It used to be a given that buying a house was a good idea. When you buy a house, you are putting money toward paying off the mortgage instead of wasting it on rent. There has been a growing sentiment that renting a house could be better than buying one and that a house is no longer a good investment. There was even a study done that showed renting a house was a better financial decision for many people. However, that study stated their results were based on people reinvesting all the money they saved on renting. The study went on to say that most people do not invest their money; therefore, a house was a good investment because it forced people to save. The facts show that the greatest majority of most people’s net worth is from their house and that homeowners have 44 times greater net worth than renters. I personally think a house is a great investment for almost everyone.
What does the most recent study say about renting versus buying a house?
A recent study from Florida Atlantic University stated renting is better than buying for most people. This study was shared by many news sites, blogs, and people on Facebook (who also stated renting is better than buying because of this study). However, I think there were some major problems with this study that were left out of those stories. The study compared buying to renting with the following assumptions:
- A renter would invest all the money they saved from not buying a house into the stock market.
- A home buyer would put 20% down to buy a house.
- A home buyer would have 2% closing costs to buy a house.
- The homebuyer would hold the house for 8 years and then sell, paying 6% in selling costs.
- Property taxes would be 1.5% of the property value each year.
- Maintenance and insurance expenses would be 2% of the annual house value.
- Homeowners would pay 25% of their profits to taxes.
There are some major problems with these assumptions. The homeowner would not pay any taxes on their gain because of the tax-free capital gain rule on selling a house you live in for 2 out of 5 years. This law could change with the new tax code, but if someone owned their house for 8 years, they will still pay no taxes under the new tax laws. Most homeowners do not put 20% down. 70% of first-time homebuyers who get a loan put less than 20% down. Property taxes are often much lower than what this study assumes for insurance and maintenance costs.
Do the assumptions in this article change how we should view a house as an investment?
To show how much the assumptions made in this study change the money you would make from buying a house, I will use an example. I will assume someone buys a house for $200,000, and this is the money that would be saved:
- If the house saw 4% appreciation every year for 8 years, the house would be worth $273,714. The study assumes a homeowner would pay 25% in taxes on the $73,714 in profit, but they would not pay any taxes with current or proposed tax laws, saving $18,428.
- The article assumes 2% of the house value would be used for maintenance and insurance each year. That means $4,000 per year would go towards these costs, but insurance would be less than $1,000 per year in most markets. That means $3,000 per year goes toward maintenance. That could be the case, but that money could also be increasing the value of the house. If you spend $24,000 on maintenance over 8 years, you are most likely making improvements as well. The increase in value caused by those improvements and maintenance are not accounted for in this article. It is hard to put a dollar figure on what those improvements would do, but I assume they will add 5% in value, or $13,685 (based on the $273,714 value).
- The article assumes the tax rate is 1.5% of the value of the house each year, which would be $3,000 per year on the $200,000 house. I live in Colorado, and the taxes on a $200,000 house would be around $1,200 per year. In many cases, the tax-assessed value is also less than the actual value. You could live in a state with even higher taxes, but in my area, you would save more than $8,000 over what this study suggests.
- If you put 20% down on the $200,000 house, you would be spending $40,000 on the down payment. There are many loans available that will allow homeowners to put less than 5% down. That would mean the homeowner is putting $10,000 or less down—instead of $40,000 down—saving them $30,000.
- You would spend $70,000 less in my area over what this study suggests when you buy a house. There would be some additional costs using a low-down-payment loan, like mortgage insurance. Even with mortgage insurance that lasted the entire 8 years (some mortgage insurance can be removed), you would spend less than $20,000.
The other major problem that this study creates is the amount of money invested when renting a house. It assumes that when you rent, you would invest that $40,000 down payment into the stock market or an equivalent investment. That $40,000 would grow to almost $68,727 in 8 at years at a 7% interest rate. The study also assumes if you save any money at all renting (which you would base on the high maintenance, tax, and insurance numbers they use for buying), you would invest all of that money into the stock market as well. Most people will never do that: they will spend the money they save and not invest it. The study admits this fact and concludes that most people should buy because of it. If most people are not putting 20% down, they are not investing $40,000 into the stock market in the first year either. With a 5% down loan, they would be investing $10,000 into the stock market, which would only increase to $17,182 after 8 years at 7% growth each year.
The reason this study shows that renting is better than buying for most people when almost every other study has shown the opposite is they made some really bad assumptions that are not realistic. They admit some of these scenarios are not realistic, and that is why they also say most people should buy. In most real-life scenarios, people would make $50,000 or more from buying than the study suggests and end up with $50,000 or less than the study suggest from renting (this assumes all money saved is reinvested into the market). That is more than a $100,000 difference, and the study still shows that it is better to buy than rent in some markets! I give a lot of credit to the study for breaking down the data in different markets based on rent-to-value ratios and other costs.
