Rent v. Owning Your Home, opportunity cost and running some numbers

Posted: February 23, 2012 in Life, Money

The saga of trying to sell our house in this unfavorable market continues. We have just lowered our price yet again.  If it sells, I have a great degree of confidence we will have sold at the absolute bottom.  We’d be thrilled with that.  To see why, let’s play with some numbers.

Is my bias showing?

Rent v. Own But before we begin, we need clear the air on a few things.  Owning a home is almost always a lousy investment, and I have a post under construction that will discuss why in some detail.  Relax. This doesn’t mean you should never own one.

It does mean you ought to be clear on your reasons and not let yourself be suckered into a false reality. It means you might want to run the numbers.

Some people love the sense of ownership and enjoy working on their property.  Neither apply to us, but maybe that’s you.  That’s fine. We can understand.

We’ve owned a couple ourselves over the years. Sometimes for schools and an environment for raising our daughter.  Sometimes just because we liked the house.  But never thinking we were making an investment, let alone a good one.  That’s folly.

Other times we’ve rented and enjoyed the freedom and flexibly that lifestyle offers.  Sometimes we’ve been both landlord and tenant at the same time, arguably the best of both worlds.

Now renting is the direction to which we are ready to return.  But we’ve never made these choices without first considering the costs.  You might want to do the same.  Using our numbers, here’s how….

The apartment we’ve targeted will cost us about $2000 per month, $24,000 per year.  Built into that are a few extra expenses we’ll pick up not owning.  Winter storage for my motorcycle and summer storage for the car’s snow tires, for example.

Our house is on the market for $355,000 and after commissions and fees we’ll net around $330,000.  (This is lesson #1.  Buying and selling houses is expensive.  Unless you are sure you are ready to settle in for a number of years, rent.  End of story.)  We are mortgage free.

Opportunity Cost

With $330,000 equity tied up in the house the first and largest expense to consider is “opportunity cost.”  That is, simply, what could this money be earning elsewhere?   Right now it is locked up in the house and earning zero interest or dividends.

Here we need to select a proxy.  In your own analysis, you might use whatever you plan to invest in.  Or, if you are renting and considering a purchase, whatever you currently have your soon-to-be tied-up-in-the-house money invested in.

I choose VGSLX, which is the Vanguard REIT Index Fund, because I intend to move the money here  to maintain my asset allocation in real estate once the house is sold.  Since VGSLX pays a dividend of about 3.5% the opportunity cost is $11,555 (330k x 3.5%).  That is, VGSLX would pay me $11,555 per year while the house pays nothing.

Capital Gains

Of course, the house might rise in value providing me with capital gains.  But VGSLX has this same potential.  In actual point of fact, the fund is the more conservative investment.  Here’s why:

VGSLX is a broad based fund holding investments in numerous properties all across the country.  The house is a far more focused holding: one property in one neighborhood in one town in one state.  As such it could provide greater or lesser gains.

During 2011 VGSLX rose about 12% while my house value continued to slide.  2012?  Who knows? Maybe the house will outperform.

Since this is unknowable, as predicting the future always is, and since the investments are both real estate, we can for this analysis treat the potential as equal.  Clearly if you strongly believe your house or the alternative investment will do better you can factor this into your thinking.

Running the Numbers

$11,555 opportunity cost. This is the 3.5% dividend our 330k could be earning in VGSLX.

$18,000 in cash expenses comes from these:

  • $2500 heating oil.  Heat is included in the apartment rent.
  • $7000 maintenance & repair & insurance (an average based on our actual records)
  • $8500 real estate taxes

$29,555 total annual cost of owning and operating the home.  Pretty shocking, no?

v. $24,000 rent =

$5,555 annual premium to live in the house.

Now looking closely you’ll notice, while the apartment saves us $5,555 per year, there is an $6,000 cash flow advantage to owning the house.  It takes 24k in cash outlay to rent the apartment but only 18k cash to operate the house.

This is similar to the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) for a business. Cash flow is critical in running a business or your household.  But the ITD&A are all real costs that you need to consider in an accurate fiscal evaluation.  So is opportunity cost.

Overall costs trump cash flow costs, simply because they are more complete.

