Rent v Buy: The Spillover Debate

Although I have followed the "rent" vs "buy" debate on UD and SE, I have not weighed in until now. Seems to me that there is a factor that is almost always overlooked in the debate/discussion. I call that factor "permanance" of living arrangement. I have seen all too often people who are FORCED to move becasue the co-op owner from whom they are renting has sold their apartment or the landlord has unreasonably raised the rent on a free market apartment. Seems to me that the quantitative debate on the financial rent vs buy discussion is only applicate if the renter enjoys statutory rights as a rent stabillized or controlled tenant. It's hard for me to factor the uncertainly of lease renewal. Maybe it's easy if you are in your 20s. But if you have children or are older, the temporary nature of 2 year leases is difficult to tolerate for many.

Forgot one big one. Whatever emotional benefit you may have as an owner, you have exposed yourself to massive risk, in a leveraged way. Consider this as just one example: you have a 30yr mortgage. What's the probability that a nuclear bomb will be exploded in Manhattan over the next 30yrs? I think 10% is in the ball-park on that (I'd say it's a low-ball), so that's a 10% chance that on the order of all of your worldly assets will become worthless or, at least, will crater in market value for a substantial period of time.

Wow. The "big one" and over 10% chance, to boot! If that was my concern, I wouldn't be living in NYC. I'd move to Idaho and stock up on shot gun shells and cans of tuna fish! :)

I think it's safe to assume that current market prices have not discounted a 10% risk of that event.

Besides, your chance of choking on a ham sandwich or getting run over by a bike messenger over the next 30 years hasn't been factored into the calculus, either.

Who is this guy Eric? Are you kidding me...you must be a renter or you still live w/ your parents...10% risk please...

If there is a nuclear attack here we will all be dead anyway, renting or not. cockroaches and twinkies will be the only survivors.

I think Eric is saying that renters will survive a nuclear holocaust. Can't say I disagree. We're a hardy bunch.

One more ingredient.. Mobility.

Sure, buying may be great for some, and perhaps for all by a certain age, but I'm 33yo and have had a chance to live in a lot of really great cities while gaining a tremendous amount of life experience and exposure to other cultures that I may not have been able to had I settled down and locked myself in to a mortgage when I was 25.

Besides, what would have been the point of buying during these past 5 years with the ridiculously obvious housing bubble that was forming? Only a complete idiot would have thrown their money down the toilet with everything that was going on.

2010 - 2012 looks like a good time to get in for me, but definitely not in any hurry, especially with the 10% rent reduction I just received.

Isn't square footage the quintessential New Yorker thing to obsess on? Well, that and whatever fab restaurant just opened down the street? Besides, there is a little sport in egging anyone on who thought $1,000 / SF was the floor when they pulled the trigger.....enjoy St Thomas - we honeymooned over at Caneel Bay and at the Ritz - saw some pretty big feesh in them waters....

comment on "1 cup: Expectations on rising vs. falling real estate values over time"

what we need is some nice financial product that can hedge and remove the risk from this ingredient. then, you'd have a nice way to compare renting versus owning. the upsides and downsides to rising and falling values is just too great when one has so much leveraged. that's why you find renters always renting, or owners always owning. they fall on one side of a very steep slope on this point.

now, if we had some exotic mortgage with insurance if home prices decline; or say one could buy index funds tied to the reverse of home prices, then one could reduce the volatility of this ingredient and have an easy way to compare.

very nice! I always wanted to find something like this .
Thank you!

i have owned four properties and currently still own a country home. this notion that currently committed renters have no flexibility of thought pisses me off. some of us look at all the ingredients and simply conclude now is not the time. and then, if you're approaching 50 like my husband and i are, there may never be a good time again.

unlike the bizarre nuclear attack scenario that's hardly the end of the world. home ownership has its positives, but it's not the nirvana that many claim that it is. it is a very physical anchor. and for those who have bought over the past 10 or so years quite possibly a very expensive mistake, depending on circumstances.

maybe if the average car cost more than $500k for just a transmission and a chassis you'd have more lease/buy arguments.

The premise that renters and buyers are immune to argument is simply false. Many of us have switched in the past and will do so again.

The reason the discussions are heated is that (1) fundamentals strongly indicate a major price decrease in the future, because at current prices, investors will create more supply (by converting rentals, building, renovating) until rent:buy ratios converge, and (2) luxury decontrol makes long term renting only an imperfect alternative (unlike most other markets, where renting and secured loans are close substitutes (eg cars,time shares, CRE)).

