Should I rent or buy in today’s housing market? 0.5% Rule.
July 2018
Being in real estate these days, it seems like the only question people want to ask me is “are we in a bubble?” The problem with that question is that there are great arguments on both sides. Anyone can pick a graph and quote things like historical trends or current supply vs demand, and make a very convincing argument. While I don’t have a crystal ball, I do have concerns that we have approached the top of the cycle. I see people that I know stretching their budget, and the banks thinning their requirements just to get a name on a deed. So I have to ask: Is now the right time to be doing this?
The beauty and the curse of owning a home in this country is that it is the American Dream. Buying that first home has become synonymous with “making it” in life, and therefore at the top of the list of things to aspire. My husband and I have owned plenty of personal homes over the years and currently live in our potential “forever home”. At the same time, I know people who are very smart and are very successful investors who swear that renting a home is the way to go. Which brings me back to the current state of the market. If I believe that annual price appreciation is going to slow significantly or even stop, can I argue that these renters are wrong?
As always when it comes to real estate, we decided to do the numbers. While we love our forever home, we are lucky enough to have access to investments that return 10-30% on our money, so the equity in our home could be doing a lot more. Obviously everyone’s situation is different, and the numbers can vary widely in different parts of the country, but we tried to use averages and historical data as much as we could. I will try not to overcomplicate it with things like tax deductions etc, since once again that is situation specific.
For easy numbers, let look at a $500,000 home.
Expenses:
Your biggest expense is obviously your mortgage. At a current 4.5% interest rate, your payment would be about $2025. Contrary to the popular argument of a mortgage “paying yourself instead of the landlord”, about $1500 of that is going to interest payments in the beginning. So disregarding principal payoff, your mortgage costs you about $1500 a month.
Property insurance. Based on our experience with houses in this price range insurance is about $125 a month.
Property Taxes. Now here is the huge swing. A $500,000 house in our area costs you about $10,000 in taxes a year. If you live somewhere in the south you just spit out your coffee because you are paying maybe half of that. In our experience with rental properties, the tax man is going to get you one way or another, but for this example to be fair we will go on the low end and use $5000 a year for property taxes. That gives us a $417 monthly expense.
That’s it right? All the rental property owners are screaming right now because the constantly overlooked house expenses are repairs and capital expenditures. There are plenty of articles you can read about how much to set aside for these numbers, but for repairs, capex, and ongoing maintenance it is usually 1-2% of the value of the home per year. Therefore a $500,000 home at 1% give you $5000 a year or $417 a month.
Adding it up we get: $1500 mortgage interest, $125 insurance, $417 property taxes, and $417 for house expenses. This give us a monthly total of $2459.
Funny how real estate numbers work isn’t it? While many of us like to use the 1% rule as a guideline on when to buy a rental property, it seems like 0.5% rule is pretty close for the tipping point when you should rent vs. buy. If you can find a house that rents for less than 0.5% of it’s value per month, then expense-wise you are most likely coming out ahead. With us living in the Northeast, renting is even easier to justify with double the property taxes.
So what did we decide? Looking at rentals in our area, it was easy to find comparable properties to our current home that are renting for less than 0.5% of the value. Plus if we sell, we can invest all of the equity in our home and get returns much higher than we believe our home appreciation will get us. We both agreed that it made the most financial sense for us sell our home, and rent. Will we actually do it? Probably not. I love our house, and I really can see our kids growing up in it. While the numbers determine most of the decisions we make in our lives, what is the point in being successful if you can’t spend some money on enjoying it?
While I’m at it, I think I’ll buy a pool too.
As always, I love to hear your comments.
Being in real estate these days, it seems like the only question people want to ask me is “are we in a bubble?” The problem with that question is that there are great arguments on both sides. Anyone can pick a graph and quote things like historical trends or current supply vs demand, and make a very convincing argument. While I don’t have a crystal ball, I do have concerns that we have approached the top of the cycle. I see people that I know stretching their budget, and the banks thinning their requirements just to get a name on a deed. So I have to ask: Is now the right time to be doing this?
The beauty and the curse of owning a home in this country is that it is the American Dream. Buying that first home has become synonymous with “making it” in life, and therefore at the top of the list of things to aspire. My husband and I have owned plenty of personal homes over the years and currently live in our potential “forever home”. At the same time, I know people who are very smart and are very successful investors who swear that renting a home is the way to go. Which brings me back to the current state of the market. If I believe that annual price appreciation is going to slow significantly or even stop, can I argue that these renters are wrong?
As always when it comes to real estate, we decided to do the numbers. While we love our forever home, we are lucky enough to have access to investments that return 10-30% on our money, so the equity in our home could be doing a lot more. Obviously everyone’s situation is different, and the numbers can vary widely in different parts of the country, but we tried to use averages and historical data as much as we could. I will try not to overcomplicate it with things like tax deductions etc, since once again that is situation specific.
For easy numbers, let look at a $500,000 home.
Expenses:
Your biggest expense is obviously your mortgage. At a current 4.5% interest rate, your payment would be about $2025. Contrary to the popular argument of a mortgage “paying yourself instead of the landlord”, about $1500 of that is going to interest payments in the beginning. So disregarding principal payoff, your mortgage costs you about $1500 a month.
Property insurance. Based on our experience with houses in this price range insurance is about $125 a month.
Property Taxes. Now here is the huge swing. A $500,000 house in our area costs you about $10,000 in taxes a year. If you live somewhere in the south you just spit out your coffee because you are paying maybe half of that. In our experience with rental properties, the tax man is going to get you one way or another, but for this example to be fair we will go on the low end and use $5000 a year for property taxes. That gives us a $417 monthly expense.
That’s it right? All the rental property owners are screaming right now because the constantly overlooked house expenses are repairs and capital expenditures. There are plenty of articles you can read about how much to set aside for these numbers, but for repairs, capex, and ongoing maintenance it is usually 1-2% of the value of the home per year. Therefore a $500,000 home at 1% give you $5000 a year or $417 a month.
Adding it up we get: $1500 mortgage interest, $125 insurance, $417 property taxes, and $417 for house expenses. This give us a monthly total of $2459.
Funny how real estate numbers work isn’t it? While many of us like to use the 1% rule as a guideline on when to buy a rental property, it seems like 0.5% rule is pretty close for the tipping point when you should rent vs. buy. If you can find a house that rents for less than 0.5% of it’s value per month, then expense-wise you are most likely coming out ahead. With us living in the Northeast, renting is even easier to justify with double the property taxes.
So what did we decide? Looking at rentals in our area, it was easy to find comparable properties to our current home that are renting for less than 0.5% of the value. Plus if we sell, we can invest all of the equity in our home and get returns much higher than we believe our home appreciation will get us. We both agreed that it made the most financial sense for us sell our home, and rent. Will we actually do it? Probably not. I love our house, and I really can see our kids growing up in it. While the numbers determine most of the decisions we make in our lives, what is the point in being successful if you can’t spend some money on enjoying it?
While I’m at it, I think I’ll buy a pool too.
As always, I love to hear your comments.