Rent Versus Buy

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FMO
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Rent Versus Buy

Post by FMO » Sun Aug 31, 2003 3:47 pm

Finding myself disappointed with the capabilities of various free internet rent vs. buy calculators, I decided to design my own. I believe that my spreadsheet represents a reasonable compromise between accuracy and simplicity. Both the assumptions and the calculations are plainly visible so that the user can understand how the results are obtained. The spreadsheet can be viewed/saved here: http://tinyurl.com/lt4p

User entered data is shown in red. All other fields are calculated. There are provisions for entering both inflation and real estate appreciation rates. These rates are generally very close, but in growing areas it is common for real estate to appreciate a point or more above the general rate of inflation. The inflation rate is applied to rents and expenses of ownership. A data point which varies greatly from one individual to another is the percentage of real estate expenses which are deductible. (exceeds standard deduction). If you feel that your non-real estate deductions will always exceed the standard deduction amount, enter 100%, otherwise you will have to reduce this figure to allow for your personal situation. If you reside where real estate expenses are not deductible, simply enter 0. Purists will want to make sure that both the rental and the owned property are comparable in size and amenities to form a fair comparison. This is not strictly necessary though for the spreadsheet to be useful.


Methodology:

1. To the extent that the renter's required yearly rental expenses are less than the ownership expenses, the difference is invested in a portfolio yielding a compound rate of return as estimated and entered by the user. Similarly, funds are withdrawn from the portfolio if the reverse is true. For any given period, the rent vs. buy determination is based on the relative values of the renter's portfolio and the real estate liquidation value. The minimum evaluation period required to render a decision is 2 years.

2. Most data significant to either renting or purchasing real estate can be entered by the user. For owners this includes marginal tax rates, financing details, insurance, maintenance/repairs, taxes, utilities and expenses of purchase and sale. For renters, rents, renter's insurance and utilities are included.

3. Real estate capital gains are assumed to be tax-free. The renter's portfolio is assumed likewise to grow tax-free.



Limitations:

1. The spreadsheet only accommodates fixed rate mortgages. If you desire to evaluate purchases involving variable rate financing, you must assume an average rate of interest.

2. Rental security deposits are ignored for simplicity.


I prepared this rather quickly and got distracted by the Hokies beating up on Central Florida this afternoon, so it is entirely possible that methodological or design errors may have crept in. As always, I appreciate recommendations regarding the methodology or accuracy of the spreadsheet. Enjoy.
FMO

"The mark of a successful man is spending an entire day on the bank of a river without feeling guilty about it."

therealchips
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Exercising Your Spreadsheet for My Own Case

Post by therealchips » Mon Sep 01, 2003 4:47 pm

Thanks, FMO. I seem to remember a lot of squabbling about the rent/buy decision. Your spreadsheet might help end that. I exercised it only for my own case (which includes no mortgage and no state income tax) and found the results believable. (I did not check your computational formulas.) The spreadsheet supports my decision to buy, saying I'm better off after just a few years. I had to make a guess at what a house like this would rent for.

My hunch is that renters are forced to incur moving expenses more often than buyers.

You have: "3. Real estate capital gains are assumed to be tax-free. The renter's portfolio is assumed likewise to grow tax-free." Under present tax law, the real estate gain is tax-free up to certain limits, but the renter's portfolio can't generally grow tax-free. Even if he rarely trades, there may be some dividend income. If you wanted to extend the spreadsheet analysis some time, taxation would be a possible area. We could pretend that we believe that the maximum income tax rate for dividends and capital gains will continue to be 15%. :?

I think it's plain in context that the entries "Real Estate Appreciation Rate" and "Investment Return" are nominal rates and the user should not subtract inflation rates in providing those estimates. You might make it even plainer, since I wondered for a while.

The spreadsheet says "deductable" while the post says "deductible". I think the post is correct. (OK, minor quibble, but that is the sort of thing I find when someone asks for an editorial review. :wink:)
Purists will want to make sure that both the rental and the owned property are comparable in size and amenities to form a fair comparison.

Yes, indeed. Otherwise, the spreadsheet will only prove what is intuitively obvious: it would be cheaper to live in a 1,000 square foot rented apartment than in a 2,000 square foot owner-occupied house in the same general area.

I did not do any such analysis in deciding whether to rent or buy. The psychological benefits of owning my house were paramount. If I could make at least 11% a year consistently on my investments, buying a house is not in my financial interest. I would do it anyway and count the house as part of the fixed income portfolio. I bought first in 1974 and stayed in that house until I bought a new one 2000. When I was working, I found a new employer rather than accept out-of-state transfers until I retired in 1993. That cost me some retirement benefits since my employers repeated tried to move me out of California. People who may have to move to keep their jobs, or who want to let an employer move them around for whatever reason, really need to do the analysis you have facilitated.
He who has lived obscurely and quietly has lived well. [Latin: Bene qui latuit, bene vixit.]

Chips

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FMO
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Post by FMO » Mon Sep 01, 2003 5:11 pm

therealchips writes:

I seem to remember a lot of squabbling about the rent/buy decision. Your spreadsheet might help end that. I exercised it only for my own case (which includes no mortgage and no state income tax) and found the results believable. (I did not check your computational formulas.) The spreadsheet supports my decision to buy, saying I'm better off after just a few years. I had to make a guess at what a house like this would rent for.