Accordingly, any semi-rational consumer is faced with a tough choice: buy a highly leveraged and obviously overpriced product with the obvious probability of losing a lot of money when supply catches up with demand, or rent and give up both security of tenure and control over design details.

Since neither choice is attractive, people spend a lot of time and energy trying to convince themselves that there is a third option.

Ana:

Thanks for the article. It's obvious that this topic has some fervent advocates on both sides. I believe (and hope) that I'm somewhat agnostic on rent vs. buy, and definitely some of the points that you and some of the bloggers make are persuasive. Permanence and certainty are definitely important elements in favor of buying. Historically, real estate prices rise steadily on average (not necessarily in a liner fashion, however), so if your time horizon is sufficiently long, the likelihood of principal losses is low. And the leverage provided by mortgages is nice. But the rent vs. buy decision is very much dependent on your opinon of where in the real estate cycle the market is at the time you make the decision.

I think that the disconnect between the cost to rent and to own is currently greater than the historical level. In addition, the gap is probably widening, as rents in the city decline (I understand that's an unprecedented event; I've heard it claimed that in the past, rents have generally stayed stable or increased when prices declined). Based on that analysis, I prefer the rental option at this time. I stand ready to change my preference when/if prices fall further.

Hope you're enjoying St. Thomas. On the timeshare topic that precipitated this post: I spent a lot of time a few years ago analyzing the economics of the timeshare business. In general, the value of the property underlying the timeshare is only a small percentage of the cost of the timeshare. So a timeshare resort that sells 52 weeks of occupancy at $10,000 a week usually invests only about 20% of that money in the actual property. That's why loans extended to buyers of timeshares are not mortgages, they're unsecured loans. So you don't own your timeshare; instead, you've committed to spending 2 weeks a year for the next 20 years at the same place (you can swap locations, but my point is that you've limited your options). And if the timeshare sponsor defaults (a fairly common occurence), your recovery is essentially zero.

One final point: Robert Schiller has developed a real estate index that allows buyers to make bets on the direction of the market. It's intended to be a hedging tool for real estate owners. I don't think its terribly successful (I understand it has some technical problems), but smart people are thinking of ways to hedge the risk, so we should see something useable soon.

Why the heat? Looking only at the financial side, things come down to predicting the future. The future value of the home, future value of alternative investment, future rent cost, future maintenance, etc. So people guess and many start to believe in their guess like it was truth. It becomes like religion.

Am back to rainy NYC :)

SR realist and JT - yes, indeed, there is now a way to hedge personal real estate exposure: UMM and DMM (both ETFs) basically allow you to short or long the real estate market and thereby offsetting whatever personal position you might hold. Shiller created them specifically with that intention in mind.
The downside is that these reflect the national housing market, vs a more local one or the 10-city index. It's better than nothing and a good start.

Regarding comments about renters and buyers being stuck in their position ... I was merely testing out a hypothesis as I get to know UD readers. Whenever I come across (or in this case generate) such debates, it seems like renters have not purchased in the last decade and likely wouldn't consider doing so for another 10 years (mild exaggeration, of course). I wanted to point to the apparent distance between the two sides and see if it was more elastic than it may otherwise appear. I myself am a former buyer turned renter now in the waiting game so I can relate to both.

As for Eric's point and the whole nuclear example, it's not particularly crazy. I say this because I remember Sam Zell talking to us at Wharton and telling us he never wanted to purchase the World Trade Center because of a very similar line of thought: too much of an attack target, too risky. (And then, of course, his comments sounded brilliant after the fact.) I took Eric's comments along these very same lines.

One more thing (Jay, you reminded me). I was catching up on my Economist reading on the plane, delayed in getting back here, and came across an article called "Measuring what matters: Man does not live by GDP alone. A new report urges statisticians to capture what people do live by."

It actually speaks to the difference between the numbers side of the buy/rent decision and the other side. I'm going to quote a few lines from this article that, while not directly parallel, made me think about the implications to our discussion.

"GDP was designed to measure only the value of goods and services produced in a country; how well off people feel also depends on things that GDP does not capture, such as their health or whether they have a job."

"Moreover, the value of production is based on market prices, but not everything has a price."

"Measures of quality of life will attempt to capture well being beyond a mere command of economic resources."

... As we don't have quantifiable ways of measuring or valuing the softer reasons for buying right now (the feeling of ownership, permanence, etc.), the financial side of the argument will always sound more legitimate.

