“Should I purchase or rent my primary residence?”
This is one question I’m rarely asked as a financial planner. Homeownership, after all, is as American as baseball, apple pie and watching World Cup Soccer at work. Like attending college and keeping quiet in church, it’s simply assumed to be the correct course of action if one is to be financially responsible and live the good life. Just over six out of ten Americans own their homes, according to the most recent Federal Reserve Board’s Survey of Consumer Finances.
“Homeownership, after all, is as American as baseball, apple pie and watching World Cup Soccer at work.”
The average equity in the primary residence in 2016 according the Federal Reserve Board was $197,500, just under the average $228,900 in tax advantaged retirement plans. Surely this vindicates putting down roots and paying down a mortgage.
True Costs of Owning Versus Renting
Not always, according to a study by two University of Iowa professors published in the May 2018 Journal of Financial Planning, “To Rent or Buy? A 30-Year Perspective.” Drs. Arthur Cox and Richard Followill decided to examine conventional wisdom and deep dive into thirty-years of data in six metropolitan areas—Kansas City, San Francisco, Chicago, Miami, Minneapolis and Stamford, CT—accounting for the true costs of owning versus renting in each market.
They used comparable square footage and include all the costs of owning—including property taxes and maintenance. Renters, they assumed, invested the money they saved in a 50/50 mix of stocks and bonds. Federal marginal tax rates of 15 and 28 percent were assumed. The comparison is a simple horse race between the value of home equity versus the after-tax value of the investment account.
“The results using a 15 percent tax rate and decision horizons of eight years, 10 years, and 12 years show that renting was the better decision in five of the six markets,” conclude Cox and Followill, adding “the one exception is San Francisco.” Over thirty years it proved a fifty-fifty split, with renters better off in three and owners in the other three. At the higher 28 percent tax bracket owing edges out renting. This conforms to expectations as the study was completed under former tax rules that allowed for substantial tax deductions for property taxes mortgage interest.
This study is significant and should be integrated by those of us toiling in the fields of personal financial planning, either as advisors, writers and commentators, or both. Rule-of-thumb advice to purchase a home should be discarded, replaced instead with an accurate comparison of the true costs of owning and renting, the likelihood of actually investing the initial savings from renting, and the relative joys and sorrows of owning versus renting.
Renters, for example, lose the pride of ownership, the ability to customize their abode and may be forced to move. In return, they have a ceiling, not a floor, on their housing expense and push the headache of inevitable repairs to the landlord. If an opportunity arises in another city or state, the costs of leaving are minimal.
Homeowners enjoy far more security and can look forward to a point when the only fixed monthly expense is property taxes. In return, they pay in principal and shoulder the burden of maintenance and repairs. If the local economy booms, as in San Francisco, they get wealthy from price appreciation. If it busts, they are left with loses.
Ultimately, the useful conclusion of the study is that the financial decision to purchase versus rent a primary residence is highly dependent on myriad factors that must be considered prior to determining the best path. Quite startling, over even the long-term period of thirty years, purchasing a house rather than renting is not a “no brainer” but rather a “coin toss” for Americans of average incomes provided they have the discipline to invest the difference.
Mike Lynch CFP® is a financial planner with the Barnum Financial Group in Shelton CT. He can be reached at mlynch@barnumfg.com or (203) 513-6032.
Federal Reserve Bulletin, “Changes in U.S. Family Finances from 2013 to 2016: Evidence from the Survey of Consumer Finances,” September 2017, Vol. 103, No. 3.