There you have it, the most fiscally precise way to compare the real money costs.  Just plug in your own numbers.

Running the Numbers another way

But wait, some will say, owning the house saves you $24,000 in rent.  Isn’t that like an investment return?This is a bit clumsier, but sure, we can approach it from this direction.

It looks like this: $24,000 rental savings (investment return) owning the house, minus:

  • $2500 heating oil
  • $7000 maintenance & repair & insurance
  • $8500 taxes

$18,000 total cash expenses =

$6000 positive cash flow in house, minus

$11,555 opportunity cost =

-$5,555 annual investment deficit, i.e. cost of house over renting.

Cash flow cost also remains the same.

What about mortgage interest payments?

If you have a mortgage, and many do, you simply need to add an extra couple of numbers to the formula.  Let’s take a look.

Suppose I had 20% equity ($66,000) in the house and an 80% mortgage of $264,000.

$2310 opportunity cost. This is the 3.5% dividend our 66k could be earning in VGSLX.

$27,215 in cash expenses comes from these:

  • $2500 heating oil.  Heat is included in the apartment rent.
  • $7000 maintenance & repair & insurance
  • $8500 real estate taxes
  • $15,120 estimated interest on our mortgage loan @ 4% (note: the portion of your months payment that is applied to principle should not be included for this purpose although you will want to add to to calculate your cash flow number)
  • -$5905 tax deduction savings.  This assumes a 25% tax bracket and includes the real estate tax and mortgage interest above.

$29,525 total annual cost of owning and operating the home.  Still shocking, no?

v. $24,000 rent =

$5525 annual premium to live in the house.

Because you have a mortgage your cash flow cost is now up to $27,215, a much larger portion of the total.

Bottom line.

So, even selling at the market bottom I come out ahead.  I can handle the higher cash flow and that $5,555 in annual savings is real money in my pocket.  Plus I get to step into the blissful renter’s life again.

BTW, while owning your own house is a lousy investment, investing in rental houses can be a whole other and very profitable thing.  As alluded to above, at one time many years ago I was both a renter and a landlord at the same time.

These days investment real estate is too much like work for my tastes.  But there is money to be made if you are willing to make the effort.  Shall we run some numbers?  Sounds good and my pal DD has done a fine job of it here:

Post Script:

In the rent v. own analysis there are several formulas that provide some rough guidelines as to which is fiscally better.  Here are two:

1.  House price/Annual rent.

If the result is 21+ renting is better

Between 16-20 it’s a toss-up

less than 16 is a vote to buy

Using our number:  $330,000/$24,000 = 13.75   This says we should buy, or in our case stay put.

2.  Monthly rent x 110 = house price.

If the house costs more, rent.  If less, buy.

$2000 x 110 = $220,000.  This one says no question, rent.

So maybe these are not much help.

More useful, I think, is to look at actual numbers for a given situation as we did above.


Addendum:  The Mad Fientist has a great post on his planned path to wealth.  In it he has a compelling assessment of how renting will help smooth the way:

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  1. Prob8 says:

    I’ve also found that during my tenure as a homeowner, I always have a desire to “improve” the house. A new fence here, a back up sump pump there, etc. Those costs don’t neatly fit into the maintenance and repair category and I doubt I’ll get my money back upon sale. They also add up over time. During my rental years, I never had a desire to spend a dime fixing up my landlord’s place. I also never had to take time away from more desirable pursuits to mow the grass or call multiple contractors to get bids to fix a problem with the house. In retrospect, my wife and I always seemed happier while renting. Perhaps I’ll return to that lifestyle one day.

    • jlcollinsnh says:

      That’s a great point, Prob8….

      ….and I do the same with my house. If you have a nice house in a nice neighborhood, it is like a trap. Not only for its own sake, but for future resale value.

  2. […] Rent v. Owning Your Home, opportunity cost and running some numbers […]

  3. […] Elsewhere: Rent vs Owning Your Home @ Jlcollinsnh […]

  4. We are currently renting. But since we live in Texas renting is actually more expensive than a mortgage. We are currently saving for a 20% down payment. Want to buy a small 3 bedroom/2 bath home. In Dallas, TX they range from $130k to $150k. Our goal is to put down 30K.
    I’m still not sure whether we should choose a 15 yr or 30 yr mortgage. We could afford a 15 year mortgage, since that and taxes will equal what we pay in rent. But a lot of people (adults who are more financially stable than us) have told us to get a 30yr mortgage, and invest the rest of the money.
    What’s your opinion?

