When buying a home doesn’t pay off
Personal finance experts have long held that homeownership is a key step to building lasting wealth. A home is an asset that generally appreciates in value over time, and buyers also benefit from leverage: You can borrow up to 80% of the value of a home, or even more with a low down payment loan.
Before individuals had access to low-cost mutual funds and brokerage accounts, the stock and bond markets were limited to institutional and deep-pocketed investors. For everyone else, buying a home was the primary way to invest, says Florida Atlantic University professor Ken Johnson, who specializes in rental housing and real estate market research.
Johnson is also the co-creator of the Beracha, Hardin and Johnson Buy vs. Rent Index. The index analyzes 23 U.S. metropolitan areas to determine whether market conditions favor renting or buying in terms of wealth accumulation.
In a recent update, the index concludes that in 17 of the 23 metropolitan areas, including Atlanta, Los Angeles and Detroit, consumers would be better off renting and investing the money they would have used for a down payment, closing costs and other housing expenses — even though rents have skyrocketed.
The median home sale price in the U.S. hit about $429,000 in late April, and 30-year fixed mortgage rates recently rose to 5.27%, the highest since the summer of 2009. Over the past 10 years of bull-market returns, the S&P 500 index has increased 11.7% on an annualized basis, compared with a 7.9% annual rise in home values.
For renting to deliver a higher return, you need to have enough money left after you pay your monthly rent to invest. And that comes down to personal choices. For example, if you would be happy with a one-bedroom unit, pick that over the pricier two-bedroom unit, or skip the complex with the pool.
Or, if you’re like me and live in an expensive metro area, you may choose to save money by living outside of the city. I have also forgone some amenities, which keeps my costs in a range I’m comfortable with.
In addition to these types of trade-offs, renters need to get in the habit of saving. Pay yourself first with automatic transfers from your checking to your savings or brokerage account.
If you have access to an employer-sponsored retirement plan, contribute as much as you can.