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Buy vs. Rent: Asking the Question in Mid-Life

One day late last autumn I awoke to find myself skidding uncomfortably close to a number that begins with a 5. Wait— how did that happen? I’m— I’m middle-aged! Heck, going by current US life expectancy figures, I’m already several miles over the hill (81 is the average for women as of 2014). Existential dismay notwithstanding, I’m in pretty good shape for a geezer. I can still race a half-marathon with ease, and don’t yet need reading glasses. Financially, I’ve done a creditable job of saving, investing, and retirement planning. There’s just one problem: I have yet to buy a home for myself.

This is not for lack of financial fortitude. The fact is I was blessed (cursed?) to be born in one of the most desirable places to live on the planet, and thus the most expensive. Real estate prices here are off the charts. Almost literally. Take a look:

 

homepricegraph

Source: Paragon

As a native of the San Francisco peninsula who still lives here, I’m a pretty rare beast; an awful lot of my contemporaries have been driven out by the ridiculous housing prices. I’m determined to stay if I possibly can, but it’s a stiff challenge on a single income. I have a vision of myself in this endeavor looking something like this:

donkey As I have saved and saved for that down payment, diligently, faithfully, year after year, home prices have continued to grow faster than my savings; I can’t keep up. The tantalizing prospect of home ownership dangles eternally before me— just out of reach!

Grab the Carrot! Or not…

But why, you may ask, did I not buy during that lovely little dip in the chart above during the recent recession? Good question. I’ve been in a position to chase that blasted carrot for a number of years because I’ve been hunkered down in the old family homestead with Mom. This works really well for both of us; while I’m furiously squirreling away cash like a good donkey, Mom reaps the benefits of having someone on hand to deal with the cable guy, take her to doctor appointments, and argue with her over the merits of the Giants’ third baseman. She’s happy, I’m happy, and my siblings are all happy knowing I’m looking after Mom.

During the recession I considered making the ultimate lunge for the carrot. I thought I could buy something and rent it out until such time as I was ready to occupy. My financial advisor, however, counseled against this. “You wouldn’t be getting any utility out of your money,” he reasoned. ”You couldn’t charge enough rent to cover the mortgage. Leave that down payment working for you in the market until you’re actually ready to move.” This was an opportunity cost I had never considered before. His point was a good one. And keeping that chunk of almost-a-down-payment in the market has indeed paid off; it’s done well during the economic recovery. But as I’ve watched housing prices skyrocket again in recent months, I wonder. Did I miss my chance, standing on the sidelines, only to see the window of opportunity slam shut?

Sink (it in a house) or Swim (in a pool of liquidity)?

Saving takes time. As time has passed and the birthdays have piled up along with the cash, a question that once seemed nearly blasphemous creeps into my mind: On the sad future day when my current living arrangement ends, should I actually consider becoming a renter rather than buying? The Rent vs. Buy dilemma is an old one: Drop a chunk of change on a down payment and tie yourself to a mortgage for 30 years, or pour cash down the voracious bottomless pit of monthly rental payments indefinitely?

The “right” choice is different for everyone. When you’re young and have little cash saved, renting is the obvious choice. It’s less obvious later in life. Middle-aged folks with a substantial amount of cash to invest have to ask: Is it wiser to freeze it into a fixed asset (a house), or continue to have it work for you making money in the financial markets while you feed the rent monster?

Professor Moshe Milevsky of Toronto’s York University makes a fascinating argument in favor of buying later in life in his book, Your Money Milestones: A Guide to Making the 9 Most Important Financial Decisions of Your Life: “When you are young the vast majority of your true wealth is locked up in human capital, which is illiquid, nondiversified, and definitely nontradable. It therefore makes little sense to invest yet another substantial amount of total wealth in yet another illiquid and nondiversifiable item like a house…. In sum, a strong argument can be made…that renting is the optimal choice when you are young. “However, when you are older (say 50 or 60) and you have unlocked a large portion of your illiquid and nontradable human capital and converted it into financial capital, you can afford to “freeze” some financial capital and lock into a home purchase. At that stage, not only do you have more wealth in total, but also your balance sheet (and especially your human capital) is likely not as sensitive to the state of the economy and its disruptive impact on wages. So, [the completely logical] Mr. Spock buys his first house–after 25 years of renting–at the age of 50.”

