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Retirees, Should You Buy or Rent When Downsizing?

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You are empty nesters and you are thinking: Our five-bedroom family home sure seems a bit, well, large, not to mention a money drain. It's time to move to a smaller place. But now you need to decide whether to buy or rent.

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The idea of renting a house or apartment can be challenging for many longtime homeowners. Owning real estate "is hardwired" into the American psyche, says Rich Arzaga, chief executive officer of Cornerstone Wealth Management, in San Ramon, Cal. But, he says, "ownership is more expensive than people imagine." And it may be more important for many retirees to secure income from investments than to sink money into a new house.

Deciding whether to buy or rent when downsizing depends on many factors. You should estimate your cash-flow needs, and assess the relative costs of home prices and yearly rents for comparable properties in a community. You also need to make certain assumptions, such as for investment growth, annual rent hikes, and the costs of home maintenance, property taxes, and homeowners and renters insurance.

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Your decision will depend a lot on nonfinancial, emotional issues, as well. Do you love the idea of owning your own place and fixing it up the way you want? Or will it be a big relief after years of ownership not to worry about the lawn or a broken sump pump?

Darrow Kirkpatrick, 54, ran the numbers and decided that renting was a better option than buying when he downsized two years ago. Kirkpatrick, who retired as a software development manager four years ago, and his wife, Caroline, now 56 and a retired school teacher, sold their four-bedroom house in Chattanooga, Tenn., for $245,000. After traveling for six months, they moved to Santa Fe, N.M., to be near their son.

They rent a two-bedroom house for $1,450 a month and pay little in maintenance. Renting "makes our monthly expenses predictable," says Kirkpatrick, who writes a blog, "Can I Retire Yet?" (www.caniretireyet.com). "We don't get blindsided with roof repairs."

Renting also fits into their new lifestyle. The Kirkpatricks don't know if they're going to stay in Santa Fe for the long haul. "If it doesn't turn out right, it's relatively easy to leave," he says. Also, Darrow and Caroline drive around the Southwest often. They're not as worried when they leave the home for long stretches as they would be if they owned. "I have more peace of mind locking up and leaving," he says.

In making a decision, first consider how long you expect to stay in your new place. Renting may be the better choice if you're not sure where you want to settle long term. "If you're buying and selling a home every three to five years, renting is likely to be superior to owning," says James Ciprich, a certified financial planner with RegentAtlantic, in Morristown, N.J.

During these moves, you're paying real estate broker fees and closing costs -- and the house probably won't have time to appreciate to cover those expenses. Throw in some remodeling and the replacement of an appliance or two, and the equation shifts even more toward renting.

Ciprich recalled one client who moved from New Jersey and bought a home in Florida. She didn't like Florida and within two years she was back north. "She lost money on the sale of the house," he says.

Another consideration is your cash-flow needs in retirement, Arzaga says. "Renting will save you a lot of capital and lower your expenses," he says. For example, if you pull out $300,000 in equity from a home sale and it's invested at 6% a year, that's $18,000 in earnings the first year. Even after taxes, that can go a long way toward rent, he says, and your ownership-related expenses will "either go way down or disappear."

One important factor in Kirkpatrick's financial calculations, he says, was the "opportunity cost" of tying up his money in a house rather than investing it. He figured he could earn more on his investments than he would get in house appreciation, which has run an average of 5.4% a year since 1968, according to the National Association of Realtors. Meanwhile, the annualized return for Standard & Poor's 500-stock index was 10% during that period. And while many people think paying rent is a waste, Kirkpatrick figures that the expenses associated with homeownership are a lost cost.

Compare Your Options

To help illustrate these points, Arzaga ran some calculations for Kiplinger's Retirement Report. He looked at a hypothetical 65-year-old couple in the 25% tax bracket who sold a five-bedroom house this year and cleared $550,000 after expenses. He ran three scenarios: buying a $230,000 three-bedroom house with cash, buying that house with an 80% 30-year mortgage and renting a comparable three-bedroom house for $1,250 plus utilities.

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