Apple pie, baseball, and homeownership. We – Americans – extol homeownership as a pillar of the American dream and the right of passage that defines graduation to adulthood. Societal norms deem that owners are more financially successful than renters. Homeownership is such an integral part of the American dream that our government spends upwards of $100 billion each year to subsidize the institution via multiple tax breaks. Pervasive in American culture is the conventional wisdom that owning a home is better than renting one.
But is it? Are Americans really better off to own rather than rent? Are the economics of homeownership better than the economics of renting? Maybe. Maybe not. What can be said with some level of confidence is that most of the common justifications for homeownership are largely unfounded myths.
And to be clear up front, I do not come at this topic as a begrudging renter who abhors the societal pressures of homeownership. I am a long-time homeowner and do not regret the decision to purchase a home. Instead, I come at this from an economic perspective to dispel the unfounded myth that home ownership is fundamentally better than renting. It is not. In my experience, many consumers do themselves a terrible disservice by simply accepting the pervasive myths of home ownership. As a financial planner, what bothers is certainly not the institution of homeownership but rather the promotion and resulting acceptance of myths that lead consumers to make poor financial decisions.
Housing Myth #1: Renting is throwing money away.
In this sense, we throw money away when we eat a meal. When we drink a cup of coffee. When we shower or brush our teeth. All of these items have an associated cost just like renting a place to live. The idea that “renting is throwing money away” intrinsically implicates one of two things:
1) Anything that has a cost is wasteful including food, toothpaste, basic clothes, etc.; or
2) We do not need shelter – we could just live in the wild and so any expense associated with shelter is a waste.
Anyone who ever uses the “renting is throwing money away” argument inherently implies one of those two points. Pick number 1, number 2, or both because there are no other ways to support the “renting is throwing money away” argument.
We wisely choose to rent items because the economics of renting makes sense. For example, we rent a seat on a Delta 747 flight across the country rather than purchase a 747 for our personal use. We rent a car and a hotel room for a week’s vacation in a foreign city rather than purchase a car and small apartment for the week. No one ever suggests that renting a home for a weekend is throwing money away versus the alternative of purchasing a home to use for the weekend.
The economics of buying a home may work out to be better than renting – or vice versa. It depends on the circumstances. But the idea that renting is a waste of money is decidedly wrong and a misinformed narrative to justify buying over renting.
Housing Myth #2: If the monthly mortgage payment is less than the cost to rent a home, then buying is advantageous.
Decidedly wrong. This logic is founded on the idea that the mortgage payment is the only cost of owning a home. Not even close. Property taxes, home insurance, HOA fees, lawncare, pest control, flood insurance, and hurricane insurance are all costs associated with home ownership that result in an average annual expense of 2% – 4% of the home’s value (note that utilities are ignored here because these costs tend to be similarly incurred by renters and owners).
Beyond these regular and predictable costs are the erratic and unpredictable maintenance costs of owning a home. While maintenance expenses vary depending on the age of a home, upkeep costs average between 1% – 3% of the home’s value on an annual basis. Of course, homeowners do not need new carpeting, new roofing, fresh paint, mold remediation, tree removal, or new HVAC units each year but these expenses and other maintenance costs like them prove to be significant when aggregated over the course of a decade or two.
And yet there is still more. Many homeowners naively ignore one of the largest expenses of home ownership simply because it is intangible and easy to ignore – the opportunity cost of owning a home. And yet it proves to be a significant cost. The opportunity cost of any expense is the amount those dollars could have earned in an alternative investment. When someone purchases a home and writes a check for the downpayment amount, this value is not available for investment in other assets like a diversified stock portfolio that might yield a higher return. Homeowners would be wise not to dismiss this cost. A $250,000 downpayment – which otherwise would have earned a 5.5% real return annually over the next 10 years versus a 0.5% real estimated return for the property – has an opportunity cost of $177,224 over the course of a decade.1
Lastly, any reasonable evaluation of renting vs. buying should include the costs incurred in buying and selling a home which tend to be massive. Real estate brokerage fees, appraisal expenses, attorney fees, loan origination costs, title insurance, underwriting fees, transfer taxes, and other closing costs tend to comprise 3% – 7% of the home’s value – on both the purchase and sale.
One of the most robust academic studies on the cost of homeownership evaluated housing costs of single-family homes in 46 metropolitan areas over a 25 year period and concluded that the annual cost of homeownership in the United States – on average, across geographies – was 5.0%. Economists refer to this cost as the imputed rent – the concept that you pay rent whether you own a home or not. The costs are transparent and easily calculable if you rent a home whereas the costs tend to be covert and/or volatile when you own a home.
