We all want our own piece of land with a big front yard to call our own, but owning is not always an option so we rent an apartment in the city.
Buy vs. Rent
After nearly twenty years of homeownership, I’ve spent the past ten months renting an apartment. I like it. And I don’t. There are pros and cons to renting a place, just as there are pros and cons to owning a home. For me, one of the biggest cons is the close proximity to my neighbors — especially the guy upstairs, who stomps around like an 800-pound gorilla.
At first I thought that buying a home would also be a smart financial decision. The more research I do, however, the more I realize that the notion of homeownership as a magical path to wealth is a marketing ploy of the real estate industry. In fact, home prices (like gold prices) generally barely keep pace with inflation.
There’s no question that buying a house makes sense for some folks, but mainly for non-financial reasons. Owning a home gives you stability (you’re not at the mercy of a landlord) and freedom (you can do what you want with the place). But financially, it’s not always the best bet.
Buying is Not Always a Finically Option
Here in the Pacific Northwest, I’m finding that the annual cost of owning a home — taxes, interest, insurance, maintenance, HOA fees — is often greater than the cost of renting. Sometimes significantly greater.
Assuming you want to make a purely financial decision whether to rent or buy, how do you begin? There are a couple of ways to stay objective.
But what does this number mean? “A rent ratio above 20 means that the monthly costs of ownership will exceed the cost of renting.” That’s a little opaque, but what Leonhardt means is that the higher the P/R ratio, the more it makes sense to rent — and the less it makes sense to buy.
During the housing bubble, the national P/R ratio came close to 20 (and went far above that in some cities). In other words, you could rent a $200,000 house for $10,000 a year (or just over $800 per month), which is a pretty good deal.
The normal range nationwide is between 10 and 14 (meaning it would cost between $1,200 and $1,600 to rent a $200,000 house). During the 1990s, just before the housing bubble, the national P/R ratio was usually between 14 and 15 (about $1,100 to $1,200 to rent a $200,000 house).
Price-to-rent ratio data isn’t widely available. If you search long enough, you can find some recent-ish info on the internet, but for hard numbers about your area, you’ll probably have to contact a real-estate agent.
House vs Apartment
Another way to gauge the cost of housing is to compare it to your family’s income. From 1984 to 2000, median home prices were about 2.8 times the median yearly family income. (In other words, the typical house cost about three times what a family earned in a year.) During the early 1970s, home prices were about 2.3 times median family income. During the housing bubble, this ratio jumped to 4.2.
These numbers don’t mean much on their own, but they can give you some sort of idea of whether housing is overpriced in your area. Plus, it seems safe to assume based on past figures that most families can comfortably afford a home that costs about 2.5x their annual income. (So, if your family makes $80,000 a year, you can afford our theoretical $200,000 house.)
Discussions of homeownership should be grounded in reality. Buying a home isn’t some magical financial panacea. You can waste just as much (or more!) as if you were renting, and you lose a lot of the flexibility and freedom you might otherwise enjoy. If you want to buy a home, do so. But don’t let anyone persuade you that you’re throwing your money away by renting.
As for me, I still plan to buy a home in the next few months. It’s not the best financial decision, but if I’m careful, I should be able to score a good deal, one that makes as much financial sense as renting. Best of all, once I own my own home, I won’t have to put up with the clump-clump-clump of a lead-footed neighbor upstairs.