NYT: Is It Better to Buy or Rent?

The New York Times
September 25, 2005

Is It Better to Buy or Rent?
By DAVID LEONHARDT

THE thought has occurred to just about everybody who owns a home in a
hot housing market: maybe it's time to cash out.

The hard part is figuring out how to do so. Only a few families can
actually pick up their life in, say, California and move it to
Nebraska. The other option - renting - has long been derided as the
equivalent of throwing money away.

But renting might deserve another look right now. After five years in
which rents have barely budged while house prices in New York,
Washington, Los Angeles and elsewhere have doubled, renting has become
a surprisingly smart option for many people who never would have
considered it before.

Owning a home often ties up hundreds of thousands of dollars that might
be invested more safely and more lucratively elsewhere over the next
decade. And while real estate brokers may hate to acknowledge it, home
ownership involves its own versions of throwing money away, like
property taxes and the costs of borrowing.

Add it all up - which The New York Times did, in an analysis of the
major costs and benefits of owning and renting, including tax breaks -
and owning a home today is more expensive than renting in much of the
Northeast, Florida and California. Only if prices rise well above their
already lofty levels will home ownership turn out to be the good deal
that it is widely assumed to be.

In the Bay Area of California, a typical family that buys a $1 million
house - which is average in some towns - will spend about $5,000 a
month to live there, according to the Times analysis. The family could
rent a similar house for about $2,500, real estate records show, and
could pay part of that bill with the interest earned by the money that
was not used for a down payment.

This gaping difference helped persuade Eloise Christensen to sell her
century-old Victorian cottage in downtown Larkspur, Calif., for $1.05
million this year. Now she rents a two-story house in Stinson Beach for
$2,400 a month. From her living room, she can sip tea and watch the
waves from the Pacific Ocean.

"It just seems out of control," said Ms. Christensen, 43, a massage
therapist and graphic designer. "It didn't seem to me that the market
was going to be able to sustain these high prices."

There are obviously benefits to home ownership beyond the financial,
like peace of mind and a feeling of stability. Owners cannot have their
home yanked away by a landlord who has decided to move back in. Owners
can also change the color of their living room walls or fix a draft
seeping through their windows without asking permission.

Surrounding her Larkspur cottage, Ms. Christensen had built a garden
with rosemary, lavender and boxwood hedges to complement the pear and
fig trees already there. She is not doing anything like that in Stinson
Beach.

Combine these benefits with the transaction costs of a house sale, and
renting probably does not make sense for most people who already own
their home and feel settled in it.

But the calculation can look quite different for those who are
considering a move anyway or who do not yet own a home. At the very
least, renters in boom markets, who often lament that they are wasting
money, should know that their choice has as powerful an economic
rationale as buying does right now.

"I am a proponent of buying," said Tchaka Owen, 37, a loan officer and
licensed real-estate agent in Miami who is renting a two-bedroom
apartment overlooking the bay there. "But you can get so much more for
your money, renting instead of buying. We're paying half the amount we
would be paying if we owned this place."

In Manhattan, 1,000-square-foot, two-bedroom apartments on the Upper
East Side now rent for about $3,700 a month. Buying a similar apartment
costs around $1.1 million, which can translate into monthly payments of
$6,000 or so.

To determine the cost of renting, the Times analysis added monthly rent
and renters' insurance. For owning, the analysis included typical costs
for home insurance, major repairs, property taxes and mortgage
payments, as well as the tax deductions they create.

Renters were given credit for a small return - about 4 percent, after
taxes - on the money they could have invested in bonds or stocks
instead of spending it on a down payment and closing costs. Buyers
received credit for the portion of the mortgage they were paying off,
as opposed to the interest costs.

When the net costs of owning are less than those of renting, as is the
case in Chicago, Dallas, St. Louis and much of the middle of the
country, the argument for buying becomes overwhelming. So long as home
prices do not fall sharply, home buyers in these places will do much
better than renters.

But when owning is more expensive every month, buyers are betting
entirely on price appreciation.

