This post was adapted from a @radreadsco Instagram story.
If the old adage “paying rent is like burning money” is true, then our family has (and will) continue to burn it for many years to come. Two years before I left Wall Street, I made the conscious decision to de-risk our financial picture by selling our 585 square foot NYC apartment. I warned Lisa that we wouldn’t be in a position to own for a long time; the income variability (or flat out lack thereof) would make it hard to get a mortgage.
In fact, I’d be totally ok if we burned money on rent for the rest of our lives. Lisa – not so much. Especially since we have enough for a down payment and the RadReads outlook is looking solid. So why not own? After all, our tax code highly incentivizes home ownership, real estate is a hard asset that tracks (and often beats) GDP growth and inflation, and it’s one of the easy ways for an ordinary Jane (or Joe) to get investment leverage. But let’s be honest, most people buy a home because they want it to be, well, their home. There’s a huge emotional “peace dividend” of planting roots in a community for your kids, never having to move again, and knowing you’ll “own” all of your improvements.
These are all very compelling, but I think that many of the emotional benefits can be replicated by renting. And people underestimate the benefits of renting including the lack of stress, extreme liquidity, and freedom.
The pros of home ownership
One of my core personal investing principles is to maximize the incentives in the tax code. This includes maxing out 401(k)s, Roth IRAs and 529 Plans. The tax advantages for home ownership are pretty delicious (albeit less so given Trump’s tax plan) and range from interest deductions, property tax deductions, depreciation (for the self-employed) and the exclusion of some gains if you sell for a profit. (Note, please don’t treat this as tax advice.) And if you are in a high income tax bracket, they become even more valuable.
Finance folks are used to thinking in terms of leverage – borrowing money to make an investment. If you make a 20% down payment on a $700k home, you’re borrowing $560k. Your gains (and losses) will be amplified accordingly.
Let’s continue this very simple example do demonstrate how leverage works:
- Purchase price: $700k
- Down payment: $140k (20%)
- Mortgage amount: $560k (80%)
Let’s say the real estate market goes up and down by 5% in a year and you have to sell. (Note: this is a highly simplified example that excludes the many tax benefits and transaction costs.) Here’s the up 5% scenario:
- Sale proceeds: $735k (700 * 1.05)
- Net of mortgage balance: $175k (735 – 560)
- Return (Proceeds / down payment) = 25% (175 / 140 – 1)
And here’s down 5%:
- Sale proceeds: $665k (700 * 0.95)
- Net of mortgage balance: $105k (665 – 560)
- Return (Proceeds / down payment) = negative 25% (105 / 140 – 1)
It would be risky to borrow from your credit card to invest in the stock market. But borrowing against an asset that tends to go up over long periods of time is something I truly miss about home ownership. (1)
The emotional “peace dividend”
But I just over-intellectualized a decision that’s predominantly driven by emotions. When you own your home you benefit from a gigantic emotional peace dividend. For starters, it’s yours. If you pay your mortgage on time, no one can take it from you. Don’t like the bathroom – change it. Want your own man cave? Build it. And unlike rent, your payments typically don’t go up (2) and you’re never living with the anxiety that your landlord will sell your place. These are all worth a lot.
You’ve “made it”
I’ve talked to many professionals who view buying a home as a status symbol. Or said differently, the money burning-renter possesses some sort of JV life status. But for most people, buying a home represents their single largest investment – by far. Do you really want such a sizable purchase to be driven by the pursuit of status?
Maybe the renters are the high status ones. After all, they’re paying for flexibility. Optionality. The ability upgrade (or downgrade) careers, lifestyles and life circumstances.
The hidden benefits of renting
Renting is low stress
As a long time renter, our living situation rarely stresses me out. Our Brooklyn apartment had its share of nicks and bruises. Broken central air, two bad leaks (that impacted other units), a silverfish infestation. In every case, all it took was a quick phone call and within a few days someone had come to repair it. At zero cost to us.
Then there’s neighbors. Luckily, we won the lottery here (and a few are actual RadReaders). But there was a single guy below us who blasted techno in the evenings and the threat of three single guys moving next door and sharing our outdoor space. In the heat of it, we’d get a bit nervous, but would always remember that (in the most dire circumstances) the cost of breaking our lease was one month’s rent.
Conversely, when I speak to homeowners, they are constantly lamenting how they have to pay for these nicks and bruises. Most of them can afford it, but there’s always the emotional cost of dealing with a problem. Finding the right septic tank company, contacting them, getting the kids out of the house when they come. One friend told me that dealing with all these contractors felt like “air traffic control.”
And then there’s the outlier case of making the wrong decision. Finding yourself in an unanticipated flight corridor, a flood zone, or realizing that your house was built over an underwater creek – eating away at your foundation (all real examples). Once you’ve closed, there’s no backsies.
It’s hard and expensive to sell a home. There are the financial costs (broker commissions, repainting, staging, and closing) and the emotional ones (keeping the home pristine, leaving during open houses, living in a state of flux). People underestimate the magnitude of commissions, typically 5-6%.
Here’s a quick hypothetical example to show the impact of commissions on sale proceeds. Let’s say you bought a home and one day after closing realized you made a drastic mistake (say, the million dollar house next door was actually a meth lab). You want to sell it the next day. So you take a 6% hit, right? You’d actually lose 30% on your investment, because of the leverage effect we described earlier. (3)
The most under-appreciated advantage of renting is the optionality it affords you. For starters, you’ve saved yourself the huge cash outlay of a down payment – which can be used to support entrepreneurship, travel, a sabbatical – or just change in general. Just the psychological burden of knowing you have a mortgage to pay is likely to be a big barrier to pursuing these changes. (Too much optionality can also be problematic.)
And we’re in an era where “contract” between the employer and employee are changing in both good and bad ways. Sabbaticals are becoming more common. Remote work is becoming a real option, enabling you to change locations. People are changing jobs more frequently. And the ability to create new sources of income has never been easier. If you want to capitalize on these changes, there’s no greater freedom than the flexibility that comes with renting.
So how do Lisa and I resolve our differing perspectives on home ownership? What will we do in a few years, when we’ve rebuilt our income profile to actually qualify for a mortgage? Well, having just embarked on a new adventure – it’s hard to even know what our state of mind will be in two years. And we’ve joked about how when both girls are in middle school, we’d like to take a family “gap year” and travel the world.
So who knows. I do think ultimately our desire to truly “have a home” will intersect with the powerful financial incentives of home ownership. But not just yet. And so we’re good burning that rent check each month until we figure it out.
I tackle complicated money issues like this in my money coaching practice. To learn more email khe [at] radreads [dot] co. And thanks to Steven Boynes for the prodding to write this post.
(1) In finance terms, borrowing against your home is non-recourse and term-funded debt. You cannot get a margin call on your house, even if its value fell by 99% – and that’s powerful.
(2) Many mortgages these days are hybrids, so your payment may jump between year 5-10. This wouldn’t be the case if you had a fixed mortgage.
(3) As time goes by (even a year) this hit can be offset by the tax benefit of your mortgage and even the slightest increase in home prices (due to leverage).