One of the most common questions I hear people asking about when it comes to housing is the decision to buy or to rent. Given the size of the monthly expense and potentially large down payment, it is probably a fair question. However, I find that many people don’t apply the proper analysis in making the decision. It is not always a question of dollars and cents. You need to understand what home ownership means and if it is a good fit for you and your lifestyle. I just recently made this decision and learned some valuable lessons from it. Now, I want to share my learnings with you.
Considerations when deciding buy vs. rent (in order of importance):
Flexibility (or lack there of) – If you rent, the world is your oyster and you can live anywhere you can afford to. When you buy, not so much. The housing market is liquid enough that you can sell your house quickly if the price is good enough. Otherwise, you could be waiting a long time to sell your house and recoup your closing/selling costs. I think this is the most important thing to consider when buying a home. Do you love the area and the house enough to be in it for at least 5 years? If you don’t, you probably shouldn’t be buying.
Market Analysis – If you answered yes to the first question, then you need to perform some market analysis in your area on home prices and monthly rents for your target properties in your area to decide the next step. You need to make sure your monthly payments on your house including utilities, taxes, HOAs, and insurance. You might even include the opportunity cost of the down payment if you had planned to invest the down payment money otherwise. I would compare this figure to the monthly rents including utilities. If rent is less than house payment, then you rent. If rent is higher than house payment, it isn’t always a given that you buy. I personally would want my savings over my projected time horizon of living at the house to be substantial. For example, saving $50 a month over 5 years is $3,000. I’m not sure that is worth all of the potential risk you have being a homeowner because things do go wrong.
Property Analysis – Assuming you can commit to buying a house and the rental market makes it a rational financial decision then you need to find a property to purchase. This is the most difficult step especially if you or whoever you are buying the property with doesn’t view it as a financial decision and attaches more emotion to it. I know you have to live there, but I’m not sure heated bathroom floors and custom closets are worth overpaying for. I would only consider overpaying for a house if I planned on being in the house forever and even then I would be hesitant. Forever is a looong time! Try to purchase a property at or below market value in a desirable location. It is not always easy, but it can be done if you are patient enough.
I recently just sold my first home and will be looking to purchase another one in the next year. Let’s look at how I did in my first purchase to see if I followed my own advice.
Requirement 1: Can you commit to being in a home for at least 5 years? We checked the box on this first requirement. My wife and I had good jobs with no plans of changing them and no plans for expanding the family. Bottom line is that we planned to be there for 5 years and couldn’t see any reason for that to change. Spoiler alert: We sold after 2 years…whoops!
Requirement 2: Does the rental market make buying a smart decision? I also think I scored a passing grade on this item as well. The rental market was commanding $1,600+ in rent and we were able to purchase similar properties under $230,000. With interest rates being favorable, it amounted to a payment of around $1,300.
Requirement 3: Can you find a property you like at or below market value? We were fortunate enough to be in a buyer’s market when searching for a home and purchased a home for $205,000 that appraised for $215,000. Seeing the appraisal being above the purchase price means I completed requirement 3.
In the end, we came out ahead in the buy vs rent scenario by almost $500 or $600 a month when you include what we made from selling the house. I believe our success was mostly due to following these principles and maybe a little bit of luck. I know they are very simple in nature even though there are so many factors to weigh in deciding whether to rent or buy. On the flip side though, I do think they provide a useful framework for making a practical decision when people sometimes act irrationally when it comes to home ownership (see 2007 financial crisis).
What do you think? Are there any big misses in my guidelines? Do you perform a similar analysis when deciding whether to buy or rent?