As I approach 50 myself, this is music to my donkey ears. I want to believe Professor Milevsky is right. But in an over-the-top market like the Bay Area, is there an argument to be made for renting your way through the second half of life?

Note that rents here aren’t a whole lot more palatable than home prices:

rentgraph

Source: Livelovely.com

They trend rather closely with monthly house payments that include mortgage, taxes, and insurance. So how does one choose?

The Older First-Time Home Buyer: Do the Math

Younger folks are more likely to regard a first-home purchase as a stepping stone to moving up the real estate chain, while older first-time buyers may lean more toward settling down and staying put. Stability of housing costs becomes far more important than appreciation as we approach retirement (and the accompanying reduction in income). With this in mind, we’ll ignore the question of home price appreciation for this exercise. We want to focus on the overall value to be obtained by either renting or buying in the second half of life.

For the record, however, note that the Wall Street Journal recently reported that compound annual return in the three decades through 2013 on single-family homes was a mere 3.6%. In the same period, the S&P 500 returned 11.1%. NOTE: The variables in any simulation such as the following are infinite, and holes certainly may be poked here; please regard this analysis as a high-level exercise that provides some useful insights.

Buy at 50…

Let’s assume that at age 50, Jane Buyer closes on an adorable 2-bedroom, 1-bath cottage in a good location for $625,000. She’s fortunate to be able to put down a substantial 35% down payment. Now let’s crunch some numbers. 30yearWhat are Jane’s monthly costs? Taking into account tax deductions for loan interest and property taxes: monthlyfor30…for the first year, anyway. Inflation will gradually increase both property taxes and homeowner’s insurance over time. We’ll assume a 2% annual increase for both of these. Taking all of the above factors into consideration, 30 years of diligent payments will add up to a total of $926,012. Add that to her initial down payment, and 80-year-old Jane will have paid a total of $1,144,762 for her cottage. Upon paying off her mortgage, her only remaining recurring costs will be her property taxes and homeowner’s insurance, which by year 30 will total something in the neighborhood of $14,000 per year (or $1,167 per month).

…Or Become a Lifelong Renter

But what if Jane opts not to purchase, and instead commits to being a renter for life? Let’s say that she finds a 2-bedroom cottage for rent at $2,000 per month. That’s certainly less than a $2,280 house payment. But rents will continue to rise over time; if we apply an annual rent increase of 3%, by the time Jane is 60 her monthly rent will have jumped to nearly $2,700. In 30 years, inflation could potentially increase Jane Renter’s rent to $5,000 per month, and her total cost of rent over 30 years would come to $1,141,810. So $1,144,762 to buy. Or $1,141,810 to rent.

Jane Renter squeaks ahead in this scenario by a mere $2,952. Heck, that’s practically a draw, right? Not so fast. We forgot something: the down payment that Jane Renter never plowed into a home. Jane Renter would invest her down payment ($218,750) in a well-diversified portfolio of assets. Assuming a conservative 4.5% annual return, Jane could potentially realize an income of $8,000 per year on this (after taxes). Over 30 years, that would amount to a return of $240,000. (If Jane left the amount to compound for the full 30 years with no withdrawals, she’d end up with $894,683… but how much fun could she have with that in her 80s?)

Taking this investment into consideration, at age 80 Renter Jane comes out ahead by at least $242,952. Jane Buyer could potentially pull out a win in the end, but only if she lives to age 86, when Jane Renter’s advantage is finally devoured by her ever-increasing rent. But 86? Remember, the average female life expectancy in the US is 81. 30yearcumulative Maybe there’s a way to boost Jane Buyer’s chances; what if we shorten the term of her loan?

