Renting Rich or Buying Broke: Rent or Buy in 2023/2024?

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Today on the show, we're discussing the age-old debate of buying versus renting. My goals for today's episode are twofold: to debunk the myth that buying is always the superior choice and to assist you in making a well-informed decision between renting or buying.

In the U.S., the concept of home ownership is deeply ingrained in the American dream, with the belief that it's a fundamental part of achieving financial success, independence, or wealth. However, this perspective might not hold true universally, and individual preferences and local conditions heavily influence the decision.

Some staunchly advocate that home ownership is the sole path, while others fervently argue that renting is the superior option. Personally, I don't align with either extreme. I believe it depends on your personal preferences and the specific circumstances of your living situation. Additionally, the economic trends significantly affect this decision.

However, it's crucial to note that economic conditions and real estate dynamics can vary widely from one neighborhood to another. What's happening in one area might differ significantly from a location just a few miles away.

While I will discuss economic trends in this episode, it's essential to remember that the information might not precisely reflect your local situation. Nevertheless, I aim to provide valuable insights to help you become a more informed buyer or renter.

For instance, in a recent video, I discussed the potential downsides of home ownership. One comment resonated with many, expressing regret about buying a home, feeling duped and describing it as a financial burden, hindering their ability to save due to continuous maintenance expenses.

This instance hints at the complexities of the rent-versus-mortgage equation and how it might not offer a fair assessment of whether renting or buying is the right choice for you.

Let's look at the current economic scenario. Home prices and rents are at historically high levels. Recently, there's been a slight easing in rental costs, which aligns with some reports from Zillow. While I've observed a similar trend in my townhouse community, it's crucial to remember this is a microcosm and might not represent the broader picture.

Over the past year and a half, the Federal Reserve has been steadily increasing interest rates. This approach aims to make borrowing more expensive in response to the surplus cash people accumulated during the pandemic. The influx of cash led to higher inflation, prompting the need for strategies to stabilize the economy.

Rising interest rates significantly impact borrowing costs. For instance, a five-point difference in mortgage interest rates can nearly double your monthly payments. This increase in expenses may deter individuals from making significant purchases, such as houses or cars, thus reducing economic activity.

Furthermore, higher interest rates also influence business decisions. With expensive borrowing costs, businesses might be less inclined to expand and hire new employees. This economic phenomenon aims to stabilize what was a red-hot economy post-pandemic.

Traditionally, rising interest rates tend to lower home prices. This is because the affordability of a house isn't just about its price tag but primarily about the resulting monthly payments. A mere five-point difference in interest rates could significantly impact your monthly financial obligations.

The current situation in the U.S. real estate market is unusual. Factors contributing to historically high home prices and soaring interest rates include a housing shortage due to limited construction investments, political influences on zoning laws, and the emergence of corporations buying and renting out entire neighborhoods.

These unique market conditions might sustain the high prices for some time, with hopes that inflation might eventually catch up to moderate the excessively high housing costs.

In this tumultuous economic climate, the decision between renting and buying isn't straightforward. Both options come with significant financial implications. Renting is expensive, while buying a house at inflated prices carries the risk of losing money if the housing market stabilizes or decreases in value.

Contrary to popular belief, home ownership isn't always the ideal investment. Houses are considered illiquid assets, unlike stocks, which can be readily converted to cash. Homeowners face various unforeseen expenses, including maintenance and repairs that significantly add to the overall cost.

Although a home might appreciate over time, the average annual home price increase historically hovers around 4.3%, accounting for inflation. Comparatively, the stock market, with an average return of about 9%, has demonstrated better long-term financial growth than real estate.

Thus, the decision between renting and buying in today's challenging economic landscape isn't straightforward. Both options come with significant financial implications, and the idea that home ownership is the ultimate investment might not always hold true in the face of various economic and market dynamics.

Let's delve into some math. Imagine having a $500,000 house. Consider a 2% rate of return, with the average home price increases at 4%. Subtracting 2-3% for inflation, in 30 years, that $500,000 house would likely be worth about $910,000.

Not too bad. Now, let's redirect that $500,000 into an index fund tracking the S&P 500. Historically, the S&P 500 has risen yearly by an average of 10.14% since the 1940s. If we account for inflation, that would be approximately 8%. So, in 30 years, with no further contributions, employing standard compound interest, that $500,000 would balloon to $5.5 million in your investment accounts.

Moreover, an index fund doesn't demand a roof, HVAC, or entail HOA fees, or chores like mowing the lawn.

Consider this: investing $500,000 in the stock market incurs less than 0.1% in fees to the brokerage firm for hosting the account. The idea that houses are the best investment is simply not true. The stock market outperforms. However, if you were fortunate to purchase a house in 2019 or 2020, it was a stroke of luck.

Speaking of historical trends, since 1991, annual home price increases averaged 4.3%. This rate escalated to 4.7% from 2000 and further spiked to 7.7% since 2012. But even at 7.7%, when considering inflation, it's not outdoing the market, despite the surge in home prices in the 2010s. The rise in prices can also be attributed to various factors such as companies acquiring neighborhoods and a housing shortage.

Reflecting on the Great Recession in 2008, the Fed repeatedly lowered interest rates to stimulate the economy. This action significantly contributed to the surge in home prices. Nonetheless, it's unlikely that interest rates will drop to the levels seen before, implying that the soaring home price growth of the 2010s might not be replicated.

An important insight: the home you purchase to live in isn't an investment. If you're financially stable, with resources for down payment, repairs, and also manage contributions to your 401k or Roth, homeownership may offer stability and personal preferences. However, it might not be the soundest financial choice if it drains your resources, hindering other investments.

Renting isn't merely squandering money. It's a different perspective on spending. By renting, you bypass expenses such as maintenance, real estate taxes, and have more capital to invest in opportunities with higher returns.

The contrast between renting and buying lies in predictable expenses. Rent remains fixed, while mortgage payments fluctuate. Both have their merits and drawbacks, dependent on personal circumstances, financial standing, and preferences. Understanding the rationale behind your decisions is crucial; it's not merely a matter of rent being bad or buying being good.

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