Before hitting the road, we had the best living conditions of every person in the Seattle area. We lived in a 1 bedroom apartment on the top floor of a 1930’s era 20-unit apartment building near the University. We were a block from the farmer’s market, a block from a Safeway, a block from our garden patch, 4 blocks from a huge park and nature trail, 5 blocks from the library, 7 blocks from Trader Joe’s, and one block from the main business street and bus artery, where we had our choice of 50 different restaurants and easy bus access to anywhere in town.
A little under 900 sq. ft, we had more space than we knew what to do with and an excessive amount of storage and closet space. We didn’t even use the free basement storage space available to us because we didn’t have a lot of extra stuff. We paid the electric bill and our DSL bill, but hot and cold water, sewer, and garbage service were all included.
Free bike storage at street level provided easy access to our main vehicles for getting around town. Since we were within easy walking and biking distance of everything, and we could hop on a bus to anywhere, we didn’t own a car.
The total price for all of this greatness: $980, a significant increase over our previous $465 a month apartment. We were living large in a small space
We loved that apartment, the neighborhood, and the overall convenience of everything. Despite our own feelings on the matter, some friends and coworkers felt a duty to suggest improvements to our lives. “You guys should really buy a house and get out of that old apartment.” “You rode your bike to work? That’s crazy. Why don’t you get a car, you can afford it.” “Housing prices are going to go up and you’ll get a tax deduction, you should really look into getting a house.”
Few people are as obsessed with financial optimization as me, and of course I had done the math on these things. The truth is, in a market such as Seattle, it makes ZERO FINANCIAL SENSE TO BUY A HOUSE!!!
The average home price in the Seattle area is ~$400,000. The 4 bedroom place everybody wants for “resale value” comes in at $515,000. Live in one of the trendier neighborhoods (like where we lived), and that home will cost you $914,000. If you are looking to buy in San Francisco, Boston, New York, or Washington, DC, the prices will be even higher. (Data from zillow.com on March 25, 2013.)
After that little financial meltdown incident in 2008, odds are a reasonable down payment will be required to buy a house. Historically that was 20%. If we use the national average 30 year fixed mortgage rate from Bankrate.com (3.78% on March 25, 2013), and assume tax filing is done as married filing jointly, this table summarizes the monthly housing finances
Purchase Price | $400,000 | $515,000 | $914,000 |
Down Payment | $80,000 | $103,000 | $182,800 |
Mortgage Payment | $1,487 | $1,915 | $3,399 |
Property Taxes | $250 | $322 | $571 |
Insurance | $67 | $86 | $152 |
Utilities (W/S/G) | $100 | $100 | $150 |
Maintenance (1%) | $333 | $429 | $762 |
Monthly Cost | $2,237 | $2,852 | $5,034 |
In the best case, we would pay over $1,000 more per month to live in a house. In the apartment, we paid $0 annually for maintenance, didn’t need to own a ladder or a lawn mower, and our weekends were completely free of maintenance duty. Paying $1,000 extra a month to live in more space than we need, comes with uncertain maintenance and repair responsibilities, is further away from the places we buy groceries and hang out with friends, and places obligations on more of our free time seems to be a poor trade
But haven’t you heard about the free money the government is giving away? It’s called a tax deduction, and you get one when you buy a house.
This is sometimes true, but generally only if you pay annual interest and property taxes that exceeds the Federal Standard Deduction. For the typical married couple, in 2012 this required paying more than $11,900 in taxes and interest. (In atypical situations where there are a lot of personal itemizable deductions then this gets more complicated.)
This table summarizes the tax differences between renting and buying for the representative Seattle homes:
Purchase Price | $400,000 | $515,000 | $914,000 |
Down Payment | $80,000 | $103,000 | $182,800 |
1st year interest | $11,995 | $15,444 | $27,409 |
Property Taxes | $3,000 | $3,863 | $6,855 |
Sales Tax Deduction | $1,635 | $1,635 | $1,635 |
Total Possible Deduction | $16,630 | $20,941 | $35,899 |
Tax Savings @ 25% tax rate (Monthly) | $99 | $188 | $500 |
Capital One 360 Interest* (Monthly) | $50 | $64 | $114 |
* If you open a Capital One 360 Savings Account via this link, you will get a free $25 and we will get $10.
