Making a well-informed decision about how to finance our housing is important for financial, personal and professional reasons. Making a good decision requires objectively weighing a lot of variables, but our society’s overwhelming bias in favor of ownership makes objectivity difficult. The commonly held beliefs that buying is automatically a “good investment” and renting is “throwing money away” are invalid and misleading. The right decision depends entirely on an individual’s unique circumstances and goals. In order to make to make a decision properly aligned with our own best interests, it’s important to recognize our underlying cultural script and adjust for its influence. By failing to do so, we risk investing our money, time, and energy in a way that could lead us further away from attaining the things we value most in life.
Our script on housing is influenced by entertainment and news media, a variety of financially vested stakeholders, public policy, and social mythology. Media outlets appeal to our material impulses by glamorizing the home buying process, and extoll the virtues of investing in real estate. Brokers are paid to facilitate transactions, but don’t have any skin in the game. The same is true for lenders, since most package the loans they originate and sell them off to investors. The federal government offers tax breaks and provides liquidity to the market for political motivations. Our friends and family are probably the strongest influences, many of whom perpetuate the same mythology I’m writing about here.
There are a lot of voices promoting home ownership. That wouldn’t be inherently bad, except those voices are so disproportionately represented they skew reality. The potential benefits of buying are blown out of proportion, the drawbacks are all but ignored, and a perfectly reasonable alternative is unfairly stigmatized.
On one level you could argue the choice about whether to rent or buy is really as boring as choosing a method of financing our shelter. For social and emotional reasons though, it’s obviously about much more than that. Owning represents status, family, community, security, success, and maturity, among other things. There is nothing wrong with making a decision to meet emotional needs, but those motivations should be made conscious in the buying process. By doing so, we give ourselves the opportunity to question whether buying a home will actually meet those needs better than some alternative. It seems like a lot of people who buy do so primarily for subconscious emotional reasons, and rely on conventional wisdom to justify their decisions as financially responsible.
I often hear people validate their desire to purchase by using overly-simplistic financial justifications, like “now is a good time to buy” and “interest rates are so low”. The first implies that prices are going to rise, but the truth though is no one knows where we are in any given cycle. This argument also ignores the opportunity cost of buying by not considering alternative investment options. The interest rate argument speaks to the cost of buying. Low interest rates make it less expensive to purchase a home today, but that’s only half the story. When interest rates rise, the cost of buying goes up and the number of people who can afford to buy goes down. There’s more to housing prices than rates alone, but they definitely influence the size of the pool of potential buyers which in turn affects prices.
I think many of us see buying as part of maturing into financial adulthood. I suspect the reality for most people though is that buying a home results in a wild over allocation to real estate in their overall investment portfolio. It is a large investment in one asset class, in one geography, at one point in time. Having real estate as part of a diversified portfolio probably make sense, but there are other more bite sized ways to invest in it that offer greater diversification and liquidity (like mutual funds, REITs, and ETFs).
I have heard the argument that we need housing long-term regardless of how we pay for it, so we might as well buy and benefit from the natural appreciation in the market. The truth is that long-term appreciation in housing barely beats inflation. There are a lot of other things we will need throughout our lives as well, but no one advocates making a huge upfront investment in gas, water, or canned goods, for example.
Buying also most likely means a long-term liability, usually 30 years. There is an argument to be made for matching the term of our liabilities with term and certainty of our income stream. Would you commit to your current job for the next 30 years, even if you could? Given how quickly the job market is changing and how frequently people change jobs it’s harder than ever to predict what your income stream will be with any degree of certainty over the long-term. For many of us, this might suggest short-term financing makes more sense, in other words, renting.
Paying a mortgage does force structured savings since a portion of the payment goes to principal, but this amounts to moving money from one pocket to the other. It’s also turning a highly liquid asset, cash, into a less liquid one, home equity, and on a relatively small percentage basis in the early days of a mortgage at that.
There are undoubtedly practical reasons for buying, like the fact that sometimes the best school districts don’t have a lot of rental options for families. It’s true that as you move from closer in locations to further out ones there is not as many rental options. There are a variety of reasons for this, but market forces are one, and the stigma of renting definitely doesn’t help drive demand.
When the discussion turns to rent, people usually say it’s a waste of money. You never hear people say that about interest, property tax, insurance, HOA fees, repairs, maintenance, and closing costs, but it’s true (with the exception of write-offs). Nor does anyone talk about the opportunity cost of the time associated with home buying process, ongoing maintenance, renting it out if you ever choose to do so, or selling it.
You could argue all rent is lost, but the financial decision is bigger than just one variable. There are lots of others. Making a fully conscious financial decision requires either building a financial model or finding an existing one to use (like this from the New York Times). The purpose is to take all the variables into consideration and holistically understand what bet you are making, as opposed to focusing on just one or two variables, like current prices or interest rates. It helps you answer questions like: what is the best case scenario from a financial perspective? What is reasonable to hope for? How long does your horizon have to be to get there? How much appreciation do you need? How does that compare to history? How much are you assuming for maintenance? How much money are you putting down? What investment alternatives do you have and what would those yield? This is just a small sample of the questions that should be considered. I would argue though the first step though should entail more qualitative analysis, like articulating personal and professional goals and thinking through whether buying will help you get closer to achieving those than renting.
It’s rare to hear people talk about the benefits of renting, but renting offers more liquidity, more flexibility, less maintenance, and often a better location for the same or less money. The commitment is usually one year at the most and the “down payment” is usually one month’s rent. If a job opportunity arises elsewhere, it’s much easier and less risky to break a lease than sell a house, especially at an inopportune time. If you lose your job you can adjust more easily. You can argue that you would need a place to live regardless, and you could always sell your home or rent it out, but owning does make it harder if to change career directions or locations. Renting can free up time, energy and money, all of which can be reallocated to endeavors potentially more apt to meet your goals and make you happier.
Obviously, home ownership is not a bad thing, but it isn’t automatically a good thing either. It’s completely relative to each individual’s own circumstances. As Americans we are constantly sold on the virtues of home ownership. Carrying that script makes us susceptible to making a big decision for the wrong reasons, which could hamper our ability to pursue the things we really value. In order to avoid that mistake we need be aware of our cultural bias, separate emotional reasons from practical ones, and look at the financial decision objectively and holistically. It would also help to destigmatize renting in order to create a more level social and cultural playing field.