Is buying *actually* better than renting?

The most conventional financial wisdom may be wrong

In this post, I’ll address the most frequently-asked question I’ve received…

If you grew up in the US, you probably assumed that buying a house was a rite of passage into adulthood. Sure, you may be able to buy alcohol at age 21, and you may get married in your 20s or 30s—but many people say they don’t truly feel like an adult until they buy their first home.

Headlines asking “is now a good time to buy a house?” often dominate the financial news (including in Money.com, Business Insider, NerdWallet, and many more websites—over just the past couple months). It’s a good question, and does require a fair amount of analysis. However, most of these discussions take for granted the fact that you do want to buy a home in the first place.

Few finance writers or gurus on #fintok address the topic from first principles: Is buying a home always better than renting one?

Of course, there are many intangible benefits to homeownership: more autonomy, the feeling of ownership, etc. In this post, we’ll evaluate the decision strictly from the perspective of an investment.¹

Throwaway costs

The conventional wisdom goes: “When you rent, your rent payments are ‘throwing away’ money. When you own, your mortgage payments are an investment.”

However, many of the costs associated with home ownership are also “throwing money away” (getting temporary benefit out of them):

1. Interest on your mortgage

2. Maintenance and repairs (which a landlord would typically cover if you rent instead)

3. Property tax

4. Homeowner’s insurance

5. HOA or condo fees (which a landlord would typically cover if you rent instead)

According to my research, if you were to buy vs. rent an equivalently-sized home in the same area, those 5 costs can easily add up to the same as what you pay on rent. In other words, if it costs you $1,500/month to rent a house, it can often cost you $1,500/month to own a house—excluding the payments you’re making toward ownership of the house (the part of your mortgage payment that goes to the principal, not interest).

When that’s true, the question becomes: how does a house—purely as an investment—compare to other investment options? In other words, if what you’d be spending on the 5 costs above would equate to the money you’d be putting into rent anyway, then if you have leftover money, is putting it into equity (ownership) of a house the best way to invest that money?

Comparing investments

A “default” you can compare any investment opportunity to is the S&P 500 (an index fund that is a good proxy for the total US stock market).² Over the long term, the S&P averages returns of 9-10% per year.³

Many people assume houses “always go up,” but that is not the case! Imagine you bought a house in Detroit in the late 1990s…

People often assume that they are savants at picking the best neighborhoods that are going to boom, but of course, as with all investments, most of it ends up being guesswork, because nobody can predict the future. If we look at the average home appreciation rate in the United States over the past 100-ish years, it’s a lot harder to estimate (understandably so—there are a lot of houses, so it’s difficult to track all of them!). The most reasonable economists’ estimates I’ve read are about 3-4% per year. That’s a lot less than 9-10%.

However, we’re not done yet. A house does have two major advantages as an investment:

1. Taxes – If you sell your house for a profit, the first $250,000 of those capital gains are tax-free ($500,000 if you’re married). In other words, you don’t have to pay capital gains tax on much of the profit from your house.⁴

2. Leverage – Most mortgages only require a 10% down payment. (For example, if you buy a house for $500,000, you only need to pay $50,000 up-front, and you take a loan for the remaining 90%.) However, the entire house appreciates, not just 10% of it. It’s as if you could invest $50,000 into the stock market, and someone would loan you another $450,000 to invest alongside it. That financial concept is called leverage and it adds up quickly.

The verdict

Do those two benefits account for the ~6% lower growth of houses (compared to the stock market)? It depends on many factors, including how long you plan to own the house. Counterintuitively, the less time you own the house, the better it is (purely as an investment), because then you benefit more from the leverage.⁵ The leverage is extremely powerful.

Thus, in order to calculate if you should rent or buy a specific property, you’d need to compare the 5 “throwaway” ownership costs to the cost of rent, then compare the house’s estimated appreciation to the S&P 500. There are further wrinkles, such as the tax deduction for mortgage interest, and the high transaction costs of selling a house.

We were also assuming that you’d have the discipline to invest into the stock market all the extra money you would be putting into your house. (Some people know they don’t have that discipline, and for them owning a house can be a good “forcing function” to make sure they’re putting some of their regular income into a long-term investment.)

On the other hand, in many senses owning a home is more risky, because you are not diversified. When so much of your net worth is tied up in the value of the home, if another real estate crash like 2008 happened, and if you had to move (let’s say for work reasons), you’d have to sell the house for less than you bought it for, or even—in some extreme cases—not be able to pay back the bank.

Getting into the nitty-gritty of this decision would require an entire book.⁶ The bottom line is that the conventional wisdom is wrong; buying a home is not always better than renting.

Perhaps that is an unsatisfying conclusion. So I’m happy to share an extremely generalized, please-don’t-take-this-as-Gospel-truth recommendation:

• If you’ve decided to settle down in one spot for at least 3 years,

  • and you have enough savings to afford the down payment without dipping into your emergency fund,

  • and you can afford the mortgage payments and other monthly costs associated with ownership without impacting most of the “necessities” on your budget,

• then buying may be worth it;

  • and, if you really want to maximize your investment, it may be best to sell within 7-10 years, so you get the most benefit from your mortgage’s leverage.

More general investing

Typically, I prefer to teach investing in a step-by-step way: what is investing? why is it necessary? how do stocks and bonds work? (Most other sources jump right into the answers, without enabling readers to understand why their final recommendations are true.)

So, at some point soon, we’ll do an “intro to investing” post that answers the above questions, and concludes with the 7 priorities I recommend to everyone in their 20s. For now, I hope that diving into one specific hot topic in personal finance has piqued your interest, and has armed with you some facts to remain critical of any conventional wisdom that dominates your newsfeed (and your dinner table conversations with boomers).

1. This post is meant to be an analytical discussion, not advice about what you should do. While we’re at it: none of my writing constitutes financial, legal, or medical advice. Please don’t sue me k thx.

2. This is a very quick-and-dirty way of introducing one of the most important concepts in investing, i.e. low-cost index funds that are relatively low-risk over long time horizons.

3. This estimate includes dividends but excludes inflation. To keep it simple, this post will only use nominal, not real (inflation-adjusted) terms.

4. There are lots of IRS asterisks around this. The main one is that it has to be considered your primary residence (where you live most of the time)—to prevent professional real estate investors from taking advantage of this tax benefit.

5. This is only true up to a point, because when you sell, you incur one-time transaction costs (like paying the realtor)—so you don’t want to be buying/selling a house too often.

6. I helped an economist build a detailed model wherein you can input all your specific numbers and circumstances to calculate the rent vs. buy difference. It has 50+ rows of data and multiple long formulas.