“Rent never ends”
“Buying a house means at least something goes to equity”
“A home is like a bank account”
These are all true statements and though they sound good, they don’t capture the whole truth.
So, if you’re wondering if it’s better to buy a home or rent an apartment, I’m going to dig into every detail and see which truly makes sense.
This is a pretty thorough article so you can jump ahead to any section you want by clicking the section below.
- Why Buy instead of Rent
- Why Rent Instead of Own
- Cost of Ownership
- Opportunity Cost of Home Ownership
- Cost of Renting
- Rent Vs Own – Opportunity Costs
- Renting better than Owning?
- When Owning Makes Sense
I’m an economist at heart and studied it for more than 7 years first as an undergrad then as a graduate student at the Ph.D. level. Long story short, I ultimately left the Ph.D. program in order to pursue my passion in real estate. That education helped me look at real estate from a different perspective and with a different mindset than most others. I spent close to two dozen hours researching and preparing this article so I hope it helps you as much as I’ve loved putting it together!
Also, play with the rent vs buy calculator I put together.
Rent vs Buy Calculator
If you Rent an apartment and try to invest any difference between the rent and mortgage, after 30 years you will have
potential gain or loss:
Should you buy or rent:
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Renting vs Buying a House
It seems like buying a home is the American Dream and it seems like everyone owns one – my parents both own their houses, my grandparents do, and I know a lot of other friends and family do as well.
On the other hand, Homeownership rates among millennials are at a historic low. There are a lot of reasons for it – massive student debt and required mobility for constantly changing jobs are just two of the major factors. To add to it, I find financial blogs and other gurus saying you should rent where you live and try to buy property as an investment (not as a home).
So which is? Is renting or buying a home a better financial decision?
Reason to buy #1:
Every month a little bit goes to my principal. Rent goes out the window. A little saving is better than no saving.
Reason #2 to buy instead of rent
Home values only go up, so I’ll get a good return on my investment.
Reason #3 people choose not to rent
A house is my biggest asset and I want to accumulate assets.
These are some of the most common reasons people choose to buy a home rather than rent an apartment. Perhaps you’ve even said them too.
Let’s look at the other side of things.
Reason #1 people rent instead of buying
I need to be flexible for my job.
Reason #2 people choose not to buy and rent instead
Places are too expensive where I want to live.
Reason #3 to rent
I’d rather invest my money.
When talking about renting vs buying a home, the first two reasons are obvious. If your job requires you to travel or move often, it’s a no-brainer to rent instead of buy. Also, if you’re simply priced out of the market, you can’t buy no matter how much you want to.
A lot of younger people want to live where the action is – near downtown areas where there are a lot of amenities. These areas cost a lot to live in and cost even more to buy homes in. So, rather than move far away, they choose the lifestyle over homeownership.
It’s interesting though that many people are choosing to invest their money rather than buy a home. The conventional wisdom is that a home is a good investment, so why are people choose this option?
To understand if renting is better than buying a home, we first need to understand the costs of buying and owning a home.
The argument goes – if your rent and mortgage are nearly equal, then buying is better because some part of your payment goes back to equity.
Equity is something you build up over time and, eventually, you’ll have a lot of it when the house is paid off. You’ll also earn some appreciation (if your market goes up).
Therefore, when debating renting vs buying, buying is better.
Seems pretty simple…but is it?
Cost of buying a house – inflation, appreciation, and maintenance
Let’s just quickly define inflation:
“Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of a currency is falling.” –Investopedia
Basically, over time your money buys less. That’s why you see the cost of milk, movies, cars, and houses constantly go up.
So, when we determine prices of a house, we need to “adjust for inflation.” If a house goes up 3% in price this year, but the economy saw a 3% inflation, your house actually didn’t go up in value at all.
You have more dollars, but those dollars buy less. That’s why you need to adjust.
I get excited talking about economics and economists, so hopefully, I can keep things down to earth for this renting vs buying a house article.
Two great economists Karl Case and Robert Shiller went back and analyzed the inflation-adjusted housing prices starting back to 1890. They created the Case-Shiller index as well which I’ve provided an image of.
You’ll notice that for about 100 years US house prices hovered around 90-120 on the index. It could be high for several decades or low for several, but it seems to revert to a mean number. You can see that after 2000 it skyrocketed and then came crashing back to reality. You can also see it skyrocketing again.
