Should You Rent or Buy in Today's Real Estate Market?

Being in real estate these days, it seems like the only question people want to ask me is, “Are we in a bubble?”

The problem with that question is that there are great arguments on both sides. Anyone can pick a graph and quote things like historical trends or current supply versus demand and make a very convincing argument. While I don’t have a crystal ball, I do have concerns that we have approached the top of the cycle.

I see people I know stretching their budget, and I’ve noticed banks thinning their requirements just to get a name on a deed. It begs the question: Is now the right time to be doing this?

Is Buying or Renting a Better Idea in Today’s Real Estate Market?

Owning a home in this country is part of fulfilling the American Dream. It’s both a blessing and a curse. Buying that first home has become synonymous with “making it” in life. As such, it’s at the top of most people’s list of aspirations.

My husband and I have owned plenty of homes over the years and currently live in our potential “forever home.” At the same time, I know people who are very smart and successful investors who swear that renting a home is the way to go.

That brings me back to the current state of the market. If I believe that annual price appreciation is going to slow significantly or even stop, can I argue that these renters are wrong?

Buying vs. Renting: By the Numbers

As always when it comes to real estate, we decided to do the numbers. While we love our forever home, we are lucky enough to have access to investments that return 10 to 30 percent on our money, so the equity in our home could be doing a lot more. Obviously everyone’s situation is different, and the numbers can vary widely in different parts of the country. But here I’ve tried to use averages and historical data as much as possible. I will try not to overcomplicate it with things like tax deductions, etc., since once again that is situation-specific.

For easy numbers, let’s look at a $500,000 home.

Expenses

Your biggest expense is obviously your mortgage. At a 4 percent interest rate, your payment would be about $1,900. Contrary to the popular argument that a mortgage is “paying yourself instead of the landlord,” about $1,350 of that is going to interest payments in the beginning. So disregarding principal payoff, your mortgage costs you about $1,350 a month.

Property insurance. Based on our experience with houses in this price range, insurance is about $150 a month.
Property taxes. Now here is the huge swing. A $500,000 house in our area costs you about $10,000 in taxes a year. If you live somewhere in the South, you just spit out your coffee—you are paying maybe half of that. In our experience with rental properties, the taxman is going to get you one way or another. For this example, to be fair we will go on the lower end and use $6,000 a year for property taxes. That gives us another $500 monthly expense.

That’s everything, right? All the rental property owners are laughing right now, because the constantly overlooked house expenses are repairs and capital expenditures. There are plenty of articles you can read about how much to set aside for these costs, but for repairs, CapEx, and ongoing maintenance, it is usually 1 to 2 percent of the value of the home per year. Therefore, a $500,000 home would cost you another $500 a month on average in upkeep and repairs.

Adding it up, we get:

$1,350 mortgage interest
$150 insurance
$500 property taxes
$500 for house expenses

This gives us a monthly total of about $2,500.

Funny how real estate numbers work isn’t it? While many of us like to use the 1 percent rule as a guideline on when to buy a rental property, it seems like 0.5 percent rule is pretty close in terms of a tipping point for when you should rent versus buy.

If you can find a house that rents for less than 0.5 percent of its value per month, then expense-wise you are most likely coming out ahead. By living in the Northeast (like me), renting is even easier to justify with double the property taxes.

The Bottom Line

So, what did we decide? Looking at rentals in our area, it was easy to find comparable properties to our current home that are renting for far less than 0.5 percent of the value. Plus, if we sell, we could invest all of the equity in our home and get returns much higher than we believe our home appreciation will get us. We both agreed that it made the most financial sense for us to sell our home and rent.

Will we actually do it? Probably not. I love our house, and I really can see our kids growing up in it. While the numbers determine most of the decisions we make in our lives, what is the point of being successful if you can’t spend some money enjoying it?

While I’m at it, I think I’ll get a quote on a pool.

What do you think? Is it smarter to buy or rent where you live? Where do you think the market is headed?

As always, I’d love to hear your comments.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.