United States: Deciding To Rent Or Buy Your House: A Tale Of Two Cities

Last Updated: March 23 2015

People often decide between renting or buying a place to live based on preferences and instinct: What do you want to do?

If they are incrementally more analytical, they may explore "how much house" they can "afford". This approach is grounded in capabilities. What can you do?

I think the most useful approach to important financial planning decisions like buying vs. renting your home is one grounded in optimization: What should you do?

Owning a house has costs – lots of them. These include mortgage payments of principal and interest, property taxes, and homeowners' insurance. While you own a house, you have to maintain it, and when you sell it, you'll pay real estate commissions.

Owning a house also has benefits, including the rent you don't pay, and the "forced savings" feature of paying down principal on your mortgage over time.

I created a model to compare renting and buying.

The model has several variables. Some of these are Facts, and easy to plug in based on your particular situation.

  • GROSS: your pre-tax gross income.
  • RATE: your mortgage rate. These seem to currently be a bit under 4% for borrowers with good credit ratings, but of course they'll rise and fall over time. (Note that the model assumes a 30-year fixed-rate mortgage.)
  • MILLAGE: the property tax rate, expressed as a percentage of the home's value. (This is easy to back out for any prospective purchase using Zillow.)
  • INSURANCE: your annual homeowners' insurance cost, expressed as a percentage of the home's value.

Some of the model's variables are Forecasts – but ones that aren't too difficult to make.

  • TIME: the length of time you own the house before moving.
  • MAINT: estimated maintenance costs for the property. Many experts range these between 1% and 4% of the purchase price each year, depending on a property's age and condition.
  • MONTHS-RENT-HOUSE-COST: this is the home's price, divided by its estimated monthly rent. This value is difficult to estimate with precision, but by spending time on Zillow in your target neighborhood, you can develop a reasonable working estimate.

To explore how these variables contribute to model results, let's consider a case study of two sisters from Louisville, Laura and Patty. Laura's a young attorney, married to a financial analyst, Henry, and they have settled in Laura's hometown. Patty is a dentist, married to an urban planner, Charlie, and they live in Portland.

Laura and Patty can each make a 20% down payment, and because they're prudent, they keep their total principal, interest, taxes, and insurance within 28% of their respective gross incomes.

In Louisville, property taxes are relatively low (MILLAGE = 1.1%), but so too are salaries (GROSS = $180,000).

Rental rates are high in Louisville compared to home prices (MONTHS-RENT-HOUSE-COST = 155). (Another way of thinking about this is that the "earnings yield" in imputed rent of owner-occupied housing in Louisville is rather high, or that the P/E ratio of Louisville housing is low – a sign of a housing market that's relatively less "frothy" than others....)

In Portland, salaries are a little higher (GROSS = $240,000), but so too are property taxes (MILLAGE = 2.4%). Rental rates in Portland are much lower compared to home prices than they are in Louisville (MONTHS-RENT-HOUSE-COST = 280).

Stated differently, Portland's housing market has a P/E ratio of 23, while Louisville's has a P/E ratio of 13.

The model suggests that Laura and Henry can buy up to $824,000 of house in Louisville and stay within their 28% PITI target. (Whether they'd want that much house is an open question, but perhaps one best discussed at cocktail parties, rather than here.)

In comparison, Patty and Charlie can buy up to $906,000 of house in Portland and stay within their 28% PITI target.

Very well – so far, we've determined capabilities: "how much house" Laura and Patty can buy. But what should they do? Rent, or buy?

In Louisville, buying is rather compelling. The model suggests that in Louisville, if Laura and Henry own the house for as few as two years, owning will cost them somewhat less than renting.

The case for buying in Portland appears weaker, because the model shows that even over very long holding periods (for instance, 20 years), owning still costs much more than renting.

After 30 years of ownership, Patty and Charlie's house will have to have appreciated in real terms (i.e., above and beyond the inflation rate) by over $450,000 (or 1.4% per year) for ownership to break even with renting. (For a state-by-state look at housing price appreciation gross of inflation, go here.)

Real estate markets are localized and far less efficient than securities markets, so the model is directional only, and should be used with caution. That said, it has certain features that generalize:

  • If your expected time to own the house is shorter, owning is less attractive
  • Higher maintenance costs make owning less attractive
  • Higher property tax rates make owning less attractive
  • Higher interest rates make owning less attractive
  • A higher ratio of the house's cost to its monthly rent makes owning less attractive

The model also helps you focus on why buying a house makes sense, if it does make sense.

Louisville is an example of a market where the case for buying is about cash flow: the month-by-month higher expense of renting cancels out other costs of ownership pretty quickly, making ownership likely the better choice in many circumstances.

In comparison, the case for buying in Portland is about price appreciation: the month-to-month savings of renting may be canceled out by long-term gains in home equity.

The real estate crash of 2007 through 2009 upset many old assumptions that real estate tended to be a safe investment, and it illustrates the importance of making a thoughtful case-by-case analysis on the question of renting or buying.

Anchor your analysis in your own local setting, including your local salary, local property taxes, and local ratios between home prices and rents. Then think carefully about whether or not job events or life circumstances might cause you to need to move, and if so, how soon.

When your analysis is personalized and localized, you'll be much more likely to make the right rent-vs.-buy decision.

I am grateful to Shaw Solomon of Rainey, Jones & Shaw Realtors for providing perspective on relocation costs and break-even times for home ownership, and to Kent Gregory of Sterling Thompson for providing information on comparative costs of homeowners' and renters' insurance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions