Rent or Buy Your Next Home?

Blog by Arnold Shuchat | January 29th, 2013

Over the last few years when real estate prices were most often consistently rising, I could not help but think that perhaps we as a family ought to sell.  Wasn't almost 300% good enough?  It seems that it was easier to advise clients to do this than to do it oursleves. "Where are we going to move?", and "I'm not renting again" were the responses I got.  "Stop thinking of the house as a financial instrument...., it's where we live".  We rented for almost 7 years until I felt it was time to buy around 9-11. Sometimes, as a family the decision to purchase or sell is not solely a financial one but carries with it emotional components which are often tied to the phase of life the family is in.

With all the market chatter about where the market is going, it is difficult to be certain of what to do.  I don't think I would be prepared to speculate on property right now.  But what if I needed a home?  Would I rent or buy? Buying when you live in the property is not speculative.  It is a hedged transaction with you as the tenant. 

I think a fair approach would be to try and get a handle on what the next 5 years might look like.  One aspect easy to calculate is the comparison of the cost of renting vs. buying on a monthly basis.  I start this example off by assuming that I am prepared to rent a home for $2,700/mo or pay the same amount towards a mortgage at 3.1% for a 5 year term.  Right now with a 25 year amortization period, over 5 years, approximately one-half of all the mortgage payments will be applied to the principal amount of the loan. Looking at a mortgage amount of about $565,840 applied on the purchase of a home worth $950k about $82,505 would be paid off over 5 years, or 8.6% of your home's value. Leaving transactions, maintennance and opportunity costs aside, to equivalent this with renting, the market would have to decline by 8.6% before you would feel you might have been better off renting. Of course, the level of upgrades in a house will impact the decision financially.

Looking back over the last 10 years, the worst drop we had locally on single family home prices was in 2008 where Europe's debt crisis and the Wall St. junk brought us down about 14.5% in about 8 months.  The last 8 months from Richmond's single Family Detached Housing Price Index Graph looks more like a decline of around 8%.  However, from the field, it feels like in the most recent case, that the 8% number is an understatement.  I have stated in the past on this blog that I have felt the true number is closer to 25%.  Although the statistics don't bear this out, were you to ask a Richmond homeowner who watches the housing market, he would likely tell you that the decline feels more like the higher number than the lower statistical one.  I think the 25% number reflects the fall from the highest point of what the expected selling price could have been to the realistic selling price one could obtain today.  Looking forward, the question is whether we might see another equal or greater decline.

It would be great if I could answer that definitively.  But I cannot.  I think the trick in markets such as this one is to realize that the reported statistics are averages.  Within those numbers there are those that sold too low and other that paid too much.  But with all the uncertainty out there, there will be sellers who will "cave" just to lock in some of their gains from the last decade, and some will cave even more.  Just as the fellow on my street who flipped a property since June of 2012 for a tidy profit of $140k, there will be bargains in this market.  To get one of those, you need to be shopping in an uncertain or perceived declining market.  If things turn around, the deals are off and the bears once again become pigs. Furthermore, in years past, I have to say that the selection was not great.  In this market there is alot more to choose from.  

So, if you think that in 5 years, market prices will be higher than approximately 8.5% below where they are now, then from a simple financial standpoint, leaving aside transactions and maintenance costs, emotional and family needs, you could start to consider a purchase. If not, renting might be a better option for you. Whatever your decision, I would caution that you make it based on housing needs and that it not be speculative in nature.  I think that for the time being we are well past the point of blind real estate speculation and as a market we can actually feel the absence of speculators.