Suck It Up: The 15-Year Mortgage

Cutting the loan term in half offers several benefits: a lower interest rate, significant reduction of total interest paid, and best of all, the opportunity to hold a mortgage-burning party when Jane is 65 rather than 80. Of course there’s one major drawback: significantly larger monthly payments. Let’s say Jane Buyer was able to swing a 15-year loan at 3.36%. Her monthly costs would look like this:  15year That’s $918 more per month than the 30-year mortgage scenario, and nearly $1,200 more than rent at the start. But a 15-year mortgage saves Jane $318,159 on the purchase over the 30-year mortgage. And after the loan is paid off, Jane’s monthly expenses are drastically reduced for her retirement years. But Jane Renter will still come out ahead… at least until age 82:  15yearcumulative It’s not looking good for Jane Buyer. It gets still bleaker when, to be quite thorough, we toss in one last cost: Maintenance. Jane Buyer can count on spending at least $100,000 over 30 years to keep her little cottage adorable (and livable). That pretty well settles the question: Jane Renter wins. Hee haw.

Live Long and Prosper!

As with any financial forecasting there’s a lot of crystal-ball-gazing here, and it would be possible to manipulate these scenarios in any number of alternate ways. However, it’s hard to ignore the big lean of the numbers in favor of renting in an expensive market. The Break Even point for buying (even before considering maintenance) comes so late in life that it’s practically meaningless. What’s very clear is that time is a friend to the young. Home ownership pays the greatest dividends to those who live longest after paying off their mortgages, so mid-life buyers begin the race with a significant handicap.

The numbers may be more friendly in less expensive areas, but in pricey locales like the Bay Area they are downright hostile. So should the Donkey here untie the stick and abandon her carrot? I’m not sure. There are psychological and emotional benefits to home ownership that potentially outweigh financial considerations. But an analysis such as this certainly removes any blinders a donkey might be wearing. And donkeys can live a really long time. Join Personal Capital For Free To Better Manage Your Finances

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96 Comments

  1. dpuglas farley

    Tricia, Great article, Politicians enjoy promoting advantages of home ownership so that they can have a solid base of voters, and gerrymander their districts. Maintenance & repairs are required also, the roof, trees, furnace, painting, siding, plumbing, windows, sewer. Over 30 years this adds up. Single family homes should be bought to enjoy, not as an investment.

    Reply
  2. Mjaycee

    I made an offer on a home in a pricey East Bay town on my 50th birthday. It was large enough to house my kids and me until they moved out and I decided to move to Sonoma County for a job. I paid $645,000 for it 10 years ago and it is now worth approx $920,000. I have it on a biweekly 15 year mortgage. Instead of selling it and buying a small home where I am now, Healdsburg, I am renting it out for $4100. per mo. and paying down my mortgage, the rent is just a tad less than the mortgage payment. But in a couple years should just about cover it. Yes I still have taxes, homeowners and insurance but I figure that by the time I retire in 5 years I can refinance it into a 30 year fixed, continue renting it out and have a nice retirement income while renting a less expensive, smaller home wherever I decide I want to settle. I would imagine if I did a total analysis like one that was done here it may not make total financial sense but it seems to work in my aging brain!!

    Reply
    • Financial Samurai

      Life has a way of surprising us on the upside!

      Reply
    • Tricia Richter

      Sounds like a really happy arrangement, Mjaycee. I’m very glad to hear that buying at 50 has worked well in your case! I think you’re right that in the end, doing what works *for you* and makes you both happy and comfortable is the way to go.

      The results of this hard-nosed analysis both surprised and dismayed me; however, they haven’t convinced me that the renter route is the absolute answer. Maybe I’m just a stubborn donkey, but I think you really just need to make the numbers work well enough so that you can be comfortable; it’s not necessary to squeeze every last penny out of one’s financial choices and investments.

      And as both you and Sam point out, there are all kinds of different ways that numbers, approaches, and circumstances can potentially be tweaked to make things pay off either way. Good stuff!

      Reply
  3. Untemplater

    Bay Area real estate is nuts. I can understand your dilemna that is hard for a lot of people to understand who haven’t seen how crazy the market is out here. Rents aren’t cheap either and finding a decent apartment is not an easy task. There are a lot of new condos beingg built throughout the downtown to Hayes region, so at least they are increasing supply to meet demand. But it’s hard to know if the pricing will be reasonable or not. Nothing is cheap in SF!