I think a lot of the heat comes from simple confirmation bias. People want to believe that the choices they made in the past are valid. It's difficult to admit that one may have made a mistake by buying or renting at the wrong time.

As for me, I currently rent, but I'm definitely interested in buying in the future. I just want the gap between the monthly costs of renting vs. buying to diminish. Even after the events of the last year or so, the difference is still significant.

After selling my apartment and renting for 2 years, I thought I would wait another year before buying again. However, I'm going to contract next week on a much discounted 3Fam in a nice part of Brooklyn. It may not be the perfect time but this individual place will work for me. I can survive with no rentals, live rent free with one rental, and turn a decent profit with 2 rentals. The numbers just seemed right and the place and neighborhood are nice. Plus, it is near my work and I can have colleagues over for dinner and schmoozing. Sure, properties values may continue to fall, but I plan to stay for at least 10 years in this place, and I think I'll really love it there.

So, I'd say there is no one answer to the rent vs. buy question. Had I not found this place, I would still be renting. But, when the right thing comes along, I think you have to summon the courage and go for it.

Ana,

Let's focus on taxes for a moment. It's not secret that high net worth individuals are being squeezed by local governments for taxes. So, what incentive do they have to continue residing in a high tax state?

For ex, let's say that I live in California. I would have to weigh the cost of taxes next to the benefits (living near beaches/Hollywood/wine valleys) against a move to a ZERO INCOME TAX state next door. The only problem is that state (Nevada) is a literal desert that derives 95% of its budget from gambling. Unless I have a passion for gambling and UFO sightings why would I live in NV?

But why can't I have both benefits? How about buying a cheap house in Nevada (no shortage these days), turning it into a virtual mailbox, and renting in California?

We also have a zero income tax state here in the north-east. It's called New Hampshire.

re: taxes. My business partner's parents, who reside in California, just purchased a 6month+1day home in NV. The key however is a full 6 months + 1 day which, according to him, the state of CA is becoming increasing nuts about enforcing. Literally - neighborhood "rats" that keep tabs on when neighbors are away for extended periods, subpoenas for phone records, etc. Here in the NE, add the EZpass system which allows the taxman to keep very good tabs on the comings and goings of residents, which IMHO, ultimately means you have to be willing to spend 183 nights a year in NH.

In Debt We Trust - I completely agree with you; in fact, Crain's ranked NYC as the most taxed city (corporate and personal) in the US, along with the highest cost of living. Discouraging ... and yet, I and others are still here :) The question we must all ask ourselves is whether the premium is worth it.
Believe me, when I let my bearish side take over, I can easily paint a picture of NYC having passed its peak not just from a national perspective but an international perspective. Coupled with our state budget picture and you can easily see the cost of living going up and services going down.
And then I breathe and listen to so many around me who believe NY will never lose its edge.
Aah, the trials and tribulations of being able to argue both sides :)

Ana,

My perspective was originally formed from trusts/estates law where lawyers are eagerly speculating on the expiration of the estate tax exemption in 2011. But the general principles are still applicable for income taxes.

Diligent record keeping MUST be kept in order to claim that you are not a state or city resident. Owning real property, a business, and business property (even a warehouse) are all subject to NYS/NYC claiming you as a resident. So is having a spouse (b/c of spousal property) residing in New York. City employees are also automatically residents of NYC. I think the courts even held that paying a child's tuition qualified the taxpayer as a state resident.

This issue comes up a lot w/the "snowbird" Florida residents - NY'ers who migrate to Florida every few months. (Florida has no state income tax). I have heard of people going so far as to keep time-sheets of their visits w/petty cash purchase receipts to prove they were only in NYC for less than the statutory minimum (e.g. 11:55 PM on the NJ border so they didn't qualify for the next day's stay).

Regarding bhh's points, unless NYC residents are willing to submit to a lifestyle of paying cash for everything (b/c it's less traceable) then they might as well buy instead of renting.

For most people, all the above measures are more trouble than they are worth.

We purchased our condo in early 2005 and just sold for a 10% gain which was a break even point for us with all the closing costs and such (purchased from sponsor)...

Anyway, a similar condo in the same location would have rented for between 3 and 4k and we were effectively paying $2200 per month after figuring in the tax benefit and common charges/taxes. And we only put 10% down with an interest only loan.
Not to mention there was nothing near as nice available to rent anyway in the area at the time. even with the small value gain in the property, that seems like good math to me especially considering we would have likely invested that downpayment in the stock market and watched it implode last september.