For the $400,000 home, the monthly savings in tax would be about $99. If the down payment money had instead been invested in a Capital One 360 savings account* at 0.75% interest, it would have earned $50 a month. In other words, for the majority of people the interest deduction doesn’t do jack, and it diminishes each year of the mortgage due to annual increase in the standard deduction and the mortgage amortization schedule
Paying tax at the 25% marginal rate requires an Adjusted Gross Income of between $70,700 and $142,700 for a married couple. The median household income in the US in 2012 was $45,018. You have to be in the top 20% to earn $100k. In other words this tax deduction only helps people buying houses worth more than about $500,000 and with incomes over $100,000. It’s an interesting point to note for those interested in the concept of economic inequality
But what about the equity that you are building? You don’t want to just throw your money away on rent. What’s the point of spending all that money if you are just building somebody else’s equity?
Unless it is for the purpose of understanding the value of becoming a landlord myself, I don’t find the financial situation of the landlord or how much equity she / he may be gaining each month as important. What is important is whether my own net worth benefits from renting or owning. In a city like Seattle, renting is better. Your city may be the same. (Like in Taipei, for example, Winnie’s hometown.)
Every month, a portion of the mortgage payments will be used to pay down the principal, but in all cases this amount is not even close to the amount saved by renting. In the case of the $400,000 home, the principal portion is about $500 a month in the first year. In the case of renting, I save over $1000. The equity portion of the home won’t help pay for groceries in an emergency, but the savings account is always available. A house has ridiculous selling fees. A savings account has none
But housing prices are going up, a lot of people get rich off of real estate.
Housing prices always go up. Except when they don’t. After 2008, this argument for home ownership is used less often, but it is still used despite the data not supporting it.
Over the entire history of tracking housing prices in the US, the value of a home has roughly tracked the rate of inflation. It has deviated substantially at times, as it did in the years up to 2008, but a home purchased in 1955 would cost the same in 2013 when adjusted for inflation. Meanwhile the stock market has increased 6X and paid dividends along the way
A house is not an investment, it’s a place to sleep and store your stuff.
(In the Seattle area, multifamily properties have much better investment returns)
After all of that math, what does all of it mean? In a market like Seattle’s (or Boston’s, SF’s, NYC’s, or Washington DC’s) renting is your ticket to Living Large. Many people will try to convince you to buy a home, especially real estate agents. Do the math yourself.
Before you know it, enjoying your life in a small apartment will yield an impressive investment account. In the case of the $400k home, 10 years of investing the savings from renting vs owning at 6% return will result in an extra $100k in your investment account. The easy walking and biking access to all your neighborhood has to offer will allow you to live car free, increasing the bank account further. Living in a smaller space means you will have less room for stuff, and having no TV will ensure you don’t feel a need to buy more.
In less than a decade, financial independence will be a reality. That’s when the true meaning of living large will become apparent: You can choose to never work another day in your life. That amount of freedom can’t be contained in any amount of space, big or small.
Hey Jeremy, how did you come up a tax saving of $188 for purchase price $515K?
Hi Chelsea, the $188 is monthly. All of the math involved is in this spreadsheet.
For the $515k property, $15,533.92 in interest will be paid in the first 12 months. In addition, $3,863 will be paid in property taxes, and since Washington has no income tax a deduction of $1,635 would be allowed. This would give a total allowable deduction of $20,941 on the Schedule A. But a married couple is allowed a standard deduction of $11,900 even if there are no other deductions, so the advantage of the mortgage interest is only the difference, $20,941 – $11,900 = $9,041. At a marginal tax rate of 25%, this saves this theoretical married couple $2,260 in tax, or about $188 a month.
$188 a month is nothing to sneeze at, but over a 10 year time period it is nothing compared to the total cost of renting vs owning.
Hope that helps
Jeremy
Gotta! That makes sense now!I thought that’s an annually saving:)
Thank you for using gender neutral language! You wrote “she / he” and it was so refreshing to see. :) Love your articles and the principles you stand for.
Thank you Dakota
I’m studying Mandarin now. At least in the oral language, there is no difference between he and she
GCC,
I used to think exactly like you when it comes to buy versus rent. But lately I am starting to think differently.
