Renting a Home Is Financially Better Than Buying—Wait, What?!
In the military, there is a popular idea that you should buy a house at every duty station. I don’t think this could be much further from the truth!
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Sure, buying a house at every duty station seems like great advice—to people that started in 2010. But what about the service members who bought at every duty station in 2004 to 2008?
Obviously, there are great intentions behind this advice. I can certainly appreciate the thought, but as the saying goes, “The road to hell is paved with good intentions.”
I have been on both the beneficial and detrimental sides of the equation.
In 2015, I purchased a residence (in this instance, a house hack) at a duty station. Then I rented a residence (base housing) when I was stationed in Hawaii.
I purchased my first rental property while stationed in Missouri as a recruiter. A year later, I moved to Hawaii and have spent the last three years renting here while investing in property on the mainland.
How to Analyze the Market When Deciding to Buy vs. Rent
Too many people get wrapped up in debating whether you should rent or buy your residence without understanding that it depends (mainly) on your market. One can argue until blue in the face that renting is dumb, but if the average home price is over $800,000 and won’t even come close to cash flowing, I would disagree.
The real question you need to ask is, “Does my market appear better suited to renting or buying?”
The market always dictates this decision for me—and it should for you, too.
How Much Are Homes in the Area?
The first thing to consider is the average purchase price in your market. If you’re earning less than $100,000 per year, you probably don’t want to buy in a market where the average home price is over $750,000.
The principal, interest, taxes, and insurance (PITI) alone could be $3,750 per month on a property like this!
That means you could spend $45,000 a year on PITI—almost half your income.
I think this expense should be enough to deter you. But just in case, remember that if you’re spending 45 percent of your annual income on a house, it will stifle your ability to save and build capital for future investments.
That means you are placing your hope entirely on appreciation, which in my opinion is a gamble (more to follow on that).
What’s the Status of the Population and Economy?
The next thing you need to look at is population and economic growth—or lack thereof.
Remember, in order for your home to be an investment, you need to buy it as an investment, not a home. That means you need to analyze the macro- and micro-factors that can affect a market.
You want to see at least 1 percent population growth every year for the last two to three years. Real estate is a supply/demand business—the more people that need homes, the merrier!
You also want to see a growing economy and ensure that its growth stems from diverse industries. An argument for the necessity of diverse industries is Detroit. The once booming metropolis has declined in population and economic prowess year-over-year for decades.
Why? Because it relied too heavily on one industry: automobiles.
For this reason, I like to see at least three different industries alive and well in my markets! For example, the area where I invest has three growing colleges, a booming industrial district, and several food/beverage manufacturers—not to mention being a transportation hub along a major interstate!
Look for diverse, growing industries to ensure a steady stream of new jobs that will keep the population growing.
Where Are We in Terms of Market Cycles?
Nobody can know for sure what a market will do in the future. We can, however, understand what a market has done in the past and determine where it is in the typical cycle.
For example, in 2005, the median home price in San Diego peaked at $572,900. In 2011, the median home price bottomed out at $370,300.
Now, the same county has reached a median home price of $627,700. As such, it can be reasonably assumed that we are (at the very least) near the peak of the market.
Understanding market cycles and weighing them into your decision-making process is critical.
I am moving to San Diego in a few months and have decided to rent (or live in an RV) for several reasons—one of which is where we are in the market cycle.
I’m not confident enough in the market continuing to trend upward to justify buying a $600,000 home.
The nice thing is that renting in an expensive market (where the median income is higher) can afford you opportunities to pump additional saved income into a more affordable market!
Numbers to Consider When Determining Whether to Invest
Cash flow is the lifeblood of rental property investing. When your properties are producing positive cash flow, (almost) any storm can be weathered. If your properties are not cash flowing, it opens the door for disaster to strike.
Cash flow, for those unfamiliar with the term, is simply the amount of money you receive from monthly rental income after you have budgeted and paid for all expenses. Cash flow is important because you can reinvest profits into more properties.
This is a less-discussed factor in the rent/buy decision—but one that is so critical. When a recession hits, cash flow allows you to continue holding properties even if the property value drops. (It is much easier to hold onto a property that has lost value when it is paying you to do so.)
Unfortunately, it can be very difficult to cash flow in expensive markets. This is because the cost of a mortgage loan climbs higher than average rent prices in the area.
Do not buy a rental property that doesn’t cash flow. Seriously. Don’t do it!
There are many people in Hawaii who say, “But it is possible to buy cash flowing real estate here.” And they are correct. But generally, buying here is still a terrible investment!
The cash-on-cash return is my strongest argument against buying in overly expensive markets.
Let’s say you find a property to cash flow $500/month in Hawaii. Is that a good amount? Maybe.
The problem is that you likely had to spend at least $600,000 (probably much more) to purchase this property. Assuming 20 percent down, this property required $120,000 as a down payment.
$500/mo. x 12 mos. = $6,000/yr.
That is a 5 percent cash-on-cash return.
Now, let’s say I buy a property for $100,000 with a $20,000 down payment in the Midwest. This property brings in $200 per month in cash flow (a conservative number in my market).
$200/mo. x 12 mos. = $2,400/yr.
That is a 12 percent cash-on-cash return.
At this rate, putting that same $120,000 (used as a down payment for the $600,000 property) into six $100,000 properties instead would bring in $1,200 a month (as opposed to the original $500 per month).
Which market was the wiser cash flow investment? Obviously, the cheaper one.
Appreciation is the number one justification for buying in overpriced markets. I tell investors who solely focus on appreciation that I’ll cross my fingers for them.
Appreciation is a great bonus to cash flowing real estate, but it is just that—a bonus!
I believe this because nobody knows what the market will do next. The homeowners who lost everything in 2008 thought the market was going to keep improving. The people who failed to buy in 2011 (bottom of the market) did so because they were convinced the market would continue going down.
Sure, appreciation can be a huge windfall when the market skyrockets after you purchase a property. But I don’t believe this outweighs the damage that can happen when the market tanks and you lose everything.
There are ways to plan for appreciation—purchasing after a crash, forcing appreciation through renovations, buying well below market value, etc. These are all viable strategies.
However, too many people buy in places like Hawaii, San Diego, or Washington, D.C. without being realistic about where we are in the market cycle or what could happen to their properties.
Don’t bank on appreciation. It shouldn’t be your motivation to purchase real estate.
Appreciation is a great bonus, and that is how you need to view it.
There is no shame in renting where you live and buying elsewhere to invest.
Heck, Grant Cardone even does it, and he is one of the largest real estate syndicators in the nation.
I think pride is often what drives the idea of buying a house no matter where we live.
“I’m a real estate investor, and real estate investors own homes.” It’s a great idea in theory, but don’t let it influence you to make a bad decision.
Always remember to buy a residence as an investment, not a home. If it doesn’t make sense as an investment, don’t buy it.
The only exception I would make here is if the home is your “forever home,” and you can cover all expenses through your other investments.
Make no mistake though, that home will be a liability—not an asset!
Do you agree or disagree? If you think I’m wrong, tell me why!
Leave a comment below.