the 5-year rental
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Viewpoint 04/21/2010
the 5-year rental
Buy, or rent? Historically there hasn’t been much debate about it; buying was better, and people who rented were sometimes looked at as having some sort of flaw. But the times they are a changing. Today I can make a pretty good argument for renting, at least in certain situations.
Any decision regarding Buy vs Rent will involve a combination of three primary factors: Financially, which makes more sense? Duration – how long will you be in this house? and Lifestyle – is there something about one or the other that just makes more sense for you?
Sometimes the decision whether to buy or rent is an easy one:
Long Time Horizon. If you’re going to keep a house for 30 years or more, buying is the obvious choice. Eventually you’ll own the home free & clear, and can keep it in your family for generations, either as a place to live without having a mortgage payment or as a place to rent out and earn additional income.
Long Term Lifestyle. Most people prefer stability over change, and home ownership offers one of the most basic means for stability. Same schools, same neighbors, same stores, same “stuff” – it becomes a comfortable part of your life.
Short Time Horizon. If you need a place to stay for less than a year, it doesn’t make much sense to buy a home and then have to worry about selling it. Go ahead and rent, and you’ll be able to walk away without any strings attached when you need to.
Short Term Lifestyle. Some people get bored with the status quo and actually prefer change. New neighborhoods to explore, new neighbors become new friends, and new restaurants to enjoy. In addition, they don’t have to worry about the major maintenance expenses of home ownership, such as replacing a roof, a/c unit, or even carpeting!
Most of the time, however, we don’t fit neatly into one of these categories. Life happens, and things change, and we don’t always know how long we’re going to live in the same place.
From a personal example, my wife & I bought a home in 1998 that we couldn’t imagine ever filling up. 8 years later, with 2 kids, 2 dogs, and a home office, we were busting at the seams and decided to move. Today, 2 houses later, we’re still trying to figure out which neighborhood to call home permanently!
Moving Expenses
The reason rent vs buy is even worth discussing at all is because there are costs associated with moving. (especially with buying and selling as compared to renting.)
Preparation: Let’s assume you put some effort getting your home into sale-ready condition. Common task list items include painting, freshening up the landscaping, minor decorating, and a couple/few incidental repairs. Cost = 1% of sales price.
Commissions: Let’s assume a typical real estate commission of 6%. I’ve seen more and I’ve seen less, but we’ll use 6% for this example.
Closing Costs on Sale: Title Insurance, Escrow fees, and a few other miscellaneous charges. Let’s assume 1%.
Closing Costs on Purchase: Buyer’s title insurance, escrow fees, and a few other miscellaneous charges. Let’s assume 1%.
Loan Fees on Purchase: These can range anywhere from $0 to several percentage points of the loan amount, depending on how many discount points you choose to pay and what interest rate you get compared with prevailing market rates. Let’s assume 2% for this example.
Total Fees: 1% Preparation + 6% Commissions + 1% Closing Costs on Sale + 1% Closing Costs on Purchase + 2% Loan Fees = 11%. The friction costs of selling your house to buy another will be about 11%.
Historical Appreciation Rates
For about 50 years, from 1950 through 2000, homes in the Phoenix area appreciated at about 4-5% per year. Yes, there was some fluctuation, and some years were better than others, but by and large we had an awfully stable market.
This means that for the 2nd half of the 20th century, you could sell your home within 2-3 years of buying it and come out ok. And if you held your home for longer than that you would actually make a profit by selling. Add in the tax benefits of home ownership and it’s easy to see why we’ve all been indoctrinated in the “must buy a home” mentality!
The Last Decade
The last decade has been so completely different from the 50 years preceding it that conventional wisdom isn’t so conventional anymore. Those who bought in the early 2000’s felt like geniuses in 2005; today they’re hoping their home is worth more than they paid. And many who bought in the late 2000’s have had their lives turned up-side-down, along with their equity! (yes, I’m in this group with you – if I don’t laugh I cry..)
