Saturday, April 2, 2011

Should you RENT or OWN a HOME?

Many people get caught up emotionally in the rent-versus-own debate.  Lets look at this rationally and figure out what works and what doesn't.

I was on this blogsite the other day, where a fellow makes the dramatic claim of never owning a home again!  While I think, like my Never Buy A Condo! posting, he is using drama to make a point, he does have a good point that the "dream of home ownership" has been over-sold to the American people.

And some people responded to his post, very emotionally, running down his opinions.  They felt threatened and had to lash out to self-justify their decisions with regard to home ownership.  And often, the "logic" they used was flawed - "I'll always have a place to go to" or "rents will go up over time and I could be priced out of an apartment!" - both of which are specious arguments that overlook the logic and value of the basic transaction.

In a way, it is like leasing debates on the Internet.  On the "buy a secondhand car" side, are people making logical arguments backed up by columns of numbers, mathematics showing that you can own a car for about half as much, if not less, than leasing.  On the leasing side are emotional arguments citing fears of repair costs or the luxury of "having a new ride" or "improving your cash flow" which of course, are all specious arguments again.

I have made a lot of money in Real Estate - but mostly on income properties.  Personal residences are another matter, and even though I have sold some for far more than I paid for them, when you do the math on the transactions, it ends up being a wash.  This is not to say owning a home is a bad deal, only that you do have to "do the math" on the concept, and not just gush over granite counter-tops and a three-car garage.

I bought my first home at age 22 for $20,000 through the Farmers Home Administration (FmHA) and sold it five years later for $35,000.  It had a subsidized interest rate, and when I took a leave of absence to finish my Engineering Degree, the mortgage payment was $80 a month.  It was quite a lucrative government program.

Of course, the government "recovered" the lost interest when I sold the house, which reduced my gain a lot.  But, oddly enough, if I had paid off the note with the income from my new job, I would have been able to keep all that gain.  If only I had been a little smarter back then!

So I "made" $5000 on that house, but I easily, over 5 years, spent more than that on repairs, utilities, mortgage interest, property taxes, insurance, etc.  I hardly "made a profit" on it.  On the other hand, I did come out ahead versus renting the same place.

My second home I bought at age 29, for $179,000 in Alexandria, Virginia.  This was my personal residence and we would sell it in 2005 to a developer, as building lots, for $650,000, which represents a staggering gain, and is one reason why I currently have no mortgage.

While I owned that home, I bought my office building at 917 Duke Street in 1995 for $210,000 in a "nothing down" deal, and later sold it in 2007 for $680,000.  Again, quite a gain, and as a bonus, it had a "positive cash flow" for the 12 years I owned it, and also used the Depreciation Deduction rules to lower my income taxes considerably.

We bought a half of a duplex at foreclosure in 1998 for $95,000 and sold it in 2004 for $265,000, which we flipped in a Starker Deferred Exchange to two condos in Florida for $165,000 each.  We sold those, three years later for $225,000 and $260,000 each.

We also bought a condo for a friend to live in, in 1998, for $38,900 and paid off the mortgage.  We still own it, it generates a positive cash flow (or could, if we charged full rent to our friend), and it is worth $184,000.  It is slated to be redeveloped and could be worth over $500,000 if converted to a high-rise.

So.... you'd think I'd be a cheerleader for Real Estate, right?  I mean, add up all the gains here and it is well over a million dollars, right?

Well, yes and no.  For my income properties, yes, there is a large gain, as the tenants are paying the property taxes, the property insurance, the utility costs, the mortgage payment, the interest on the mortgage, the repairs - all the overhead - from their monthly rent checks.  So long as a property is rented it is very, very profitable.

And, by the way, this illustrates why vacancy kills off amateur landlords.  A property left vacant for even a few months is hemorrhaging cash - cash from your pocketbook.  And yet at the height of the Real Estate madness, I knew amateur landlords who jumped into the business and thought you could make money merely by owning property - and were lackadaisical about renting them out!

