One of the things l love the most about having a blog is the way in which I often bring up a subject and then get a stream of commenters — many of whom know much more on the subject than I do — really move the topic forwards.
A prime example is my post from Friday on rent vs buy calculations, itself prompted by a previous comments stream. My back-of-the-envelope calculations only looked at the position after one year, but a number of commenters have looked out much further than that, and one even did a Monte Carlo simulation! What’s more, my commenters didn’t just pull numbers out of thin air, as I did, but gave me some very useful real-world datapoints.
Nicholas Weaver put a spreadsheet online for one property in California, assuming rent stays constant starts at $1325 a month and rises by 3% a year, and using a real-world purchase price of $400,000. Upshot? Renting was a lot cheaper. Now, he says, his rent is $1675, for a house worth more than $600,000.
And RichB, in England, came up with an even more elaborate spreadsheet for a UK place listed at ß£795,000 which is renting for ß£2750 per month. (Remember that the UK abolished mortgage-interest tax relief, with no appreciable effect on housing prices.) He assumed upkeep costs of 0.5% of the purchase price (about ß£330 per month), and rent rising at 3% per year. Again, renting was a lot cheaper than buying: if you held the house for 10 years and prices rose by 6% per year annualized that whole time, you’d still be ß£115,000 worse off by buying.
But. Buying is what economists like to call a “commitment device” — one of those situations where you can make yourself better off by reducing the number of options available to you. RichB, for instance, makes this crucial assumption:
The difference between the monthly mortgage payment and monthly rent, as well as all up front costs, are assumed to be invested at 5.5% (with a 40% tax rate).
This strikes me as both reasonable, in terms of the rent vs buy calculation, and also, at the same time, utterly unrealistic. People stretch themselves and bend over backwards and perform all manner of other metaphorical financial calisthenics to make their mortgage payments every month so that they can continue to live in their home. People buy homes at the outer edge of the affordability envelope because they value all that space and light and convenience in terms of commuting, and so on and so forth. No one will have the same kind of real and emotional attachment to a monthly plan involving paying a certain amount of money into a savings plan yielding 5.5% per annum. In other words, the difference between rent payments and mortgage payments, if the mortgage payments are higher, is not likely to get invested: it’s likely to get spent.
So maybe there’s a good reason why people buy houses even when it would be mathematically cheaper for them to rent: it’s a forced savings device. All that money they save and scrounge up for the down-payment; all that extra money they find every month for a mortgage payment which they wouldn’t bother doing if they were renting — it all goes towards building up equity in a very valuable home. Theoretically, they could do the same amount of savings with money rather than with property, but in practice very few people ever do. To take RichB’s example, after 10 years someone who bought the house would have hundreds of thousands of pounds of equity in his house. While someone renting the house would have memories of great holidays and meals at restaurants, and would have a spiffier wardrobe, but would have much less total net worth.