Are You Wasting Money Renting?

are-you-wasting-money-rentingPeople generally buy property in hopes that they will be better off financially down the road than if they did not buy property. However, for many people, it’s better to skip property ownership and stay a renter – at least for a while.

If you find yourself in any of the following scenarios, you may be someone who is better off as a renter than a homeowner.

Scenario 1:

Whether you buy or sell a home, real estate has significant transaction costs. If you want to come out ahead financially, the value increase of the property you buy has to be more than the total transaction cost of the deal.

The chart below shows a two-year ownership scenario with the property going up in value 3.5% per year – a healthy projected increase in value – and then taking out typical costs on the buy and sell. Notice how the owner put in $35,000 to buy and is left with only $25,440 in the bank after two years. Look at all those transaction costs, $5,000 + $8,560 is $13,560 or 13.5% of the $100,000 purchase price.

It is clear to see that this person would be better off financially after a couple of years if they stayed a renter.

This doesn’t even account for all the money this owner may have paid for upgrades such as new flooring, landscaping, and appliances — things that will not add much value to the property. The current owner will never get to enjoy them, but the next owner certainly will.

Who should avoid ownership? A few groups that should really think hard before they buy are military people and professional athletes. Both of these groups move often and in general would most likely be much better off to stay renters until they are settled in a city where they are sure they will be staying for a long period of time. Additionally, parents considering buying properties for their college students to live in during school will be probably end up being a short-term ownership situation – skip the hassle!

Five years is typically the break-even point where it probably is better to own over renting, but again depends on the difference between the cost of renting and the cost of owning.

Scenario 2:

On a monthly basis, it is almost always more expensive to own, but let’s just talk about when it’s expensive to own on yearly basis, which is most often the case in areas where there is plenty of nearby land to build upon. This is common in revitalizing downtown areas where cities construct  luxury condominium projects, and there are still many lots available for building additional properties, as well as a glut of vacant or rental properties.

It probably makes sense to consider staying a renter in those areas, because rentals are widely available and most likely more affordable. You might be paying an extra $750 per month or $9,000 per year for the “pride of ownership.” Year two as an owner may still have $8,750 more in costs than if you rented, year three could cost $8,500 more to be an owner – and these costs add up each year! You could be in the “red” for ten years, adding up to $60,000 to $70,000 or more to your costs. Your hope would be that the appreciation in value would compensate for these huge cumulative annual negative amounts – but the odds are against you.

Staying a renter is the best choice for many people, and for many, renting does not equate to throwing money away. If you want to purchase real estate, consider the surrounding area and rentals, and make sure you own the property for at least five years or more to recoup costs.

Your best chance of increasing your wealth through real estate ownership is buying property that suits your wants and needs and to hold it for a long, long time — the longer the better!

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  1. Andrew Russell says

    Thanks a lot for the article Leonard. It was very easy to understand and made me see things from a different angle.

    With that said, am I thinking about scenario 1 correctly?

    Owner’s cash flow after 2 years:
    -$35,000 (cash outflow at time 0)
    -$3,956 (opportunity cost of the $35,000 for two years at 5.5% after tax)
    +25,540 (cash inflow at time 2)
    = -$13,416 or $559/month during that two year period to have a place to live ($13,416/24).

    So, if one were evaluating that scenario at time 0 for buy vs rent they would want to RENT if they could find a place for anything less than $559? Otherwise, in a perfect world you would end up in a better financial position after 2 years by buying, right?

    Other thoughts:
    – I know there are tax benefits that I’m missing in my cash flow but I’m not exactly sure how to calculate that impact. Is the tax benefit material enough to consider?
    – There are definitely other costs involved like you mentioned in the article for upgrades, etc. that I’d have to factor in.
    – Variables to consider: rate of return in opportunity cost calculation, home value after two years, unknown issues/rehab with the house while an owner.

    I’m currently facing this situation and want to make sure that I’m including everything in my hard analysis, not accounting for the soft benefits of renting vs buying (flexibility, less worry and risk, etc). Am I missing anything?