Feb022016

Top six reasons to rent instead of owning a home

For long-term home occupancy, owning is generally more financially favorable; however, there are strong reasons not to buy and rent instead.

psycho_homeownerConsidering the many benefits of home ownership, why would anyone chose to rent? It’s said that the decision to own is emotional whereas the decision to rent is financial. During the housing bubble, renting was a wise financial move because it cost twice as much to own than to rent, but now that prices are much closer to rental parity, there are fewer compelling financial reasons to rent rather than own. Between 35% and 40% of Americans chose not to buy and rent their primary residence instead. The reasons vary, but they all generally relate to commitment and finance.

1. Flexibility to move

The primary reason people chose to rent is flexibility. For homeowners selling a house takes time and effort, and with real estate commissions and closing costs, considerable expense. Renters face none of these issues. For a renter, at the end of their lease, they simply pack up and move, and they have no further financial obligation to the property. Owners don’t have it so easy.

As a general rule, it costs an owner about 8% of the resale value to move (6% commission plus closing costs). If houses appreciate 3% to 5% per year, it takes two or three years of ownership before an owner can reasonably expect to get out at breakeven. rent_not_for_losersMost people who recognize their current living situation is not likely to last more than two or three years generally chose to rent, and wisely so. Unless they want to become landlords or take a loss, people who must move within two or three years of buying a house give up their freedom of movement.

2. No money spent on upkeep

Homeowners must pay all the costs of upkeep on their properties. If a dishwasher or water heater goes out, if the roof springs a leak, or any of a number of other maladies strike, the homeowner must pay for it. Renters don’t face these unexpected and sometimes costly expenses. Renting eliminates the unknowns.

3. No risk of loss

gone_with_the_windRenters know how much their housing costs, and they know what they will leave with, at best their deposit — at worst, they lose their deposit. They have no financial risk based on changes in value in the resale market. Owners face uncertainty as to the costs of ownership, and they don’t know how much they will leave the property with. Sometimes it’s a gold mine, and owners obtain a significant equity check at closing. Sometimes, the end up with nothing but bad credit after a short sale or foreclosure. Ownership is a giant lottery.

4. Monthly payments exceed comparable rental

One of the best reasons to rent is to save money. In volatile markets like California, prices often get bid up so high by the kool aid intoxicated that the monthly cost of ownership greatly exceeds the cost of a comparable rental. This is also the telltale sign of a housing bubble ready to pop. Rental rates establish where property values should be. Rental Parity is a balance point where there is no financial advantage to choosing renting or owning; a point of theoretical indifference.

If we had a group of theoretically indifferent people who always acted rationally based on perfect information, prices would always be at Rental Parity; any price below rental parity would be perceived a bargain and bid upward, and any price above rental parity would be perceived as too high, and there would be no bid interest. Of course, we all know that people are not indifferent; in fact, they can become very emotional about buying and selling real estate. When they participate in a market, they get caught up with the herd and move prices without regard to fundamentals; short-term price movements become accepted as the market’s long-term trajectory. Trees really can grow to the sky.

rental_parityRental parity becomes a baseline — a fundamental. Prices are loosely tethered and may depart for long periods, but prices always manage to return to rental parity in time because as a logical point of indifference; it is the natural resting point for a market purged of kool aid intoxication.

5. Take on too much debt

Another reason many opt not to buy houses is due to their total cost. Even if very low interest rates make the payments affordable, people get uncomfortable borrowing five or six times their total yearly gross income, and rightly so. Many people blithely take on this debt because they believe they won’t pay it off — their future buyer will take care of that. The folly of that attitude became apparent when people discovered that real estate doesn’t always go up in value.

6. Ties up too much savings

Many people don’t buy homes because it ties up a substantial amount of their personal savings. Money tied up in a down payment has an opportunity cost. For people with attractive investment opportunities, it may be wiser to invest that money rather than sinking it into a house. Money put into a house reduces the mortgage payment, so the return on that money is equal to the mortgage. If other investment opportunities provide a greater return than the current mortgage interest rate, then putting money into a house is counterproductive.

Mistakes and fallacies about renting or owning

specialSometimes people buy for the wrong reasons. People make rational purchase decisions based on faulty reasoning and irrational beliefs. Most of these center around false assumptions on the financial rewards of owning real estate.

Buying for rapid appreciation

Buying a home for rapid appreciation is a fools game. Most would-be real estate moguls base their opinion of long-term home price appreciation on short-term market trends. By the time the general public becomes convinced house prices will go up forever, they have already been rising in an unsustainable manner for far too long and most likely ready to crash.

Real estate investors during the housing bubble put their money to work on faith. There’s no logical reason to believe house prices only go up. In fact, there have been two prior periods in California’s recent history where house prices did, in fact, go down. However, with kool aid intoxication, otherwise known as faith-based investing, reality is ignored.

Renting is throwing away money

There are two legal ways to obtain the beneficial use of real estate; owning and renting. Since most people borrow money to buy homes, people are actually choosing between renting money to “own” real estate or renting real estate directly. Both forms of rentership have a cost. Owners pay the cost of renting money in the form of interest payments, and renters pay the rental rate in their lease agreement.

There are many forms of money rentership, some have fixed payment rates and some do not. The primary advantages of owning versus renting over the long-term are the ability to lock in a fixed cost of ownership, and the ability to accumulate equity through loan amortization and appreciation. Of course, most people overestimate the benefits of appreciation, and this causes many of them to overpay or use adjustable-rate mortgages which negate the advantage of a fixed cost of ownership.

The key point here is that renting is not throwing away money. A renter does not participate in the change in value of the property, which in the long-term is generally a benefit for a homeowner. However, if the homeowner pays far more in interest than a renter pays in rent, the renter gains a substantial short-term advantage. Further, if the owner buys at the wrong time – something often tied to paying far more in interest than in rent — the owner may participate in a decline in property values that makes their decision to buy even more costly. Renting is an insurance against a decline in home prices, and it’s a particularly valuable policy when owners are paying a premium to own near the peak of a housing bubble.

Owners are better people than renters

One of the most galling fallacies in the owning versus renting debate is the smug belief among homeowners that they are superior human beings, mentally, emotionally, spiritually superior. Their children do better in school, they demonstrate greater financial control and sophistication, they take better care of their property, and they are more valuable members of their neighborhoods and communities.

Of course, the fact that they believe these things is the proof that none of it is true.

Some renters do not meet the necessary qualifications for home ownership because they have emotional and behavioral problems, but the majority of renters are either young people just starting out who are on the path to home ownership, or people later in life you enjoy the freedoms of rentership. People who choose to rent are just as valuable to God and society as those who chose to buy, and based on the behavior of many owners during the housing mania, as a group owners can’t claim moral superiority.

California_Kool_Aid

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