    Reply
    • Nila Ridings

      I enjoyed this article but Tricia Richter left out a major factor that anybody thinking of buying or renting a property in this day in age should educate themselves about BEFORE they buy or rent.

      HOMEOWNERS ASSOCIATIONS AND CONDO ASSOCIATIONS!!!!!

      Over 60 MILLION Americans now live in one of these insane places. There are over 350,000 of them existing on American soil.

      I’ve learned the hard way and I will share the basic details with you here. I will also give your great resources for learning more. I have studied HOAs extensively since getting caught in this nightmare in 2005. There is far more than meets the eye when it comes to HOAs.

      First off….when you sign on the dotted line to purchase you are signing away your US Constitutional Rights, you are becoming business partners with every one of your new neighbors in a non-profit corporation, and you are making a personal guarantee on any loans, lawsuits, settlements, embezzlements, liabilities, construction defects and disaster rebuilds for that HOA or COA. How does this happen? The board which is comprised of other homeowners who volunteer to be on the board and make all decisions on behalf of the HOA have a right to assess you for money for anything they deem necessary. My experience has been that board members are ignorant, arrogant, unskilled, power-hungry, and bullies. If you dare disagree or you expose them (as I have done) you will become a target. And they have all the money to fight you in court and they also have the power of their HOA insurance company to fight you in court. The deck is immediately stacked against the homeowners. The stress of dealing with these ignorant bullies is beyond words and it does have negative affects on your health. (internet search for Dr Gary Solomon HOA Syndrome)

      I paid cash for my townhouse at age 51. The maintenance was not done, the siding rotted to the point the electric meters fell off the house, the gutters were not cleaned and caused the basement wall to crack causing flooding that destroyed the finished basement, and I had to spend the money to completely repaid and replay all this damage. On top of that I had a lawsuit to deal with because I refused to pay dues of over $200 per month for no services being rendered as per the contract.

      The HOA had the same president for over 26 years. Investigations revealed no audits had been done for seven years (required annually by the by-laws) and TEN MILLION DOLLARS was unaccounted for…and still is to this day seven six years later. On top of that there was $500K in unpaid bills. There were many other problems but in the middle of the investigation and lawsuit to try and get to the bottom of what was going on and have access to the financial records the board president suddenly died. He had just purchased two more homes in California where he was running for the board out there.

      The results we live with now are property depreciation by 45%. The HOA board took out a ONE MILLION DOLLAR loan and we have over 25% rentals and countless foreclosures. I have spent my retirement savings repairing this townhouse and paying legal bills. If I sell tomorrow I will lose $200K and all homeowners are sitting here with the risks of assessments to pay off the million dollar loan and anything else the HOA board decides they want money for. In addition, the HOA has had their insurance canceled twice in three years and that adds additional risks to the homeowners.

      Dues…whether paid monthly or yearly it is money you will never see again. In the case of the HOA hiring the vendors you have no say in who they hire, when or if the work is done, or the quality of the work. That means if there is a fire and it burns your condo building down you could be paying a condo payment, condo dues, and for another place to live during the rebuild period. If the board decides to hire Uncle Billy Bob with a shiny new hammer to rebuild your place you are at their mercy. If it’s done and things are not working correctly, leaking or just plain poorly constructed you are at their mercy. If you scream and squeal….you will become their target. Fines…depending on the CC&Rs you can be fined for things like the wrong color of window treatments, parking on your driveway, leaving your trash can out for an hour too long, a dog that weighs a pound over the limit, a child that rides a skateboard, an cooking odor that offends a neighbor, leaving your garage door open too long, or flying the American flag…this is a very short list of what you can be fined for and if you don’t pay the fines you have only one option….hire an attorney and try to fight the battle. Keeping in mind the goal of the HOA or COA is to bankrupt you. In the end, they can and will foreclose and take your property.

      Embezzlement is massive across the country in HOAs. There is little to no oversight over HOAs. Very few laws are in place and those that are give the HOA the control. California has the Davis-Stirling Act and it hasn’t proven to help the homeowners but certainly gives massive rights to the HOAs and property managers and their attorneys know exactly how to use it to their benefit.

