There’s a lot of debate on whether it’s better to rent or own. If you are a renter, I’m sorry to say the return on rent is always negative 100%.
After years of renting, you will have nothing to show for your money. Whereas if you own, at least you have a chance of growing your net worth through greater home equity. And based on the history of real estate appreciation, your chances are really high you will build wealth owning.
I remember when I bought my first 2/2 condo in 2003. I felt a sense of relief that I no longer had to pay ever-rising rents. Even though the $2,300/month mortgage payment was about 15% higher than my previous rent after a 25% down payment, it felt good knowing my costs were generally fixed.
What I’ve recently realized is that many homeowners over the years have not had to pay a single penny for housing costs. In essence, they’ve lived for free! Not only have the lived for free, thanks to tremendous home price appreciation, homeowners have also made a tremendous amount of money as well.
Let me show you how homeowners have lived for free with an example. It doesn’t involve mooching off your parents as an adult child.
How To Live For Free In An Expensive City
Here’s the profile of a 3/2 home that was purchased for $1.3 million in 2011 and sold for $2.2 million in early 2019. He put down 20% and took out a $1,040,000 mortgage at 3.5%. Below are some approximate numbers to highlight the power of homeownership.
Financial Positives Of Homeownership
- Monthly rent avoided for eight years: $5,500
- Total rent avoided after eight years: $528,000
- Net proceeds after fees, principal pay down, all taxes from selling house: $1,100,000
Financial Negatives Of Homeownership
- Opportunity cost of not investing $260,000 (down payment) in the stock market from 2011 – beginning of 2019 = $286,000 (110% appreciation to $568,000)
- Net mortgage interest cost after eight years = $203,000
- Net property taxes after eight years = $90,000
- Maintenance cost after eight years = $20,000
- Principal pay down over eight years = $100,000
Net cost of living = ($528,000 + $1,100,000) – ($286,000 – $203,000 – $90,000 – $20,000 – $100,000) = $929,000.
Based on this simple math, not only was my friend’s family housing free for eight years but he was also paid $929,000 to live in San Francisco. That’s pretty good value for just living.
Obviously, experiencing a 69% appreciation in his property was a big factor in this equation, but so was not having to pay $528,000 in rent during this time period. Further, one can debate whether paying down $100,000 in principal is truly a negative.
Even if the property only appreciated by 3% a year, my friend would still have been paid over $480,000 to live in San Francisco for eight years.
This example is probably similar to hundreds of thousands of homeowners over the years. Now compare the return on rent. There is no comparison.
Related: Reinvestment Ideas After Selling A House
How Much You’ll Spend On Rent In Your Lifetime
Check out this chart about how much money you’ll spend on rent for a median-priced home in various major cities. The calculate is based of about 10 years, 20 years, 30 years, and 40 years of renting. The figures clearly show the return on rent is always negative.
It’s kind of crazy to see that a San Francisco resident would pay $2,468,000 in rent for a median-priced property by the time he or she turns 60. If you see this figure and live in San Francisco, your goal should be to buy your primary residence as soon as you can based on my 30/30/3 home buying rule.
Is your city on the list? If not, add up how much you’ll end up spending on rent for your desired property if you never buy. I don’t think you’ll like the results.
With such massive amounts paid in rent over one’s lifetime, is it no wonder why the desire to buy property is so strong?
I’d love for property prices to decline by 20% so I can snap up another Golden Gate Heights panoramic view property in San Francisco. Alas, unless I get really lucky, another investment property is not in my cards.
Takeaways On Living For Free Through Homeownership
It is amazing that many homeowners have been able to live for free all these years. With the housing market heating up because mortgage rates have plummeted and so many people working from home, housing has become an extremely attractive asset.
Here are some takeaways from this post:
1) The return on rent is always negative 100%.
Yes, you get a place to live, but if you buy, you also get a place to live. Once this variable is canceled out, what’s left is the owner’s optionality to sell the asset. Who said high school algebra was a useless course.
2) It’s easier to invest in real estate than stocks.
Although buying a home is making a concentrated bet with leverage, buying a home may ironically be easier than investing the same amount of money in the stock market. This is because you’re buying a tangible asset that may improve the quality of your life. With stocks, there is no utility. Further, prices could decline out of the blue.
