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Revisiting My Rent vs. Buy Analysis from 2005

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Two and a half years ago, I did a quick and dirty rent vs. buy analysis prior to purchasing my home. At 3% annual appreciation, my breakeven point was approximately 8 years away. At 6% annual appreciation, the break-even point was a mere 2.3 years away. I believed the regional market I was buying into was only slightly bubbly and that 6% “seem[ed] somewhat reasonable” for an appreciation rate. Nearly three years have passed so how did my analysis stand up?

First, let’s try to establish the “actual” appreciation based on recent home sales in my neighborhood. In the three years, five homes have been sold in my little cul-de-sac (homes within two hundred feet of my front door). These homes have nearly the same configuration as mine with some minor differences. For example, none of them had fireplaces, none of them had finished basements, one of them had original 20-year-old windows. In the last six months, two of those homes were physically connected in my row of townhouses and they sold for $305k and $309k. On paper, my home was likely going to command a higher price. However, we’ll just assume a nice round conservative premium of $10,000 (for new windows, finished basement, and a fireplace) putting the value of my home at $319k. That’s an appreciation of $24k from my purchase price of $295k.

That’s an annual appreciation of 3.67% over the last two and a half years, or slightly higher than my low estimate and far short of my “somewhat reasonable” guess of 6%. Had it appreciated 6% over two and a half years, we’d be looking at a sale price of $341k. Was it reasonable back then? Hard to say, I can’t put myself in that mentality, but it’s certainly unreasonable now.

So, did I make a mistake in buying? I don’t think so. In my original analysis, I also assumed a monthly rent of $1,100 and a marginal tax rate of 20% (among other things, but those were the big “wrongs”). In this area, $1,100 gets you an apartment with less square footage than one floor of my townhome. I think a more reasonable figure for rent is $2,000, based on estimated rates based from Craigslist. The marginal tax rate of 20% is also low (plus that bracket doesn’t even exist) for me, I believe the 28% rate is more accurate. Based on those numbers, plus the reworked appreciation rate of 3.67%, the new breakeven point is 1.3 years.

What!? How did that happen? The difference is in the estimated cost of rent ($2k instead of $1,100). If it were adjusted back to $1,100, the breakeven point would be 3.6 years – or close to the 3% estimate. During my analysis, I wasn’t comparing apples to apples, I was comparing one destined for Snow White versus one destined for apple sauce! There’s no way, definitely three years ago, one could rent a townhome for $1,100. I can’t fault myself for using that number because I wouldn’t have rented a townhome, but it was a mistake to use that number for this comparison. You can’t compare an apartment to a townhome in that way.

Did I make a mistake in my analysis? If I performed the analysis correctly and the numbers just didn’t work out, that’s fine. If my approach was wrong then I have the potential to repeat the mistake. In this case, I think bounding the lower rate at 3% was too optimistic. I think I did make one error (not counting the aforementioned apartment to townhome comparison), I didn’t plan for the worst case. While I don’t explicitly state that 3% is my worst case scenario, it became the de facto worst case because it was the worst of the situations I looked at. I should probably spend more time thinking about the lower bound in the future and be comfortable with the results should that happen. This is typical risk analysis type thinking, assign a worst case and a probability; are you comfortable with those values? If not, how do you mitigate? Luckily it didn’t burn me (yet).

So, based on my analysis, it sounds like I’ve broken even on a home! I’ve broken even mostly because I’m not “throwing” money away in terms of rent, but even that argument is tenuous. While the strict numbers may say I’ve broken even, the fact of the matter is that the decision isn’t really between renting a townhome and buying it (at least back then). Either way, it’s good to revisit decisions and analysis, it’s something I don’t think many people do and luckily I have the benefit of reading old blog posts!

What do you think of my analysis? Any glaring holes (or not glaring holes)? I agree that it’s a very rough analysis, I don’t consider things such as home improvements and maintenance costs, but I think on the whole it’s a decent look at the problem.

{ 17 comments, please add your thoughts now! }

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17 Responses to “Revisiting My Rent vs. Buy Analysis from 2005”

  1. I rent a townhouse with a garage and a small pool for slightly more than a large 2 bedroom apartment. Townhouses compete with those kinds of apartments because they are, in my area, in the same neighborhoods and have the same amount of space.

    I didn’t think I could afford to rent a townhouse, using the same 2K vs. $1,100 math. It turns out when you have a weak market and an owner can’t sell, market price becomes only slightly more than the apartment. I wouldn’t take a random Craigslist offer as the actual going rate for renting a townhouse.

  2. Traciatim says:

    I think the argument is mostly moot. You have to live somewhere, and if it’s renting or buying you’re not sleeping on a park bench. How can you quantify things like the feeling of coming home to YOUR house. I think that feeling will be even greater when the place is paid for.

    Last April I moved from a fairly small apartment (680 sq feet of living space) to a decent sized house (~1150 sq feet). I’m by far paying more to live here than there, and will it ever break even? When I look at my kids playing in the back yard when I didn’t have a yard before; I already have.

    I find mostly the argument boils down to:
    1) Have home prices gone way overpriced in your area?
    2) Have rents gone overpriced in the area you want to live?

    If rents are increasing, but purchase prices are stagnating then maybe it’s time to buy, if rents have stayed pretty stable but home prices are ballooning then maybe just stay renting and see what happens.

    Except for investment properties I think the main question is “Where do you and your family want to live” and strive for that. The finances on your primary residence should only come down to the “Does this fit in my budget, and does it fill the family needs for X years”.

  3. B-rad says:

    what about all the other things you have spent money on? How can you leave those out of the equation? Closing costs, insurance, taxes, assessments, HOA, etc, etc?

