Should you rent or buy? This is probably one of the most common financial questions people likely face in our lives. Financial factor is not the only thing we would consider when answering this question but it is essential. This week, I will show you how to figure out the numbers.
If you search "Rent vs. Buy Calculator" online, you could find many of them. The one I like the most by far is the one from realtor.com.
You should be able to fill out most of the information about the property you like by using the numbers from some real estate listing websites, such as Redfin. There are also a couple of assumptions you need to make. The most important two are "Home Appreciation" and "Investment Rate Of Return". For the projected home appreciation, you could refer to the price history of the specific property and similar ones from websites like Redfin. For the projected investment rate of return, you could make assumptions based on your own historical investment performance. A significant caveat here is that you need to make sure the price and investment history you are based upon are long enough to cover both up and down of a market cycle. Otherwise, the numbers can be very misleading.
Let's take a look at a real example.
This property is a condo with 2 beds and 2 baths in Playa Vista, CA, one of the hottest and fastest growing community in the Los Angeles area in recent years. The rent for a comparable apartment is about $3,000 per month. The estimated property tax includes both Los Angeles city tax and the Mello Roose tax. The annualized appreciation of this property and similar ones for the last ten years was between 5-6%. Taking into consideration the current real estate market cycle, I used 5%. For the expected investment rate of return, to be conservative, I used 6% for a young couple with a globally well-diversified portfolio.
Here is the output from the calculator. Buying becomes cheaper than renting after 4 years.
If the actual "Home Appreciation" is only 3% instead of 5%, buying becomes cheaper than renting after 9 years instead of 4 years as shown below.
On the other hand, if I save all the money in a high-yield savings account earning 2% interest, buying becomes cheaper than renting after 3 years instead of 4 years as shown below.
As the example indicated above, besides the specific property, mortgage, and rent information which are relatively objective, the output of the Rent vs. Buy Calculator also heavily depends on our assumptions of the "Home Appreciation" and the "Investment Rate Of Return". Our goal is to make our subjective projections as objective as possible which relies on our understanding and knowledge of the real estate market and investing.
In summary, the "Rent vs. Buy Calculator" is a great tool to help us figure out whether buying a home makes more sense than renting one financially. The key is to make sure the inputs to it are realistic based on your specific situation.