Given real estate is less risky than stocks, you can ironically make much more from real estate than you can from stocks.
3) Real estate helps with financial discipline.
Renting and investing the difference in the stock market and other assets is a great idea. Unfortunately, most people often fail to do so due to a lack of financial discipline. Without a proper automatic invest strategy in place, chances are high the saved difference gets spent.
4) Time is your friend when it comes to owning a property.
Over time, the cost to rent rises to barf-inducing levels. Meanwhile, the appreciation of a property also sometimes rises to unbelievable levels. The only way you can survive as a renter is if rents stay flat or go down. Unfortunately, inflation tends to always push rents higher.
Rising rents and rising property prices will crush your financial progress. Therefore, it’s important to at least get neutral real estate by owning your primary residence. You can also relocate to a lower cost of living area.
Large rent increases won’t last forever. However, homeowners should hold onto their rental properties to benefit from rising rents.
5) To live for free, you’ve got to take risk.
Staying in a rent-controlled apartment is somewhat akin to working at a safe day job with no upward mobility. You’ll likely never starve, but you’ll likely never get rich either given the return on rent is -100%.
If you take some risk by buying real estate, you might do very well just like if you decided to start your own business or hop to a different employer. Alternatively, you might go bankrupt if you buy inappropriately. At the end of the day, no risk no reward.
6) Living for free strengthens the real estate market further.
Living for free is another phrase for rising home equity. The more home equity there is, the larger the buffer in case of a recession. Given lenders have significantly tightened their lending standards since the 2009 financial crisis, only the most credit worthy borrowers have bought homes.
When you combine high credit worthiness with record high home equity and low mortgage rates, it’s hard to see another crash in home prices again. The best we can hope for is a 10% – 15% decline window before another recovery.
Arbitraging To Live For Free
Once you own your primary residence, you won’t truly know until after you’ve sold your property whether you lived for free all those years or not. In the meantime, you can make educated estimates every year about whether buying or renting made more sense.
If you really want to live for free in the present, you’ve got to figure out a way to make investments that will produce income. Once you’ve got enough passive income to cover all your housing expenses, you are living for free.
The concept of Buy Utility, Rent Luxury (BURL) is one logical strategy. You basically rent in a high cost of living area and invest in real estate in a low cost of living area with a higher rental yield to cover your rent. This can be done through a speciality REIT or through real estate crowdfunding, where I’ve got 18 different commercial real estate investments.
Aggressively saving money on the short end of an inverted yield curve to cover your longer duration borrowing costs is another strategy, especially when the yield curve is inverted.
But the easiest strategy is to simply not rent for life. If you rent for life, you are going to look back 30 years from now with regret. Your kids will also likely hate you for not buying so long ago.
If you’re not willing to build assets for yourself, at least do it for your children. Just make sure the numbers make sense and you can withstand downturns.
Real Estate Recommendations
Now that you know the return on rent is always negative 100 percent, I suggest you buy rental properties. The value of rental income has gone way up. Low interest rates mean more capital is required to generate the same amount of income.
I’ve bought another rental property during the pandemic because I found a good deal. I’m also building a real estate portfolio for my kids to manage, just in case they can’t find gainful employment.
In addition to buying rental properties, you can invest in real estate crowdfunding through Fundrise. Instead of needing to come up with a big down payment, you can invest as little as $500 into a diversified real estate fund. You’ll generate passive income and diversify your investment exposure. For most people, investing in a diversified eREIT by Fundrise is the smart way to go.
If you are bullish on the demographic shift towards lower-cost and less densely populated areas of the country, check out CrowdStreet. CrowdStreet focuses on individual commercial real estate opportunities in 18-hour cities. If you have a lot of capital, you can build your own select real estate fund with individual properties.
Both platforms are free to sign up and explore.
I’ve personally invested $810,000 in real estate crowdfunding across 18 properties to earn income 100% passively. To build wealth, you must invest. Otherwise, inflation will eat away your purchasing power.
For more nuanced personal finance content, join 50,000+ others and sign up for the free Financial Samurai newsletter. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009. Everything is written based off firsthand experience.
The Return On Rent is a FS original post.