Housing Myth #3: Rental costs go up every year whereas a fixed mortgage is stable.
A fixed mortgage is stable. But the other costs associated with owning a home tend to increase each year at an inflation rate that is similar to that of rental price inflation. Insurance costs, real estate taxes, lawncare, maintenance costs, and all the other aforementioned costs associated with home ownership also tend to go up each year – just like rents. Buyers should not trick themselves into believing that the costs of homeownership are magically fixed.
Housing Myth #4: Buying a house rather than renting allows an owner to take advantage of home price appreciation.
Perhaps, but several glaring mistakes are made in this logic.
First – and this will come as a surprise to many – a house is a depreciating asset over any meaningful time period. The day after a house is built and completed, it is at its peak value. Wear and tear and usage then begin to reduce the value of a house. The value of a home only retains value because homeowners invest money in the home to repair the roof, fix rotting wood, repaint walls, replace carpets, and make other necessary repairs. Without such maintenance expenses – the value of a house would eventually go below zero (where there is a demolition cost to get full value for the land). The reasons that home values appear to appreciate over time is that the land value appreciates and the money we sink into homes for maintenance is naively perceived as appreciation.
Second, the idea that homes are a good long-term investment is a counterfactual myth successfully marketed by the real estate brokerage industry. Consider that since 1890 – a period of 131 years – housing prices in the United States have a real annual return of 0.59%2. Keep in mind that this modest increase in value is largely manufactured by the maintenance costs described above which we inaccurately perceive as appreciation. Data in Europe goes back a few centuries and the results are similar. The average house value in London, for example, increased by 1.1% per year in nominal terms between 1290 and 2016.3 This roughly equals the inflation rate over that 700+ year time period meaning that home values kept pace with inflation but did not produce a positive real return.
We tend to exaggerate historic home price appreciation because our brains are inherently prisoners of the moment, assigning far greater importance to the recent past than to the more extended history. The chart below demonstrates that over the past five years, US housing prices have increased by nearly 6% per year – among the best five year periods ever. This recent history – where many markets have experienced after-inflation returns in excess of 6% per year – clouds our perception of the past in a potentially dangerous way.
As a result of this recency bias, we tend to rely on continued home price appreciation as a justification for home ownership when the multi-century history of home prices suggests that we might be foolish to rely on any appreciation as a case for buying versus renting.
Housing Myth #5: At least when I own a home, I’m and getting the tax breaks of deductible property taxes and mortgage interest.
This one used to be a legitimate claim but stopped being broadly true with the 2017 Tax Cuts and Jobs Act (TCJA). Prior to the tax law change in 2018, 31% of taxpayers itemized and there was no limit on the amount of real estate taxes that could be deducted. Subsequent to TCJA enactment, less than 10% of taxpayers now itemize and most of those who itemize get zero tax benefit from their property tax payments and only a limited benefit from their mortgage interest payments. That is – the TCJA dramatically reduced the benefits of homeownership and moved in the direction of leveling the playing field between renting and owning. The reality is that the overwhelming majority of homeowners – especially married filing jointly taxpayers – get no tax benefits or minimal benefits from either mortgage interest payments or property taxes, despite their perceptions to the contrary.
Housing Myth #6: Homeowners are happier than renters.
There is robust international research on this topic and no compelling evidence that homeowners experience greater happiness than renters. If there is evidence in one direction, it is for a negative relationship between homeownership and happiness. A robust 2011 paper by Wharton professors, The American Dream or The American Delusion, examines a large data set of women in single family homes to control for any gender bias. After further controlling for health, income, and housing quality, the authors find that the “average female homeowner consistently derives more pain, and no more joy, from their house and home” relative to renters. The added pain and displeasure for home owners is found to be significant. Furthermore, the authors find that female homeowners tend to spend less time on active leisure or with friends, experience more negative affect during time spent with friends, and find less satisfaction with their health than renters. In fact, the research shows that homeowners weigh 12 pounds more than those who rent, when controlling for other factors.
Additional literature studying Swiss homeowners and German homeowners presents no clear positive relationship between homeownership and happiness. Depending on how happiness is measured, the data often points to a negative relationship between ownership and happiness.
Presumably, more time spent on home tasks, repairs, lawncare, and maintenance by homeowners takes away from leisure or fitness activities. Coupled with this is that the added debt homeowners assume to purchase a home has a negative relationship with happiness. Evidence finds that households with more debt are less happy and have greater marital conflict.
