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Rent or Own?

Your Guide to the Rent


Versus Own Decision

Rent or Own?

Renting Versus Owning ........................................................................................................................................................ 3


Reasons to buy a house .......................................................................................................................................................................... 5
Have a place to raise a family ................................................................................................................................. 5
Be a part of a neighborhood and community .................................................................................................. 5
Following parents advice ........................................................................................................................................ 6
Build equity and hedge inflation ........................................................................................................................... 6
Acquire an asset to pass on ..................................................................................................................................... 7
Gain a tax deduction ................................................................................................................................................... 7
Reasons not to buy and rent instead ................................................................................................................................................ 7
Flexibility to move ...................................................................................................................................................... 7
No money spent on upkeep .................................................................................................................................... 8
Monthly payments exceed comparable rental ............................................................................................... 8
Take on too much debt ............................................................................................................................................. 9
Ties up too much savings ......................................................................................................................................... 9
Mistakes and fallacies about renting or owning ...................................................................................................................... 10
Buying for rapid appreciation .............................................................................................................................. 10
Renting is throwing away money ....................................................................................................................... 11
Owners are better people than renters ........................................................................................................... 12
What is Ownership? ............................................................................................................................................................ 13
A Conceptual History of Real Estate Ownership ...................................................................................................................... 13
Money Rentership (Loan Ownership) .......................................................................................................................................... 15
What is Rental Parity? ....................................................................................................................................................... 16
Rents Capture Premiums ................................................................................................................................................................... 16
Moving Beyond Rental Parity ........................................................................................................................................................... 17
Uniqueness and Quality ...................................................................................................................................................................... 17
Reservoir of Value ................................................................................................................................................................................. 18
How Much a House Really Costs ..................................................................................................................................... 19
Mortgage Payment ................................................................................................................................................................................ 19
Property Taxes ........................................................................................................................................................................................ 20
Homeowners Insurance ...................................................................................................................................................................... 21
Private Mortgage Insurance .............................................................................................................................................................. 21
Special Taxes and Levies .................................................................................................................................................................... 22
Homeowner Association Dues and Fees ..................................................................................................................................... 22
Maintenance and Replacement Reserves ................................................................................................................................... 23
Tax Savings ............................................................................................................................................................................................... 23
Hidden Savings ....................................................................................................................................................................................... 24
Lost Down Payment Interest ............................................................................................................................................................ 24
Ownership Cost Math .......................................................................................................................................................................... 25
Cost of Ownership Detailed Analysis ............................................................................................................................ 27
Four Major Variables that Determine Market Price ............................................................................................................... 27
Borrower Income and Wage Inflation .......................................................................................................................................... 28
Prices should mirror incomes .............................................................................................................................. 28
Allowable Debt-to-Income Ratios .................................................................................................................................................. 29
Interest Rates .......................................................................................................................................................................................... 30
Interest Rates Impact Mortgage Balances ...................................................................................................... 31
What happens when interest rates rise? ......................................................................................................... 32
Down payment requirements .......................................................................................................................................................... 35
Savers gain advantage bidding on real estate ............................................................................................... 36
PITI .............................................................................................................................................................................................................. 37
Property Taxes ........................................................................................................................................................................................ 37
Mello Roos Taxes ................................................................................................................................................................................... 38
Determining Mello Roos ......................................................................................................................................... 39
Homeowners Insurance ...................................................................................................................................................................... 40
Homeowner Association Dues and Fees ..................................................................................................................................... 40

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Rent or Own?

Renting Versus Owning


Renting versus owning is both an intellectual, financial decision and an emotional one. The financial decision is first
and foremost an analysis of the comparative cost of renting versus owning. The cost of a rental can be determined
fairly easily as there are usually a number of comparable properties on the market to establish a realistic rental
rate for any given property. Of course, it is easy to justify in one's mind a comparative rent that is higher than the
market will bear. A house someone is in love with will almost certainly rent above market in their minds. Also
when looking at similar products the rental rates may not be realistic in the marketplace. It is probably a good idea
to take 5% off comparable rental rates on properties offered on the market. Once you have established what you
believe to be a comparative rental rate, and you have gone through a realistic evaluation of the true costs of
ownership (as outlined below), a simple comparison of the two figures will tell you if a property is overvalued,
undervalued or just right.

