Of the many conceptual arguments playing out in the personal finance space, buying versus renting has got to be one of the longest-running ones.
Based on what I have seen over the past couple of years, the “buyers” represent a solid majority.
After all, most folks who have achieved financial independence own their own house. And for many who are currently on the journey, homeownership represents one of the core pillars of the strategy.
But is it really that simple?
Where Math Fails
In theory, there’s a straightforward and rational way to approach the buy vs. rent decision. All you need to do is run two scenarios:
Scenario 1: Buy A House
You put some money down and make thirty years’ worth of mortgage payments. You are also on the hook for a long list of other expenses, such as repairs, renovations, insurance, and so forth.
However, in three decades or so, you (hopefully) end up with an asset in the form of a paid-off house. Voila – you’ve arrived!
Scenario 2 – Rent
Instead of buying (and assuming you don’t already own a place), you just keep on renting.
No need to save up for a down payment. Hopefully, your rent is lower than the mortgage payment, and you also don’t need to worry about all those pesky expenses.
Instead, you take the money left over and invest it in the stock market.
In thirty years, you don’t end up owning a house – but you do own a portfolio of nicely diversified index funds.
You can go on to liquidate that asset at a minimal cost (take that, homeowners!) and live happily ever after.
It all sounds easy enough, doesn’t it? And yet, show me a person who performs this rational kind of analysis and I will show you a unicorn.
Garbage In, Garbage Out
The problem with running the kind of mathematical comparison outlined above is that it involves making numerous assumptions over long periods of time.
You need to take a view on the evolution of house prices and rents for the next couple of decades.
You also need to make an assumption about your housing needs going forward.
Are you going to buy a bigger house once you have a family? And once you do have little ones, will you try and move to be closer to a good school?
Or perhaps you will land that dream job in Tokyo and up selling your place, moving countries, and never coming back again. Who knows?
What about the cost of homeownership in the first place? As anyone who has ever owned a house will tell you, roofs leak, boilers break – and all these things tend to happen at the most inopportune moments.
And that’s before your wife decides she wants a new kitchen, or the hubby starts talking about a basement dig because he’d really like that man cave downstairs.
You can run your little excel spreadsheet for as long as you’d like, but it’s unlikely to improve the accuracy of your analysis. Kind of like some banking models I’ve come across in my career.
Ultimately, this is why most folks resort to what I call “emotional arguments”. And no one has more of those than the proponents of buying.
The Advantages Of Buying
I don’t necessarily subscribe to every word of the “buy your own house” sermon. That being said, I am a believer in real estate as an asset class and will be the first one to admit I see some very specific advantages in homeownership.
Below are my top 5 reasons for owning your home:
#1: Commitment To Asset Ownership
The time, effort, and complexities involved in selling your primary residence make it unlikely you will panic and sell your home if the real estate market wobbles.
Not so much for stocks, as many folks have realized back in March.
In addition, the ongoing decline in interest rates over the past three decades has resulted in a broad-based increase in asset prices. Real estate was no exception (save for some regional variations).
In other words, it’s been good to be a homeowner (recently).
#2: Alignment Of Incentives
Another advantage of owning is that it is often easier to convince your spouse to buy (and hold on to) a house than other investments.
Your significant other may feel nervous about equities or bonds, but they are unlikely to object to living in their own house. Most folks feel a sense of security when they own the roof over their heads.
In other words, buying a house may well be a way to combine marital AND financial harmony.
#3: Forced Savings
This is a big one.
Many arguments for renting are built on the premise that you will take the money you would have spent on a mortgage payment and invest it in the stock market.
Sounds good in theory but rarely plays out that way in practice. It takes some proper willpower and discipline to take that extra cash sloshing around in your bank account and put it to work.
A mortgage payment, on the other hand, is non-negotiable. Nothing like the Damocles sword of repossession hanging over your head to encourage some financial discipline.
#4: Tax Benefits
No, I don’t mean the US-type deductibility of mortgage interest for tax purposes.
Imagine you have decided that you need £20k of annual income to retire (before housing expenses).
If you already own a house, you are done. However, if you are renting, you need to increase that £20k by your annual rental expenditure.
The extra money isn’t the problem here – provided you’ve been diligent and have been “investing your mortgage” instead.
However, unless your entire investment pot is held in tax-efficient investment vehicles, you will likely end up with a higher tax bill. And given that taxes will probably go up over time (someone’s got to plug that deficit!), the financial impact may be meaningful.
#5: “Home-made LBO”
For those not familiar with the concept of a leveraged buy-out, it is essentially how private equity makes their money.
The recipe is simple – buy an asset, finance it with a ton of debt – and a sliver of equity. As long as the return on the asset exceeds the cost of debt, the difference will accrue to the equity holder.
And that is exactly what a mortgage is – especially in the early years, when you’ve got a very high LTV.
The Case For Renting
While advocates of renting may well be outnumbered, they sometimes put forth pretty convincing arguments in favour of forgoing homeownership.
Jeremy Schneider of Personal Finance Club is probably one of the most credible proponents of renting. Jeremy runs a pretty good Instagram account and isn’t afraid to shine a light on some of the hidden costs of homeownership:
As someone who owns multiple rental properties, I am particularly attuned to his argument about the costs of buying and selling properties. In fact, that is one of the biggest reasons I never buy real estate unless I’ve got a 10+ year time horizon in mind.
Sadly, real estate agents and lawyers don’t work for free.
The Road Less Travelled
There is, of course, a third option. It’s not one you come across very often, but I wanted to cover it off anyway, not least because I wouldn’t want anyone to accuse me of being hypocritical.
You can always rent the place you live in – and own rental properties at the same time. And that is exactly what our family does.
In a very non-FI way, we rent a townhouse in central London. It’s costing us a pretty penny every month. At the same time, we own multiple rental properties.
So why do we continue to do so? A few reasons, some of which I have touched upon above.
The most important one is uncertain housing needs.
Put bluntly, we don’t know where we are going to live in the near future. We may stay where we are. We may move outside London. And there’s always the option of leaving the UK behind.
The other one is transaction costs.
Over the past few years, we’ve come close to buying a house in London on a couple of occasions. However, the effective stamp duty on a £1.5m house (which doesn’t go very far in central London) works out to about 5%.
In other words, you need the house to appreciate by at least 5% to break even – and that’s before you consider other expenses.
Most importantly, it’s the fact that we are still long real estate. It’s just that instead of owning our primary residence, we own rental properties with better yields.
The bottom line here is that buying versus renting is as much of a lifestyle choice as it is a financial decision.
There’s a high risk that you won’t end up making the decision that maximizes your net worth. Thus, might as well make the one that maximizes your happiness.
Thank you for reading!
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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