Thanks for the review. I am always interested in improving my spreadsheets. As a fellow excel fanatic, I know you understand. Every time this issue comes up, nothing ever seems to get resolved, even once you get past the lifestyle issues. This is not surprising considering the number of variables which bear on the analysis. It is nice to be able to play with the variables and ascertain the sensitivities of the problem. The model reinforces my belief that the capability of fixing the majority of your housing costs is a powerfully in favor of the buy decision. The greater the anticipated inflation the more powerful the effect. It appears that under most combinations of rent to price ratios, the advantage of renting is usually very short-lived. Renting rarely turns out to be the indicated course of action unless gross rent multiples exceed 200 or so. When I run the model with data characteristic of my local market for a typical starter home, renting is only advantageous for very short periods. This is as would be expected since the purchase closing costs have to be overcome. Thanks again.
FMO

"The mark of a successful man is spending an entire day on the bank of a river without feeling guilty about it."

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ataloss
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Post by ataloss » Tue Sep 02, 2003 7:26 am

Yes, indeed. Otherwise, the spreadsheet will only prove what is intuitively obvious: it would be cheaper to live in a 1,000 square foot rented apartment than in a 2,000 square foot owner-occupied house in the same general area.


intuitively obvious to some of us but an argument for renting in some circles :wink:
Have fun.

Ataloss

MaiPenRai
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Post by MaiPenRai » Tue Sep 02, 2003 3:12 pm

I agree. Every way I do the math on renting versus buying it's not even close... and it seems the only way to come out behind when buying is very short rental periods, even when counting big expenses in the first five years like a new air conditioner, termites, etc.

As mentioned, it seem many of the rent vs. buy debates end up comparing properties of different values that might give widely different levels of satisfaction to those living there.

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Post by therealchips » Tue Sep 02, 2003 7:16 pm

Someone may rationally choose modest housing over expensive housing as a way to live below his means. That way, he could achieve FIRE sooner or reduce living expenses or capital requirements in retirement. That's what I did during my accumulation period. As a LBYM strategy, it works fine. The authors of Millionarie Next Door observe that the cost of the fancy house is not just the direct housing costs, but also the indirect costs of the "obligation" to match the expensive habits of the other people in the neighborhood.

I know from recent personal experience, however, that more expensive housing may very well be worth the price because of the security, safety, satisfaction and comfort it offers. Further, a sufficiently long period of living below your means, and enjoying decent investment returns, may make it possible to move to better housing in retirement. At that time, the proximity of jobs doesn't matter anymore. It worked for me. YMMV
He who has lived obscurely and quietly has lived well. [Latin: Bene qui latuit, bene vixit.]

Chips

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Post by Trex » Wed Sep 03, 2003 3:26 am

Chips:
Someone may rationally choose modest housing over expensive housing as a way to live below his means.

That's what we're doing and it pays in more ways that you described. I think most people (probably no one here) overlook the tax burden of an expensive house. Real example: My annual mortgage payments are cheaper than the taxes on a particular $600,000 house I saw a few days ago. All I could think about was- "you fools".

Trex

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Post by MaiPenRai » Wed Sep 03, 2003 6:43 am

My annual mortgage payments are cheaper than the taxes on a particular $600,000 house I saw a few days ago. All I could think about was- "you fools".
I get the "you fools" feeling a lot when I see people in hummers. Here in suburbs of Phoenix they've become quite trendy... youngish people tooling around from home to shopping center in their waaay expensive bright yellow SUV.

Then there is the coworker of mine who drives the new BMW. He's about 27, probably makes in the upper 30s, and is always bitching about not having money. I think all his money goes into his car payments and the expensive weightlifter powder he's always mixing to drink.

Sorry wandering OT again...

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"Endowing" an unmortgaged house.

Post by therealchips » Wed Sep 03, 2003 9:36 am

I agree, Trex, but then who would quarrel with a Tyrannosaurus rex? (adult weight: five to seven tons :lol:)

Consider some round numbers: Suppose the costs of an unmortgaged $600,000 house are 2% a year for property taxes, maintenance and insurance. That comes to $12,000 a year. Suppose further that the safe withdrawal rate is also 2%. Then the $600,000 house, unmortgaged in retirement, ties up another $600,000 in retirement capital just to "endow" or support the house by generating $12,000 a year. I'm ignoring income taxes and the possible deductibility of the property taxes, but the general idea must hold.
He who has lived obscurely and quietly has lived well. [Latin: Bene qui latuit, bene vixit.]

Chips

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Post by Trex » Wed Sep 03, 2003 9:39 am

Hi MaiPenRai,

Then there is the coworker of mine who drives the new BMW. He's about 27, probably makes in the upper 30s, and is always bitching about not having money. I think all his money goes into his car payments

I almost fell into that trap. Not hard to do when you think you have the money. Read a great book by Barbara Ehrenreich (sp?)- put a stop to that craving.

Trex

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Post by TRyan » Thu Sep 11, 2003 7:33 am

The attached cites the largest deterrent to renting (rising costs).

http://cbs.marketwatch.com/news/story.a ... iteid=mktw
"Buy Low Sell High"

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Post by Trex » Fri Sep 12, 2003 12:51 am

The housing wage has increased 37 percent since 1999, when a person had to earn $11.08 an hour to afford the national fair-market rent. The federal minimum wage has remained at $5.15 an hour since 1997. The housing wage has risen every year since 1999.

Shouldn't be too much of a shocker that some folks can not make a living. I feel very badly for people who are playing by the rules, grinding it out every day, and still sinking. This clearly slants the debate of rent vs. buy.

Trex

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