Ana Maria, I don't think NYC is going anywhere. Even if it's not the international capital of the world it will take something quite spectacular to oust it from being America's epicenter. This speculation is all generalizations and extremes. Ultimately individuals will do what they can afford and what they believe in and doing what's right for them is what is right. I own simply because it's the belief system I was born into - in my family - renting is a dirty word for various reasons not worth getting into. Owning is right for me because I can afford to own and I can afford, Thank God to wait out 10 and 20 year real estate cycles. I think the majority of kids growing up today still dream of coming to New York and I don't think this city is going anywhere. We tolerate the high expenses which are indeed painful because it's so darn convenient and exciting to live here. Commutes are hellatious, I like my quality of life living here which affords me to see my family and not be forced into a rigid and stressful commuting schedule. I know people from the burbs who once the kids are gone they move back here because it's exciting and there's so much to do. My feeling is rent or buy, you're here because you need to be here or you love to be here and there's 8 million others like you. This city won't fall out of favor and whoever survives the nuclear attack will just think DISTRESSED OPPORTUNITY BUY BUY BUY!!!!

Anonymous - I am enamored your spirit :) I know all too many people who relate to your love of NYC ... my hubby can't imagine himself living anywhere else, along with many of my business school friends.

Here's to that love continuing and spreading throughout the city!

http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html#

This is a link to a rent v. buy calculator which shows how you make out financially over various time periods. The outcome is still heavily dependent on the assumptions inserted into the model. I suspect many buyer advocates would be surprised by the results (unless they put in very bullish assumptions), but for people willing to stay in the same property for a long period of time like 10 years or more, buying usually works out for them. It is just a financial indicator, but it may clarify how much intangible value is being placed on ownership.

Oh, and don't forget to look into the advanced settings on the top right. Has a number of variables that are often forgotten like renovation costs, etc.

I think NYC will do ok, overall.

The problem is that taxes are going to go up significantly until the people hold their politicians' feet to the fire like they are starting to in CA.

The opportunity is demographics: I predict that due to increasing energy prices, in combination with dollar devaluation, living in the suburbs will become much more expensive, making the city look better in comparison.

I'm thinking Baby Boomers will start to leave the burbs and move into the city for the ease of doorman living and no more staircases to climb in their old age.

Thisson, those are interesting perspectives. I think your first point makes sense, but the second one is difficult. Why would older people want to move to a chaotic city? Most older people want peace and quiet. Also, what money do baby boomers bring? Most will probably not have the means to live in New York and would opt for a cheaper alternative like Florida, etc.

In my opinion, it is the young to mid-career financiers and other professionals that drive real estate prices here to their hefty valuations. That group would need to grow and remain as wealthy to keep demand in additional to availablity of financing, etc. I do agree that there are probably a small subset of baby boomers that would like to move to New York, but I am skeptical that this would be significant enough to affect the overall market.

Actually, Thisson, I think your demographic analysis is supported by other think tanks' work.
Indeed, the long term view is that as our population ages, Baby Boomers and the generations thereafter will be looking back to urban spaces in which to live as they age.

This is because of the proximity to every-day conveniences and to one another, without the hassle of transportation and energy costs, while benefitting from the very built-out infrastructure that large cities can offer. That, along with access to a wide range of cultural venues, educational institutions, etc. is expected to bring about a death of suburbia (at least in its current manifestation).

This is why we're seeing "smart" urban planning evolve so quickly to create self-sufficient, mini urban centers and combat the urban sprawl we've seen expand over the last few decades.

With respect to NYC, it will be interesting to see how that plays itself out with respect to rental vs purchase properties, but now we're in a 10-25+ year prediction range.

This has been a captivating and informative thread; it's interesting to see the varied perspectives on rent vs. buy. I would agree with Jay that people can get religious over this, but when they do they risk appearing cynical.

Despite all the calculations and analysis done, there can be no right or wrong side simply because no one has a crystal ball that can say with any certainty whether their decision will result in the best ROI- or best quality of life (if you care less about ROI and more about where you live). There are too many variables: time, local events and developments, politics, personal life changes, the economy, etc.- so it all just comes down to preference.

