At this past weekend’s open house we were approached by someone eager to engage in the age old rent vs. buy debate. And, as homeowners and ownership advocates, it was a welcome conversation.
Let us start by saying that there are many barriers to entering our East Bay real estate market - the most obvious being price. To even be able to consider buying a home locally one typically needs to save, sacrifice, and have a little luck (or family money) on their side. It takes a level of desire and dedication that is admirable. Not everyone has the option, but if you do – here is some advice and a few of the financials to consider.
Have a long term perspective.
Home ownership, or real estate investing, is something that pays off in spades, with time. Time being the operative word. In the short term, renting is cheaper. We aren’t going to sugar coat the reality. But, in the long term, owning beats renting time and time again.
For this example, we compare two trajectories: purchasing a $1.3m home vs. renting a $1.3m home
If you bought a home for $1.3m today, with 20% down at a 6% fixed rate, the total monthly housing costs would be approximately $8,147. That same home would rent for approximately $4,500/month. Short term that is hard to stomach….we get it. We have been there!
But, with the average rent in the East Bay experiencing a 4-5% annual increase over the past 25 years, it is important to think long term with any investment decision. You aren’t day-trading housing!
The ownership costs for those locked into a 15 or 30 year mortgage are relatively fixed. Unless you refinance into a lower interest rate, your mortgage payment will stay exactly the duration of that mortgage. Due to Prop 13, your property taxes are capped at a 2% increase annually. Since insurance has historically increased at approximately 3% annually, your total monthly housing expenses only experience marginal increases.
How does that same $1.3m home play out over time?
Seven years from now, with the compounded increase in taxes and insurance and without refinancing to a lower rate, your monthly ownership costs will be $8,468 (with approximately $1,570 going to principal each month). Rent for the same home will be $6,124. And, rent isn’t a tax write-off - all that interest is. Once you factor in the principal contributions being paid directly to equity and the tax write-offs (hello new $40k SALT cap!), it is around year seven when the annual cost to own and rent are equal. From there the benefits of ownership start to accelerate.
By year 15, the monthly cost of owning is $8,904 (with $2,530 going directly to your principal), while renting the same home will cost $8,709 (with no tax write offs or equity gains).
By year 20, the monthly cost of owning is $9,221 (w/$3,415 going to principle), while renting the same house will cost $10,853.
And, by the glorious year 30, if you never refinance down, you will only have insurance and tax expenses on a monthly basis (IE $3,741/month) vs a total rent of $16,850. Consider it a forced retirement savings. Or, a well of equity from which you can pull.
Even better? If you run these same numbers with only 5% down, the outcome isn’t drastically different. While you would need to be able to swing the higher monthly payment, or buy a more affordable home, by year 8 the monthly cost of ownership is in balance to the monthly cost of renting. And, the benefits of ownership beyond year 8 accelerate in a similar fashion to the 20% down scenario.
If you have heard the saying, “It's time in the market, not timing the market” this right here is why.
Leverage, leverage, leverage!
The typical rent vs. buy debate always comes around to the assertion, “if the down payment, closing costs, and extra monthly amount spent to own a home were invested in the stock market it would be a better financial play...I would NET more.”
Great, in theory!
But, that ignores two things; most people do not have the diligence to act this out in reality, and home appreciation is realized on the full property value instead of investment gains on just a fraction.
Consider this: in that $1.3m purchase scenario, with 20% down, the down payment and closing cost would run approximately $286,000 out of pocket. And, the $3,647/month difference in monthly expenses would equate to another $43,764 of additional investment for the year. (let’s no factor in the tax savings from homeownership - that is a little too far into the weeds). Assuming a modest stock market return of 10%, that $329,764 would grow by $32,976 in the first year. In contrast, assuming a very modest 5% property appreciation, that home's value would grow by $65,000 in the first year.
What does this have to do with leverage? Here is the part where Dave Ramsay will disagree. IF YOU CAN, leverage your assets so they work harder for you.
If you only put 5% down on a $1.3m home, the down payment and closing costs run approximately $91,000. The $4,817/month difference in monthly expenses equates to another $57,804 saved to invest for the year. If you didn’t buy a home, that $148,804 invested at a 10% return would grow by $14,880 in the first year. While that $1.3m home would still appreciate by $65,000 in the first year.
Whether you put 5% down, 20% down, or more, you still get to realize the appreciation on the full property value.
Do not back yourself into a corner with a monthly payment that is not sustainable! But if you have the means, leverage, leverage, leverage.
Get Creative!
As we said at the beginning, buying a home in the East Bay is not for the faint of heart. Unless you have gobs of money, getting creative might be your best move. Explore neighborhoods and locations that offer an easier entry point without losing too much of what you love in a community. You might surprise yourself and fall in love with one of those “more affordable” options (that is how Alissa ended up in El Cerrito 15+ years ago and never turned back)!
Look for properties with potential. Detached garage that can be converted into an ADU in the future? Full height basement just waiting to be finished? Large, flat lot with a tiny home and a smaller price tag? Older kitchen and bathroom? Be willing to squeeze into a less than perfect home if it has the potential to turn into the perfect home in time.
Or, buy a duplex or multi-family home so that you can off-set your monthly expenses with rental income – creating an easier near-term payment while building an investment portfolio in the process. Keep in mind that rent increases will quickly grow to a point of cash flow that you can leverage for the next home. If you want to read more about “house hacking” check out our recent blog on the topic.
Okay, we can go on and on…..sorry! We haven’t even mentioned the personal reasons for owning (never being evicted, paint and decorate to your heart’s content, dogs & cats oh my!, pride of ownership, and so much more). Clearly we are in the right field.
In short, don’t fall for the tiktoks and youtube videos espousing the virtues of renting for life. It doesn’t make financial sense.
Above all, have a lovely weekend!