    • jlcollinsnh says:

      Hi SFL….

      Welcome back!

      Congrats on running the numbers and your decision to buy.

      Ordinarily, I’d say go with the 15 year and get it done ASAP. But these are not ordinary times. These are times of extraordinarily low mortgage rates.

      If you are absolutely certain you have the discipline to invest the difference and leave it invested for the long term, go with the 30 year mortgage. You can always accelerate your payments and turn it into a 15 year or less if you choose.

      But if you have any doubt at all about relentlessly investing the difference, stick with the 15 year.

      If you would, please let us know what you find and how the deal comes together!

      Good luck!

      • We are not going to be buying until late 2013. According to my time table, this is when we will have saved our 20% down payment, and have enough of other savings to feel comfortable to purchase our home. Plus that’s when our lease ends.
        I am pretty disciplined when it comes to investing and I’m positive we will invest the difference. I will let you know what comes of it when we get close to the home buying deadline! Thanks for your advice!

  5. […] Rent v. Owning Your Home, opportunity cost and running some numbers […]

  6. […] Rent v. Owning Your Home, opportunity cost and running some numbers […]

  7. […] Rent v. Owning Your Home, opportunity cost and running some numbers […]

  8. Executioner says:

    Per your request, I am re-posting this comment from another location.

    I submit that there are some intangible benefits to owning that will never show up on a rent/own comparison analysis. These have to do with stability and flexibility.

    – Rent can increase
    – Landlord/Property Manager can go bankrupt, die, decide not to renew the rent, decide to sell, forcing you to move

    If you are a renter, it is much more difficult (if not impossible) to do the following:
    – Cultivate and harvest natural resources from your land (timber, crops, livestock, etc)
    – Add-on or remodel at will (add a garage, plant a tree, repaint the interior, add energy-saving improvements, build a shed, destroy a shed, knock down a wall, add a window, remove a door, build a moat and drawbridge, and so on)

    I also re-iterate the point that I’ve made on many blogs in the past (including yours I believe) that if you rent, you are indirectly paying the landlord’s taxes, insurance, and fees. Those costs are unavoidable. The only thing you can avoid as a renter is maintenance costs in the short term, although in the long run you’ll probably end up subsidizing them through your rent payments too.

    Finally, if you value privacy and elbow room, it’s a lot more difficult to find a rental property without neighbors on all sides (often sharing walls or floor/ceiling).

    I’m not saying it doesn’t make sense to rent. However I don’t think it is quite so straightforward as running a financial analysis and going with the cheaper result.

    • jlcollinsnh says:

      Thanks E…

      much appreciated!

      Regarding your comments, we are mostly on the same page. There are many non-finacial reasons to buy a house, and to rent. Depends on individual needs and preferences.

      My main point is that running the numbers provides an objective measure of what the comparative cost will be. since most people don’t bother they are unaware of the real cost of their house purchase and rely on the propaganda of the real estate industry.

      Having run the numbers I KNOW my house costs me $5-6000 dollars more each year than the equivalent apartment. Raising my daughter, especially in this school district, made that extra expense worthwhile. Now, not so much.

      Oh, and RE taxes, repairs and maintenance can and do rise very bit as quickly as rent.

      When you get your moat and drawbridge finished, let me know. I’d love to take a ride up to see them! ;)

  9. sendaiben says:

    Love those final metrics. I made my way over here from MMM’s wonderful site, and am slowly reading all your back articles. Currently renting in Japan, and doing the math our target house price divided by current and (forseeable future) rent is over 100!!!

    Guess we’re staying renters despite the wife’s nesting insticts :)

  10. Hi JLC – found you from MMM and really appreciate this post. I had never questioned the economics of owning vs. renting, I guess just because of that pervasive ‘American Dream’ attitude. I will be much more conscious of the tradeoffs and definitely run the numbers when my time comes, so thanks for opening my eyes!

