Are You Better Off Renting Than Owning?
If you live in a housing market that has boomed, the answer might just be yes. Here's how to decide if it's a good time to sell.
(Business 2.0) – Here's something you don't see every day: an economist testing an unconventional theory on himself. But Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C., had a notion, and he was the only one he could persuade to serve as his guinea pig. His hypothesis: In many regions of the country, you're now better off renting your home than owning it.
That cuts against the grain of conventional dogma, which holds that, given tax advantages and potential appreciation, owning a house is almost always one of the best investments you can make. But Baker is among a growing group of analysts who believe that the housing market is bubbling over. So in May, Baker sold his two-bedroom condominium in the trendy Adams Morgan neighborhood for $445,000, clearing $270,000 after taxes and commissions. He then rented a nearly identical two-bedroom condo just two blocks away. His monthly nut of $2,200 is about the same as what he was paying in mortgage, taxes, and maintenance at his former digs—and he has invested his cash windfall in corporate bonds paying about 7 percent annually in interest. "I'm just much better off renting," he says.
The logic isn't limited to the nation's capital. In many markets, the financial appeal of home ownership has waned. As mortgage rates began tumbling in early 2000, bottoming out at 40-year lows in the middle of last year, renters everywhere jumped at the opportunity to own. The result is that home prices have soared and rents have fallen, creating an unusual imbalance in the housing market. So if you've owned your home for, say, five years, you might want to consider cashing out and renting.
Real estate economist Michael Sklarz analyzed select markets for Business 2.0 and found that renting is now substantially less expensive in many of the country's richest housing markets, including Honolulu, New York, Washington, and the major metropolitan areas of California. Even when figuring in the benefits of the mortgage tax deduction—a major lure of home ownership—Sklarz found that renters can now save thousands of dollars a year over owners of similar homes. Renting a single-family home in San Diego, for instance, saves you about $10,400 annually. In the Los Angeles area, renting saves you about $6,600 a year, and in New York, you should come out $4,500 ahead.
In fact, across much of the country, residential vacancy rates are near record highs, often knocking rents back to where they were almost 10 years ago. Vacancies exceed 10.3 percent in Atlanta, Austin, Houston, Indianapolis, Raleigh-Durham, Tulsa, and five other metropolitan areas, according to real estate research firm Reis. As a result, potential tenants have bargaining power that was unheard-of just a few years ago, with landlords often tossing in a month or two free when you sign a lease. "Giving deeper concessions is becoming the rule, not the exception," says Reis analyst Andrew Wright.
Adding to the appeal of cashing out is the rising cost of property taxes—a factor that would-be owners need to consider carefully when weighing renting vs. owning. Property taxes have steadily risen across much of the country as local governments, squeezed by a still-struggling economy, turn to homeowners to plug budget gaps. Research firm Runzheimer International studied a dozen major suburbs and found that property taxes on 2,200-square-foot homes rose an average of 39 percent from 2000 to 2004.
Tempted? Before you put up the "For Sale" sign, run the numbers on your own situation, as Baker did. (See "An Economist Does the Math," left.) Total up what you spend on your home—mortgage, taxes, condo or association fees, insurance, utilities, and other maintenance costs—and then back out the federal tax benefits you get from mortgage interest and property taxes. Compare that total with what you'd pay in rent. Now come the wild cards: the increase or decrease in your home equity, including the principal you pay down every year; the return you'll make on the cash you reap from selling (if you've lived in your house for at least two of the past five years, you won't owe capital gains on the first $250,000 if you're single or $500,000 if you're married); and the possibility that your rent will increase over the years.
It is true, of course, that you could lose out on even greater gains from your home if prices defy expectations and rise further in 2005 and 2006. But if you're worried that your local housing market may be ripe for a fall, grabbing your money now makes abundant financial sense. Don't you wish you had cashed out of stocks in February 2000?
An Economist Does the Math
Why Dean Baker moved around the corner.
[*] From investing $270,000 in capital gains on sale of house.