by Steve Harney on May 6, 2014 in For Buyers
Our founder, Steve Harney, occasionally asks to do a personal post on what he sees as important to our industry. Today is one of those days. Enjoy! – The KCM Crew
I have been a subscriber to the Wall Street Journal (WSJ) for as long as I can remember. In my opinion, it is the single greatest source of financial information and insights available. I don’t always agree with their analysis but I always respect their position.
However, in an article this past weekend, The New Math of Renting vs. Buying, they flat out got it wrong. Below are a few excerpts from the article and the reason why I believe the analysis to be incorrect.
In the article, they discuss that homeownership is more expensive than renting in many large metropolitan areas.
"The monthly cost of renting was lower than buying in 20 large metropolitan areas at the end of last year, the most recent period for which data are available, according to figures provided exclusively to The Wall Street Journal by Deutsche Bank. That is up from 15 large metropolitan areas a year earlier.”
The challenge is that more recent data from two very reliable sources has shown that not to be the case. Among the 35 largest metro areas analyzed by Zillow in the first quarter, every metro showed it would be cheaper to buy than rent if you plan to live in the home for at least 4.2 years.
According to a study by Trulia:
“Homeownership remains cheaper than renting nationally and in all of the 100 largest metro areas. Rising mortgage rates and home prices have narrowed the gap over the past year, though rates have recently dropped and price gains are slowing. Now, at a 30-year fixed rate of 4.5%, buying is 38% cheaper than renting nationally.” (emphasis added)
The article goes on to explain that as a renter you have many less expenses than you would have as a homeowner:
"Renters, for example, don't pay property taxes, homeowner's insurance and, in most cases, maintenance costs. These expenses can cost homeowners about 3% of the price of their home annually, experts say.
While those costs can be folded into monthly rent, apartment renters often pay a smaller share as landlords spread the costs among many tenants, says Stijn Van Nieuwerburgh, director of the Center for Real Estate Finance Research at New York University. If a window breaks or the toilet plugs up, your landlord—not you—pays for the repairs."
Don’t kid yourself – the landlord does not pay the taxes nor pay for repairs. The tenant does. It is incorporated in the rent. It is true, if it is an apartment building, that the property taxes are shared by all tenants. However, realize that the amount of property taxes for an apartment building with “many tenants” will be far greater than a single family residence.
We think this situation is best explained by Eric Belsky, Managing Director of the Joint Center of Housing Studies at Harvard University, in his paper on homeownership - The Dream Lives On: the Future of Homeownership in America:
“Households must consume housing whether they own or rent. Not even accounting for more favorable tax treatment of owning, homeowners pay debt service to pay down their own principal while households that rent pay down the principal of a landlord plus a rate of return. That’s yet another reason owning often does—as Americans intuit—end up making more financial sense than renting.” (emphasis is mine)
The WSJ article claims that, if a renter invests the difference between their rent payment and a potential mortgage payment had they purchased, they would be better off financially in the long run.
"Renters don't end up with a valuable asset, as buyers do when they pay off a mortgage. But renters might be able to make more money by investing the monthly savings, as well as the cash they would otherwise use for a down payment, he says."
They go on to explain their reasoning as follows:
"The value of the average single-family home increased by 3.6% a year in the three decades through 2013, compounded annually, according to mortgage giant Freddie Mac. By contrast, the compound annual return on the S&P 500 over that period was 11.1%, according to Chicago-based investment-research firm Morningstar."
As to the idea that the return on investment would be greater by investing in the stock market rather than purchase a home, I think the article in the WSJ forgot that housing is a leveraged investment. Belsky, in his paper, explains:
“Few households are interested in borrowing money to buy stocks and bonds and few lenders are willing to lend them the money. As a result, homeownership allows households to amplify any appreciation on the value of their homes by a leverage factor. Even a hefty 20 percent down payment results in a leverage factor of five so that every percentage point rise in the value of the home is a 5 percent return on their equity. With many buyers putting 10 percent or less down, their leverage factor is 10 or more.”
That 3.6% average annual appreciation is really an 18% return on cash to a home buyer putting down 20%.
They also assume the renter will save any difference in housing expense. However, that does not happen in reality. In their ongoing research for their paper, Beer and Cookies Impact on Homeowners’ Wealth Accumulation, Eli Beracha and Ken H. Johnson reveal that homeownership creates a ‘forced savings’ plan:
“It appears that homeownership creates extra wealth mainly through its ability to force owners to save rather than through property appreciation. Thus, homeownership appears to be a self-imposed savings plan, which through time leads to greater wealth accumulation as compared to comparable renters. In short, buying a home makes Americans save.”
And Belsky from Harvard agrees:
“Since many people have trouble saving and have to make a housing payment one way or the other, owning a home can overcome people’s tendency to defer savings to another day.”
To further make this point, we can look at a study by the Federal Reserve which showed that the net worth of a homeowner ($174,500) is 30 times greater than that of renter ($5,100).
Looking at financial advantages of homeownership from every angle still reveals that it is a much better investment than renting.