    • jlcollinsnh says:

      Hi Arya….

      and welcome! Thanks for the very kind words and glad to hear you found value in the post.

      Hope you’ll stick around, read some more and keep commenting.



  11. Just popping over to say hi; you already know that I think that the more expensive your house is the more sense it makes to rent and invest the equity.

  12. Shilpan says:

    Good thinking. My wife and I are also thinking about downsizing as my daughters have gone to college. We have a huge house(over 9000 sq feet), which we don’t need for two of us. I’d rather invest my money wisely than to pay mortgage.

    • jlcollinsnh says:

      Thanks Shilpan…..

      That’s a lot of house for empty nesters. good luck when you decide to sell. moving ours is turning out to be far more of a challenge than I’d have ever guessed.

  13. Good article. There are lots of different ways of looking at this.

    From your description, you are going from a house to an apt. Renting will usually be cheaper because the equivalent housing value is lower. Where I live, the average home goes for 750K. The apt I have looks like a bargain in comparison when you compare monthly outlays, but if the apt could be priced at market it will would be much less than half the average home. So, renting beats owning because you are “buying” less property.

    In many parts of the country, owning is cheaper when comparing it by market value. I wonder if you could rent your same house, would it still be cheaper?

    • Trish Rempen says:

      To “6-Figure Investor”:
      That’s an aspect of buying or owning that so few people consider: Maybe you really don’t NEED the 3 car garage, the extra media room, the fitness room or the 5th bedroom…!
      When I buy a house as a rental, I always make it a small one – there will always be a market for a small (and hopefully cute) stand-alone house in an area around hospitals and universities.
      Big simply costs more. If you buy it – or rent it – make sure you need it. There’s always a cost involved.

      • jlcollinsnh says:

        excellent and important point. This is why we are looking to downsize into a smaller space.

        We are looking to rent because the money will be more productively invested outside a house.

        I’ve noticed most successful RE investors buying houses follow Trish’s path. I would.

    • jlcollinsnh says:

      Hi SFI….

      Nice to see you here.

      Executioner asked very similar questions in his comment below. You might want to check out my response and analisis there.


  14. I have seen the argument against home ownership from an investment standpoint before, and while I tend to agree, there is one thing I don’t understand.

    First of all, it can’t be a losing proposition to own, because if it was then you wouldn’t be able to rent. Because nobody would bother owning properties and renting them out.

    Now, you may say “well, rental properties are a different story”

    OK, But if you buy a house, what are you doing if not just renting to yourself? The best, most reliable tenant you could get?

    For example, Lets say you took the $330,000 from the sale of your house and instead of the REIT you bought a rental property. Most people would say that is a good investment (as long as the particulars of that house were sound).

    But what is the point of owning a house, renting it to somebody else , and renting ANOTHER house, from somebody else, for yourself?

    How would your calculations change if you counted yourself as a tenant, and ran the numbers for home ownership that way?

    • jlcollinsnh says:

      Hi Mr. Monk…

      great to see you over here and thanks for commenting. great questions!

      It is possible to think of your house as an investment and yourself as the tenant. That is a bit what we do by approaching it with my second set of numbers above titled:

      “Running the Numbers another way”

      Or you could take a look at the numbers in my response to Executioner below for another take.

      Owning rental properties becomes an entirely different thing because of the actual income received and the tax deductions.

      Let’s say I view myself as a tenant in the home I own and even pay rent to myself into a separate account. From this account I then pay the operating expenses. That’s fine as far as it goes. But the IRS isn’t going to want to hear it come tax time.

      If instead, I rent to you all of those expenses are now deductible and I can also take a depreciation deduction as well. Then you buy the same house across the street and rent to me. You can do the same.

      Another issue is the type of house. Our home, in mint condition and at it’s price level, doesn’t offer an investor the same opportunities as a more modest home in need of some repair. You can see this very clearly in Dollar Disciple’s post (see link above)

      If not for these two factors, you are absolutely correct. Personal or rental, the investment evaluation would be the same. But these are pretty big factors.

      Hope this helps?

  15. Executioner says:

    Greetings from another NH resident.