My personal residence seemed to be profitable, too.  But in reality, I merely got very, very lucky there, and sold out at the height of a bubble market - which is something no one can count on, and probably no one will be able to count on for at least 20 years (the number of years between the bubble of 1989 and 2009).

And as I noted in my cost of home ownership posting, I put a lot of money into that house, in terms of mortgage payments, repairs, improvements, additions, a pool, property taxes, insurance, lawn care - you-name-it.  In fact, it is entirely possible that when I sold that house for $680,000 that I merely broke even, if you added up the costs of all the receipts from Home Depot and Lowes.  I got lucky there, not brilliant.

And my homes since then illustrate how lucky I was.  We bought a vacation home in Upstate New York on a lake for $340,000 and sold it five years later for $399,000.  A $50,000 gain, right?  Not when you factor in the $70,000 barn we built, the $30,000 mahogany deck, the $10,000 asphalt driveway, the $5000 slate walkway, the plantings, the trees, the split-system air conditioners, the new roof, the new boiler, the new hot water heater.... well, you get the idea.

And that house was hardly a "fixer-upper" but rather just a typical home needing typical repairs over time.  And while profits on vacation homes are taxable Capital Gains, losses are not deductible.  So that was a real loss to me, that I had to pay taxes on to boot.

In retrospect, it would have been cheaper to RENT a vacation home there, than to buy one.  But that was a painful $100,000+ lesson to learn.

Our present home is a house on Jekyll Island, Georgia, which we paid $440,000 for, completely remodeled.  New roof, new kitchen, new bath, but it will still need maintenance over time, and we have already spent $6,000 on a screened room and over $10,000 building a studio annex.  With the market the way it is, we would be lucky to get what we paid for it, perhaps slightly less.  Moving forward, it may appreciate slightly over time.

So the answer is clear:  You don't really "make money" on a home.  You might, at best, save a little when compared to renting.  But the key word is might.  There are scenarios - scenarios that have played out very recently - where people have lost their shirts buying homes, and wished they rented instead.

And in fact, in any market, you can lose your shirt, if you take a cheerleader approach to "the American Dream of Home Ownership" and chant mantras and slogans instead of getting a dull pencil and a legal pad and sitting down and "doing the math" on a home purchase.  Think Logically, not Emotionally about buying a home - there is just too much money at stake to do otherwise!

A home is a staggeringly large commitment, and yet many people buy these (and cars) based on emotional, not logical needs.  In Northern Virginia, some people changed houses every few years, when we lived there - often selling one house to move to a "better neighborhood", then deciding they didn't like it, and then moving back to the neighborhood they started in.  Talk about squandering cash!

So how do you decide whether it is better to RENT or OWN?  Here are a few questions you should ask yourself before signing on the dotted line:
1.  Do you plan on staying for at least five years?   When you buy and sell a home, you pay about 10% in transfer overhead costs.  This includes a 6% Real Estate Agent's fee when you sell, mortgage points and application fees, document fees, tax and deed stamps and recording fees, transfer taxes, surveyor fees, attorney's fees, termite inspection - the list goes on and on.  So if you buy a $200,000 house, you will end up paying $20,000 in fees, combined on the buying end and selling end, if you sell within a few years.

Houses appreciate anywhere from 2-5% per year, in a normal market.  In the current market, I think 2% a year or so is optimistic - housing prices will remain flat in many markets and perhaps drop slightly in the next 5-10 years, as we work down an excess in housing inventory.  At a 2% rate of appreciation, the $200,000 house will be worth about $220,816 in five years, so buying a home and staying for only five years will end up being a wash.

2. Does it cost more to own than to rent the same property?  If you are looking at houses or condos in a particular neighborhood, and there are houses for sale and for rent, does it cost less to rent the same house as it does to buy it?  This happens far more often than you think, as the cost of rent is not tied to the cost of home ownership as many folks think.  Rents are determined by supply and demand in the rental market, not by taking the home ownership costs and adding a "profit" to them.