      I promised resources…read Neighbors At War by Ward Lucas and check the daily stories he posts on his blog neighborsatwar dot com. He spent 40 years as an investigative reporter in the television industry in Seattle and Denver. He heard many stories and learned the dirty little secrets of the HOAs and the CAI and exposed it. Shu Bartholomew has been active in HOA exposure for over 25 years and she has a fantastic radio show that exposes every dirty secret you can imagine in the HOA world. You can listen to the live show or the podcasts at onthecommons dot net.

      Finally, I will say this to the readers: I would not own another property in an HOA or a condo if it was paid in full and given as a gift. My experience has taught me how ruthless and dangerous living among ignorant power-hungry neighbors can be. No matter what sales story you hear there is no such thing as a good HOA. Every single one of them is just one vote away from being a hellhole like I have experienced. One vote puts a rogue board member in power and all homeowners become victims. I would not rent in an HOA because if the owner doesn’t pay the dues the renter loses the privilege of using the pools, tennis courts, golf course, exercise room, etc. In addition, in some areas the renters are finding when the owners don’t pay the dues the HOA puts a boot on their car and holds it hostage until the owner pays the back dues. This can cause massive and expensive inconveniences to someone that innocently rents an HOA controlled property and has no rights to vote for board members or even read the CC&Rs.

      If the listing says: HOA, I say stay away!!!!!!!!! I feel HOAs and condo associations are destroying lives, health, happiness, and financial security of home ownership in America.

      Again, I appreciate this article but this one very big aspect of home ownership needed to be included in this article. If there are no other options for ownership or rental besides an HOA or condo association the readers should consider living in an RV!

      Reply
  4. Alex Valdes

    I like the post but did you forget the asset? I didn’t see it in your calculus. It seems you are missing the fact that the buyer, at age 80, has an asset that she can sell (or borrow against). I believe this puts the buyer ahead.

    Reply
    • Tricia Richter

      Hi Alex—

      Here’s the thing: Yes, our friend Jane will indeed own the asset once the mortgage is paid off. But she still needs a place to live; selling puts her right back into the position of having to choose whether to buy or rent in a future market that has become even more expensive.

      This, again, is where time is not on Jane’s side. A younger buyer has more of an opportunity to take advantage of price appreciation and “trade up”. The older buyer has fewer precious years to build up equity in the home in order for price appreciation to benefit her.

      Remember that the WSJ noted that compound annual return on single-family homes was a mere 3.6%. At that rate, in the 15-year scenario Jane’s home would be worth $1.06 million when she pays off the mortgage. That would indeed put another $236k in Jane Buyer’s “plus” column, but that still leaves Jane Renter ahead by $264k at that point. And, that’s only in the event Jane Buyer actually sells her asset (which will also involve further costs, and forces her to find other housing).

      I explicitly set aside price appreciation for this analysis largely because it’s less of a benefit for older buyers. Plus, even if the buyer does end up selling in order to reap the profits, the costs to establish a new living situation quickly eat up that profit. It’s likely that the Bay Area’s price appreciation will exceed the 3.6% average, but even in that case, selling leaves Jane having to deal with that more expensive market.

      Thanks for asking the question, it’s a very valid one. And who knows, an enormous housing price spike at just the right time could very well put Jane Buyer way out in front! By the same token, however, there’s always the possibility of a crash….

      Tricia

      Reply
      • Financial Samurai

        Tricia,

        Although annual apprise is a mere 3.6%, that’s 18% per year return on a 20% downpayment. I’ll take that any day + having the asset to pass down when I’m dead.

        The ability to make it easier for someone or the next generation in terms of living costs is a great blessing. I’m thankful I could go back to Hawaii and live for free in a house my grandfather purchased 60 years ago or so. Just knowing this gives me peace of mind to take more risks.

        Sam

        Reply
        • Tricia

          Hmmm. Interesting angle, Sam— I never thought of it that way before! My question would be, though, how much of that 18% increase would get eaten up by 12 months of mortgage/tax/insurance payments, plus the costs to sell in order to actually realize a profit?

          Reply
          • Financial Samurai

            Mortgage rates are 2.75%-4% now. Add on 1% for maintenance and another 1% for insurance and you are at 4.75% to 6% for a net increase of 12% a year. Not bad if that is indeed the return!

