Why Own When You Can Rent?

You see the ads everywhere, and the idea seems at the core of American culture. Talk to any Realtor and you’re bound to get a half dozen reasons why owning is better than renting. The Searchlight Crusade has a whole series of persuasive articles arguing that now is the best time to buy in San Diego. Implicit in his analysis is an estimate of future appreciation rates, which are anybody’s guess.

I used to own 4 houses. My parents have been part-time real estate investors since I was a young kid. I guess, at bottom, I buy into all this “buy versus rent” crap, myself, as I’ve recently been seriously thinking of buying something—anything—so that I’m not just “throwing my money away.”

But, really, is it true that owning is always and everywhere better than renting? It seems a foregone conclusion that buying a home in Phoenix in 2000 was a good idea (though at the time, of course, things were far from clear-cut). What about now? Sadly, certain knowledge about the future is impossible. Nonetheless, it seems unlikely that the price trends of the past 6 years are going to continue unabated.

There is, however, another way to look at the problem—one that doesn’t require gazing into crystal balls or reading tea leaves. It’s a “back of the envelope” technique that you’re also not likely to learn from your typical Realtor or real estate guru, either, even though it can tell you quickly and unequivocally whether a given property is a “good deal” or not.

In a nutshell, the idea is to take a property you are interested in and compare the monthly cost of renting it with the monthly cost of owning it at 80% LTV. If it’s cheaper to rent it then the house is overpriced. If it’s cheaper to own it, then buy it!

Let’s take a look at some actual Phoenix area properties and see what we find.

Here is a home in Avondale renting for $1,150/month. A substantially similar home down the street sold in January for $255,000. Monthly housing costs as an owner for this home, then, would be $1,583 ($1,263.00 principle and interest payments on a $204,000 loan at 6.3%, plus $55 HOA fees, plus $70, plus $195 taxes).

In other words, if you were to put 20% down on a house in that neighborhood with the intent to rent it out, you’d be subsidizing your renter to the tune of almost $5,200/year—and that’s before any expenses.

One hopes that the owner of the actual rental isn’t faced with such a situation. However, what can be said with certainty is that their return on equity is unacceptably low—unless the property’s value is appreciating a lot faster than $5,200 yearly. This was the case the last few years, but who can say it will continue that way much longer?

Here is a condo in Phoenix renting for $1,190/month that would cost you $1,462/month ($1,219 monthly payments on a $197,000 loan at 6.3%, plus $135 HOA, plus $108 taxes) to own. Were you maybe wondering why there were so many condo conversions recently? There’s your answer. What apartment building owner wants to lose $272/month on every unit they own? What could you do with an extra $3,300 a year?

Suzette wants to “make a deal” on a lease-to-own condo in Chandler—with a current asking price of $264,000. Let’s be generous and assume a market rent of $1,300/month. In that case, any “deal” that involved paying more than $220,750 would be a bad one (unless you’re Suzette, I mean).

Here is a 3 bedroom house in Scottsdale you can rent for $1950/month today. To buy it today, on the other hand, would cost you $2,602 a month ($2,352 principle and interest payment on a $380,000 loan at 6.3%, plus $100 insurance and $150 taxes). Whoever ends up renting that place should kiss their landlord’s feet, as they are basically being given a $7800/year gift.

What can we take away from this analysis? First off, I think it’s fairly clear that pretty much no one in Phoenix is making money as a landlord right now (I mean to say: specifically when calculating a return on equity). Secondly, people who say it’s a “buyer’s market” don’t know what they’re talking about. Thirdly, something’s gotta give! There’s no way real estate investors are going to continue to lose money hand over fist over the long term. Either housing prices have got to come down or rents have to go up. I imagine that the future is going to see some combination of those two things.

Meanwhile, I’m gonna keep renting—and putting the money I’ll be saving into something likely to provide a much higher return.