Anyhow, the point of showing this is to simply debunk the notion that houses always appreciate. In fact, there is no evidence that homes appreciate over a long period of time. Sure, they can go up and stay up for a few decades, but there is no way to know when or if they will go up or down. So, to make broad stroke arguments when debating renting vs buying a house, we cannot rely on any form of appreciation.
Let’s look at some more evidence:
Since 1996, you actually see no real appreciation in housing prices. Housing is actually the closest item on the list that matches inflation.
Even during the bubble around 05-06, you can only see a tiny blip in its increase and the crash was a very very small decline in prices compared to inflation.
So yes, housing prices do fluctuate and can be high or low for decades, but eventually, prices will correct.
You read that correctly – the evidence shows that your house doesn’t appreciate once adjusted for inflation.
The great thing to know is your property will probably not lose value over the long term due to the destructive effects of inflation, but you can’t count on earning a profit through appreciation. Don’t let this stop you from making good investments though, fear is what holds most people back.
But housing is going crazy in my area, clearly owning a home makes sense!
Sure, there are fluctuations in local markets. Some do well and some do poorly. This is really dependent upon very local changes based upon government regulations, industry, demographic changes, etc.
There is also a lot of research that shows immigration being a major driver of local price fluctuations in housing.
So, you may benefit or suffer from local price fluctuations. But, when planning and analyzing, we can’t plan for appreciation.
Don’t forget about maintenance
Alright, so putting appreciation aside for a minute, we need to discuss maintenance. The cost of maintenance depends on a million factors, but the average cost is going to range from 1-2% of the home’s value.
So your $200,000 house will have a $2,000-$4,000 maintenance bill every year on average. It might seem high, but it averages in those expensive things like driveway repair, a roof, heating systems, and other major things that might break every 5 or 10 years.
So in 15 years, you can tack on an extra $30,000 in maintenance items.
But what about tax savings?
My friend Joseph Hogue over at Peer Finance 101 brings up a great point and points out that the average family saves about $1,200 in taxes due to homeownership.
While this is absolutely true, I generally don’t consider tax savings in my very long-term purchase decisions. The reason is simple – the government can change the tax rules at any time.
I have absolutely no idea if I will continue to save taxes in 30 years or 10 years or even next year.
If an investment only makes sense because of tax savings, it probably isn’t a great investment.
Opportunity cost is what you have to give up in order to get something else. For example, when you work an extra hour at work, you lose an hour with your family.
When you drop $40,000 into buying a house (remember the down payment I mentioned), you lose the ability to invest that money in the stock market or a new business.
What if we invested that $40,000 in the stock market? I punched it into my handy dandy compound interest calculator – in 15 years it triples in value to about $127,000 (at 8% interest, the inflation-adjusted growth of the S&P 500 over the last few decades) which is a total earnings of about $87,000.
If you take what you put down ($40,000) and what you paid down in principal ($51,793) you have $91,793 in equity if you bought a house.
By just investing the original $40,000 we would have $127,000. So, the opportunity cost is $45,207
Renting seems to be winning this fight, so let’s talk about renting.
Renting is a bit easier to calculate.
We don’t have to worry about maintenance and other costs. We simply need to figure out what you’re going to pay for rent.
Fortunately, people study this stuff and I can just cite it. Take a look at this graph:
As with everything, the numbers fluctuate, but it can be interpreted that the average yearly rent is roughly 5% of the average house price. After the year 2000 when housing prices shot up, you can see the ratio drops as renting becomes relatively cheap compared to buying a house.
As prices crashed, renting became comparatively expensive. You can see rents getting cheap again, though not as low as the bubble, still lower than any time in the last 5 decades.
Either way, the historical average is between 4.5% and 5.5% so I’ll use that.
So in theory, you can buy an average house for a certain price or you can rent an average apartment for 5% of that price per year.
If the average home costs $200,000, then the average rent costs around $10,000 per year or $833 per month.
The option is to have a mortgage for $1,150 per month (that adds in some insurance and taxes to the example) or to have rent for $833 per month.
With renting you have lower opportunity cost, lower cost per month, and no maintenance. So far it seems way better, but there are still some things we need to think about.
Remember where I showed how inflation and appreciation balance out? Well, with renting you don’t have any appreciation for balancing the inflation. Rent just keeps going up and up.
