Friday, April 25, 2008

People who rent are just throwing money away!

If you rent, you hear this all too often. And some of you first-time buyers out there (Hi!) feel pressure to be fiscally with-it and get in the game. Well, take comfort renters and first-time home shoppers, renting has been the right choice in Los Angeles since 2004. How do I figure? I'm glad you asked!

What ya do is take the cost of owning and divide that by the cost of renting a comparable property. If you get a number greater than 1 that means owning is more expensive than renting. If you get a fraction like 1/2 well then it might be an excellent time to buy because renting is more expensive than owning.

Let's do the math. For a home that recently sold at or around $750k the tax would be about $6k a year (because the assessed value would be a bit lower than $750k). Let's say your mortgage payment is about $4k a month (times 12 months would be $48k/year). So just tax and mortgage on your $750k house is $54k/year. If your roof leaks or your sink clogs or a pipe breaks -- you'll have to pay for that too. And even if there are no repairs, you still have to pay for a gardener and big water bills to keep your lawn green. Let's be conservative and say you have about $4k/year in maintenance costs. Now you are at just shy of $60k per year or $5k per month.

What would be a fair rent for your house? I can tell you that in Sherman Oaks, most homes that were recently selling in the $750k range are renting for about $3,500/month. That puts the own to rent ratio at 1.43 (5k/3.5k).

I can hear you squawking about the tax benefits of a mortgage already. Well, zip it. There are other ways to get tax benefits. Yeah. That's right. Like you can do a pre-tax contribution to your 401k and IRA. Maybe you could do that in addition to your home ownership -- assuming you can still cough up the $5k a month -- but you could definitely afford it if you were renting.

In this market, nobody is going to sing the praises of home equity to me because: guess what? If you bought after 2004, you are upside down right now. Yes. You. Are. If you are very lucky, you can sell your home for exactly what you paid. But that would still be at a loss because you have to deduct all this from the sales price: (1) the 6% you will fork over to your agent and the buyer's agent; (2) 1.5% in closing costs; (3) all the interest you paid on your mortgage every month that you owned the house; (4) the cost of any improvements or repairs; and (4) lost opportunity costs (i.e. if your money were just sitting in the bank it would've at least shown you a 3% positive return but you didn't do that). Yup. And that's if you sold for what you paid -- imagine if you sell for less than what you paid. In that scenario, you not only lost a big old hunk of cash but now your credit is all jacked up.

So our renter spent $42k/year while our "home owner" (quoted because, in fact, the bank owns this house) spent $60k/year for the same privilege. And our homeowner lost more than the extra $15k extra he paid in tax, mortgage and maintenance every year, he also lost $56k in transaction costs when he sold his house for exactly what he paid. Sort of looks like it wasn't our renter who was "throwing money away" after all.

The chart below shows when it was the right time to buy a house in Los Angeles over the last 28 years. As you can see, there were plenty of opportunities to buy. Just not recently. And certainly not right now.



By the way, if our "home owner" earned a modest $150k per year, that leaves him about $600/week to cover the rest of his expenses. In LA, gas and car insurance are about $100/week. A cell phone is about $25/week. Utilities and cable are about $75/week. If you ate all of your meals at home you could get by on $100/week. Thus, after the basics, he'd have $300/week assuming he didn't: have a wife or any children, buy any clothes or gifts, have any student loans, lease or make payments on a car (that never breaks down or needs an oil change), get sick or injured, pay for health insurance, or spend any money on vactions or entertainment beyond cable TV. And that's pretty much the only way our homeowner could hope to save 10% of his gross income for retirement. I guess that's why they say your mortgage should be no more than 2 or 3 times your gross income, huh?

8 comments:

Nancy said...

I love this article! It points out exactly what I've been telling my co-workers. I SAVE money by renting instead.

I am definitely forwarding to all my friends to read.

Emil said...

There are plenty of good online calculators that compare renting vs. buying. Try for example:

http://www.dinkytown.com/java/MortgageRentvsBuy.html

Kate said...

Nancy:

Thanks for your comment! But I feel obligated to share with you something somebody wisely shared with me (Hi John!) and that is:

"Talking to recent home buyers about real estate is like talking to Jews about Isreal."

That's kind of why I blog about the bubble but avoid the topic (as best I can) in person. If you are in the market you definitely want to talk about it but you need to find people who are willing participants. And if you are going to argue about it -- well, better to fight with anonymous Internet strangers than your loved ones.

So tread with caution Nancy! :-)

Anonymous said...

I don't get the "Jews about Israel" reference?

ProblemWithCaring said...

I don't get the "Jews about Israel" reference?

Let's just say they are predisposed to being biased and leave it at that...well someone else say it, 'cause I, personally, am a racial transcedentalist and like Stephen Colbert don't see race.

Also kate: Thanks for the article. All this bears repeating as you never know what key word will show up in some potential knife catcher's search....

kate said...

Dear Anon 6:44,

The "jews about Isreal" comment just means that it's an emotional topic -- something that you can expect a passionate response about. So, you want to be very careful and very informed before you throw out an opinion.

UserAndy said...

I think the 3x rule should be reiterated to buyers and lenders alike: No one should buy a home that costs more than 3x their yearly gross pay.

Alternately, no one should be paying more than half thier monthly take-home pay on their housing costs. I like this rule better because it's just as good for renters as it is for potential home buyers.

However, you don't address people that are buying to STAY. There is a really big monthly savings for home-buyers that have payed off their mortgages altogether. Not only does their month-to-month living expense drop significantly, but they now have a nice big asset that long-term renters do not. Prices, in the long run, will go up for both renters and homeowners.

For that fact alone, it SHOULD be (Andy's rules of Fairness) less expensive to rent than buy!

Renters Insurance Quotes said...

Great article. Thanks for posting!