, 120m2 was too much space for us – not to mention the monthly utilities costs when living in lofts with high ceilings!
On top of that the rent was €1700 +parking €75 + all the other costs. The landlord did not want to sell either in the near future. :)
We were then faced with a dilemma. I wanted the same modern Scandinavian finish in a smaller apartment. We could not afford to buy a loft and could not find anything smaller to my taste without doing some work.
On top of that, as I have my own business – I did not have time to follow up with potential renovations. Time is money and being away from my desk is a loss.
The only alternative option for us was to buy a 70m2 apartment that was being built at that time. We had 210k from the bank with a 2.2% interest and a monthly pay back of €900.This was a significant lower figure for us, from the initial €1700 we paid for rent.
I used an extra 20k from savings to get those high finishes on quality materials and all A+ appliances.
The other day a friend of mine asked if we are interested to rent, and made an offer of €1200/month + charges.
1/2 years later, the apartments that are built now in the same area as we are, sell for €240 k for the same m2 and basic set up.
Was this a good choice financially? I am not as financially literate as some readers here.
What I know for sure is that we now have a place that we call “home”, looks great and it fitted with our personal circumstances at that time.
Perhaps I should mention we live in Brussels.
Apologise for the language mistakes, EN is my third language. :)
Currently renting in NYC and 50% of my income goes toward rent. I make ~$2400 per month and my portion of rent in a shared 3bed2bath is $1200. In the back of my mind, I always knew that paying so much for rent is not financially logical but my justification is living in NYC >> suburb of northern Virginia with parents. To my best effort I have managed to put ~$3000 in a 2.1% APY savings account. I’m debating on whether I should invest the $ with a roboadvisor service or maybe Fundrise. Alternatively I could leave the savings where it is for a rainy day. What do you think would be a good decision for my situation?
A recent release from ATTOM Data solutions, a property data provider, shows that the median home prices are unaffordable to wage workers in 71% of U.S counties. This startling conclusion was reached by comparing wage data from the Bureau of Labor Statistics to the income required to meet mortgage expenses on a median priced home.
This looks great. The problem I have is being in the military and moving every 3 years. I have seen people get burned buying and selling that quickly. Buying, holding, and renting out is difficult as well and what if it is not rented. With 9 years left in military, I think our best bet is to wait to know where we are going to settle before buying. Thoughts?
Since you are military, i would recommend looking into a VA loan to acquire a duplex/quad that you can live in and rent at the same time. Living in one unit and renting the other is a great way to offset your own out of pocket costs allowing you to save more while still benefiting from the rise in rents/house prices. When you move in 3 years, simply rent the unit you were living in and find a reputable management company in your area to manage it for you when you’re gone (Usually costs 8-10% of gross rents). This route allows you to acquire a great rental property for little to no cash down (VA Loan), should provide some solid cash flow, and allow you to gain exposure to the RE market.
Obviously, this requires you to be able to find a place in your current location (which may not always have the best market) but can provide huge benefits in the long run considering the lack of cash as a down payment.
I used to live near a large overseas Navy installation and became friends with quite a few service members.
I know a family that bought a house at every PCS and kept them. They are on their way to becoming financially well-off.
Basic rule of thumb: only buy a house that you are willing to have your family live in. Odds are there will be many service members behind you willing to rent your property after you PCS.
How do property taxes factor in? I was renting a place for $1,000/month in the Chicago Suburbs. Now I own and my taxes are $8,500 per year. Essentially 70% of what I was paying to live last year is now just “wasted” on taxes and I still have to pay a mortgage. What am I missing?
That’s just the premium you have to pay to live in such an amazing city. I mean, someone has to fund the coroner. It’s not free for him to scoop up the 1000 murder victims every year.
Where I’m from the average house price is 48000. The average household income per annum is $22000. Rent is 600+.
Banks don’t do mortgages on houses under 50k. Sellers want cash. No family earning 22k a year and paying 600 a month rent can afford to buy.
Period.
Where are you from?
Brownsville, PA.
I appreciate the post, and I think it is generally true for most parts of the US. The one thing I’d be careful of is relying on an example that starts in 2011, when we had historically abnormal returns in both SF real estate and the stock market. At 40x price to rent, the calculation becomes a little closer..