And to make such a calculation requires a lot of math and figuring - the overall cost of ownership, including mortgage payment, interest, taxes (which will likely go up when you buy the home and go up over time), insurance, maintenance, utilities, etc.  And of course, you should subtract any benefit from the mortgage interest deduction - over that of the standard deduction.  It isn't a much as you'd think, particularly if you are in the lower tax brackets.

If there is no demand for your product, you cannot sell it at a profit, merely by taking your product costs and tacking on a profit margin.  GM learned this the hard way - and many amateur landlords do as well.  Rents are determined by supply and demand in the rental market, not by the landlord's overhead structure.

And some landlords, having owned properties for years, have low cost structures, and can rent out a house for a lot less than it would cost you to buy it.  Other landlords are renting out at a loss, which can be problematic as we saw during the last recession, as they went bankrupt and people were tossed out of their rental properties.  Avoid landlords like this, if you can.

Some homeowners convince themselves that it is OK to pay more to own than it does to rent, on the basis that either rents will go up over time, and they will be "locked in" at a lower rate, or that with the capital gains they will make out in the end.  The former is an interesting argument, as it is a means of the market "buying head" of itself, which often happens in stocks as well - people think, "Yea, I am paying too much for this stock, but it will go up over time and I will be OK".  But if you are paying too much, you are paying too much.

During the height of the Real Estate Insanity of the 2000's, it cost nearly double to own some properties (particularly condos) as it did to rent them. This is a sure sign that Real Estate is over-valued. In some markets today, it is far cheaper to own than to rent, particularly with the bargain prices around. But some folks won't buy, out of fear that prices will drop further (hint: They can't drop much further than they have).

3.  Are You Buying Too Much Home?  One emotional reason people have for buying a home is to buy a "look at me" house - one with granite counter-tops and stainless steel appliances, the whirlpool tub, and the "guy's garage" with speckle-paint floors.  People fantasize about how great it will be to live like a mini-millionaire in their mini-mansions - and how envious their guests will be, when they invite them over for Chardonnay and canapes.

But really, that is a shitty reason to buy a house.  And yes, people do it, all the time.  And Real Estate Agents and builders know this, which is why they throw up these cheaply made nightmares in a corn field, trimmed out to look like Jed Clampett's house - from a distance, at least.

And people put themselves into "mortgage stress" by owning such places - and basically cannot afford to furnish them or do anything else, other than work and make mortgage payments.  And usually, they end up spending more money - on credit cards - to live the lifestyle they think they deserve, as part of the mini-mansion set.

And worst of all, many folks resort to funny-money loans to get such houses - convinced they "deserve" it, and that any sacrifice is worthwhile to live in the lap of luxury.

But the reality is, owning stuff gets old, real fast, and the fantasy of the show-off home fades very quickly.  And of course, today, the market is flooded with such while elephant nightmares that are impossible to heat or cool.  A Real Estate Agent last night told me of one such place on St. Simons Island, on the market for $2,000,000 -  sold for $489,000.  No one wants such a home - except at bargain basement prices.

Funny thing, too, is that back in the day, "real" rich people had such homes at the turn of the Century, and many of them devolved into apartment houses and the like, as the rich moved out, (when income tax laws were enacted) and no one else could afford these money-hungry monstrosities.

So figure out how much home you actually NEED instead of WANT.  Six bedrooms is nice and all, but the average American family has 2 kids. And when I grew up, sharing a bedroom was considered normal in most households.

4.  How Handy Are You?  Home ownership involves a lot of chores, both big and small.  Gutters have to be cleaned out, or you WILL have water problems, as they clog with leaves and water pours over the edge, ruining your siding and eroding your foundation.  Various bits of trim need to be painted and maintained, and even "maintenance-free" vinyl siding needs to be cleaned on occasion.  And this does not even address the weekly drudgery of lawn mowing.  In a rental, you call the Landlord to do all that - or he hires someone to do it for you.