Why else is a house a good investment?
There are other reasons that buying a house is better than renting one—reasons that this study does not mention. They mention most of the advantages but leave out buying below market value. Buying below market value is a huge advantage and can add net worth and equity immediately after you buy. This is how I have bought all of my rentals and flips, but you do not have to be a real estate investor to get a good deal on a house.
- You can buy real estate below market value. It takes some work, but it is possible to get a house worth $200,000 for $170,000 or less. This is how real estate investors make their money. I have 19 flips going, and I make money by buying them way below market.
- When you buy a house, the interest is tax deductible. If rent is $1,000 per month and a mortgage is $1,200 per month, the mortgage may actually be cheaper because of the tax savings. Rent is not tax deductible. Please note that this advantage could be changing with the new tax laws.
- You can get loans for owner occupants with less than 5%, or sometimes 0%, down. When you rent a house, it can actually take more money with first month’s rent plus deposit and sometimes first and last months rent plus deposit. When you buy a house, you also usually skip your first mortgage payment. You still get the same appreciation when you buy with less money down, which greatly increases the return on investment.
- Renting is not always cheaper than buying, even after considering taxes, insurance, and other costs. As a real estate agent and investor, I see rents hundreds of dollars higher than what a mortgage payment would be on the same house with a low-money-down loan. I bought 20 rentals in the last 6 years, and on all of them, I make my money because of the huge gap between market rent and my mortgage payment. I put 20% down, but that gap would still be there with less money down. Rents can also go up as soon as the lease is up. Your mortgage is locked in.
- One of the best tax breaks in the US tax code is for owner-occupant buyers (this may change). If you live in a house for 2 years and sell that house, in most cases you pay no taxes on the profit (assuming you did not run a business or rent the house out). If you buy below market value, make some repairs, and sell the house in two years, you could make tons of money tax-free. I made $100,000 on a house I sold after owning it for three years and paid no taxes on it.
- Real estate does not have worse returns than the stock market. When you buy a house, you have to factor in the rent you save and that you are getting a loan. Yes, real estate may appreciate at 5% per year in some markets versus the stock market going up 7%. However, you may only put $10,000 down on a $200,000 loan. So a 5% increase in value actually makes you a 100% return on your money.
Real estate can be an investment because of the tax code and the ability to buy below market value. It is not easy to get awesome deals but is well worth the effort. Many people will not take the time to get a great deal or learn how to best buy a house, but buying is still better for almost everyone. For those that take the time to learn the best ways to buy a house, it is a slam dunk that buying is better.
For more information on the best ways to buy houses, check out my book: How to Buy a House: What Everyone Should Know Before They Buy or Sell a Home. It is for sale on Amazon as an eBook or paperback.
What are some advantages to renting a house?
Even though buying a house is the better option for most people, it is not better for everyone. If you want to make the best financial decision, you need to look at your situation, your needs, and how much time and effort you are willing to devote to the process.
- If you move constantly, selling a house is expensive, and it can take months as well. If you are constantly moving, maybe renting is better.
- If you cannot qualify for a regular loan and have to pay high interest rates, buying may not be worth it.
- If you do not take the time to get a good deal or overpay for a house, it could take years to make up for it.
- If your area has really high property taxes, really high insurance, or the rent-to-value ratios are really low, it may make sense to rent. For example, in one market you may be able to rent a $100,000 house for $800 per month. In another market, you may rent that same house for $1,300 per month. It all depends on supply and demand. This again assumes you are moving fairly quickly and not staying in one house for many years.
Buying a house is almost always the best choice if you take the time to get a good deal. The tax advantages are amazing, as is buying below market value.
What do the numbers say about renting versus buying?
The vast majority of most people’s net worth is in their house. If you look at the chart below, it shows the total percentage of people’s net worth in the United States from their home equity.
Homeowners also have 44 times the net worth of renters. A lot of factors go into that stat, like the fact almost every wealthy person owns a house, but it shows that homeowners are much better off.
So in theory, it could be cheaper to rent a house in some markets, but that assumes people pay full retail, they reinvest the money they save, they put 20% down, and they end up paying taxes on their profit. Most people will not invest all the money they save from renting (if they save any), which is a huge reason why renters typically are so much worse off financially. People who buy houses are forced to save money, which helps them later in life when they have failed to save or invest anything else. Even for those who invest the money they save from buying a house, buying can be the better option if they get a great deal and because they may not pay any taxes on the profit.