To me, real estate is a classic internal rate of return/IRR finance problem. You have to cash outflow a down payment and other buying costs now, but then cash inflow the benefit over time with saved rent, tax breaks, and future appreciation on a sale. By inputting all the relevant inflows/outflows associated with a house, one can estimate the IRR of the cash put down for the down payment. Nice and theoretically clean – (shameless plug) my most recent blog post from two weekends ago updated my spreadsheet on buying a house for the TCJA changes.
By the way, I’m totally on board with the rationale in prior posts about owning real estate as a hedge against future living costs – being neutral rather than short for the long run.
The net proceeds and the ‘rent avoided’ are a bit confusing to me. Maybe I’m just missing it.
Is net proceeds after costs and deducting remaining mortgage, or does that also net out any principal you paid on a monthly basis?
For rent avoided, is that rent minus monthly principal payments or just rent?
Effectively, you have to account for monthly principal payments somewhere if you compare against rent. Rent vs. (interest+tax+maint.+principal payments). Principal payments won’t be gigantic in 8 years of course, just wasn’t sure if it’s accounted for.
Sam,
There is something wrong with this analysis.
a). I calculate the monthly payments (mortgage + insurance + property tax + maintenance – tax write-off) to be $4,776.
b). I see that a 2 bedroom apartment rental in the same area averages $3,100 per month, in addition to the $260,000 down payment, a renter would have an extra $1676 to invest every month.
c). If the renter invested this down payment money along with his monthly cost savings in any number of stocks on the DOW or S&P 500 he would have a total investment near $2,000,000 dollars (I used MSFT as a blue-chip stock example for my calculation), this offsets the benefit of buying a home. Over 8 years his rent only cost $300,000 netting him $1,700,000 on his investment of free capital.
d). The renter did not need to leverage money in order to grow his net worth; this results in reducing his downside risk if either the stock market or housing market were to go sideways or down.
e). Avoiding a housing purchase also allows for the renter to relocate for better career opportunities as they become available; this has an added benefit of lower/zero state income taxes on his capital gains if he waits to sell his stock investment after relocation.
I like your point d.
They avoided rent on a three bedroom, two bath home.
A 2/2 was my condo example.
How’s it going with you? Love to hear your situation between renting and owning.
Sam,
Even if we add another bedroom, that would be a wash. Consider the dividend payments associated with owning a stock/index for 8 years. Sticking with my previous example, the dividend yield on MSFT is 1.5%/yr, that would provide an additional $2,500/mo of income at the capital gains tax rate (could easily pay for another 1 bedroom apartment).
Things are going great for me, I have a month-to-month lease at a below average market rate in LA. Just had a clogged sink in the kitchen last night and a plumber was there within 20 minutes to fix it! I feel sorry for the millennials paying $1M + for a 3 bedroom 1960’s style house, if only they did the math before jumping into single family residential real estate.
That’s great. So long as you are happy with your finances, that’s all that matters. I’m sure your landlord is happy with your rent too.
Everything is rational.
Yes, I’m extremely happy with my choice to rent. And as happy as my landlord may be, I’m sure your friend’s real estate agent was even happier with the commission on the $2.3M sale.
Everything rational may not be logical.
Most definitely. It’s important to keep both sides happy. And the sale price was $2.75 million, not $2.3 million. That extra $450,000 pays for a lot of cheeseburgers!
See: https://www.financialsamurai.com/why-i-sold-my-rental-home/
I was totally willing to accept anything around $2.5 million, but she got me more, so I’m fine with paying her what she deserves.
how did you find your real estate agent?
I have a friend who has his primary home if Florida but spends the summer in Minneapolis. Really high property taxes in MN. So instead of buying $1 million condo he kept the money in his brokerage account and rented a nice apartment down town MINNEAPOLIS for $4500 per month.
He says the return on his $1 million in his brokerage account plus the flexibility to move at the end of the lease is better than buying at age 65.
Your thoughts
Very smart! And I approve! Check out this post https://www.financialsamurai.com/real-estate-investing-rule-rent-luxury-buy-utility/
How many SF renters have almost 5 years of rent saved for a down payment?
Or anywhere for that matter. 20% net savings will get you there in about 8 years without any retirement contributions. That’s the depressing reality math instead of the unicorn math.
