To buy, or not to buy, that is the question:
Whether ‘tis Smarter for the pocket to buy
The House and hope for outrageous Fortune,
Or to Rent and ne’er repair a Thing
Buying vs. renting: the eternally debated question on financial independence and personal finance forums. Conventional wisdom says that buying property is the way to go. However, the path to FIRE flies in the face of all things conventional and some FIRE bloggers have come out strongly against the idea of buying. As we grow older we learn to accept that there are few absolutes in life, and the correct answer to this question is a disappointing ‘it depends’. It depends on where you plan to buy, and when, and for how long and a host of other factors.
We bought our house back in 2012, back in the dark ages when our savings sat in a Bank of America savings account, way before we had ever heard of FIRE. Now I find myself wondering, was buying the right financial decision for us? We live in an extremely high cost of living area (the San Francisco Bay Area) and property prices here appear to be increasing every day. “Everyone” says that buying a house here is the best investment ever. Is everyone right? What are the facts of our particular case?
Bravely, I decided to find out, even though I don’t have a time machine in my garage, waiting to take me back to 2012 so that I can undo any stupid mistakes or maybe even become my own grandmother. Time travel is odd that way.
In order to construct a parallel universe in which the BITA’s are carefree renters I had to make a few simplifying assumptions. Here they are:
- If we were renting, we would be renting a condo, or a townhome, not a single family home.
- Said rental would be much closer to our place(s) of work, so even though it would be smaller than our home, we would pay in rent what we are paying for our mortgage plus property taxes now.
- Everything that we do spend on our house now, we would have instead invested in VTSAX. Every last dime. We are assuming that we would have frittered away nothing.
The Cost of Buying in the Bay Area
We put down $167,918 to buy our home. This includes the down payment, closing costs, cost of fumigation, inspection costs etc. Our monthly payment (mortgage + homeowners insurance + property taxes) is close to $4000. I’m going to round it up to $4000 for the rest of this article.
I estimate that we pay an extra $290 every month for the privilege of home ownership (alarm system, pool maintenance, extra electricity because of the size of the house and the pool etc.). Every year we spend $150 on pest control. These, then, are the fixed annual costs we enjoy for the privilege of being home owners in sunny California.
Now we come to the truly fun part of home ownership. The oh-shit-that-broke part. And in an elderly house like ours, things break all the time. Here is a breakdown of the variable cost of home ownership by year.
I won’t bore you with an itemized list of these expenses. I will give you a flavour though. This includes things like the cost of buying a new dishwasher, AC repair, fence repair, and new carpet installation. I am sure that there are folks out there who maintain their own homes and hang on to their hard earned dollars. Not us. Put together we are about as handy as a single doorknob. No, wait. Less actually. Even a doorknob has its uses.
Renting instead of Buying: The Numbers
As I said above, I’m going to assume that our rental would cost us $4000 monthly. I will also assume that we put down $4000 as a safety deposit. So, in this parallel universe, in 2012, instead of buying we would have invested a lump sum of $163,918 in VTSAX. $163,918 = $167918 (down payment etc.) – $4000 (rental deposit).
Then we would have made monthly contributions to VTSAX. For simplicity we are going to take our variable annual ownership expenses and divide them by 12 (except for 2012, where we divide by 3, because we start investing in October) to get monthly costs. To this we will add our fixed monthly expenses as detailed above. The sum will give us a monthly amount to throw into our theoretical VTSAX investment.
This is how much we would have contributed to VTSAX per month from Oct 2012 to Dec 2016, once we combine our variable and fixed spending on home ownership.
The average works out to be $786 per month. I then fed this data into the Portfolio Visualizer Backtesting Tool.
The result: our portfolio, if we had rented, would have been worth $329,024 at the end of December 2016.
Rent Or Buy in the Bay Area
Given that we exist in this universe as home owners and not in the parallel one as renters without a care in this world, how did our house purchase fare from 2012 to 2016?
Based on comps that local realtors feel compelled to leave under our front door mats, similar homes in our area are selling for around $1,100,000. Redfin confirms this and estimates our home is worth $1,134,644. Zillow thinks, oh wait a minute, nobody cares what Zillow thinks. Let us be conservative and assume that our home would sell for $1,050,000. Let us further assume that brokerage costs, escrow fees, title transfers, maybe painting the house eat up another $75,000. We would be left with $975,000. Subtract the pound of flesh we owe the bank and we would be left with $407,000.
But wait, we’re not done yet. Buying has in its corner one more trick – mortgage interest tax deductions. Every year we have been able to deduct approximately $21,000 from our taxable income for the purposes of federal taxes. Even without a mortgage we would be itemizing (because we can deduct our state taxes as well), so I’m not going to take standard deduction into account. At a marginal federal tax rate of 35%, we save $7350 every year. Our state allows us to deduct mortgage interest for state taxes as well and our state marginal tax rate is about 9%. So at the state level we save an additional $21000 – $8000 (standard deduction) * .09 = $1170. So let us throw this $8540 into VTSAX every year and ta-da we end up with about $39,000.
So in the final analysis we have
We are currently ahead by $116,976.
Home Ownership for the Win?
So should I be celebrating the fact that all those years ago when we made a blind choice we lucked out and chose the option that has come out ahead? Maybe. I’m still not sure that I can call it a definitive win and move on.
Why not? What if we had rented a cheaper place? Instead of $4000/month, if we had decided to live in a smaller place, or maybe one further away from work, maybe our rent could have been as low as $3000/month. If we threw that extra $1000/month into VTSAX, renting would have resulted in a portfolio of $392,509. That brings us to within $53,491 of home ownership, a much less comfortable margin of victory (roof replacement, I’m looking at you). The point I am trying to make is that this is a hypothetical parallel universe and there are so many variables I could tweak that would affect the outcome. e.g. maybe because we stayed closer to work, we spent less on cars and gas, and invested that money too.
On the other hand, back in 2012 I invested nothing, and had never even heard of Vanguard or index funds, so if we hadn’t bought at the time we would probably be a lot further behind financially than we are now. So for us, personally, the biggest factor in the eternal rent vs. buy argument boils down to something other than the financials of the matter. It comes down to who we were at the time. We were not financially savvy nor were we investors. Was buying in our market better than doing nothing with our money? Absolutely.
And now that I’ve established that I don’t have to stew in a pot of regret over past decisions, I’m off to tinker with that time machine in my garage. You know, the garage that I own, as part of my house.
What about you? Are you confident in your rent vs. buy decision?