So, a home will lock you into one (mostly) fixed payment every year (only insurance and taxes will go up) while with renting you rent can go up or down depending on the market.
I ran some calculations (I’ll spare you the pain), but it appears that by year 12 you are going to be paying more in rent than if you had locked yourself into a mortgage on a house.
By year 30 you will be spending $11,000 more per year than if you had bought a house.
Though your taxes, insurance, and maintenance keep going up, your interest keeps going down as you pay off principal.
Finally, buying a house wins a round.
Let’s sweeten the pot.
The mortgage ends after those 30 years and suddenly you aren’t paying any interest.
In year 31, the total payments will drop to $13,350 while rent will be $24,273. That’s a difference of almost $11,000.
Score one more for owning rather than renting.
So, is that it? Buying a home is clearly better than renting.
Maybe, but I’m not done yet.
We know the renter starts off saving a lot of money (no down payment, remember?) and the have a much lower monthly payment.
So, what happens if they invest invest their savings every month?
I won’t put up more charts, but based on the previous info, if invested at 8% return, after 30 years they will have a net savings of $22,442.
At the beginning, they are saving some every month. By year 12 they start dipping into that savings as rents go above the cost of the mortgage.
But, by year 30 the renter is still up by $22,442.
But you can see that high rents will be digging into that savings. By year 33 those savings will have been completely depleted. It takes a while but owning a house beats out renting one.
That’s 3 points for owning a home. Can renting put some points back on the board?
Owning a house requires a down payment, renting doesn’t
Not quite done yet. We forgot about that $40,000 down payment. I know a lot of renters don’t have that kind of money saved. But to have a fair apples to apples comparison, we really need to include it.
Let’s say the renter socks that down payment away at 8% then also saves the extra earnings. In this scenario, owning a house never beats renting a home.
In this scenario, the growth in savings always exceeds the growth in rent.
As an example, by year 39, the savings have skyrocketed to $638,215 in this scenario.
Even though your rent is $18,000 more than your house payments, your interest is far exceeding those costs.
You are literally living off your passive income now!
Buying a house just locks that money into the house and it doesn’t lose or gain any money. It’s well protected, but it’s also not earning any interest.
Putting the downpayment into the stock market is clearly a financially better choice.
Regardless how you slice it, renting makes more financial sense than buying a house unless you’re in a crazy local submarket with high appreciation.
We know the national housing market always corrects itself, so we can’t assume appreciation anywhere. You might get lucky but you also might not be so lucky…
That’s why we can’t say that it’s a good decision – some people can make out, and some people can lose. The averages are what I use to analyze things and the facts show that on average, renting makes more sense.
Paying down Principal is a Terrible Idea
Everyone wants to be debt free, so it makes sense to pay off a mortgage, right?
Do I even need to do the analysis for you? Just go back to what I said about your down payment and now think about it.
Does paying down the principal make sense? NO, of course not.
You would just have locked up $200,000 earning no interest at all. It’s a little better than cash since it won’t lose value, but not much better.
If you are going to own a house, it seems it would be better to never pay it down. Instead, invest the money in something that pays interest.
Buying a House vs Renting – Revisiting the Arguments
Every month a little bit goes to my principal. Rent goes out the window. A little savings is better than nothing.
I’ve clearly covered this. Thought this is part of the renting vs buying equation because a little goes toward principal each month, but that money essentially earns nothing. So, while the statement is true, it is misguided.
It is better to save the money and invest it in something that has a return
Home values only go up, so I’ll get a good return on my investment.
House prices do generally go up, but they are matched by inflation. So, even if your house went up 3%, it is likely that inflation was near that 3% number.
Prices vary up and down so you may find a decade or two with rising or falling prices. You also may find local markets that don’t follow the national trend.
So, you may be able to beat the averages for a while, it isn’t a guarantee in every market or for everybody.
Either way, there is no evidence that prices continually go up.
A house is my biggest asset and I want to accumulate assets.
This may be true…but you could have a larger asset if you had just invested the money in a simple S&P 500 fund.
Does Buying a House Ever Beat Renting?
Yes, of course. Buying beats renting all the time…
If you don’t buy for financial reasons.
Clearly, a home is not an investment. So, if you don’t care about money or your net worth then get what you want.
