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Revisiting My Rent vs. Buy Analysis from 2005

Two and a half years ago, I did a quick and dirty rent vs. buy analysis [3] 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.