Renting vs. Buying as a Mid-Twenties Investor
This is one of the hottest topics among my peers, especially given the dramatic rise in demand and housing prices in the D.C. Metro area. Let’s explore both options to allow you to make an informed and financially sound decision.
Pros to Buying:
Buying allows for the freedom to customize and personalize your home. There is no rental agreement in place to limit things like upgrades, renovations, and pets. Additionally, home improvements will likely increase the value of your home.
Speaking of value, owning real estate is an important asset to any portfolio and will theoretically grow over time. According to HomeGuides.com, national appreciation of home values increase about 3.5-3.8% on average per year. While there is no all-encompassing benchmark to compare home appreciation across different regions and time frames, this is historically a reasonable expected rate of return. And to make things even sweeter, you are exempt from the first $250,000 of capital gains upon the sale of your home ($500,000 for couples). In order to qualify for this exemption, the home needs to have been your primary residence for at least 2 of the last 5 years.
Cons to Buying:
The first thing I think about is the lack of flexibility. Here’s some questions to ask yourself: Are you ready to settle down where you currently live? Do you have aspirations to live in other states, countries, or cities? With the success of working from home during the COVID pandemic, flexibility is even more important. Living in close proximity to your job may not be the necessity it once was.
Owning a home also has costs that go beyond the mortgage payment. Who do you call when there are leaks, damages, or maintenance needed? Ghostbusters? Nope. Your landlord? Nope. It all falls on you, which can take time in addition to the costs.
If you’re considering buying a home for rental purposes, it is important to be wary of the costs and responsibilities of being a landlord. In a hot summer like this year, let’s say the HVAC system goes out. Are you prepared and financially solvent enough to replace the system for your tenants? Any issues with the property typically will fall on the owner. Managing a property also takes time – assuming you have a full time job, you may have to hire a property manager to assist in finding and handling tenants.
If you do decide to buy, you will need enough cash for a down payment. To avoid private mortgage insurance (PMI), you will need to put down 20% at a minimum. Especially in the D.C. metro area, this can be a significant outlay of capital. If you don’t have enough cash to cover the down payment, PMI is simply a monthly premium added on top of your mortgage payment to protect the lender.
Pros to renting:
Renting a home allows for more flexibility and freedom. Whether your lease is month-to-month or yearly, it’s easier to make quick decisions or have the ability to relocate when life happens.
There is also not a huge amount of responsibility when it comes to renting. Typically, maintenance costs and responsibilities are a phone call away to your landlord. With renting, you know how much is due each month, and you can budget and plan accordingly. This may mean the ability to save more to a 401k, a brokerage account, or emergency funds with increases in salary.
Cons to renting:
When renting, you lose the ability to build equity as your rent payment is technically an economic sunk cost. While you may consider it “your” home, it is not your asset so all payments and increases in property value will benefit the landlord. Landlords can also decide to raise rent, which can push certain tenants out of their price range and require a move.
The rental contract or lease agreement can also restrict your ability to have pets and make changes to the home, as mentioned above. Evictions can also be a possibility if certain contract obligations are breached.
Now for my 24 year old perspective:
I believe I can see a greater average rate of return when investing aggressively in a brokerage or retirement account than using that money towards a down payment. On average, the S&P 500 has returned approximately 10% in the last century and roughly 9% over the last decade, as opposed to the 3.5% annual appreciation rate I mentioned earlier. While this is not exactly an apples to apples comparison, ultimately at this age I would prefer to invest my capital in the broad stock market as opposed to real estate.
Looking at the big picture, I prefer the flexibility and stress-free lifestyle of renting. Knowing my monthly expenses and avoiding sporadic large cash outlays allows me the ability to invest and grow my investment portfolio. Keep in mind this is based on my age and current financial situation, I plan to eventually purchase real estate when the time is right.
Ultimately, there are many factors that you should consider before making this decision. These factors include but are not limited to your lifestyle, goals, cash flow, assets, and liabilities.
Resources:
https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp
https://homeguides.sfgate.com/much-homes-increase-value-10-years-100948.html
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