Real reason #1 to buy a house instead of rent
You value stability. Renters may have to move from time to time which is less stable. If you want one place to live and raise children, then there is really only one option.
It’s impossible for me to place a value on stability. Some people value it a lot and others don’t. So, if YOU value stability and raising a family in one place, then buying a home makes a ton of sense.
Real reason #2 to avoid renting and buy instead
You find enjoyment in fixing/maintaining a house.
If you enjoy gardening, fixing things around the house, having a beautiful landscape etc… you may find value in homeownership. Most landlords don’t want you messing around with their property and won’t appreciate when you are digging up half the yard to plant things.
Real reason #3 to own a home instead of rent
Your specific market is out of whack with the rest of the country. If you’re in a local market that you think will appreciate above and beyond the national average, then it might be worth the purchase. Understand your market well before doing this.
I made a lot of assumptions when writing this article. Assumptions are necessary in order to draw conclusions about averages…but sometimes they need to be taken with a grain of salt.
There’s a funny joke that some economists made up decades ago.
There is an Economist, a Physicist, and a Chemist stranded on a desert island with one can of food. They are trying to figure out how to open it.
The physicist starts by calculating force, estimating some distances, and devises a method to open the can by applying just the right force at the precise angle to open the can.
The chemist develops an elaborate system using the chemicals and naturally occurring ingredients available.
The economist says “you two are making this far too complicated. I’ll just create a model to solve this problem.” After thinking for a bit, he says “first, assuming we have one can opener….”
Perhaps only an economist will get the joke. The point is not all assumptions are realistic even though you need assumptions in order to model the economy.
Buy vs Rent is driven by Price to Rent Ratio
My biggest assumption when debating renting vs buying was a 5% price to rent ratio. It’s currently far lower and sometimes it’s much higher.
As the price to rent ratio rises, the decision begins to move toward buying instead of renting. As the price to rent ratio drops, renting makes more sense.
I used the historical national average around 5%. You’ll notice right now the ratio is around 4% which really means you should rent.
Your particular area may be different, though. If you find the ratio in your area is up around 6% or higher, you may want to jump in and buy a house.
Using the example above, if the average home price is an area is around $200,000, the average rent may be around $666/month with a 4% ratio, but rent would be around $1,000/month with a ratio of 6%
Your total mortgage is $1,150 per month for that house, so you can see how the math changes dramatically by changing the ratios. As markets change if the ratios get way out of whack, you might change your decisions.
The Case-Schiller index is about the very, very long-term
Over the course of decades and centuries, house prices tend to go back to a mean value.
But you can see that in the last century there were 2 decades of low prices. The life expectancy was about 60 years back then meaning 20 years is alf of your total adulthood.
So, you may live your entire life in a bubble or with deflated prices. You don’t know when the market will correct even if it inevitably does.
The key is to keep an open mind and be able to adapt as things change.
Buying makes sense when you can add value
I’ve made a lot of money buying properties that were undervalued. Then, I add value to them. Homeowners can do this as well.
Basically, you find a house you can live in, but needs a bit of work. You do the work over the course of a few years.
After a few years, you sell the house and do it all over again.
The profits cover all the expenses (meaning you paid nothing to live) which puts money in your pocket tax-free (consult with your accountant). You can then invest the profit.
But What About All Those Real Estate Tycoons? Clearly Buying Beats Renting!
A lot of people make money in real estate. I have made a killing in it as well.
But I bought investments – I bought property that pays me rent.
When you are earning rental income, then it makes sense to buy property. When you buy investment property then real estate beats the stock market every time.
But, that’s not what we are talking about here. We are talking about buying a home. A home just doesn’t make sense financially (on average). It makes sense under certain circumstances and in certain areas. It also makes sense when you have certain goals.
Conclusion – You Should Probably Rent Instead of Buy a Home (but not always)
When I started research for this article, I really didn’t expect to see such overwhelming evidence against buying a home. I thought there might be some solid arguments for both sides, but the results would be inconclusive.
I actually crunched the numbers so many different ways and literally spent days doing it.
But the numbers were so overwhelming, they wouldn’t point toward ownership in virtually any realistic scenario. So, I’ve concluded that:
The evidence is overwhelming: For the majority of Americans, it makes financial sense to rent instead of own.
You realize that buying a home is an emotional decision and not a financial decision.