How to Answer the Rent vs. Own Question

Published: Wednesday, April 29, 2009 12:04 PM PDT

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Headshot Guest-host Leonard Baron, a real estate professor at San Diego State University and principal of LPB Services, a real estate consulting firm, tackles your real estate questions today as part of Savvy & Sage: Tips on Buying and Selling in 2009.

Here's a question from Rick:

How do I really decide if it is a better to own versus just continuing to rent? I want to own, but I am worried about further price declines.

Hi Rick,

Rent vs. Own is a great topic to discuss. Price declines are a separate issue, so let's tackle rent vs. own first. There are lots of issues in making this decision to buy or keep renting - a few important guidelines:

1. If you are not planning to own the property for at least four-plus years, it probably makes sense to stay a renter. No need to deal with all the risk, hassles and costs of being the owner (and the high cost of sale) for a short period of time.

2. Buying a starter home to "move up" is not necessarily a good idea either unless you plan on living there many years or keeping the starter home as a rental. There are significant costs each time one sells a home -- from sales commissions to escrow fees, repairs and financing costs. The appreciation in value in a few years is probably not going to be more than all those costs -- so don't buy if you plan on moving "up" in a few years. Save your money until you can afford the "right" home for a longer term.

So, the rent vs. own question. The real question is, in the area where I would like to live, what are the market rents vs. the cost of ownership? This of course assumes that you have the financial wherewithal, credit, job and assets to qualify to buy a home.

For example, in La Mesa or east San Diego, I can rent a nice two-bedroom, two-bathroom condo for about $1,350 per month (check Zilpy.com). I could buy that same condo for, let's say, $125,000 and homeowners association fees are $225 per month (check Redfin.com or your real estate agent MLS listings).

On the $125,000 purchase, my down payment at 20 percent is $25,000. Add another $7,000 for closing costs, financing and repairs and subtract your $8,000 first-time buyer's tax credit (although you will not receive this until you file an amended tax return) for $24,000 to close -- those expenses are also known as your equity.

In that example, the cost of monthly ownership will be:
Mortgage payment $568,
Property taxes $115,
HOA fees $225,
Maintenance/repairs $100,
Insurance $25
Total $1,032 in expenses.

Keep in mind, I am paying down my mortgage balance (saving money) by $109/month (the principal portion of my mortgage payment). So the total estimated costs of $1,032, less that $109 equals $923 total cost per month.

So I am saving $427 ($1,350 rent cost minus $923 ownership cost) per month by owning this property. Multiply that $427 times 12 months, for $5,125 in savings per year.

Recall I invested $24,000 to buy this property, and my net savings are $5,125 per year. That means instead of leaving my $24,000 in the bank earning 2.5 percent, I can effectively earn 21.35 percent on my money ($5,125 savings /$24,000 equity). That is worthwhile!

This analysis does not show good results in areas where prices are really high compared to market rents in that area, or where there are really high HOA fees. But there are other reasons for buying property -- a place to live, you love the areas, etc. So use this as one tool in your toolbox.

Use the Rent vs. Own spreadsheet on my website to analyze your property. Also, this does not include any long-term appreciation in value or tax benefits, which could be substantial.

On the price declines, forecasting the future is tough to do. Moderately priced areas when prices have already declined significantly and investors are fighting over properties probably are close to stabilizing. Higher dollar properties have a higher risk of additional declines and time will tell.

If you have more questions for Leonard Baron, please leave a comment or send an e-mail to kelly.bennett@voiceofsandiego.org.

-- LEONARD BARON

5 Comments so far on this story...

He avoids the most serious issue: falling prices. Prices are falling about 2% per month. Compare that to a mortgage (or rent) which less than one-half of one percent per month and suddenly buying looks really stupid. In otherwords, his $125K condo might lose about $2,500 per month. You save money buy renting while prices are falling.

Posted by Keegbert | reply to this comment
April 29, 2009 12:37 pm

Hi Keegbert - I take a long term perspective. So I am not that worried about prices, it is more the yields that count - especially since I am attempting to buy in areas that have already significantly decreased prices and their yields (the rates of return) on those assets are very good - some over 10% cash on cash. Just to let you know, buyers are fighting over properties in the lower price ranges $75,000 to $250,000 - and when there is a high demand, and not enough supply, that seems like a market equilibrium is near. The media has been reporting the good deals lately...and that is good news for all of us. Higher priced properties, which do not trade (sell) based on cash flow fundamentals - they are a different animal so that market is a little tougher to gauge.

Posted by Leonard Baron | reply to this comment
April 29, 2009 2:46 pm

Home prices in San Diego could easily fall another 30-50% from where they are now. For example, look at the high and rising unemployment. Look at the flood of option-arm foreclosures about to swamp the markets. Google "shadow inventory" (or read about it in the voiceofsandiego website). ----- People are better off to rent now, then buy for significantly less later. Having that extra money for emergencies, or having it later for their retirement is a better long-term plan than to foolishly buy while prices are falling. ----- For many years real estate "experts" have been encouraging us to buy using the same tired and foolish "logic" you use. Meanwhile prices keep falling and falling with no bottom in sight.

Posted by Keegbert | reply to this comment
April 29, 2009 5:10 pm

Clearly, you "save" money when you don't buy when prices are falling...except that wasn't the question. You might try to predict the future, but would you have been correct in 1999? Historically in SD over the last 80 years, homes are up about 5% to 6% per year. Leonard's answer doesn't look at pricing, it's looking at rent vs. buy decision. He's making an assumption you are buying the house to live in more than 5 years, not to cash out your equity in a few years. The losses you talk about mean nothing if you own the house for 20 years, they are paper losses, but look at the savings (assuming you can make the payment). By your logic, you'll be looking at a condos worth zero in a few years and that doesn't pass the sniff test. Pricing is another question.

Posted by discdude | reply to this comment
April 29, 2009 2:12 pm

"Historically in SD over the last 80 years, homes are up about 5% to 6% per year." Really? Data points please... yawn... Even if, at 5-6% up per year how long will it take us to get back to bubblezone numbers. Hint. Google "Rule of 72."

Posted by JR | reply to this comment
April 30, 2009 11:37 pm

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