Buying vs Renting
The eternal dilemma
Buying a house is one of those things that you are supposed to do to become a grownup. It shows commitment, maturity, and stability. It’s another milestone along with graduation, marriage, starting a family, and so on.
As the narrative goes, life is not completed without the picket fence and the perfect lawn. So it goes without saying that you must own your house. Clearly, it has many benefits and brings many advantages to renting…or does it?
So, why would anyone in his right mind choose to rent instead?
Let’s have a look
Considerations
There are a number of factors we don’t normally take into account when making such an important decision. Here, there are some characteristics of real-estate.
Houses are stationary
A house is stuck to a location, you can’t take it with you when you move. You choose a location because it is nice, good neighbors, near your job, convenient, etc. Potential for the area is also considered -you wouldn’t buy if you think prices are going down- yet, nobody knows the future, therefore all these future projections about prices going up are just hot air in the realtor’s narrative to push up the price.
When you buy a house you are betting on the future. You hope that your investment increases in value and that you are going to live there for the foreseeable future. That’s a risky bet. You never know what’s around the corner.
Economy
Can you guess the state of the economy in 10, 20, or 30 years? What about tomorrow afternoon? If you do, please let me know. Also, let all the economists know because they don’t have a clue either.
You would not buy a house if you thought the prices will go down, you would wait. So, when buying a property you must be confident that the economy is going to improve, and with it, your investment.
The job market is linked to property prices. Detroit used to be a popular and expensive city to live in. Not anymore.
Politics
What is going to happen when your government needs more money? They can raise income tax and also property tax. Companies can move from one country to another but houses don’t move, so when the economy is down you can expect an increase in your tax bill.
In this kind of scenario it’s very difficult to sell without incurring in a hefty penalty, so you’ll be stuck. Either you pay or you lose the house.
Future
Predicting the future it’s just impossible, now more than ever. With AI, automation, exponential growth, disruptive technologies, remote work, global warming, pandemics, and more Black Swans, the future is more uncertain than ever. Don’t get me wrong, it could be great, but we just don’t know. Whoever tells you differently, is lying.
The reason property prices go up is supply and demand. Demand is linked to the economy and other factors. Right now starting prices for apartments in Manhattan is $1 million. The reason for such a hefty price is high demand. Many wealthy people choose to live there because there are good-paying jobs in the city. If those jobs disappear prices will drop. Here is my prediction: real estate prices in big cities will go down at least 50% in the next 20 years.
Silicon Valley is the opposite example: soaring property prices in the middle of nowhere due to rising demand.
The cost of ownership
Transaction costs, principal, interest, tax, insurance, maintenance, opportunity cost, all this can add up to 5 % of the capital annually, often more.
The 1% rule
Rule of thumb: If a house costs $100.000 to buy and the monthly rent of an equivalent house in the same area is $1000 or less you are better off renting. You can see the details of this calculation here.
Pros and cons
Renting
Pros:
- Flexibility to move at a short notice
- No hidden cost
- No responsibility
- No risk
- No surprises
Cons:
- No control over your environment
- Lack of emotional attachment
- No equity building
- Less stable
Owning
Pros:
- Non-financials, i.e stability, freedom to modify your environment, etc
- Building equity
- Appreciation of the asset (if any)
- Tax breaks
Cons:
- Depreciation
- Risk: Economy, natural disasters, etc
- Maintenance
- Tax
- Transaction costs
- Opportunity costs
- Insurance
- Illiquidity
Generally speaking, if you want to avoid risk, renting is the better option. Owning should only be considered if you plan to live in the same place for a long time (at least 10 years) and you have reasons to believe there will be an increase in demand in your area.
Alternatives to renting
Renting could also be expensive in certain areas with high demand like inner cities. If you have a choice, try to earn a living with location-independent work. Failing that, there are some unusual alternatives. Mind you it is not for the faint-hearted.
- Airbnb. It’s similar to renting but with more flexibility. If you look around you can find good deals
- Hotels. Long-term hotel accommodation offers ample discounts and is worth considering in some cases
- Building your own home. If the land is cheap this could be an interesting option, especially in those latitudes where you can get by with a very simple house
- Mobile homes. You will have the flexibility of moving around every few years
- House on wheels. Caravans or adapted vans. It not the most comfortable but it’s the most flexible
- House sitting. It’s usually free and the houses are very often spectacular. Take care of a villa while the owners are away. Perfect for bohemians
- Becoming a nomad. There are many countries where the cost of living can be very low and the weather it’s nice. You can use that to your advantage and live in paradise for a fraction of what you pay now
Conclusion
When you make a long term decision involving a lot of capital you are taking a risk. Generally speaking you’ll be better off avoiding risk as much as you can. The future is very uncertain and no one can predict what’s going to happen. For the moment it’s not looking great.
Even if things remain as they are and property increases in value slowly over the years, you are still better off renting in most cases, apply the 1% rule.
If you do buy a house and take out a mortgage, don’t pay the mortgage off even if you have the money. The reasons behind this are opportunity costs and risk. While you owe the bank, they are taking the risk, when you own the property the risk is yours. With that money you can have a better return elsewhere than the cost of interest, that is the opportunity cost.
The only reasons to buy a house are non-financial or future appreciation.
In these uncertain times, flexibility and liquidity are the best assets to avoid risk. Cash is king. Risk should be minimized wherever possible.
Don’t put all your eggs in one basket especially if that basket is attached to the ground.