    Just playing devil’s advocate here…how would the numbers look if you had done this comparison using the rental price for your house, instead of an apartment? How much would you charge someone to rent your current home from you?

    I wonder if running this comparison between a $330K home and an apartment might not be exactly apples-to-apples.

    It sounds to me like you’re gaining some of the “renting advantage” simply by downsizing. Couldn’t you gain a similar advantage by selling your large house and buying a smaller condo? I think you’d see extra cash flow in that scenario too, without bringing rent into the equation.

    • jlcollinsnh says:

      Hi Ex, and welcome.

      You make an excellent point and, in fact, we can look at this with some precision. A few months back someone looked at the house and made an offer to rent it @ $2500 per month, 30k annual. This seems a fair rate and it does make your point that some of the benefit we’ll realize is from downsizing. Here are the numbers:

      $11,555 opportunity cost. This is the 3.5% dividend our 330k could be earning in VGSLX.

      $18,000 in cash expenses comes from these:

      $2500 heating oil. Heat is included in the apartment rent.
      $7000 maintenance & repair & insurance (an average based on our actual records)
      $8500 real estate taxes
      $29,555 total annual cost of owning and operating the home.

      v. $30,000 rent +
      $2500 heating oil. (In renting the house tenants would pay for heat) =

      $32,500 to rent the house
      – $29,555 to own it

      $2,945 annual premium to live in and own the house.

      Of course, we can also change other numbers too. For instance, we could invest our 330k in RAI which pays a 5.5% dividend. The numbers then:

      $18,150 opportunity cost. This is the 5.5% dividend our 330k could be earning in RAI.

      $18,000 in cash expenses comes from these:

      $2500 heating oil. Heat is included in the apartment rent.
      $7000 maintenance & repair & insurance (an average based on our actual records)
      $8500 real estate taxes

      $36,150 total annual cost of owning and operating the home.

      v. $24,000 rent =

      $12,150 annual premium to live in the house.

      What I’ve tried to do with this post is to provide a framework for others considering the rent/buy issue. What makes most sense is to plug in the actual numbers for a specific situation and see what comes up. I just used ours as an example. Make sense?

      BTW, congrats on “executing” your mortgage last year. Great feeling, that! Where in NH are you?

  16. Trish Rempen says:

    I’ve owned a lot of homes, starting with the cottage in Ireland on an acre – that cost me 2000 pounds.(US 4000.) With the romantic stream. (Of course, it had no plumbing, but hey-)
    Bought another farm in Ireland for 5000 pounds (US 10,000.) An acre, 2 storey – and plumbing! Coupla outbuildings and barns…and an acre of bog.
    Then there was the villa in Spain, gorgeous view of the Mediterranean, bought for $28,000. (Furnishings were an extra $3000.)
    These were pretty easy purchases. No mortgages. Few costs.
    Between now and then, I’ve sold or bought (I think) 18 properties. Still own 5 of them. Maybe 6.
    Still no mortgages.

    And yet – after all that – I agree with your post! With few exceptions, buying a house, unless you like houses and don’t need a mortgage – is a responsibility. I just understood real estate better than I understood funds. I never did the homework – or had your blog to read! If I had, I might not have bought the houses! (And yes, I do have the VTSAX now—)

    PS: Yes, the villa in Spain is sold. Sorry.

    • jlcollinsnh says:

      As I recall, you’ve owned several rental houses and those can be very sound investments. Do you still have them?

      In some places around the world the numbers plugged into the formula could look very different.

      When we were in Cuenca, Ecuador last year we looked at some apartments. You can buy a beautiful 2-bed/2-bath place for 125K or rent one for $800 per month:

      $4375 opportunity cost. This is the 3.5% dividend our 125k could be earning in VGSLX.

      $1700 in cash expenses comes from these:

      n/a heating oil.
      $1200 condo fee for maintenance; repair; insurance; security
      $500 real estate taxes

      $6075 total annual cost of owning and operating the home.

      v. $9600 rent =

      $3525 annual premium to rent. So here buying makes more sense. I’ll bet the number on your places in Ireland and Spain would have equally favored buying.

