To buy or rent a house? That is the question…
I recently sent an email to my network letting them know that Kim and I bought a home:
If you’re interested in learning more about the research I did and why I ultimately chose to buy a home (even though there are much better financial investments), reply to this email and I’ll send you my notes.
To my surprise, hundreds of people replied to my email requesting my notes. After all, I claim that there are “much better financial investments”.
Because there was such a high demand for my notes, I took the time to refine my research with my good friend Steven Chen.
I find it surprising that to this day, many educated, savvy millennials are brainwashed to believe that buying a home is a “smart financial investment.” In fact, as you’ll see in our research, buying a home (to live in) is a terrible financial investment when compared to the alternative (rent and invest in the market).
Without further ado, let’s dive into the research.
I could not have published this article without the help of Steven Chen. Thank you my friend.
Also, thank you to my friend Tiffany Chin who worked tirelessly to find us our perfect home. If you’re in the hunt for a home in Southern California, then I highly recommend you give Tiffany a call.
The key question: during a 30-year span, what gives you a higher return on your investment: buying a home or renting + investing in the market?
The key assumption: the alternative to buying a home is investing in the market — the down payment and the monthly income that you save from not paying a mortgage is invested in the market.
This will be a hands on activity. Take the following steps below to follow along and conduct your own research:
Step 1: create a copy of our spreadsheet
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- Click here to view our research spreadsheet
- Click on file => Make a copy
- Now you can edit your own spreadsheet and use your own numbers
Step 2: set your values for home ownership
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- Set the value of your home
- Set your down payment
- Use 20% as a minimum down payment amount
- 25% down payment will get you a much better interest rate
- Set your interest rate
- On January 2016, I was quoted a 4.15% interest rate for putting 20% down and 3.75% interest rate for putting 25% down
- Leave the terms to 360 months
Step 3: set your taxes, HOA fees, and maintenance costs
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- Set your state tax rate
- The tax we pay for our home in California is 1%
- I suggest checking online for the tax rate for your state
- Set your HOA fees
- We bought in Irvine, and they have the worst HOA fees :(. We have fees for the city, the condo, and the community. Yikes!
- Set your monthly maintenance costs
- Newer homes will have much less maintenance costs than older homes
Step 4: set the annual appreciation rate for your home and the agents’ commission fees
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- Set the annual appreciation for your home
- This is how much the value of your home will increase year-to-year
- According to this article, the price of new homes per square foot went up by only 4.2% annually from 1963 to 2008
- Steve and I used 2.5% to be conservative
- Expect to pay 5% – 6% in real estate agent commissions
Step 5: set the rent and market factors
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- Set the rent price
- Rent is difficult to estimate as the price will vary greatly throughout your lifetime. If you’re single, then rent prices will be relatively low; if you have a family, then you need multiple bedrooms so the rent prices will be relatively high. Do your best to estimate a starting rent price that is representative for the next 30 years.
- Set the annual rent increase
- We have rent control here in San Francisco and the rent increases from 1.2% – 2% on a year-to-year basis.
- Your initial investment will be equal to your down payment
- Your investment is the different between your monthly total (for owning a home) and your rent price
- The investment is how much you’re going to invest in the market on a monthly basis
- Set the average annual market return
- Steve and I use the agreed upon average rate of return of 7%
Ok, your research numbers are complete. Let’s dive into the analysis.
Analysis: buying a home vs renting
Note: the analysis is based on the default values Steve and I used to compare buying a home vs renting:
- Starting home value: $700,000
- Starting rent cost: $2,500
You take an immediate hit on your investment when you buy a home
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Immediately starting in month 1, renting + investing in the market beats home ownership by a substantial $40,702.
The culprit: the 6% real estate commission fees you pay when you sell your home.
If you rent instead of buying a home, then you’ll have $551,579 more in your bank account at the end of 30 years
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“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
– Albert Einstein
This is the beauty of compound interest — the money in the market (7% year-over-year growth) is growing faster than the value of your home (2.5% year-over-year growth).
If you hold on for 10 more years (40 years in total), then you’ll have almost $2,000,000 in your bank account!
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Let’s say that at the end of 30 years, you decide to continue living in your home because it’s completely paid off and now it’s like free rent! Sounds good in theory, right?
Well, because of compound interest, after 40 years, you will have almost $2 million more in your bank account. That’s a huge difference in your retirement!
Play around and customize your numbers
Your numbers will most likely differ greatly compared to the default values that Steven and I used. Real estate and rent prices differ greatly across states and cities. Share your numbers with us in the comments section!
Ok, now I’m sure you must be thinking: “if renting + investing in the market is so much better than buying a home, then why did you and Kim buy a home?”
Good question.
Ultimately, the Google Spreadsheet analysis can only give you an analytical, tangible-benefit analysis; however, it misses out on the emotional, intangible benefits of owning a home.
Furthermore, there are many personal, professional, and financial variables that one must factor into a decision to buy a home or rent.
Why Kim and I ultimately chose to buy a home
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There are so many reasons why we bought a home, but ultimately, it just felt right for us.
The neighborhood was perfect, the amenities were awesome, it’s a close distance to our friends and family, the elementary school is completely new and state-of-the-art, and most importantly, Kim has always dreamed of owning her own home, and like I always advise my friends: happy wife, happy life.