These numbers seem high to me, at least for my city. If one rented from age 22 to 30, it would mean an average rent of $1074 a month. I don’t know anyone here who was paying that much in rent a month let alone that age group- most people in that age group get a room, pay $5 to 700? Totally possible to pay similar for a studio if you look around. I paid between $400-550 for a room or small studio in the 2010s. In 2017-18 paid $650/month for a small 1 bedroom (jr 1 bed) in Chinatown, $400 for a room in NoLibs in 2019, $575/mo for a TINY studio in Fishtown in 2020. There are parts of the city you could rent a whole house for that much.
The other thing to think about is rental arbitrage. When I had the Chinatown studio I regularly rented it out on AirBnB because it was close to the convention center and a couple larger music gigs. I would occasionally crash at a friend’s (or be travelling myself) but usually stayed in a cheaper airbnb somewhere. Made like $10k that year. Would have done it in Fishtown last year but, covid.
Anyway some thoughts.
The Return on Rent isn’t always zero.
The return on rent is the difference between a mortgage and the rent cost, invested in your favourite investment, essentially dollar coast averaging (DCA). For me, this is DeFi, where I expect minimum 20% per year on cash equivalents.
The comparison is against whether than is better than the capital gain you will receive on a house that you live in minus it’s financial drag (interest payments, maintenance, rates etc).
The house you live in it is not an investment unless you have tenants. You can not compare renting to an investment property, because you still have to live somewhere. Mortgage repayments are just forced savings that you can’t invest.
In most circumstances, this DCA strategy grows quicker than the equity in the house that you live in.
Financial Samurai says
Bob, you can tell yourself this, but you would only be lying to yourself. You gain ZERO equity/wealth when you rent. There is no guarantee building wealth owning either. However, at least there is a chance.
Just like shorting the S&P 500 long term isn’t a good idea, shorting the housing market by renting long-term isn’t a good idea as well.
You’re neutral real estate if you own your primary residence and that’s it. If you want to go long real estate, you need to buy rental properties, REITs, and or private eREITS.
“3/2 home that was purchased for $1.3 million in 2011 and sold for $2.2 million in early 2019.”
“Net proceeds after fees, principal pay down, all taxes from selling house: $1,100,000”
Something got distorted in edits of this article, or your simple math was too simple, or the way you adjusted the figures is confusing.
2.2 – 1.3 = 900k. Subtract another 100 in selling costs. 800k in gains is 300k in taxable income if he’s married, and 550k if he’s single for more than 3 of the last 5 years. The bill on that is at least 25% in CA.
20k in maintenance costs for 8 years on an San Fran 3/2 is not realistic. Maybe if it were new construction, but at 1.3 that would likely make it a condo, with HOA fees that terrify. You also gave a healthy tax deduction for the mortgage interest and property taxes. Applicable to the time, but non existent in the current tax laws where SALT is limited to 10k and the personal exemption got absorbed into the standard deduction.
Last, 2011-2019 was a near best case scenario. i did the same, buying at 800 in late 2012 and selling for 1425 in early 2019. Net gain was just under the 500k exclusion, so zero tax bill to me, and quite a profit considering my PITI was less than the combined rents of myself and my now wife.
The long term history of SF suggests market rents increase at 5%/year, or double inflation. In the decade+ picture, your thesis is well maintained, esp with the lower interest rates of this century. If you can swing the down payment and you want to stay here long term, you’re pretty damn happy after the first decade. Your costs have barely moved. The market renter downtown saw rents go up more than 100%. A renter in a rent controlled apartment also like his rent after 10 years, but only if he’s still happy in the quality of the apartment. There aren’t rent controlled SFHs, and newer apartments are also subject to market rate increases. Just as owning has opportunity costs, so do the tin handcuffs of an apartment. And should the owner ever Ellis Act you, or there is a fire or other disaster, suddenly your cost of living might triple or more. You better be banking that cash flow.
Financial Samurai says
Sorry that it is not more clear. Please re-read the section again given the use of a mortgage and paying down principal over the eight years of ownership. Those are the big items you are missing from your calculation.
However, you are free to calculate the returns however you want as there are no set variables.