Check our: https://www.financialsamurai.com/a-massive-generational-wealth-transfer-is-why-everything-will-be-ok/
Hello FS,
Other personal finance bloggers such as Go Curry Cracker actually implore their readers to rent instead of buy as houses can change a lot in value and you can lose money even over the long-term compared to renting:
gocurrycracker.com/renters-for-life/
I personally like renting because I hate having to fix stuff and I see it as a waste of time. But when I decide to have a family in 5-10 years, I’m torn as to whether having a “forever” house is a better investment; especially if that residence is a townhome where a homeowner’s association takes care of any repairs…
Would you say that timing the real-estate market correctly during a slight downturn is more cost-effective in coastal cities compared to the midwest, where you have a greater chance of making money on your house and “living free” compared to a house in suburban Michigan for example? Property taxes can be quite high in the bay, but I imagine that if you choose the right area in SF or Palo Alto for example, your investment can appreciate nicely and even make you money despite the yearly tax cost.
Everybody has their opinion and can do what they want to.
If I missed out on the massive Seattle property marked boom, I probably would stick to believing renting his best forever as well.
I think most Americans would like to live or retire in America. GCC are happy to live in Taipei, which is a great city with awesome food and a much lower cost of living.
But I venture to guess that most people would be unwilling to retire in Taipei or Thailand or wherever it’s much cheaper. I don’t think anybody wants to feel forced to have to live outside of the country to save on living expenses.
Having options due to having more wealth is a much better situation IMO.
Thanks FS! Couldn’t agree more.
I travel constantly and having that leverage to pickup and move as a single guy to increase my net worth (and salary) through promotions and other opportunities is what values to me right now so I happily rent. But when I have a family in say, 5-10 years time, priorities change and I will be looking at housing.
If I can invest in a property now and see it appreciate until I’m ready to finally settle down in a home, even better.
As an aside, Taipei is one of those crazy markets where it is far cheaper to rent than to buy. It is also more susceptible to geopolitical winds (i.e., Chinese missile tests, fly-overs, etc.) and economic cycles which impact prices.
As with any market, you need to consider how long you will stay and pricing volatility in your purchase decision. During 2008/2009 in SoCal, depending on where you owned, prices dropped anywhere from 15% to 50%. Wealthy people are better able to ride out the storm and not flood the market with foreclosures. I have a friend who bought a house at peak prices in the fringes of San Bernardino County in a new development. He walked away from his house at the trough. It wasn’t the most ethical thing to do (because he could afford the payments) but it was the right financial decision–he was hopelessly underwater.
The thing is, it’s not just Taipei where it’s cheaper to rent. Some Bay Area cities have crazy price-to-rent ratios, Palo Alto is about 40:1, which means that your effective yield on capital is 1.4% (100/40=2.5% minus property tax = 1.4%).
Trulia is saying it’s now 12% cheaper in San Jose and 5.8% cheaper in San Francisco to rent than to buy. https://www.trulia.com/research/rent-vs-buy-summer18/
What was true in 2012 is not necessarily true in 2019
My problem is I feel paralyzed. I currently live with my gf and we split the rent here in San Diego. My portion is $1115/mo. I own a business where my gross income was $211k last year and will probably go up this year given it’s my third year in.
My monthly expenses total to $5k +\- $200 which includes rent and $1k/mo child support for my son who lives in N. Idaho. Also included in that number is our Heath insurance which is $704/mo for me and my boy.
I’ve got $130k siting in a high yield checking Acct at 2.33% and the rest in Sep IRA, Roth, and brokerage accts. Fico is 800+. I want to move to Idaho to be with my son and housing prices are so much cheaper there but at the same time feel I’m saving so much In rent that to buy a place up there which has everything I want would cost me a $2k + Mortgage before PITI.
I’m trying to get $200k in cash so I’d have 3 years worth of living expenses as a cushion to last me through any recession. Given my line of work, it is not unrealistic to have a $150k quarter in income with minuscule overhead. So, the business is almost pure profit.
Slap some sense into me or paint a scenario to make me see the light. Median housing in Idaho is about $250k where I’d want to live which is either Sandpoint or Coeur D’Alene. I’d like to buy in the $400-$500k range as that covers all the bases.
I have a friend who is (early) retiring this month and moving from LA to Idaho with his wife and 2 kids (all CA natives). He has never owned a house before but has purchased a very nice one in Idaho–one that he could never afford in LA.
Since you’d like to be with your son in Idaho, you should consider a third option of renting in Idaho. I would imagine that rents are proportionally cheap.