What if you purchased the 900 sq ft apartment, rather than renting it for say 10 years? Would you have been better off or worse off in your quest for financial independence ( accumulating assets).
Best Regards,
Dividend Growth Investor
Hi DGI
Would we have been better off? Not in the least. It is not difficult to meet people that “made money” by selling their single family home or condo, because they sold for a higher price than they paid. But when real estate agents fees, taxes, maintenance, mortgage interest, homeowner’s dues, time spent mowing lawns, painting, etc…, are factored in, the returns don’t look as impressive
In some markets (meaning ones that aren’t popular) buying a house can make financial sense. It can also make sense for non-financial / emotional reasons.
There are also non-financial / emotional negatives. Your neighbor likes to throw large parties and mow the lawn at 3 am? The roof is leaking? A serial sex offender just moved into the neighborhood? That house down the street is a meth lab? The home owners association is upset because your grass is 12 mm high rather than the covenant’s maximum stated height of 11.5 mm? Having your name on the title makes it a lot harder to move
Real Estate can be a good wealth builder at scale, particularly in multi-unit buildings. I once made an offer on a 7-unit building in Seattle, where the 7th unit was a private 2000 sq.ft. penthouse with a professional chef’s kitchen and a private roof top. Having 6 other people pay your mortgage for you is a nice bonus. That was about 5 years ago, and even with leverage (the mortgage) the stock market has provided greater returns.
We may still purchase a house (we almost did in Mexico) but I don’t expect it to benefit us financially
I think this post by Jim Collins is a great read for anyone considering making a purchase. It also makes for good conversation at house warming parties: http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/
Cheers
Jeremy
Love than you ran the numbers long term to see what the better deal was. The real estate market is very different where we are and we were able to purchase a 2500 sq. ft house on 2 acres for 92k. We purchase before the housing bubble, had a wonderfully low interest rate and said house is now paid off. However, rent was more expensive than a mortgage in our area. I would tell anyone to consider options carefully, the better deal often depends on your region. We are also both pretty handy so maintenance is not much of an issue;).
if you live in a state with state tax you pretty much always itemize, so tax saving on interest and property tax is high. also if you rent out a room the equation changes too.
i think the issue here really is getting more room than you need is buy. i.e. stranded asset, but if you turn those into productive asset, i.e. renting it out then its fine
Love your blog, lots of great info. However, this post is misleading, because you compare renting a 1 bed apartment to buying a 4 bed house. This is not a rent vs buy analysis, it is a lifestyle choice analysis. If you do an apples to apples comparison and you account for all expenses, over the long term (20 years or more), the house buyer almost always comes out ahead. You state that real estate appreciation roughly matches inflation. That may be true, although most numbers I have seen, say that real estate has appreciated faster than inflation. And if you buy with leverage, your rate of return will generally be much higher than inflation. If you put $80K down on a $400K house, that appreciates 3%, you make 15% on your investment, not 3%. You also, don’t mention the fact that rental rates are going to rise with inflation as well, whereas the principle and interest portion of the mortgage will not. 20 years from now you will be paying WAY more in rent, than if you were to buy now.
I think in your case, since you like to move a lot, it does not make sense for you to buy a house. I think moving a lot is the strongest argument against buying and for renting. However, for people who are going to stay in one place for 10+ years, buying a house usually makes sense.
There are also so many other benefits and ways to make money with real estate that you don’t mention. For instance, you don’t have to put 20% down on a primary residence, you can put as little as 3.5% down. I personally rent out my basement, in addition to my rental properties. My family lives in a nice 4 bedroom house for less than it would cost to rent a two bedroom apartment in our area.
Think about it this way: Do you think your landlords are losing money on you every month? Of course not! So you, as the renter are actually paying ALL the costs of the property (mortgage, taxes, maintenance) plus putting money into your landlords pocket every month.
Again, it probably does not make sense for you to buy, because you move so much. But for a lot of people it makes more sense to buy than to rent.
Of course it is a lifestyle choice analysis.
This idea that one must compare living in a house vs renting the same house is a limiting belief. People can choose to live… anywhere.
Now thanks to not following the conventional wisdom of “buy the biggest house you can afford” or “buy the worst house in the best neighborhood”, today we could buy multiple 4-bedroom houses. Cash. And still be retired.
Case in point.