Rent vs Buy
The common mistake people do when comparing rent vs buy is thinking that is an apple to apple comparison, people thinks that if you can buy a house with a monthly mortgage payment less or equal to the rent of a same value house it’s a good deal which is not that’s not how it works. A good way to compare buy vs rent is to compare unrecoverable costs of owning vs unrecoverable costs of renting and it is not as difficult that is may sound.
An unrecoverable cost is the money spend on a commodity and service that cannot be refund or resold. The unrecoverable cost of renting is the monthly payments of rent. As for owning is a bit harder to find.
The unrecoverable cost for owning a house start with a mortgage payment which is the rent for the money the bank loan you to pay the house but is not really an unrecoverable cost. The unrecoverable costs for house owner are property taxes, maintenance costs and cost of capital. The property taxes are the taxes you pay the government to own the house it’s on average 1% of the house price. The maintenance cost cover expenses like replacing the floor, renovate the kitchen or repainting the façade to maintain the value of the house. The data of maintenance costs are not available, but we can estimate it at 1% per year. The cost of capital is the most difficult to assess. It can be broken down into cost of debt and cost of equity. The most common way of financing a home is through a mortgage, let’s say a new homeowner put a 20% down payment and finance the other 80% through a mortgage at 3% interest that’s the cost of debt. The cost of equity in our example is let’s take the 20% down payment that create opportunity cost instead of investing in a house you could have invest that money in the stock market, in a business or any other investment, those missed opportunities is what we called opportunity cost. To figure this cost out we must come up with an estimation for expected returns for let’s take the case of an investment in stocks. Globally the return for real estate is 1.3% as for stock it’s 5.2% after inflation if we assume inflation at 2%, then we have a 3.3% return for real estate and 7.2% for stocks so we have and expected return difference between stocks and real estate of 3.9%. Let’s take that down to 3%, considering 3 costs calculate above we obtain what we call the 5% rule with allow us too compare rent vs buy on an apple to apple bases.
So, let’s some up, you take the price of a house multiply be 5% and divide those 5% by 12. If you can you can rent for less than that, then renting is a better choice than buying. So, if you can rent a 700000$ house for less than 2917$ than renting is a better choice. This is and oversimplified rule but it’s steal works very fine.
Quick tips: if it doesn’t bother you to share you space with other person you can always rent the extra rooms in your house or buy a small apartment building an pay your mortgage while making extra cash with the rents.