Should You Buy or Rent Your Home?
Not a week goes by where I don't encounter an article giving advice on whether now is the better time to buy or rent a primary residence. While definitely an important subject to review, the matter cannot simply be as black or white as some of these opinion articles state. The overall economy does not reflect each individual's personal economy, so you do have to dig in a bit further. Here are 3 questions to review that will help ensure your choice to buy or rent your home will also prove to be a strong personal financial decision.
1. Are you moving to unfamiliar territory?
Buy or Rent: If yes to the question above, then rent. If no, proceed to the next question below.
Explanation: Careers, families, friends and opportunities can take us all over the world. If a life event has you moving to new terrain (city, state, or country), rarely does it make sense to buy unless you are already well-versed on the area. Renting for a year will allow you to become familiar with the new location and then further hone in on a more precise area to stake roots.
2. Will you be living in this home for less than 5 years?
Buy or Rent: If yes, then rent. If no, buying could be an option. Please proceed to the next question below.
Explanation: New home buyers are often surprised by all the ancillary fees that arise from a home purchase. Home appraisals and inspections, miscellaneous closing costs, moving expenses, property transfer taxes (if applicable), and realtor commissions can often add 5% (or more) onto the purchase price of your home. Combining both purchase and future sell costs automatically put you in the hole by upwards of 10% or more. It's best to own a primary residence for longer than 5 years to better your odds that price appreciation will help counter your transaction costs.
3. Is the price-to-rent ratio greater than 12?
Buy or Rent: If yes to the above, then rent. If no, and the above two questions are also no, then buying should be a lucrative move.
Explanation: The price-to-rent ratio is calculated by taking the purchase price of the home divided by the corresponding gross annual rent you could expect to receive on the property (Home Price / Gross Annual Rent). This ratio is helpful because it's a simple way to measure how expensive a home (or neighborhood) is valued relative to other properties (or locations). Think of this ratio as the home equivalent of the price-to-earnings ratio (P/E) used to value stocks.
Let's look at a scenario that is quite reflective of the home prices and rents you could expect to see in today's market:
Home A: Purchase price of $100k, Rental rate of $950/month, Price-to-rent ratio = 8.77
Home B: Purchase price of $350k, Rental rate of $2,250/month, Price-to-rent ratio = 12.96
In this scenario, Home B appears quite expensive relative to Home A. If looking to live in the neighborhood of Home B, it would likely make the most sense to rent, as there are better opportunities to invest your money and grow wealth elsewhere.
Bonus note: You might notice that this scenario shows an inverse relationship between home prices and rental yields, meaning that the lower priced home (Home A) has the potential to yield more rental income per dollar invested than the higher priced home (Home B). This is common, as increasing home purchase prices usually result in decreasing rental yields. Due to this inverse relationship, you're normally better off renting in expensive neighborhoods and investing/owning in more reasonably priced neighborhoods.
Do you have any additional rules that you follow when making a decision to buy versus rent a home? Please share in the comments section of this post!