For new home buyers, prices in New York would need to rise roughly
another 13 percent over the next five years for the average buyer to do
better than the average renter over that span. In Northern California,
where the gap between house prices and rents is largest, home values
would need to go up about 19 percent by 2010.

Over the next decade, the break-even increase is about 25 percent in
New York and 40 percent in California.

Such increases have been easily achieved in the recent past. But even
economists who do not consider the real estate market to be in a bubble
predict that price gains will slow. Other forecasters argue that values
will fall, as they did on the coasts in the early 1990's, or be stuck
near their current levels for years to come. No matter who is right,
the buy-versus-rent debate is a closer call than it has been in years.

"If you believe you'll be moving in the next four or five years, I'd
rent," said Thomas Z. Lys, an accounting professor at the Kellogg
School of Management at Northwestern University . "If you're a
long-termer, I still would buy."

The single biggest misconception about home ownership, some brokers and
economists say, might revolve around tax deductions. Many people seem
to believe that buying a home can actually save them money because the
interest on their mortgage is tax deductible.

But all that deduction does is reduce the cost of borrowing the money -
a cost that would not exist if the family were not buying the home.
Families spend about six years in a house, on average, according to the
National Association of Realtors. In that time, the interest on a
$600,000 mortgage would add up to about $120,000, even at today's low
rates and even after the tax deduction, according to National City
Corporation, a large lender.

"Don't be buying a house because you think you're saving on the taxes,"
said Frank Borges LLosa, owner of FranklyRealty.com, a brokerage in
Arlington, Va. "You'll save even more by not buying and renting."

Mr. LLosa added: "I'm not saying not to buy. I'm saying don't buy just
for the tax reasons."

Many homeowners also do not receive the full deductions from home
ownership. In the Northeast and California, homeowners now have so many
deductions that some must pay the alternative minimum tax. This tax
effectively wipes out part of their property-tax deduction, further
cutting into the benefits of home ownership.

Other homeowners do not itemize their deductions or, if they do so, end
up with total deductions only a little larger than the standard
deduction that the government offers to all taxpayers, even renters.

"A lot of people hugely overvalue the mortgage deduction," said Dean
Baker, co-director of the Center for Economic and Policy Research, a
liberal group in Washington, "because they compare it to no deduction
instead of comparing it to the standard deduction."

Mr. Baker is one of the avant garde renters. He and his wife sold their
condominium in Washington last year for $445,000 and now rent a similar
one nearby for $2,200 a month.

The Times analysis made a number of assumptions favorable to buyers,
like giving them full credit for the deductions for mortgage interest
and property taxes, noted Mark Zandi, chief economist of Economy .com,
a research company. Still, the monthly costs of buying were more
expensive than those for renting in any market where the price of a
typical house was more than 20 times larger than the annual rent to
live in it.

In the Bay Area, this "rent ratio" exceeds 33. In New York, Boston, Los
Angeles and Miami, it is just above 25. A typical four-bedroom house in
Brookline, Mass., for example, costs about $1.2 million to buy and
$4,500 a month to rent, according to Chobee Hoy Associates Real Estate,
a brokerage there.

At 20, Washington is right near the cutoff. But renters who live in
apartment buildings, like Mr. Baker, often get an extra benefit: some
portion of their utilities bill is typically covered by the building's
owner.

Mr. Owen, the loan officer in Miami, and his girlfriend, Polly
Thompson, pay $1,700 a month for a top-floor apartment that has views
of both the city's skyline and the Atlantic Ocean. After talking to
brokers, he said he thought that the apartment would sell for close to
$650,000, giving it a rent ratio of more than 30.

"It's obvious," he said, "that renting is such a better deal."

But to many people, the psychological benefits of buying are almost
impossible to overcome. Owning makes them feel that they have achieved
the American dream, or it gives them the secure sense that, if nothing
else, they have a tangible asset where they can sleep at night.

Those are nice feelings, indeed. The question is how much they are
worth to you.