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At a time when home values are soaring in most metro areas, along comes The New York Times with the thought that renting may well be a better financial choice than buying. The Times says that "after five years in which rents have barely budged while house prices in New York, Washington, Los Angeles and elsewhere have doubled, renting has become a surprisingly smart option for many people who never would have considered it before." (See: Is It Better to Buy or Rent? September 25, 2005)

As evidence, the paper looks at ownership and rental costs over five years and finds that "when the net costs of owning are less than those of renting, as is the case in Chicago, Dallas, St. Louis and much of the middle of the country, the argument for buying becomes overwhelming. So long as home prices do not fall sharply, home buyers in these places will do much better than renters. "But when owning is more expensive every month," says the Times, "buyers are betting entirely on price appreciation." The problem with this analysis, as with all economic projections, is that we don't actually know what will happen in the future. Moreover, as the Times observes, counting on price appreciation has been a very good bet in the past few years in most metro areas -- whether it will also be a good bet in the next few years is unknown.

If you look at many high-priced areas you can see that renting -- on the basis of today's costs -- is far cheaper than buying. For instance, in my area a $450,000 home might rent for $2,000 a month. The renter has paid no money down other than a deposit and can invest the money not used for purchasing. An owner, meanwhile, may have a 90 percent loan at 6 percent. Over 30 years the monthly cost for principal and interest for a $405,000 mortgage will be $2,428.18, property taxes might be another $250 a month and insurance is perhaps another $50. In addition, the owner is losing the interest that might have been earned on the $45,000 down payment plus thousands of dollars in closing costs. In rough terms our owner has an effective monthly cost of perhaps $2,800 or $2,900 -- before tax write offs such mortgage interest, depreciation and property taxes.

So yes, the renter spends less cash per month -- at least at first. But is the renter ahead? We don't know what will happen with home prices -- it's possible they could rise and it's also possible they could fall. This is the core "x" factor. The Times article says nothing about amortization. For those with a fixed-rate loan, the balance falls each month. Even if home prices stay the same, equity increases.

Financing rental properties with ARMs, option financing, interest-only mortgages, etc. means that monthly loan costs can change -- bad news for owners if interest rates rise or if the properties are not refinanced with fixed-rate mortgages before higher monthly payments kick-in. Renters may get income from money not invested in real estate -- but they do not get write-offs for property taxes, depreciation, etc. Rents can increase. Rental properties can be vacant, require repairs and have associated costs such as management expenses.

Ownership over five or ten years does not really reflect investment trends. What often happens is that Smith owns an investment property for a few years, sells and then buys a replacement property to avoid capital gains taxes. Equity from the first property is used to reduce costs for the replacement property or to buy a more expensive investment. In effect, the value of amortization and equity growth is often passed through a chain of related investment purchases. The value of real estate is measured in dollars. As inflation erodes dollar values, it takes more cash to buy a typical home. When the value of the property grows faster than the rate of inflation real wealth is created -- a real estate benefit unavailable to renters.

When investors sell they typically get the advantage of low capital gains tax rates. When they die, properties are passed through to heirs at their stepped-up value which means there is no tax on the capital gains -- but there may be an estate tax if the estate is sufficiently large and not properly planned. The bottom line is that buying real estate represents real risk -- and so does renting. Given a choice, I prefer ownership if only because it's hard to find long-term real estate investors who are poor. But that's just me.

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