investing

Sometimes Renting Is Better Than Buying

A home is an asset that generally appreciates in value, but it might not be the most optimal way to build wealth from an investment point of view.

My life as a renter is well known to my colleagues and friends, and even to Kiplinger readers (see "How to Negotiate a Break on Rent"). And while my previous attempts at rent negotiations didn’t succeed, I eventually ended up moving into a different (and bigger) unit in the same complex at a cheaper rate. However, as I watch my friends go through the home-buying process, it makes me question whether I’m throwing away my money and the wealth-building potential of owning a home. 

Personal finance experts have long held that homeownership is a key step to building lasting wealth. A home is an asset that generally appreciates in value over time, and buyers also benefit from leverage: You can borrow up to 80% of the value of a home, or even more with a low down payment loan.

Before individuals had access to low-cost mutual funds and brokerage accounts, the stock and bond markets were limited to institutional and deep-pocketed investors. For everyone else, buying a home was the primary way to invest, says professor Ken Johnson, of Florida Atlantic University, who specializes in rental housing and real estate market research. Johnson is also the co-creator of the Beracha, Hardin and Johnson Buy vs. Rent Index. The index analyses 23 U.S. metropolitan areas to determine whether market conditions favor renting or buying in terms of wealth accumulation. 

In a recent update, the index concludes that in 17 of the 23 metropolitan areas, including Atlanta, Los Angeles and, surprisingly, Detroit, consumers would be better off renting and investing the money they would have used for a down payment, closing costs and other housing expenses—even though rents have skyrocketed. The median home sale price in the U.S. hit about $429,000 in late April, and 30-year fixed mortgage rates recently rose to 5.27%, the highest since the summer of 2009. Over the past 10 years of bull-market returns, the S&P 500 index has increased 11.7% on an annualized basis, compared with a 7.9% annual rise in home values.

How to Rent Strategically

For renting to deliver a higher return, you need to have enough money left after you pay your monthly rent to invest. And that comes down to personal choices.

For example, if you would be happy with a one-bedroom unit, pick that over the pricier two-bedroom unit, or skip the complex with the pool. 

Or, if you’re like me and live in an expensive metro area, you may choose to save money by living outside of the city. Even with my rent increasing $50 a month in August, it’s still cheaper than rates for closer-in apartments in the Washington, D.C., area. I have also forgone some amenities, such as a pool, in-unit washer and dryer, and up-to-date appliances. This isn’t to say that I am not comfortable in my apartment—I can entertain groups of friends, and there’s plenty of sunlight for my plants—but the lack of these amenities keeps my costs in a range I’m comfortable with. 

In addition to these types of trade-offs, renters need to get in the habit of saving. Pay yourself first with automatic transfers from your checking to your savings or brokerage account. If you have access to a 401(k) or other employer-sponsored retirement plan, contribute as much as you can.

While I’m currently focused on paying down some credit card debt, I have a nice chunk of money invested in my retirement savings accounts. Once I pay down debt, I plan to increase the amount I’m investing in those accounts, and I’ll continue to review whether home buying fits in with my long-term wealth-building goals

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