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:
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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:
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:
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.
What are Jane’s monthly costs? Taking into account tax deductions for loan interest and property taxes:
…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.
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:
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:
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.