Where do we go from here?
Now we get to the part where I’m making assumptions about the future, so let me pull out my crystal ball and see what I see…
Recovery Begins. I’ve written several times that we won’t see any significant recovery until the bank-owned foreclosure homes stop hitting the market like tidal waves each month, and I expect that to happen in the 2nd half of 2011.
Adjustment Period. Once there are fewer foreclosures on the market, “regular sellers” will have an adjustment period while they a feel for the new marketplace. Buyers will still want bargain-basement prices, but sellers won’t want to sell at these prices since there aren’t any bank-owned homes left. It will take several months for buyers and sellers to meet in the middle and establish a new fair market price.
Slow Growth. Many economists have written about the next decade being one of slow growth due to a jobless recovery. Yes, we’re improving and we aren’t losing more jobs, but we aren’t gaining new jobs very quickly either. It’s expected to take several (many) years before employment gets back to prior levels.
The 5-Year Rental
Now let’s put it all together.
A. We’re not expecting much, if any, price appreciation for the next couple of years.
B. Once prices do start to appreciate they do so at a slower pace than normal (let’s assume 3-4% instead of the historical 4-5%)
C. The friction costs of selling and then buying can be approximately 11%.
D. Based on A, B, and C, if you buy a home today, it could be 5 years before you’ll be able to break even on selling it and buying your next house.
Therefore, if you’re in the market to buy a home today, and your time horizon is 5 years or less, renting may be the better financial option for you.
Additional Variables and Concerns
There may be something which makes your situation different from somebody else’s, and there may be something out there which we can’t foresee but which will have an impact on our forecasts. Here are a few; I’m sure there are dozens more:
Income Tax Implications. You may have significant tax advantages to owning a home which could shift the breakeven point forward in time.
Interest Rates and the Greater Economy. Could the global economic crises and our national trade deficit push interest rates higher than we’ve seen in the last decade? If you think interest rates will be at 8%, 9%, or even 10% a few years from now, you may want to lock in a purchase at today’s lower rates.
Government Action (and Inaction). We’re seeing financial strain across the board, from countries (ours included) to states, to cities, to families… Any changes in policy at the local, national, or foreign level could have unintended consequences here on our local real estate market. Changes to the tax code or tax rates; Health care reform; Budget deficits; Terrorism; Trade wars and protectionism; etc., etc.
In the end, there isn’t really a right or wrong answer – or at least we won’t know which one was right until we get 5 years out and see what has happened! The best thing you can do is to think clearly, weigh your options, and make an informed decision.
We’ve spoken with several people over the last year who say something along the lines of, “I’ll buy this house now, and then in a couple of years I’ll sell it and move up to something better.” Sure, it might work out for you. Or you might end up trapped in a home you don’t want anymore, and nobody likes being trapped.
Additional Reading
Here are a couple/few things we’ve written recently which you might find interesting:
20-year mortgage interest rate chart
Changes to lead-based paint rules
New distressed listings by month chart
Moving Stills – pictures from out & about in the Phoenix area, as taken from my car!
I hope you enjoyed this e-newsletter and found something of value you can take away from it. You can leave a comment on something you read or add to the discussion by clicking here and using the comment form at the bottom of the page.
Your believes good landlords and good property management companies will flourish over the next few years Realtor,
Chris Butterworth
Chris & Heather, The Phoenix Agents
at Thompson’s Realty
http://thephoenixagents.com
623-570-9940
Chris Butterworth and Heather Barr are The Phoenix Agents at Thompson’s Realty. The Phoenix Agents are Realtors in the Greater Phoenix area, who have built a loyal following over the years by offering superior service levels coupled with a low-pressure approach. You can visit http://ThePhoenixAgents.com online to learn more about Chris, Heather, and the Phoenix-area real estate market. If you have real estate questions or needs, please contact us anytime; we’d love to hear from you.
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