Not to rehash tired arguments, but when there's a new contribution to the literature on a relevant topic, it seems worthwhile to provide an update. A recent paper looks at whether renting or buying a house would have been a better bet over the last 30 years. At right is the main figure from the paper; I'll let Felix Salmon summarize it:
This needs a little bit of explanation. Basically, you consider two people, one of whom rents and the other of whom buys. If it costs more to buy than to rent, the renter takes the difference and invests it in the market — a mixture of stocks and bonds which has the same amount of risk as home equity. After eight years, the buyer sells. Then you see who’s worth more money.
The lines on the chart above are what you get when you take the amount of money that the renter has and subtract the amount of money that the buyer has. When the number is positive, the renter wins, when the number falls below zero, you would have been better off buying.The chart looks at rolling eight-year periods, starting with people who bought in 1978 and ending with people who bought in 2001; while there are significant regional variations in the northeast, which had a nasty property slump in the 1990s, the big picture is that there are a hell of a lot more datapoints above zero than below it. And The only negative datapoints are the ones which involved selling during the bubble. Here’s how the paper describes the chart in English:
When the U.S. as a whole is considered, renting was preferred to buying 75% of the time. On average, the annual required appreciation return was 2.04% higher than the actual appreciation. In retrospect, the period spanning the mid 1990s to the early 2000s was the only time frame in which buying was preferred to renting. This narrow time period is associated with homeowners that purchased a home just before the recent boom and sold it shortly before its sequential bust. However, because most homeowners never transfer back to be renters, it seems unlikely that most homeowners, who benefitted from home appreciation during the boom period, avoided the subsequent housing collapse.
The authors go to great pains to make this as accurate a comparison as possible. Specifically, they do a lot of things which weight the scales toward owning rather than renting:
· They assume a standard 30-year mortgage with 20% down and no nasty tricks.
· They give the owner the option to refinance every year.
· They give the owner the benefit of the mortgage-interest tax deduction.
· They don’t allow homeowners to lose money on an underwater mortgage: the authors assume that you’re buying in a non-recourse state, and that the rational homeowner will strategically default rather than lose money on a sale if that’s the most lucrative option
Felix goes on to explain that even considering all of this, renting comes out ahead. He, and the folks at e21 explain that this is because, whether one is renting a home or buying it, they will both actually be renting. Whereas one is renting the house, the other is simply renting the capital. The paper:
Two major findings evolve from the analysis. First, individuals, on average, were better off in economic terms to have rented for most of the years in the study period. This first result is strongly dependent upon fiscally disciplined individuals that, without fail, reinvest any residual savings from renting. Second, fundamental drivers now appear to be in place that favor homeownership over renting in the near term future.
While the first finding might seem to fly in the face of the homeownership paradigm (specifically wealth creation), it is reasonable to find that most individuals still preferred homeownership during the sample period because ownership is in essence a self-imposed savings vehicle. Periodic mortgage payments (most typically monthly and amortizing) reducedany debt affixed to the residence and property appreciation, which occurred almost universally during this time period, allowed owners to take advantage of a levered appreciating asset in lieu non-wealth enhancing consumption spending. Said another way, while renting may have been wise, any extra savings from renting might be spent on non-wealth enhancing goods resulting in any benefits from renting versus owning disappearing in a cloud of consumption spending rather than savings.
As we've said before, it appears that some of the benefit of owning a house is the forced savings that are associated with having a mortgage. It makes you stretch. Felix puts it terms our readers are familiar with: "People get real value out of consumption, and so when you buy rather than rent you’re essentially denying yourself all that extra fun and pleasure. And if you both rent and deny yourself the extra fun and pleasure, then you’ll end up with more money than the buyer."
The paper concludes with a balanced synopsis of past and current conditions, saying that there have been "significant periods during the recent past over which renting was the actual superior financial decision. This result is conditional on an individual taking any residual money from renting and reinvesting at a rate equal to, or greater than, the risk free rate. Additionally, and perhaps surprisingly, conditions (historically low mortgage rates and relatively low rent-to-price ratios) now seem in place to favor future purchases." As always, check your local conditions using reasonable metrics and caveat emptor.