
I’m about to become very unpopular by making a case for renting versus buying a house. The American dream is to own your home–your slice of the pie, and a popular way to become rich.
I’m saying that in San Francisco, in 2007, you can rent and not be throwing your money away. To understand how this can be true you need to compare apples to apples. Most arguments for buying a home in the bay area hinge on moving to a cheaper neighborhood, getting a fixer-upper, or paying twice your old rent. I don’t consider these fair comparisons.
To level the playing field I’ll look at the same apartment, same condition, in the same neighborhood, paying the same amount of money, and then look at selling out of your home in five years and see who ends up ahead, the renter or the owner?
If you bought an SF condo for $700,000 today, and sold for $900,000 in five years most would say you did pretty well… lived rent-free and earned a profit while the renter threw their money away. But I say the guy who rented that same condo for five years came out ahead! Impossible? Here’s how I figured it:
I found two comparable apartments on craigslist, one rented for $1,650, the other sold for $710,000. Both were 800 square foot one bedroom apartments, on a high floor with a city view, in an older restored building in good shape on the same street, seven blocks apart in essentially the same neighborhood. Both were good deals priced below average.
For the condo buyer I considered a $100,000 down payment, with 30-year 7% loan for a $4060 mortgage. HOA was given as $504/month, $10,650 property tax (1.5%), $13,000 closing costs and I’ll assume $3,000 annual maintenance costs. This brings the homeowner’s total annual costs up to $68,000 and if he qualifies for a maximum tax savings of $15,000 then his net annual cost is $53,000.
To make a fair comparison look at the renter spending the same amount for an equivalent apartment. The $100,000 down payment goes into a CD earning 5% or $5,000 annually bringing the total annual rent outlay down to $14,800. Now here’s the key ingredient, to normalize the two cases the renter should also pay $53,000/year. That’s $14,800 rent and the rest ($38,500) into some guaranteed cash investment.
That’s one way owners build home equity so fast, the huge mortgage payment. The equivalent renter also builds equity totaling $224,000 in five years at 5%. His accumulated monthly outlay was $267,000 so after five years he posts a total net loss of $41,000.
Meanwhile, assume the owners sell their condo for $910,000 five years later. Looks like a cool $200,000 profit, but wait. First, pay off the $573,000 loan balance then subtract the $380,000 paid over five years and you end up with a net loss $43,000. The renter comes out $2000 ahead even with the huge tax bonus the buyer earned.
I make a lot of assumptions and these numbers will turn out different in real life. I may also have made a huge miscalculation so let me know. If you lose your job or business slows down then not only is the mortgage gonna be tough but you’ll need to come up with an extra $15,000 to cover that missing tax credit, the double whammy! The market could rise at 25% a year like it did a few years ago and then the owner could pocket $1.3M on their sale, more than many people make in a lifetime! The renter never has exposure to that kind of a gain. But that’s like talking up the stock market because Google gained 600% in 3 years. Owning makes total sense in places like Texas or Michigan where a small down payment gets your monthly costs below the rental value and after 30 years you get to keep it, plus the huge lifestyle benefits of owning over renting no matter where you live. But there’s also a lifestyle hit in sweating a $5,000 monthly payment in an earthquake zone where no one has earthquake insurance. The point is sometimes renting may not be as bad as it seems.