Although I’ve never invested in Idaho, I have enough nationwide investing experience to consider the following:
1. I doubt that Idaho appreciation can keep up with CA. As much as I can attest to what the Financial Samurai has written, it does not apply to every market and at all times.
2. What is the price volatility of your desired Idaho market? If prices fall, how much will they fall? In my Midwest investing experience, prices effectively fell to zero in some places–the city was practically giving away foreclosed homes to people who would spend the money to fix them up.
3. Is the market going up or down? Certain markets like NYC and SF have turned.
4. What are external factors affecting the town? My friend is one of many Californians moving into that city and driving up prices. Will you miss the boat if you don’t buy now?
3 years of safety cushion seems excessive. If your income disappeared, wouldn’t you do everything you can do to lower your expenses including renting a small place in Idaho? Your $5000 monthly expense might be half that in Idaho.
My wife and I pulled off a similar “trick” as the one you describe by purchasing a house in Davis CA when our son went to school there. We purchased a four bedroom in central Davis for $425,000 in late 2010. We received about $1,925 in monthly rent while our son lived there. Since then, we have been receiving $2,765 monthly in rent. The property is worth somewhere in the vicinity of $700,000 to $750,000 in today’s market. In short, we made money sending one kid off the college.
Great article. I make a low six figures in NYC and I simply cannot buy anything here. There are some areas in the boroughs that may be possible, but then my commute is 90 minutes plus.
I do want to buy rental property in the Midwest or the South, but as long as I live in NYC, I cannot see myself buying a primary residence without some strange windfall–which I don’t expect!
but how do we know this trend will go on for the next years? real estate prices reached again a crazy levels in many places in the world, can that be sustained? what if another 2018-like crash is around the corner?
my questions might be, is it better to waste money in rent and wait till I can buy cheaper, or buy avoiding rents but having maybe a setback in a few years from now?
Thanks
The key point in making money off selling the real estate is being able to hold on for many years. Otherwise, there are very high transaction costs on both the purchase and sale. You get a lot of upside in the geos that are most expensive to live in (SF, NYC, DC) so you really need to know you can afford to stay there (you just wrote a post about how you need $300k to be middle class:)). You also need to come up with the very high initial buy-in — in NYC down payments of more than 20%, as much as 50%, or all cash purchases are not uncommon. Many of the units are coops which require Board approval, and for desirable buildings, approval requires additional liquid holdings (retirement assets don’t count) of 1, 2 or more years worth of monthly payments. So there are reasonable reasons why even the most disciplined saver doesn’t enter the real estate market in an expensive city.
Example for Madison, WI. This is a highly desirable area in the heartland (named to Forbes ten best cities multiple times in past decade). A few things affecting local prices: the isthmus creates a natural squeeze on available property in close proximity to the Capital and a slow-and-steady influx of young professionals working in tech and biotech keeps prices moving up. Property taxes are also high. Currently renting a small 1/1 apartment with grad student neighbors and happy with the decision. Using a “luxury” 1/1 condo in same area for comparison. (there is no non-luxury RE for purchase in this neighborhood) Results are forward projections.
Pros
Location: 5 min walk to work and 10 to center of downtown
Able to save or invest the $850 monthly delta between PITI and renting
Opportunity cost of current $95,000 at 5% return over next 5 years is $121K
Net saved cash is $51K plus $26K of opportunity cost gains = $77K
Total cash plus investments = $198K
Negatives
Monthly rent: $850 accounts for 1.25% yearly increases based on past couple years raises (ALL utilities included)
Total rent over 5 years: $51,000
$270K condo purchase price with 35% down payment yields $1,500 monthly for PITI before utilities
Broken down
Principal increase: $18,000
Mortgage interest: $29,000
Net property tax after 5 years: $24,500
HOA dues after 5 years: $13,200
Maintenance cost estimate: $1,000
Purchasing this condo I would need nearly 7% yearly price appreciation just to break even to my current living situation.
Sale price of $365K less 5% for commission = $346,750
Pay down $18K in principal based on 3.5% loan amort 30 years leaves $157K loan balance
$346,750 minus $157,000 = $189,750
It’s roughly a $10,000 difference to live in the same neighborhood. Yes the condo is a little bigger and nicer, but I’m giving up liquidity. I’m much less concerned about earning 5% annually in non-RE investments than 7% annually on a condo. Disclosure: IF I were to live in a newly built luxury apartment the numbers would probably favor owning.