      • Trish Rempen says:

        Still have 3 rentals here in NM. But I wouldn’t have done it if there had been a mortgage involved. And yes, you’re right on the European ones…
        Of course, if you want to put in plumbing, it’s best to own the place.
        And the absence of plumbing didn’t deter the previous owners from raising 14 children in the house. We had different priorities.

        • jlcollinsnh says:

          how have they been as investments?

          and where are your other two houses?

          • Trish Rempen says:

            Overall, good. I like the places, would live in any of them myself. I use an agency, so I don’t deal with too many of the issues, and I bought them all at a good price.
            The other houses? I live in one, and the other is a cabin in the Jemez mountains!

      • jlcollinsnh says:

        an additional thought on this. In running these numbers you should demand buying be less expensive than renting to compensate for the additional risks of ownership.

  17. Timely post, as I’ve been going through this argument in my mind and on paper (as I do calculations).

    I’ve come to the overwhelming conclusion, that while buying will likely come out ahead monetarily for me if I stay in one place for 10+ years, However, I don’t really like the idea of being chained to a location (and house) for that long. 10 years is a long time in one person’s lifetime, as life is relatively short.

    I like the idea of one day living off my dividend income and perhaps traveling to low cost locales like Ecuador, Thailand, the Philippines and what not. Being tied down to a house in hopes it appreciates and sells so that I can go somewhere is uninteresting at best, and sickening at worst. And, even if I don’t travel and stay in the United States once you’re no longer tied to a specific geographical location through employment…then you’re really free to come and go as you please and that’s a freedom that I’m willing to pay a premium for through renting.

    There’s always the option of renting out a house, but who wants to worry about landlording when you’re off living a wonderfully exciting life somewhere 5,000 miles away?

    I don’t enjoy cutting the grass, painting walls, customizing a living room, landscaping, impressing neighbors, being tied down to one location, being tied down to an object or having most of my net worth tied up in one illiquid asset that is slowly falling apart.

    Great post!

    • jlcollinsnh says:

      Hi DM….

      Wonderful comment, and I just read it out loud to my wife. We can relate, and you had us LOL with your last line. Amen!

      As you may know from my other posts we are in the process of trying to sell our house to return to the blissful, carefree, flexible and more profitable life of a renter.

      You’ve absolutely nailed all the downsides to homeownership. The only thing I’d question is your thought that you’d come out ahead with a house after ten years.

      Houses are terrible investments. Unless someone needs a forced savings plan thru lack of discipline. That’s certainly not you.

      I have a post under construction about this, but renting for the fiscally disciplined is always the more profitable choice.

      Your plan of living in various places around the world matches ours exactly. We spent last summer in Ecuador and highly recommend it. Wonderful place. This year we’ll be in Peru and Bolivia. My wife loves her job but working for the schools at least she has the summers off.

      Our daughter was in Thailand a couple of years ago and raves about it. Sounds a bit hot and humid for our tastes, but she had a great time and loved the people.

      As for the Philippines, the son of a pal of mine recently married a Philippine girl. They traveled there to meet her family and he’s been talking about moving there ever since.

      There are a lot of very cool places to visit in the world. Beats the hell out of mowing the grass.

  18. Thought provoking post! Loved the analysis tools at the bottom, but I agree…looking at all the numbers realistically is even better. Does the 2k/month include utilities?

  19. jlcollinsnh says:

    I paid off our mortgage a few year back when rates were higher.

    However with rates at these exceptionally low levels, were I making the decision today, I’d keep the mortgage and leave the money invested in VTSAX for the higher long-term gains.

    For somebody running a real estate investing business like you DD the decision, is as you say, easy.

    Readers, to see DD’s wonderful analysis of leverage in investment RE, hit the link in my post above.

  20. Interesting analysis! I always roll my eyes (hopefully people can’t see me) whenever someone repeats the mantra “Your home is your biggest investment!” No.. investments make me richer! My house is just a place to live. Everyone needs somewhere to live and some people just prefer houses.

    The opportunity cost is an interesting angle and it changes the whole game. That’s actually one reason why we opted NOT to pay off our house and instead buy the rentals. Our mortgage is at 4.75% and our rental portfolio is yielding 24% (albeit, with some input of time on our part). The math was easy :)

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