Buyside Hustle says
Don’t completely agree with this if you are young, live in a large city and want to retain flexibility to move to other cities for your career.
Take NYC for example. If you factor in taxes, insurance and the very high maintenance fees, the math does not work out unless you assume the property appreciates in value. Cap rates are so low in these cities that it makes more sense just to rent.
That said, if you can buy in downturns like 2001/2002 and 2009/2010, then it absolutely makes sense to buy.
Mindy Jollie says
Yikes, that table with the list of rental costs in each city for each age is frightening! That’s far more money than I was thinking in my head. I see your point about finding a way to buy property as soon as possible! I’ll have to look for a property or get a realtor to help.
A.J. Shannon says
To quote Uncle Lou* – “Its amazing what a little time will do”. He meant this regarding investing in the stock market and in a positive way, but the same could be said about the down side of paying rent.
* Louis Rukeyser – the host of Wall Street Week on PBS every Friday night in the ’90’s.
Santos Capital says
Buy a property in the city then have it rented out while you move to the suburbs and pay a lower rent.
I apologize if this question has already been covered in the comments (I confess I skimmed the bottom half of them). The market seems very hot for sellers in Newark, DE where my boyfriend and I are looking. Currently renting in an odd house (kitchen in the basement?) with the rent reflecting the unique layout of the house. At this point I would like to buy because I want to have a dog and it seems very difficult without lying to have a dog in a lower cost rental. This is a college town and I understand the perceived fear of irresponsible college aged students with large dogs causing property damage or problems with neighbors. I’m concerned the housing market will turn soon, in less than five years, and leave us underwater on a mortgage. We could have the 20% down payment in a year but it would drain the majority of our savings (not including my retirement funds). I also have concerns about the real estate management company raising rent.
What would you recommend in my situation? Start looking for a house? Start looking for a different pet friendly rental? Keep saving coins and wait for a change in the market? Or all of the above?
I was in the same situation that you are now, 3 years ago. After renting for 15+ years in different countries we (myself and my husband) decided that we needed to make a change. At that time we were living in a new 120m2 loft.
Unfortunately, despite of another reader’s reaction, 120m2 was too much space for us – not to mention the monthly utilities costs when living in lofts with high ceilings!
On top of that the rent was €1700 +parking €75 + all the other costs. The landlord did not want to sell either in the near future. :)
We were then faced with a dilemma. I wanted the same modern Scandinavian finish in a smaller apartment. We could not afford to buy a loft and could not find anything smaller to my taste without doing some work.
On top of that, as I have my own business – I did not have time to follow up with potential renovations. Time is money and being away from my desk is a loss.
The only alternative option for us was to buy a 70m2 apartment that was being built at that time. We had 210k from the bank with a 2.2% interest and a monthly pay back of €900.This was a significant lower figure for us, from the initial €1700 we paid for rent.
I used an extra 20k from savings to get those high finishes on quality materials and all A+ appliances.
The other day a friend of mine asked if we are interested to rent, and made an offer of €1200/month + charges.
1/2 years later, the apartments that are built now in the same area as we are, sell for €240 k for the same m2 and basic set up.
Was this a good choice financially? I am not as financially literate as some readers here.
What I know for sure is that we now have a place that we call “home”, looks great and it fitted with our personal circumstances at that time.
Perhaps I should mention we live in Brussels.
Apologise for the language mistakes, EN is my third language. :)
Han Truong says
Currently renting in NYC and 50% of my income goes toward rent. I make ~$2400 per month and my portion of rent in a shared 3bed2bath is $1200. In the back of my mind, I always knew that paying so much for rent is not financially logical but my justification is living in NYC >> suburb of northern Virginia with parents. To my best effort I have managed to put ~$3000 in a 2.1% APY savings account. I’m debating on whether I should invest the $ with a roboadvisor service or maybe Fundrise. Alternatively I could leave the savings where it is for a rainy day. What do you think would be a good decision for my situation?
Steven Polit says
A recent release from ATTOM Data solutions, a property data provider, shows that the median home prices are unaffordable to wage workers in 71% of U.S counties. This startling conclusion was reached by comparing wage data from the Bureau of Labor Statistics to the income required to meet mortgage expenses on a median priced home.