By: Dividend Sensei
Renting Is Actually Much Cheaper
Buying a home shouldn’t necessarily be thought of as an investment but rather a forced savings plan. Over time your mortgage payments pay down the loan and you gain equity. And assuming you own the house long enough (say the full 30 years on the mortgage) then you should at least not lose money over time. But since everyone needs housing isn’t it true that housing should be thought of as a utility? Something you need anyway and so is a better alternative than renting? While for some people (depending on your circumstances) this may be true for disciplined people it’s actually not.
How Much More It Costs To Buy Vs Rent
According to NerdWallet in 2017, despite fast rising rental prices, it was cheaper to rent the same sized home than to buy it in all 50 states and DC by an average of 54%. How much cheaper? That depends on your location. In Florida it’s 33% cheaper to rent, while in New Jersey buying will cost you 93% more. NerdWallet has a great calculator that lets you determine how long you’d have to live in a home before it becomes profitable for you (not accounting for maintenance, property taxes, closing costs, realtor commissions, mortgage fees, etc).
For example in Sarasota Florida a $250,000 home, with a 20% down payment and 4.6% 30 year fixed mortgage becomes more profitable than renting after six years. To account for those fixed costs a good rule of thumb is to double that figure (in this case buying is better starting at about 12 years). In Trenton, New Jersey however? That same $250,000 home with the same terms doesn’t break even on price (vs rent) until 10 years, and about 20 years accounting for all fixed costs (including very high property taxes). What about some other major metro areas?
As you can see in America’s largest metro areas the breakeven point for renting vs owning usually ranges from 12 to 16 years. This means that for buying a home to be the best option the average person must commit to staying in the home for at least 11 years, and in some cases (like in New Jersey) 20 years.
Ok so for most people renting for a decade or less may be cheaper in terms of costs. But how exactly is not buying a home going to actually help you financially? After all if you stay in the same home for 15 years you’ll at least break even on housing costs in most places and you’ll have built up a lot of equity. Renting gets you no equity so must be the worst choice right? Well that’s where the awesome compounding power of the stock market comes in.
Why Renting Is Always More Profitable For Disciplined Investors
So let’s use the national averages to determine just how renting can be a huge help in meeting your retirement goals. According to the US Census Bureau’s American Housing Survey in 2015 (latest available data) the median cost of owning a home (including mortgage, maintenance, and property taxes) was $1,492. In comparison median rental cost was $972. That means the median monthly savings of renting over buying amounted to $520.
Assuming you were to invest those rental savings each month into a low cost S&P 500 ETF (like VOO) and then achieve the market’s historical 7.0% inflation adjusted annualized return (since 1871) then over the course of a 30 year mortgage you’d end up $630,000 richer.
And if you use a highly diversified, low risk, value focused dividend growth portfolio (like what I’m using to fund my own retirement), then you can do even better. In fact investing the rental savings can mean an extra $1 million or more for your retirement over time. And keep in mind that the portfolio would be paying approximately $40,000 per year in dividends, which would be growing at about 8% adjusted for inflation. But of course these calculations assume that you are disciplined enough to take a buy and hold approach to those savings. Americans are notorious for not saving enough and attempting to time the market, which is why most investors achieved about 2% annualized total returns over the past 20 years according to JPMorgan Asset Management.
This is why, while suboptimal, home ownership might actually still be a good option for many people. In my next article I’ll explain how you can use the forced saving discipline imposed by owning a home to help you fund your retirement. A strategy that works better for anyone who doesn’t feel comfortable with the my “rent and invest the savings in stocks” retirement plan.