We tend to think of buying a home as a mandatory part of the American dream. But despite the constant messaging telling us to buy, homeownership may be overrated. A lot of people who shop for homes would actually be better off renting.
We tend to overlook the historical factors that made homeownership so ubiquitous. Long ago, most families rented or (more rarely) built their homes. Since the New Deal era, the federal government has subsidized homeownership through loan guarantees and the mortgage interest deduction. This policy framework has greatly benefited the real estate industry, as well as millions of homeowners (particularly those who are already wealthy). But owning a home doesn’t make sense for everyone, and in some areas renting could be the smartest move.
(Full disclosure: I own my New York coop but I often wonder why—New York has great rental stock and regulated landlords.)
Renters Don’t Pay For Repairs
Here is one of the biggest joys of renting. When things go wrong, renters call the landlord. The stove breaks or the roof leaks—the landlord pays. The average annual cost of home repair and maintenance costs is typically something like 2-4% of the value of the home, and that doesn’t include thousands more in insurance and other costs.
What’s worse is that repair expenses don’t come in nice even charges. Depending on the nature of the repair, it can get quite costly in one year. Those tempted to skip maintenance are participating in the destruction of their own property.
Renters Get Nice Stuff Too Expensive For Owners
One of the most wasteful aspects of American life is the existence of dead pieces of capital that many of us own but use only 5% of the time. The two-ton car parked in the garage, the dusty gym equipment, the in-ground pool, the pricey washer and dryer: these consumer durables sit unused because you alone own and operate them. (Some people rent out their unused automobile capital with Lyft and Uber, but you have to apply your own labor to that.)
Who can own a pool? Answer: far fewer people than can open a fraction of a pool! As it happens, we typically only use a fraction of a pool. Luxuries such as a gym or a luscious garden come standard at many apartment complexes. Owning a home often means owning deadweight capital.
Renters Don’t Tie Up Their Money
Another advantage is not having to put up a huge upfront cost like a down payment. Although renters often pay a security deposit and first and last month’s rent, these costs are small in comparison to those made by owners. When purchasing a home with a mortgage, you’re required to have a sizable down payment far more than the renter’s upfront costs. If you put down a chunk of money, say $50,000, towards a down payment to buy a home, that is your asset. That $50,000 could instead be earning high risk-adjusted returns on a low-fee investment—say a Vanguard mutual fund—which is a lot more liquid and a lot less expensive to manage than putting all those eggs in one basket.
A note about prices: If the house you are looking to buy costs more than 20 times the annual rent the home could fetch, get the house may be overvalued. For example a $400,000 home should rent for $1,667 per month or more. If so, it is a good deal. This ratio is based on a price earning ratio of 20. In times of low interest rates the breakeven ratio can be higher, especially in areas with soaring home prices.
Renters Have More Bargaining Power at Work
You need to be able to credibly leave a job to be well treated by employers. Mobile workers can move for a pay raise or to make a career move. Monopsony power is tied to low mobility and anchoring yourself to a place just gives that power to the employer.
Renters can also live in neighborhoods beyond their reach, whereas home owners stay with their socio-economic spheres. Renters can live virtually anywhere—a tiny apartment in Greenwich Village or a townhouse in Queens. Homeowners are more restricted to neighborhoods they can afford.
Renters Have More Flexibility In Recessions
Some of the worst-hit families in the Great Recession were those who lost their jobs and were stuck in their homes. It was even worse if you had to sell assets in your 401(k) at depressed values to pay a mortgage for a house that was underwater (that is, where the mortgage was more than what the house was worth).
By contrast, renters can move to a cheaper place without the hardship of selling assets or paying a mortgage in a recession. Landlords bear the risk of financial hardship, but they are usually more able to plan and capitalize losses.
Renting Can Be Good For The Economy And The Climate
Renting is better for the earth than buying, thanks to better-managed properties and the sharing of amenities and capital. Since landlords bear the risk of utility costs rising during the term of the lease, they have an incentive to keep costs low through better energy efficiency.
Rentals are also usually smaller than houses, which keeps down insurance and utility costs. That said, renters do pay some portion of insurance costs because they are folded into the rent, as are property taxes. (A side note: Some people might think that a benefit of renting versus owning is that renters don’t pay property taxes. They do. Taxes are folded into the rent. There are good reasons to rent and not buy, but property tax is not one of them.)
The Bottom Line
Homeownership does have its merits, of course. Owning a home might be beneficial over the long run if the house price appreciates more than a diversified financial portfolio, or if people don’t have to move for their jobs or family, or if marriages last, or if neighborhoods and financial situations don’t change.
Crucially, the housing market is often segmented, meaning rental stock can be of lower quality for the same carrying costs as homeownership—in that case, buying might make sense. Some people really like to improve their homes and renovate, while your landlord will only make “necessary repairs.”
However, for those who want bargaining power at work, would like to avoid the hassles and financial uncertainty of homeownership, and don’t like owning so much durable consumer capital, renting might be a better option.
Leading Global Private Equity Firm 