Own a House vs. Rent a House: Let’s Do the Math

Not everyone wants to be a real estate investor. For that matter, not everyone wants to own a home of any kind. And that is okay. Some people just don’t want to be “tied down” or have to deal with a leaking water heater or have to take the chance on replacing a roof. I get that.

But for those of you who are still wavering between buying and renting and are wondering how the current market plays into that decision and whether or not it is worth it and…

Let’s just lay it all out there for you so you can make up your own mind.

Here is our scenario: A house in Kansas City that costs about $140,000 will rent for about $985 in most of the area. Some areas will be higher, some lower, but those will be our numbers. The house is a 3 bedroom, 2 bath with a 1 car garage. In reasonable condition. And we are going to project that you will either rent there for 8 years or own there for 8 years. That seems to be about the average length of time a home owner stays put. Renters will move more often but will usually move into another rental house or finally buy a home. So those are the rules.

RENT

We’ll start with the renter because the numbers are more simple. Starting rent will be $985/mo. We’ll raise the rents approximately 5% every other year. Years 3-4 will be $1025/mo. Years 5-6 will be $1075/mo and years 6-8 will be $1125/mo. Sound reasonable?

At the end of the 8 years you will have paid to your landlord $101,040. And the good news is you didn’t have to shell out any other expenses for repair type items.

OWN

Taking the $140,000 house we are going to say that you are going to get a 100% loan. (I’m not for these. I’d rather you have a minimum of 3% in the house, but in this case, a 100% loan.) The first 80% of the loan you will get at 6.5% amortized over 30 years. Your payment will be $708/mo P&I. The additional 20% you are amortizing over 15 years at 9.0%. Your payment will be $284/mo P&I. You do have to account for taxes and insurance. Both of those will rise over the 8 years. Averaging out what I think they will be you will have an additional $285/mo to T&I. Therefore, your monthly payment will be $1,277/mo. PITI.

THE RESULTS

Over that same 8 year period you will pay PITI of $122,592.

That is $21,552 more than if you rented.

Now we have additional factors we have to take into account. Over that 8 year period you will have paid in interest alone $72,170. Home interest is deductible on your Schedule A of your taxes. If you are at the 28% tax bracket you will have seen a tax savings of $20,207 over those 8 years.

Now the difference is still in RENT’s favor, but only by $1,345 over the 8 years.

Another thing to think about is principal reduction. Over those 8 years each month you paid your mortgage some of that money (at first a very small amount) went towards reducing the amount of money you owe on the house. Using an amortization table you will find that the principal reduced adds up to $23,046.

The difference is now in OWN’s favor by about $21,701 over the 8 years.

Still one more factor to take into account. Appreciation. There was a lot of talk about appreciation the last few years. Now the talk is about lack of appreciation. Here in Kansas City, we see neither the great ups, or downs. My zip code (66062) appreciated 6.6% last year while my best friend’s zip code (66224) appreciated 9.3%. However, Waldo & Brookside (64114) depreciated 2.5% and where I grew up (66212) depreciated 1.9%. (Source is Kansas City Star.)

Historically, the Kansas City housing market appreciates at 5% a year. But for our purposes, we are going to use a yearly average appreciation of 3%. 8 years at 3% per year appreciation (on average) will make that $140,000 home sell for about $177,000. That is a $37,000 gain.

Now OWN’s favor is by $58,701.

It is fair to say that after 8 years there will be deferred maintenance that will have to be caught up. So subtract from OWN $4,500 for carpeting, $1,000 for appliances, $5,000 for painting and $5,000 for miscellaneous.

You are still left with an advantage to OWN by about $43,201.

There are, obviously, multiple variable and unknowns. The market could go south like some gloom and doomers believe. It wouldn’t surprise me at all if we stay flat this year and next. Real estate goes in 7 year cycles. Look it up. Some people would have had us believe the last stock market run-up of the ’90’s and the real estate boom of the 2000’s wouldn’t end. It did. Now we are to believe that the market will never rebound. We’ll see. For all I know the market could really take off next year. Or remain the same. I don’t really know. Neither does anyone else.

Another factor is lifestyle. As I stated before, perhaps you just don’t want to own. I’m good with that. I’ve sold duplexes where the tenants have been there (I am not making this up) 30 years, 24 years, 17 years and 12 years. They liked what they had and didn’t see any reason to do anything different.

The bottom line is, it is your individual decision. There is the math, if you are on the fence. Let me know if you have any questions.

5 Comments

Filed under Kansas City Real Estate

5 responses to “Own a House vs. Rent a House: Let’s Do the Math

  1. Josh B

    Hi Chris

    I liked the post. You’ve put it in simplest terms possible. What do you say to someone in a market where the mortgage pmt and rent are severely different.

    Ex: House rents for $1400. But on a 30 yr amortized loan that you mentioned the pmts together are about $2000. Over eight years that’s over $55000 difference.

    Is a large down payment the only solution to this challenge?

    Thanks in advance

  2. Chris Lengquist

    Josh,

    Excellent question. Each city has it’s own unique circumstances. As you might have seen I talk a lot about real estate investing and why KC is a great place for it. Over at http://www.bawldguy.com you have a San Diego real estate agent saying NOT to invest in his home city because the numbers do not make sense.

    Without working all the math all the way through it looks like your situation would be more towards break even over 8 years. Now a couple more things come into play;

    1. Why is that ratio out of whack? Probably because you live in a city that gets better appreciation than we do here in the Heartland. You’ll need to time the market more. Your upswing can be so much better. But if something arises and you have to sell in a downswing, well, that won’t be pretty.

    2. If at all possible, I do recommend a minimum of 3% down. I would really rather see at least 10%. It will protect you better against market swings and lower your monthly payment.

    3. Emotional factors like pride of ownership.

    4. And let us not forget about principal reduction. Either way you are doing it. One if for the landlord. The other if for yourself.

    5. Sometimes it does not make sense to own. You may be better off, from an investment stand point, renting and investing the difference into another vehicle.

    Good luck with your decision. Without knowing more that is all I can say.

  3. Jeff Brown

    Chris – I should clear up a misunderstanding I’ve apparently caused. Although I do think there’s no argument in favor of investing in San Diego income property, I’m not at all against buying your home their.

    Of course, I’m of the old school breed who believes your home is an investment second, and a fort for your family first. 🙂

    Buying homes in which to live in SD isn’t a bad move at all – especially these days. 🙂

  4. Chris Lengquist

    Perhaps the mistake is mine! I never meant to let people think you were not for buying personal residences in San Diego. Just investment property. Sorry if it came off that way.

    When I say it’s better for people to rent sometimes I am speaking of a guy looking to live somewhere 12-36 months with 2% appreciation, and the like.

    There are so many reasons to buy a personal home that go beyond simple math. We all know that. Again, sorry if I didn’t come off that way.

  5. charleston south carolina real estate

    Thanks for spelling or should I say calculating the scenario so succintly…Will be using this example with several people, who have heretofore not “gotten it”…perhaps your explanation will help.

    Becca

    Charleston South Carolina Real Estate

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