Many people who are renters for a long period of time are shocked to discover how much work a home can be - and how boring most of the work it.  And many don't do the work, and wonder why the home is falling down around them.

If you don't like to be "Mr. Handyman" then maybe a rental apartment might be a more appealing decision.

5.  NEVER buy a Condo!  As I noted in my posting on that subject, Condos bear special mention.  Imagine renting an apartment, but every time the sink backs up, you have to go to a committee meeting of all your neighbors to get them to agree on which plumber to call.  They decide to form a "special committee" to discuss the matter further and find a plumber - and will report back in a month or so, unless they need more time to review the matter.

You think I am being facetious, but that pretty much sums up the antics of Condo boards, which are made up of amateur building managers like yourself.  With a landlord, you live under a dictatorship rule of one person.  While this has its disadvantages, it also means that when things need to get done - like fixing a hole in the roof, the landlord calls a roofer.  A Condo board will vacillate for months, if not years.

And I know of one condo, where several units are boarded up, full of toxic mold, because the condo board screwed up the roofing job.  As an owner, you are stuck - and have to sue the Condo Board to get your money back.

As a tenant, you can simply move out, if the landlord doesn't keep the property in good repair.

And if you pay your rent on time, chances are, the landlord won't care if you want to put a door mat in front of your unit.  A condo board will harass you to no end on such petty issues.

Ask anyone who owns a condo how they like it.  Chances are, they will bend your ear for hours about angry Condo Board meetings, decisions poorly made, and staggering condos fees and $10,000 "special assessments".

Ask the same person RENTING a condo in the same development, and chances are, they will say it is a nice place to live - they are insulated from all the bullshit that owners have to deal with.

Condos change value rapidly - escalating in a strong market and then tanking in a weak one.  You can really lose your shirt on a Condo.  And if lawsuits develop, well, market values can go all the way down to nearly nothing.

Frankly, I can see very few instances where owning a Condo makes any sense at all.  There is no great savings, and in most cases, owners are paying more than renters to live there.  If you are buying a Condo because "it is the only thing we can afford" think carefully about renting for a few more years and saving up to buy a house instead.  

The main thing in analyzing all of these factors is to be detached, analytical, and honest with yourself.  Take emotion out of the picture.  Are you buying a place so you can have bragging rights to being a "homeowner" and feel ashamed to be renting?  You'd be surprised how many people do this.  And women are more often victims to this than men.   If your girlfriends at work all have "look at me!" houses, then maybe you start to think you "deserve" one, too, just to show them you are not poor.  That is a horrible reason to buy anything and a sure-fire way to go broke.

Are you buying a house based on how nice it looks and some fantasies you have about the house?  If so, perhaps you really need to think about this.  A house is a thing - a place to stay out of the rain and wind - and little more.  Getting emotionally wrapped up in  a "home" makes little sense - and yet Real Estate Agents are the first to spout the blarney about HOME ownership (instead of HOUSE ownership) and push the idea that this building your are buying will become some sort of family homestead or nest for you and your family.

It may very well be that, but thinking in those terms is one sure way to get completely screwed.

Our government, of course, pushes the "American Dream of Home Ownership" on policy grounds.  Such tax incentives help the home building industry.  And the idea of people having an equity stake in their neighborhoods is thought to promote better neighborhoods and reduce slums.

But I am not sure that is true, either.  There are apartment buildings on Park Avenue that are hardly slums, and yet everyone in the building rents.  And there are homes occupied by owners in the ghetto that are falling down around them.

Slumlords often buy homes for cheap, rent them out for whatever they can get, and then walk away after a few years as the properties fall apart.   These are usually older buildings where repair costs would dwarf the resale value of the property, and oftentimes the properties are worth little to begin with.  Taking poor people and selling them such nightmares is not an "answer" to slumlording.  Of course, public housing projects aren't the answer, either.

I think, though, regardless of political or policy implications, renting versus buying is a personal decision that you should approach logically - and not let the hoopla of the industry - or politicians, or your neighbors, get in the way.

Updated December 11, 2012