Buying vs renting housing: which is the better financial choice? A case study Part 2

6/23/2024

Back by popular demand: another case study on buying vs renting. My most popular blog post comes back around to look at the death of San Francisco real estate. I take on the myth and cult of home ownership to show that renting is sometimes the better financial decision and you aren't throwing money away if you choose to rent instead. Let's look at the opportunity costs of the buyer and the renter that took advantage of them.

Meet The House in our case study

In the last episode of this blog, I actually used my own house in Denver Colorado that I sold in March 2022 at the height of market values right before interest rates went up. I had the records to support the analysis and got comfortable with some assumptions and basics I could use to work out an imagined case study on another property (one that I have never seen or owned).

In this episode, I spent a few hours browsing properties in San Francisco to realize the horrors of crashing prices there. Like this gem that sold for $665,000 in 1997; $1,200,000 in 2000; and $725,000 in 2024. From 1997 to today, SPY, which is an index investment fund that tracks the S&P 500, has returned 1,022.58%. This piece of property has returned a measly 9% over 28 years. And if you were the person that bought in 2000, you definitely lost a lot of money.

But today, we're going to analyze less of an outlier, 1624 Filbert St APT 1, San Francisco, CA 94123. It was purchased in June 2015 for $895,000. It was sold again in June 2024 for $800,000 which is an obvious loss but is an even bigger loss than it seems (which we look into in this blog). Though the home was sold again in between I'm going to just stick with these two dates and numbers for the case study as the average American home owner will own their home between 10 to 12 years.

First the numbers, then the breakdown

The inputs

I assume that the renter and the buyer are the same person but that just made a different personal choice to rent vs buy the exact same property. This means that their income and personal circumstances are mirror images of each other.
The $179,000 downpayment (20% made by the buyer) is assumed to be a sudden gift or bonus at work. The results are even more astounding when we consider instead that this individual had been diligently saving up for this downpayment in the years prior (more on that later - Bonus Material).
I assumed a mortgage rate of 4% which was roughly accurate in 2014/2015.
I assumed annual maintenance costs quite low and adjusted by 3% each year. These costs are low to be conservative because this is an apartment/condo. I also assumed this was a move-in ready apartment that didn't require any renovations during the 9 years of home ownership which is also conservative.
I was able to obtain the annual property taxes from Zillow. I was able to obtain the current monthly HOA from Zillow which is a shocking $700 per month in 2024! I worked backwards for the prior years assuming a conservative 3% annual increase.
Building insurance (for disasters) is usually included in the HOA so I have not added that on extra. I also did not factor in contents insurance (for personal belongings inside the apartment) because both the buyer and renter would be paying for that so it doesn't create a difference in the outcomes.
I can see on Zillow that this home was listed for rent in 2022 for $4,100. For 2015 and the first few years I assumed a $4,000 rent which is likely vastly overinflated given that the average rent in San Francisco for a 1 bedroom in 2015 was $2,900. I increased the rent to $5,000 for a few years and then dropped it again to $4,000 as we have seen rents drop the past few years post-Covid with the real estate crash. This can also be seen in other listings where in 2022 and 2023 people have been listing apartments for rent and slowly dropping the prices.
I assumed that the tenant had some maintenance costs on move-out like cleaning and painting.
The most important input is the opportunity costs of having (or not having) invested in the S&P 500 via an index fund like SPY, VTI, VOO, or VTSAX (as examples). I used the real returns each year and made the important assumption that the person renting would be taking the money that they didn't spend as the owner (column "Cash Diff") and invested it in the S&P 500 instead.

Interpreting the results

I am assuming that both the renter and the buyer are effectively the same person that made different choices, which means that they both earn the exact same income. As such, in the years that the renter is spending less of their money on the house than the buyer would be, they have extra left over to invest in the stock market (I choose VTI as my example). This outcome is reflected at the bottom reconciliation on the line "Stock Market Returns" and represents actual returns on VTI for each year. Compounding growth is amazing.
The house that was purchased for $895,000 in 2015 would need to sell for $1,718,547 about 9 years later just to breakeven with having rented those 9 years. If the sales price were less, then renting would have been the better financial choice -> only on the basis that the tenant was investing the savings difference in the S&P 500.
In this specific case, the sales price is well below the breakeven point being sold at $800,000 in June 2024. The person that lived in this house and investing the savings difference would have been financially better off being the renter.
With a mortgage interest rate of 4%, equity does not get built fast. In around 9 years the mortgage went from $716K to $580K. The early years of a mortgage are mostly being paid towards interest which is equally as "throwing your money away" as paying rent is perceived to be.
When you rent, you are paying the ceiling price. When you buy, you are paying the floor price. Home ownership is expensive and unpredictable.
Am I cherry picking this house for my case study? Absolutely yes. That is because real estate investment evangelists do the same thing, they use their own personal story to convince people that real estate is the best path to wealth. So I'm here to cherry pick stories on the other side to show that renting and investing the difference can give you the same or better financial outcomes. There is no single correct answer.
I'm not here to prove that real estate is or is not a good investment or that the stock market always returns (in the short term, it may not). I'm here to disprove the myth that buying is always the better financial choice, and show cases where renting can be the better financial choice. If you are renting then you are still a fully formed adult who may be making the better financial choice, not to mention the non-financial reasons for preferring renting over buying.
Side note: the American Dream of Homeownership was invented by the banks to sell mortgages, and make money on interest. People in the US mostly rented before that. I'm a big fan of the German attitude, where over 50% of people rent their homes (long term).

"BUT you're not factoring in ...."

I already thought of whatever you're about to say and it's covered in Part I here. Even if those assumptions are incorrect, they would not wildly move the needle on these numbers to have made buying the better financial choice. We have a $1M difference in this case study.

Key takeaway

Of course, many people buy property for more reasons than the financial ones. But for those people that do not feel the urge to own the roof over their head, who enjoy the freedom that renting provides, and who hate renovating and maintenance: I need you to know that you are a fully formed adult that could be making the better financial choice for your life and geographical situation. You are not throwing money away on rent. Every city and personal situation could render a completely different outcome. The point is that it is not a slam dunk that buying is always financially better than renting.
You do you.

Bonus material!

Surprise, the numbers turn out even better for the renter if I change one input. In the original inputs, this individual received their $179,000 downpayment suddenly one day as either a gift or a bonus at work. In reality, most people save for a long time for their downpayment. Let's consider a person that saves $1,500 per month for 10 years (2005 to 2015) would have $179,000 in cash for that downpayment. They likely would have been putting that into a savings account that yielded very little interest income to them.

So what if instead they had been investing that $1,500 per month into the S&P 500 via index fund over those 10 years? They would have had $351,709 in 2015. And what would be the compounding growth of that up to 2024? See below.

Not only does the break even house price go up to over $2M, but we can see at the bottom that "wealth in hand" of the renter is $1,205,778 and the homeowner that sold for $800,000 has just $169,084 (of course ignoring other investments that this individual would have made during this time outside the facts of this story).

Want the FREE finance and tax checklist for moving abroad or digital nomads?

cartoon png from pngtree.com/

0 Comments