  4. jim says:

    B-rad: That’s a good point, I should’ve included those but didn’t because at the time (two years ago) I didn’t know exactly what they’d be, excellent point.

  5. B-rad says:

    A potential topic to discuss for potential homebuyer’s in a future post? How does one estimate extra cost impact when looking to buy?

  6. jim says:

    I was just thinking the same thing 🙂 thanks b-rad

  7. Clever Dude says:

    Jim, are the selling prices you’re seeing reflect how much the sellers paid towards closing costs? The local realtor in my area sends out quarterly reports and recently added those figures. We’re seeing homes selling for asking price, but they’re on the market up to 6 months (or even more) with $10-15k cash back from the sellers.

  8. jim says:

    CD: I don’t know the specifics of the deals other than knowing the final sale price, but the two most recent homes were on the market less than a week.

  9. RacerX says:

    For my personal psychology it just feels better to own. It is the whole “Its my wall and I can hang up a picture” argument.

    But for us we had more money as a renter, but this is due to us buying to big. When the house is paid off, I will have a pretty valuable asset.

  10. Miller says:

    Jim, awesome post! What a brilliant idea! =P

    Glad the numbers still make sense (perhaps even more so than before!). The “apples to apples” piece is key. The slight twist is that you would have been willing to live in a (much less nice) apartment for $1100. But none the less, you would have *rented* there. On the other side, knowing you, I sincerely doubt you would have rented a place as nice as your current place because it would cost you ~2k/month! Hence, the rub (certainly not specific to you).

    We’re willing to buy nicer places than we rent, even though it costs us because we’ll *own* it (duh). Renting is temporary and the mentality is “it’s not mine” so it isn’t a reflection of of ourselves. Hence, saving money out weighs having a nice place (especially if you don’t have kids).

  11. plonkee says:

    Given that your time frames to break even are quite short term, I’d have considered the effects of no appreciation or even a decline in prices. I think that it helps to consider pretty much all the scenarios even if they vary wildly.

  12. Patrick says:

    Your conservative $10k estimate for a finished basement, windows, and fireplace is probably very conservative. You can generally expect to get 80% of your value back out of a basement remodel, and new windows are a great selling point. Of course, I don’t know what you spent on your basement remodel, but they usually cost a minimum of $10-20k (even when you do some of the work yourself). We did ours last summer and it was toward the upper end of that range.

    Either way, I think you made the right decision to buy. It is nice to have a place to call your own, and it is great to build equity. 🙂

  13. The long term growth rate of real estate is the inflation rate, no more, no less. 3-4% is more reasonable that 6%. The NAV is as far as I remember annual rent – 30-40% of that for maintenance, property taxes, etc. divided by the risk free rate plus a couple of percent. If NAV is higher than the house price, buy. If it is lower, rent. In CA where NAV is half of the going price, renting is a no-brainer.

  14. gubmintmole says:

    I always find it interesting to read this debate, and as several others have mentioned it can’t be boiled down to a purely financial decision.

    I’ve lived in several places as a renter which I loved and had no intention of leaving when I was single. Unfortunately, in all 3 cases the landlord sold the place out from under me and I was forced to move. This was when I was single.

    Now married, with two kids I wouldn’t even think of renting anywhere unless I absolutely had to. I’ve owned my house now for 6 years and as much as I hate having to take care of everything myself instead of calling the landlord, it beats being kicked out on a periodic basis. My only house regret is buying a bigger house than I needed. I find the more stuff I own, the less time I have. I don’t own all the crap I have, it owns me.

  15. MoneyNing says:

    Hmm. I recently decided to move to a higher end apartment where the monthly payment was almost the same as buying a home. I decided that I still wanted to rent because I believe:

    1. The price of houses in California is going to drop more than the rent I will pay
    2. There are much more expenses of owning a home other than the mortgage payments.
    3. I’m not sure I want to stay where I am long term yet.

    Of course, reason #1 might be a big “if” so we will see whether my decision was financially correct or not. As I see it, houses in my area (orange county, CA) will be depreciating for the next few years.

  16. cory says:

    You didn’t include anything for maintenance of the owned dwelling. Plumbing repairs, HVAC checkups, water heater failures, are the little ones. Tack on accruals for a new roof and paint and new HVAC and you have a whole new cost of ownership.

    I rent a single-family home on the same street that I previously owned. My PITI was $1950 with a good loan. My rent is $1300. The houses are the same from a livability point of view. I’m $6600 a year ahead, NOT counting maintenance costs and accruals.

    I think most homeowners are fooling themselves about the financial aspects of it, and it is really just the only way that they can save—it’s sort of a forced savings, and even then only as long as there is appreciation. With ANY depreciation, renting is the hands-down winner.

    If I am willing to pay in rent for a home similar to what I can buy, AND I invest the difference instead of spending it, I will be able to live in the same neighborhood and it is my contention that I will win financially every time. I will gladly trade this comfort for the “comfort” of calling it my own.

    I think it’s crazy that an “investment” with a long-term annualized return of 3-4% BEFORE COSTS is even considered as an investment. That rate of return on any financial instrument would be considered very poor–tax free bonds do better!

    I agree that having a landlord sell under you is a hassle, and has a moving cost associated with it as well as the more intangible costs, but the right deal with the right landlord should minimize potential for this.

  17. datruth says:

    Everyone open your 3rd pyrmd eye.its only a dream to own.its the banks house,buildings,loans,tax,the new world order of the american dream! I call it the new way to fuck and slave any idiot who takes that stupid greedy step for a dream. Find your soul,peace,god. in god i trust

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