This point-in-time analysis of the relative worth of a house does leave out a couple of important financial factors:
inflation and transaction costs. Inflation is the erosion of purchase power of money over time, or looked at another
way, it is the increase in the price of some set of goods and services in a given economy over a period of time. It is
measured as the percentage rate of change of a price index. The effect of inflation on housing costs is that it tends
to increase the cost of renting over time, and theoretically, it will increase the value of a house over time as well. If
the cost of rent is increasing, but your cost of ownership is fixed (assuming a fixed-rate mortgage,) then owning a
home becomes less expensive over time and serves as a hedge against the impact of inflation. If you are a
homeowner, inflation is your friend. If you are a homeowner with a lot of debt, inflation is particularly welcome.

There is one big cost of home ownership that works against the positive impact of inflation: transaction costs.
When people buy a house, they pay some closing costs, but many of these get rolled into your loan and forgotten.
When people sell a house, they generally go to a realtor to help them market the property and complete the
paperwork necessary for the transaction. Real estate commissions for many years have been held at 6% in the
United States, and the seller is the one who pays this commission. From the time of purchase to the time of sale,

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Rent or Own?

inflation (or irrational appreciation) must have increased the value of the house enough for the sales price to cover
the real estate commission or the seller will lose money. This is why it is often recommended for people who are
not going to live in a given area for more than 2 or 3 years to rent instead of own. Renting is freedom -- freedom to
move when you wish (within the terms of your lease.) Homeowners who go underwater lose this freedom of
movement. This advantage of renting is nullified during a price rally as owners have this same freedom during
those times, but this forgotten benefit becomes readily apparent once prices start to fall.

Some people spend a great deal of effort evaluating the costs of ownership to determine if is a correct decision,
but many people do not. Some people make the decision to purchase the most expensive asset they will ever own
with no analysis at all. The decision to buy a house is primarily an emotional one. Even those who go through all
the analysis generally only do so to provide rationalizations for their emotional decision. During price rallies, greed
becomes a powerful emotion motivating people to fudge their financial analysis in order to justify their emotional
purchase. Another factor often called the "nesting instinct" causes both men and women to want a place to call
their own, particularly when there are children in the family. There is nothing wrong with deciding for emotional
reasons. Most people pick a spouse this way. The real challenge is to have the emotions and the intellect working
together to make a decision that is both fiscally sound and emotionally satisfying. This is easier said than done.

The need for shelter is basic, often closely followed by the desire for community. In the United States, this often
translates into a desire to take on a very large mortgage to buy real estate. These basic human emotions drive
much of the activity in real estate markets. Most people buy because it is the right time for them. Their career,
age, family circumstances all come together to push people toward ownership at different times. Some are
fortunate and buy at the bottom of the real estate cycle. Some are not so fortunate and buy at the peak.

The most damaging aspect of our current system is the price volatility. It capriciously rewards some and destroys
others. Home price volatility creates a culture of Ponzi borrowing and dependency. The goal of government policy
should be price stability, but lately it seems their goal is price maximization. The end result of their policies is an
endless series of market stimulus and manipulation which creates even more volatility.

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Rent or Own?

REASONS TO BUY A HOUSE

Many people choose to rent to avoid the negatives associated with home ownership, and many more rent because
they can't meet the down payment or credit requirements to qualify for home ownership. However, most people
who hold down productive jobs have a choice. Anyone who chooses not to buy is making a choice to rent by
default. There are many different reasons people chose to buy homes to live in, some of them are good reasons,
and some of them are not.

Have a place to raise a family

The primary reasons to buy a home are emotional, not financial. At the top of the list is the desire to provide a safe
and comfortable home to raise a family. It's a primal urge. Although it shouldn't make a difference, there is an
emotional quality to home ownership that is not replicated by renting. Satisfying one's emotional needs is an
instinctive drive, and this compels many people to buy houses. Unfortunately, some people turn this emotional
satisfaction from home ownership into a reason to feel superior to their renting brethren, a group they perceive as
being less involved with family, neighborhood and community.

Be a part of a neighborhood and community

As people grow and develop during their life cycle, they first learn to take care of themselves, then their families,
then their neighborhood and community, and finally the whole world. Being part of a broader community one can
work to build and improve is a basic human need. Most people see this as a natural extension of buying a house.
They dream of watching the children play with the others in the neighborhood, enjoying block parties, and
participating in organized events. All things being equal with the house, people will chose to locate in
neighborhoods with others of their same demographic with whom they can make friends and socialize.

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