I have been having this discussion with my 27-year-old daughter, Kayla, for the last couple years.
Tradition says, “Own your home and don’t throw money down the drain on rent.” You will have the pride of homeownership, and your home will become a valuable asset for you in the future.
My dad has already told Kayla he’ll help her out if she wants to buy, and her boyfriend’s parents may do the same. This is a good example of how the traditional thought process about owning your own home is still part of our society. But is buying the smarter way for her to go?
My answer is “no.” She is better off renting her home and investing her money elsewhere.
What? That doesn’t make sense coming from me, right? I’m a real estate guy, and much of my business in recent years has been based on getting people into homeownership or helping them stay in their home. But for Kayla, I think homeownership would be a bad idea right now. Here’s why:
Financially, hands down, she is better off renting than owning. Let’s look at the facts.
If you were an investor and you bought a single-family home today in Reno, NV with the intention of renting it out, you would be challenged to make a positive cash flow return with a 20% down payment. Homes are expensive, and even though rents are also going up, they always lag home prices. If you’re planning on making your money through appreciation, you’d be taking a chance on something that’s purely speculative. So, if you can’t make a good return through cash flow alone and you can’t count on appreciation, renting is the better financial model because the renter has the better deal.
You might argue, “But Greg, that home will keep going up in value, and since they will have paid the mortgage for all those years, the investor will be the winner in the end!” Maybe. Maybe not. No one knows what the future holds.
Even if that were the case, once we calculate the actual return on the home with the appreciation, it will still probably come out a poor investment. It’s all about timing, and since you don’t buy and sell the home you live in based on timing the market, chances are, your timing won’t be good.
However, Kayla has the luxury of doing exactly that: she can time her purchase as long as she doesn’t mind renting until then. The key factor in this decision is really whether she is mentally and emotionally happy renting instead of owning.
From a strictly financial perspective, Kayla can make way more money by investing in our funds — something she has been doing since she was 16 years old (with a little help from me). She knows how to save money, and she’s had the advantage of being able to invest it at better than 10% returns for her investing life.
Let’s see what this scenario would look like by using some real numbers. Let’s assume Kayla’s house costs $300,000. We’ll give it 3% appreciation per year, which equates to $9,000 per year.
With a $60,000 down payment, Kayla would have a $240,000 mortgage. Let’s assume a 4% interest rate amortized over 30 years. That would amount to $86,577 in interest for the first 10 years of the loan, or an average of $8,657 in interest per year.
We can assume that her homeowner expenses such as property taxes, insurance, maintenance, and repairs will be about equal to her mortgage payment. That leaves her with $9,000 in appreciation but $8,657 in interest expense per year, essentially making the purchase a wash. (By the way, this doesn’t include the $20,000 or $25,000 in expenses she’ll face when she goes to sell property.)
Instead, if she chose to invest the $60,000 and could sustain an 8.5% return for ten years (she has already sustained better than 8.5% for the past eleven years), her $60,000 investment would be worth $139,958. That would put her ahead by almost $140,000 with none of the headaches of homeownership, without being tied down by her home, and without having to sell the property and bear the expenses when she needs to upgrade, move, etc.
The decision as to whether Kayla should rent or buy can be boiled down to two things: finance and emotion. If she’s emotionally okay renting, then it’s a no-brainer — the numbers tell a pretty convincing story. But if she feels strongly about owning her own home, that’s a decision she will have to make and be happy with, regardless of the numbers. No spreadsheet of mine will be able to come up with that answer. Only she can.