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Monday, March 07, 2005

 

why renting is better


the economist, in overviewing the global housing bubble, quickly illustrates why buying a house today is actually a bad investment compared to renting. as more and more housing is bought for speculative/investment purposes and subsequently rented out, the rental market is experiencing a massive glut, driving down rents just as housing prices are booming.

The unusual divergence between house prices and rents does not just affect investors; it also undermines the conventional wisdom that it is always better to buy a house, because “rent is money down the drain”. Today in many countries it is much cheaper to rent than to buy.

Take a two-bedroom flat in London, which you could buy for £450,000 ($865,000). To rent the same flat would currently cost £1,700 a month. In addition to a 6% mortgage rate, a buyer would face annual maintenance and insurance costs of, say, 1.25%. In the first year, the rent of £20,400 compares with total mortgage interest and maintenance payments of £33,000, a saving of £12,600. Interest payments would be less if a large deposit were paid, but in that case the income lost from not investing that money elsewhere has to be taken into account.

Assume that rents rise by 3% a year, in line with wages, while house prices from now on rise in line with inflation of 2%. At the end of seven years (the average time before the typical homeowner moves), you would be almost £35,000 better off renting, taking account of the capital appreciation and buying and selling costs. In other words, even without a fall in real house prices—which many believe to be likely—buying a house in Britain today seems a poor investment.

The figures look even more striking in the San Francisco Bay Area, where it is possible to rent an $800,000 house for $2,000 a month. Making the same assumptions about rents and house prices, but also deducting tax relief on a fixed-rate mortgage and adding property taxes, a buyer would pay $120,000 more over seven years than if he had rented. House prices in San Francisco would need to rise by at least 4% a year (2% in real terms) for it to prove cheaper to buy a house. Since 1950 American house prices in real terms have risen by an annual average of just over 1%. To expect them to rise faster from their current dizzy heights smacks of irrational exuberance, to say the least.
in local terms, a three-bed two-bath in my neighborhood rents for about $1400 and sells for $340,000. even with a large downpayment ($80k), the interest/maintenance/insurance/property tax expense for the first year amounts to $23,100 -- and would decline by only $200/year or so over the first few years. a year's rent is $16,800 -- representing a savings of $6,300 over the first year. this doesn't include the tax credit for mortgage interest itemization, of course, which might be worth as much as $3000, but not enough to make buying intelligent.

more on price-to-rent from calculated risk.

part 2


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