Housing: Buy or Rent Calculator Part 2 of 2

In 2000, billionaire Nicolas “the homeless billionaire” Berggruen traded his New York apartment and private island for continual visits to 5-star hotels. This was likely a lifestyle rather than an investing choice, but it can be seen as an extreme version of the analysis I started in my last post on buying or renting.

When I first set about analyzing the issue, I wanted to give a definitive answer in favor of one side or another. However, there are too many factors at play. I’ve created a flexible excel model that allows your inputs to compare the payoff from buying and renting. Download it by clicking here:

Buy vs. Rent Calculator 10.26.12

The model compares the projected value of two portfolios:

  1. House equity — House Value less long-term debt.
  2. Investment portfolio — The expense saved from renting instead of buying is instead contributed into a stock market portfolio.
All assumptions can be adjusted on the third sheet. Sheet 2 gives a detailed look at the cash flows on all projected months. The first sheet graphically shows the value of each portfolio over time.
By default, I have a fifteen year mortgage analyzed for 30 years. With the default assumptions, the stock market portfolio can easily pay for the saved rent after the house is paid off. However, the appreciated value of the house makes the first portfolio worth far more. With the default specification, “buy” beats “rent” under every time horizon. However, if your individual situation merits different assumptions, then the forecast may change.
If you play with the model, you’ll quickly realize that it is extremely sensitive to changes in the house appreciation rate. If you are confident you’ll experience capital gains, then buying is usually a solid investment. However, you shouldn’t rush into a home purchase just because an excel model showed that buying was marginally better. If you get stuck in a bad location and are unable to sell the house for a profit, then the decades of reduced liquidity were for nothing.

Housing: Buy or Rent Calculator Part 1 of 2

Many Americans allocate the majority of their household’s assets into their home. Deciding whether to rent or buy isn’t just a lifestyle choice, it’s an investing decision that should be approached with as much caution as choosing the right stock.

The primary benefit of buying is that you retain the principal of your mortgage payments. All rent money is sacrificed to the landlord. Additionally, you might profit from any appreciation in housing prices.

Renting, however, is not without its benefits. Renting requires no down payment and is usually substantially cheaper per month, even before considering the additional expenses of home ownership (maintenance, insurance, HOA fees, property taxes, etc). Assuming one was financially secure enough to afford the house, the additional savings from renting can instead be placed into another investment, such as the stock market or a personal business, from which one might expect a higher return.

While higher returns from the market aren’t guaranteed, as 2008 showed us, neither is house price appreciation. Even in normal times when house prices are steadily marching upwards, house prices in certain areas may be drastically declining. Furthermore, while the median house sold has increased in price over the past five decades, the median house sold has also become larger, newer, more modern and more comfortable. Individual houses owned by a single owner become larger and more modern only after large capital expenditures, and they never become newer.

But even if the returns of the stock market might be higher with less overhead, that doesn’t mean that one will make more money from investing in the stock market. Real estate is not only an investment, it is a leveraged investment. A 2 percent annual house appreciation is applied not just to the down-payment but to the entire value of the house. Most Americans cannot achieve that level of leverage in the stock market. As long as the house value increases, it is a definite benefit.

Considering all of these factors, is home ownership a worthwhile investment? This is a quantitative question that I can’t answer with qualitative arguments. In my next post, I’ll share an excel workbook that you can customize with your specific situation.