Home Buyers

As a Realtor, it’s expected that whenever I’m asked if it’s the right time to buy, my immediate answer will be, “Of course, forget <insert good reason why not to buy>, now is the perfect time.” Unfortunately my father taught me that it’s best to understand a client’s needs and suggest appropriate actions that meet those needs. For example, let’s assume my client is a doctor who carries large student loans and plans to leave in the next two years for her fellowship. I’d suggest renting in this instance because it offers a short term commitment with fixed costs. In other words, it gives her the ability to pay down her loans and the freedom to move at anytime.

Assuming you are in a financial position to own a home, when does renting make more sense? Renting provides lack of responsibility and increased freedom. Some examples: the burden of maintenance is largely assumed by the landlord and moving is always an option (although prematurely breaking a lease agreement forfeits your security deposit). Therefore the most compelling reasons for renting, in my opinion, are the freedoms it provides from the burdens of owning a home.

In many instances, the rent payment is one-third to one-fourth the cost of the gross monthly payment for a home (loan payment, property taxes, and maintenance costs). Consequently the savings incurred (versus owning) make sense when other financial objectives are more important, such as saving for a home, paying off student loans, or supporting family members. What happens when life throws you a major curve ball? Consider the following life changes: divorce, new job, death of a spouse, and transition to a new city. Renting may provide the optimal platform for dealing with these situations.

Finally, buying a home requires years to build equity and sell at a profit. The time requirement is often between 4 to 7 years, the commitment needed to build enough equity to cover selling fees (which total around 8%) and make a return on investment.

Conclusion

Renting makes more sense when

1. You are not staying for long ( 2 years or less) or
2. Other priorities are superior to the responsibilities of home ownership

Basically you pay for predictability. The downside is that your payments build someone else’s equity (as opposed to your own).

Additional advantages of renting:

1. Amenities that are unaffordable as a buyer are accessible as a renter. Many of today’s high end apartment complexes offer pools, spas, fitness centers and recreation areas.
2. Large complexes provide a sense of community. (Unfortunately I must disagree. My memories of UCLA apartments are of filth, dilapidated buildings and sleepless nights).
3. A long lease agreement (1-2 years) provides short term stability. Despite the fluctuation of housing and oil prices, rental costs remain fixed.
4. The price of entry is small. Just 2 months rent give the right to occupy a space.
5. The option to move is always available. Whereas breaking a lease agreement prematurely may cost $5,000 (the price of the security deposit), selling at the wrong time may cost $50,000 or more (if the home is sold less than the purchase price).

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Many of us are uneducated about the benefits of homeownership. We hear on the news and from others that real estate is a good investment, yet we do not understand the basic math. Without the principles and an idea how the numbers work, its easy to postpone the decision to buy. Thankfully the math is quite simple. When you consider the financial power of owning a home, you intuitively realize that its a path you must begin sooner than later.

The Power of Appreciation
First, its important to understand the power of appreciation. Between 1972 and 2002, the US Department of Housing annd Urban Development data show that median home prices appreciated at an annual rate of 6.1% Why?

1. First, general inflation drives up the replacement cost of housing (construction material and labor) and therefore the value of real estate.
2. Second, as the population increases, so does the demand for housing.
3. The power of supply and demand is further compounded when you consider the uniqueness of our area – the Bay is highly desirable, and there is no new space to build.

Now consider the law of compounding. If a property appreciates at an annual rate of only 3% (low appreciation) for five years, then it appreciates 16% overall.

The Power of Leverage on Rate of Return
6.1 percent appreciation may not seem like a lot, but that figure is deceiving when you consider rate of return on investment verus rate of return on price. Consider the following example:

With a financing today, a mortgage gives buyers the benefit of appreciation on the full value of the home while only investing a small portion of that value. Consequently the rates of return on initial money invested are as follows:

• 30.5% with 20% down and 6.1% appreciation in one year
• 61.0% with 10% down and 6.1% appreciation in one year
• 172.3% with 20% down and 16% appreciation over five years

The Power of Deduction on Taxable Income
Tax law allows various deductions for the expenses of owning property, such as interest paid towards a mortgage and property taxes. The ramifications are significant for someone with a sizable income. Consider the impact of owning a $500,000 home on a $100,000 income:

In our example, owning a $500,000 home provides $14,525 in annual tax savings. Put the money into a high-interest savings account and use it to reduce your monthly payment by $1210 a month.

Additionally, there are many unquantifiable reasons why owning a home is a good thing. For example, it feels amazing coming home to and awaking in a home that is yours. Moreover building that sense of home is an enjoyable and satisfying experience. It takes years to imprint your personal touch through painting, remodeling, landscaping and furniture placement.

Next week we continue the series with a look at reasons why renting makes more sense.

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