A young person who is taking Economics in school recently told me that their instructor told the class that they should buy a house early in life, before making any other investment. While I question the instructor’s advice, it does once again bring up a point that has been debated for years, especially by those who are thinking of buying but aren’t sure if they really want to own a house: Should I rent a place or should I buy a place?
My short answer: It depends on your location and your time frame, and it is not purely an economic decision. Owning a house may be part of the American Dream, but there are drawbacks to home ownership that may point the decision in the other direction for you.
The Journal of Financial Planning is a monthly magazine I receive as part of my membership in the Financial Planning Association (FPA). Each month the Journal publishes articles by Ph.D.’s about various financial planning issues. The most recent issue (May 2018) has an article by Arthur Cox, Ph.D. and Richard Followill, Ph.D. titled “To Rent or Buy? A 30-Year Perspective”. Here is a link to the article. In it, they analyze whether people should have bought a house in 6 different US cities, or whether they should instead have invested their money in the markets and lived in rental housing.
Dr’s Cox and Followill conclude that it would have been better to buy a house in markets (San Francisco; Minneapolis) that have increased in value, and it would have been better to rent in markets (Chicago; Stamford, CT) that have decreased in value. Not really an earth-shaking conclusion in my opinion. They look at the rent/buy decision purely as a financial one, and they analyze only the financial aspects of the decision.
There are several problems with this rent/buy study and with any other decision one will make about renting vs. buying:
- Apples vs. Oranges: You are most likely not going to make a rent/buy decision regarding the same house or condo. Instead, you will decide whether to buy this specific house or condo versus renting an apartment in a different location. Yes, you may look at renting an entire house, but most likely it will be a single unit apartment.
- You have to live there: It is not just an economic decision. You have to decide where you want to plop yourself every night after work.
- It is a long-term decision: The Ph.D.’s point out that you probably won’t make much money buying unless you live there for several years, in part because of the commissions and closing costs associated with selling your house. The decision tilts more favorably toward buying when you smooth out these costs by holding the house for several years.
- Moving: Owning a house limits your ability to adapt if you need or want to change jobs and move to another city. If you are not extremely confident of keeping your current job or at least finding another job in the same city, then you have to think very hard before buying a house. I know a person who is stuck in a small town because they bought a house there and now they have retired and can’t find a buyer for their house and so they are stuck in the small town.
- Property Taxes: Here in California we have Proposition 13, which means property taxes can only increase a small percentage per year if you continue to own your home. If you sell your home and buy a new place, however, your property taxes will be marked to market. That means, if you move up, you also move up on your property tax basis, which can be a killer for the decision to move up to the big house. Some older people can’t afford to sell their homes, meaning they can’t afford any more property taxes than they are already paying, and they can’t afford the rent that they would have to pay if they move to a rental.
I believe rent vs. buy is a lifestyle decision, first and foremost, with the financial aspect being secondary. Yes, you can make a lot of money by buying and holding on to your home for many years, but it limits you in a number of ways. In your rush to own a part of the American Dream, consider the significant downsides to owning. Renting might not be a bad call for you if you are upwardly mobile.