      • Chris

        Tricia, this is a nice post, since we rarely seriously consider renting as a better financial move. I want to add on to your comment about the asset value. If the buyer sold her home (in the example $1.06 million at the end of 15 years), she wouldn’t just get back the appreciation, but the entire equity she has built: in this case $1.06 million after 15 years, minus realtor fees and capital gains taxes, etc. She would be in position of having to rent again, but she would have ~$1 million in capital to use and/or invest. So instead of adding $236K to the buyers plus column, it would add $1 million. She would have to find other housing, but the renter will likely have to find other housing at various times. Alternatively, if she just wants liquidity, the buyer could borrow against the house and have a similar payment as the renter again but with a large amount of cash from the refinance.

        Reply
        • Tricia

          When I noted that selling would put the buyer ahead by $236k, that took into consideration all of the expenses paid out over the years in order to reach the point of completely owning the home. Yes, selling would put a lump sum of ~$1m in Jane’s pocket, but a large portion of that amounts to “getting back” money she had already earned and subsequently paid toward owning her home. Thus, you can’t consider it all profit.

          In other words, you can’t add $1m to the buyer’s “plus” column, because that column is net expenses, and is intended as a comparison with Jane Renter’s “plus” column (also net expenses).

          It’s fascinating how many different ways you can look at this though, isn’t it? It sort of is confirming my belief that, if I can just make the numbers work *well enough*, I’ll be ok to go ahead and buy (despite what the numbers seem to say about renters coming out ahead in this market).

          Reply
      • Keith Burkhardt

        Your scenario is pretty static, there are many variations to consider. You assume that after buying a house the buyer is broke, income and saving stops. Buy when you can afford to and what you can afford. I put 20% down, which was 15% of my total cash. I now have a home with a fixed payment, my investment portfolio is up 25% this year, house is up 20% and I continue to save money (and invest), I just turned 50.

        Reply
    • Anonymous

      I agree w Alex. Plus the tax deductions from the mortgage interest. On the downside, there was no mention of maintenance for new roof, Hvac, etc which
      Would add up to a large number over 30 years.

      Reply
      • Financial Samurai

        I don’t think it is THAT bad, maintenance. A roof is every 15-20+ years. Same with water heater and stuff.

        Reply
  5. Financial Samurai

    Such a fantastic post Tricia, I was laughing out loud!

    You post a dilemma that I don’t think many people really think about until the hit middle age.

    Most homeowners I know of pay their mortgage off far earlier than 30 years. I like how you did the exercise of comparing rent and ownership. So many variables and unknowns.

    Who woulda thought the real estate market would go ballistic again so soon after the financial crisis?

    I say if you find your forever home you love, and have done the math, then go for it. Up and to the right is our friend over the long term.

    Reply
    • Carrie

      The one aspect that is missing in the buyer scenario is that often people in markets such as SF are able to sell their house and cash in on the equity – sometimes netting several hundred thousand dollars (which also has tax implications). This type of cash-out may not be very useful when you are 82, but if you do it t age 65 and then go into a rental, you might come out further ahead. The other thing that Jane Buyer did was sink 35% into a down payment. My financial advisor always says cash is king, so some may prefer to hold onto their cash and invest it. It would be interesting to see these scenarios with lower down payments and a split between buying for some years and then renting later in life (in a retirement community where costs are lower). Great article!

      Reply
      • Tricia

        Good call on the compromise approach, Carrie— sell halfway through to pull out the equity and then rent in a retirement community. I wonder how I’ll feel about home maintenance when I’m pushing 70… I’m hoping that I’ll be pretty spry, given my (extremely) active lifestyle and family history of longevity, but you never know. I may still be happy to push a lawnmower and vacuum up dog hair (the dog is a must… and a big part of the reason why ownership continues to hold great appeal).

        I agree that running the numbers with a lot of different variables could be really interesting. Hard to cram multiple scenarios into a blog post, though— tough reading! But the “if…then..”‘s are pretty intriguing. And the comments here are really insightful as well. In fact, I’m delighted to see so many folks poking holes here. Good stuff!

        Reply