For me, 'security of tenure' as RO put it is very important. I also value the ability to renovate, upgrade appliances, choose or do my own repairs, etc. completely at my own discretion- but that's just my personal preference. I have friends who live a more transient lifestyle and couldn't care less about these things- in fact, they don't want to be bothered with them. Anecdotally, if you look at market trends over this decade, I also happen to have a much better ROI than if I had rented- but this wasn't the primary reason I bought. You could argue I got lucky, and you'd be quite correct because I did not forsee the bubble that occurred.

Hand's down I would prefer to be King of my own Castle and have space to boot but the reality is if you bought after 2005, you are underwater. Certainly folks who bought in the late 90s or just after 9/11, have fared very well. I think one of the points here is that while NYC deserves a juicy premium, the current ask is way way over extended. I wouldn't hold my breath for the onslaught of boomers (who btw have to sell their current digs in order to make this sojourn to city...) since they in general are looking to reduce fixed cost and will most likely look at other urban centers than NYC. Look, it's really simple. Jobs will determine what NY real estate is pricing at in a year or two or three. We must realize that all of the appreciation since 2003 was in large part due to the availability of jumbo financing and the massive hiring that took place in the mortgage-related industries. Those mortgages and jobs are gone and not coming back. I think it's dangerous to pretend that NYC real estate is in a vacuum when the real buyer is in fact comparing cost to live here versus elsewhere. For the cost of a 3 bed in the UWS you can own a home in Rye or Greenwich - both of which offer great public schools and services. Yes, you lose the city but when you have a family, that's what you do. The $64,000 question is if 3+ beds keep falling (which it sure looks to be the case), how does that impact 1 beds and studios?

Fred - that's a silly statement, that anyone who purchased after 2005 is under water. Each individual transaction is judged on it's own merit. As an example, we bought in 2007, but got a great deal on a fixer-upper. The same line 2 floors down sold in early 2004 for 4% more than what we paid (equivalent cost when factoring renovations). So based on your statement, we are under water and our neighbors are not.

I think anyone who bought an index fund on Manhattan property post-2005 may be under water, but it is like discussing the Russell 2000 vs. it's individual components. The index could be down over several years but there could be standouts within.

OT - you make a good point but i would argue that "fixer uppers" fall into a unique category because the time to renovate is treated very differently than completed. i would also suggest that the proper comparison would be with another fixer upper in a similar bldg/neighborhood versus a renovate unit.

Fred - I would agree that fixer-uppers occupy a unique niche, but even excluding them, I think people can find good deals in heated markets, and conversely, get screwed in weak markets. Blanket statements that "everyone" who bought during a particular time period lost out are valid only at the macro level and don't apply to individuals.

I would concur that many who purchased in 2006 or more recently are even or under water, but I guarantee there are plenty who would make a tidy profit if they were to sell today, renovation or not.

you know, something that occurs to me in terms of why the rent vs buy gets so heated is the simple fact that only urban markets offer a true alternative to owning. if you live in the suburbs, the rental market for single family is irrelevant and you end up comparing an apartment with a house. in other words, the premium a home owner pays for the luxury of their castle gets sidelined as an issue because there's really only one option, to own. while NYers want to separate the psychologies of renting versus owning, the practical truth is rental rates are highly correlated to sales prices over time. perhaps the real argument should center around where rental rates are going?

Interesting twist, Fred. I actually found a chart just a few days ago (went only up to 2007) that showed a crazy high correlation between wages and rents. According to the data, between 2002 and 2007, wages were actually growing a bit faster than were rent prices. Wish I could see what 2008 and 2009 would have looked like on the chart.

For the near term, I would say rents won't increase due to the high inventory not just from traditional landlords but also from co-op, condo and new development inventory that would otherwise be sold but must be rented for the time being.

Fred, I agree that observing rental rates on their own is much more useful discussion because this debate, while very interesting from a psychological point of view, lacks real merit. The dichotomy seems to be more between sideline buyers and owners than which is a "better" long term strategy, hence the religiosity. And as you point out, there is a causal relationship between the two over time anyway.

There are some who were nimble enough to sell, becoming renters, but still own or recently bought "strategic real estate". I guess that makes them owner/renters.

The emotion, Ana, comes from the way people argue a point. It's perspective. People generally come into the argument trying to support a position that they are already aligned with instead of hearing the possibilities. Then, they seek out those statements or evidence that supports their view while dismissing opposing views. (the WMD in Iraq...)

Either way, the Yankees will be back this winter signing big name free agents again, living or not.

Ana - what do you make of the model suing the building on the upper east side? Will this be a problem for sellers?

Thanks so much for the information. Great real estate stuff.