Additional research shows that because homeowners often stretch their finances to afford a home and then put money back into their home for improvements, maintenance, and furnishings, that they have less to spend on vacations, eating out, and other experiences. Robust evidence over the past two decades finds that life experiences yield far more happiness than material goods and yet homeowners tend to do just the opposite of what actually generates happiness by sacrificing experiences in favor of material items.
Lastly, owning a home undeniably limits freedom and reduces flexibility. Homeowners are more anchored to their job, their lifestyle, their neighbors, their social network, their commute. Obviously, a homeowner can still change jobs or buy a new home closer to friends and family but the flexibility and ease for a renter to make these changes is far greater. Research and evidence overwhelmingly supports this case.
This is not to say there are no emotional or psychological benefits to homeownership. There clearly are. All else equal, research finds that people are happier when they have control over their own property. Owners can make improvements to a home for their specific desires – such as adding a deck or renovating a bathroom – something that renters cannot necessarily do. But the key takeaway from digging into the empirical research is that homeowners tend not to be happier than renters. Homeowners expect they will be happier and seek to justify a purchase by picturing greater happiness. The data, however, indicates that if there is any greater happiness, it is afforded to renters – not owners.
Housing Myth #7: When mortgage rates are historically low, I would be well served to purchase and lock in a low rate mortgage.
Low mortgage rates do not exist in a vacuum. All else equal, lower monthly interest costs increase affordability and attract more buyers (higher demand), which causes home prices to rise. Conversely, when mortgage rates rise, higher interest costs reduce affordability (lowers demand) and home prices tend to decline.
Buying a home when mortgage rates are low is not – in itself – a flawed approach. But buyers should be aware this is not a free lunch and that higher mortgage rates in the future may be accompanied by declining home values.
Housing Myth #8: Owning a home by the time I retire will help reduce my retirement expenses and likely give me a better financial outcome.
Only by way of sneaky mental accounting and not by objective economics. The problem with this myth is that buying a home requires an upfront investment and monthly mortgage payments. If we consider the purchase of a $500,000 home with 20% down, this purchase requires a $100,000 upfront investment and principal payments each month starting at around $630 and increasing over time (as the interest component of the mortgage amortization declines). Those amounts – the $100,000 initial payment and the monthly principal payments reduce the value that can be invested for retirement. As a result, they reduce the nest egg that someone has to draw off of in retirement.
It is true that once the home is paid off, the monthly cash flow burden is less than it would be for a renter. But, this ignores half of the equation. If all we know is that someone spends $8,000 per month in retirement, there is no way to assess whether this is good or bad – whether it is viable in the long-run or not. The useful way to evaluate retirement spending is the monthly cash flow burden divided by the amount of financial assets – what is referred to as the “retirement distribution rate”.
If a renter keeps the upfront payment of $100,000 invested that the buyer used as a downpayment and she wisely invests the excess savings each month not going toward mortgage principal payments, then she ends up with significantly more financial assets to support retirement spending. So while her cash outlays may be higher each month, the distribution rate – which will ultimately be the judge of her financial success in retirement – could be lower or higher than the owner – depending on the underlying economics.
Concluding Comments
None of this is intended to discredit homeownership or encourage renting. The purpose is simply to dispel some of the flawed arguments supporting home ownership. There are a lot of narratives to support the American dream of home ownership but many of them – especially the “renting is throwing money away” narrative or the concept that home prices appreciate at an attractive rate over time – rely on misinformed facts or faulty logic.
We often use a robust spreadsheet with numerous inputs to evaluate the estimated breakeven period – the length of time required for the economics of home ownership to surpass that of renting given variables specific to the location.4 It is generally true that the holding period in a specific geography needs to exceed seven to ten years and sometimes longer before the economics favor buying a home versus renting. This is just the quantitative side of the equation and does not consider the flexibility or added leisure time afforded to renters.
The underlying takeaway is that consumers would be wise not to dismiss the economics of renting based on misguided narratives, societal pressures, and false logic.
- This actually understates the true opportunity cost of homeownership as it ignores the added opportunity cost of principal payments on a mortgage during this period.
- Shiller housing price data can be found here
- Source: Global Financial Data
- A similarly robust evaluation tool can be found here although this tool has not been updated to reflect tax deduction impacts of the Tax Cuts and Jobs Act (TCJA). If using this tool, we recommend setting the tax rate to 0% as a way to properly adjust for TCJA.
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