Since the dawn of mankind, the question has raged – should I buy or should I rent?
Okay, maybe the question had been debated slightly less longer, but it is a hot topic these days. Plenty of analysts will crunch numbers and show you a seemingly simple rent versus buy index result explaining why renting on the West Coast or in Manhattan is the better decision while buying in the Midwest or the South is the better choice.
It’s not as simple as those number-crunchers would have you believe. It’s not as simple as comparing monthly rents to mortgage payments for similar units or houses. Let’s see what those widely-used indices don’t indicate:
- Duration – conventional wisdom has always been that if you plan to live in a place for less than five years, renting is better; if puchasing, it takes at least five years to offset transaction costs. However, because of the recession, prices are purchase prices are so low that buying looks good for as few as two years.
- Future pricing – which will experience higher increases during your time living in the new place, rents or home values? June 2012 rents were up over 5 percent compared to a year ago, while home values were up only 0.2 percent over the same timeframe. In this case, buying might be the better move, especially once values stabilize and rents continue to skyrocket.
- Tax considerations – while tax breaks probably aren’t a dealbreaker when making the rent vs. buy decision, but deducting property taxes and mortgage interest are nice bonuses.
- Maintenance – this is a double-edged sword. On one hand, you remodel, paint, or landscape as you wish; on the other hand, burst pipes, termite infestation, and clogged sinks will all cost the homeowner.
- Transaction costs – while the down payment is the main upfront cost, there are other, less upfront costs (such as closing costs, setup fees, inspections, homeowner or mortgage insurance, among others) that can have an effect on your monthly mortgage. They can also affect how much money you’ll have to have saved before you start house-hunting.
The problem with traditional price-rent ratios is none of the above is taken into consideration when computing the indices. They also don’t take into consideration things such as quality of home (rentals are usually of lesser quality).
As a result, Zillow has introduced a new way of comparing rent vs. buy called the “breakeven horizon.” Simply put, it calculates how many years of owning a home it will take before it’s more financially advantageous than renting the same home. In addition to computing the above – such as tax benefits, maintenance costs, etc. – it also figures in utilities, and expected home value and rental price appreciation.
Potential buyers might consider this new metric of more use because it’s more comprehensive:
- It includes all relevant information
- It’s more intuitive than the other, more abstract ratio
- It allows buyers to target specific cities or metro areas, especially if they know they want to buy.
- For buyers who aren’t sure whether they want to buy or rent, but know where they want to live and for how long, this offers guidance.
As an example, a comparison of two cities – one in New Hampshire and one in Georgia – finds exact price-rent ratios (15.3), but the Georgia city’s breakeven horizon is 2 while the New Hampshire city’s is 6. To major reasons why are the differences in property taxes between the two areas and the differences in rental and for-sale inventory being used to compute the price-rent ratio.
In sum, the question of whether to rent or buy is simple. The answer, however, isn’t. There simply are too many factors to consider, so why not use a metric that incorporates more of these factors?