When Renting Makes More Sense Than Owning
A couple of years ago, three to be exact, my youngest son was finishing up college and my wife suggested to me that she’d like to downsize our primary residence. It really made sense, both of our children had moved out of the house and with just the two of us, we really didn’t need a 5 bedroom, 3500 sq. foot home anymore on over an acre of land. So I started to look for the type of home we were after. Our criteria was simple; obviously we wanted something smaller and newer. We also wanted a place that enabled us to have the freedom to be able to travel without having to worry about things like lawn care or exterior maintenance. We both have enough of that anyway since we own 19 residential and commercial rentals, as well as a vacation home, so the idea was to keep it simple.
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After a little searching, we found the perfect place. It had everything we were looking for and was in new condition. It was a spacious 3 bedroom, 3 bathroom with a porch, small yard and a garage. The community was great too; with a pool, fitness center, and clubhouse. Also all of the exterior maintenance was included. My next step was checking in with my loan officer.
Well, let’s just put it this way, it was a good thing the property was up for rent or sale. Even though our credit score was over 750, our debt to income ratio was “unusual” (by their standards of course), and the lenders were stricter then I had ever seen. Keep in mind this was right after the market crashed, but I was still shocked when they were saying things to me like “We’re not sure 30% down can get it done but we definitely think 50% down will.” Although I had the money I had to ask myself, why? It seems part of it had to do with me, having started my company in 2007, I knew they preferred 5 years in business to count any of my earned income.
I even went to my partner Bob and said “you know I haven’t rented a place since just after college, what do you think?” He said, “If you give the bank 50% down, you’re an idiot.” Well, sometimes I just need to hear that from someone else! Because he was right, he explained that I could rent this place for $700 less per month than owning it and invest the money (which in this case was $165,000) at 18% in some notes and mortgages. Whether I invested in private 1st mortgages or institutional 2nds, I’d still be making $2475/month! My rent was only $1800/month so I could live for free and make $675/month extra.
So I ended up doing a 3 year rent-to-own for $330,000. Since then the property has dropped in value about $30,000 – $40,000. So do I regret not buying it? I think we both know the answer to that. I probably wouldn’t have thought of this idea if I hadn’t remembered seeing this old Real Estate guru years ago named Ernie Kestler. Now I’ve seen everybody, and it’s not because I always believe in what they’re selling or plan on doing their exact method of investing, but really to get ideas. And seeing Kestler precisely did just that. I saw him speak years ago before he passed. He owned all kinds of rental properties, but his strategy that stuck in my mind was that he never owned the house he lived in. I thought at the time he was totally nuts, but for his situation it made perfect sense. When you consider purchase costs, yearly costs, lost opportunity costs (aka if I didn’t invest my money in notes and just sunk it into my primary), and selling costs, owning a house can be pretty expensive. Not to mention, you don’t really have much responsibility or repairs when you rent and you can pick up the phone and call the landlord when there’s a broken toilet. You can also move to wherever, whenever. You have total freedom, and today I get what old Ernie was preaching.
In fact I can think of four good reasons to rent instead of owning:
Living in a High-end Primary Residence
Wanting to live in places like Maui, New York City, San Francisco, or any ocean front property, it could definitely be a good idea to consider renting instead of owning. Let’s use Maui for example. I have a friend who rents a 2 bedroom, 1300 sq. foot house in Maui. Now it’s not right on the beach but it’s damn near close, with only a 5 minute dirve. How much does a place like this cost to own? Oh, only between $800,000 to $1 million dollars. And how much to rent? Less than $2300/month. So put in $800K into an amortization schedule, try and factor in your PITI to your payment, and tell me what’s more worth it? Or put $800K into notes and 15% – 18% and make $10,000/month!
I actually covered this topic in an old blog post of mine entitled “Are Vacation Homes Good Investments?” Vacation homes often make more sense to rent, not only because your lack of time spent really using the place (or worse, being forced to go there because you own it) but they’re also really hard to cash flow. The only reason I own one, besides using it at least once a month to get away from it all and focus on a project, is for a tax loss to offset my earned income.
Living in or running a shared living space like a drug and alcohol recovery house or student housing can make sense to rent because of two reasons. One is the maintenance, you can stay for 3 or 5 years and just simply move onto another place without having to paint or re-carpet. Also if you have problems with neighbors or townships, you can just up and move. Student housing also makes sense because you can sub-rent the rooms, often times giving you the ability to rent your own room for much cheaper or even free. I know plenty of people who do that and they aren’t even students, it just takes a little bit more of finagling.
Commercial properties make sense to rent sometimes, especially if you have the right to sub-rent. This is just like the student housing mentioned above where your business can rent space for cheap or free. You also have a lot more flexibility if you’re not exactly sure of your growth rate. Say my company could demand another 50 employees over the next year, I wouldn’t want to be stuck owning a piece of commercial real estate when we can just up and move to something bigger and better. Also if your business is designed to be sold some day, sometimes it’s a lot easier to sell if you don’t own the building.
Now these are just a few reasons renting could work for you, and remember owning has it’s place too. You just have to know not only when and where to rent or own, but why you’re doing it as well. Think about the long term, upkeep, and most importantly the math. It really comes down to running your numbers. Just remember though, it’s like my partner Bob says, “We’re all renting space on this earth anyway. Stop paying your property taxes and you’ll see who really owns your property!”