Renting a Home Is Financially Better Than Buying—Wait, What?!

by | BiggerPockets.com

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!

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.

real-estate-over-stocks

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.

Related: 4 Reasons Renting & Investing Beats Buying & Owning, Hands Down

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.

Man search apartments and houses online with mobile device. Holiday home rental or real estate website or application. Imaginary internet marketplace for vacation lodging or finding new home.

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!

Related: When Renting Makes More Sense Than Owning

Numbers to Consider When Determining Whether to Invest

Cash Flow

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!

Cash-on-Cash Return

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.

real-estate-market-invest

Appreciation

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.

Bottom Line

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. 

 

About Author

David Pere

David Pere has been active in the U.S. Marine Corps since 2008. He got his start as a real estate investor in 2015 and since then has bought and sold over 50 rental units, partnered on multiple fix-and-flips, and built a growing community of like-minded investors. Through these experiences, From Military to Millionaire was born with the goal of teaching personal finance and real estate investing to service members and the working class. David is the host of The Military Millionaire Podcast and has created a YouTube Channel where he shares the knowledge that helped turn his life around. In four years, David has gone from living paycheck-to-paycheck to replacing almost half of his income. He aspires to help others follow in his journey to financial freedom!

26 Comments

  1. Russell Brazil

    Couldnt disagree more ??.

    Build wealth for yourself, or for your landlord. And you should always be buying in high demand markets like DC. “Appreciation” is simply what happens when demand is high. When demand is high, that means you are buying a lower risk asset and or market. Buying in the lower risk, hugh demand markets is simply the easiest and least risky way to build wealth. ??

    • Vaughn K.

      Low risk market huh? Which places saw the largest drops during the recession again? Oh yeah, the “low risk” markets that had sky high prices.

      IMO if you know ballpark where the market is in the cycle, there’s nothing wrong with buying into trendy places… But I wouldn’t touch any of them with a 10 foot pole in 2019. The fundamentals are waaay off, and even in “world class cities” they go right back into the numbers that align with fundamentals of a healthy market during corrections, just like everywhere else.

      If you live in an expensive market and intend to stay there for decades, I do agree buying in is not horrible, as you WILL be shelling out rent either way. The real way to do the math is to see if the extra money you’re paying for your mortgage there, once taking into account building equity, works out well enough to where you couldn’t simply invest elsewhere and make enough to cover the lost equity AND still make more money. In other words it’s not the total numbers, it’s the differential. If you can rent for $2,000, but mortgage is $2,500, you have to factor in the equity you’re not getting on that first $2,000 a month in payment, not just that you’re paying $500 more.

    • Amanda Gant

      I live in DC. I own 5 units here, and am currently living in a rental. At first I felt sheepish about it, but I realized that in this particular market, I will probably never live in a place I own again (unless it is that forever house he talks about, which as a young investor with no children, doesn’t yet make sense to purchase). So, what’s the deal here? I was living in a 3 BR unit I owned with a roommate. I realized I could rent it out for $3000… if only I could find a good deal elsewhere. I found a 3 BR HOUSE in a better neighborhood for $2250/month rent. Thus, I moved, and rented out one of the places I own. Great decision. As long as there are plenty of great homes on the market for $2500-$3500/month when the respective mortgages would easily cost $5000-6000/month (plus maintenance, please!) I will be renting.

      This will vary market to market, but I feel very confident about my ability to afford a higher level of living at a smaller per month cost WHILE saving my money to make more investments.

      I love the prospect of being able to “trade up” (or down) at any point in time, depending on my life goals and how my growing investment portfolio is doing.

      • Vaughn K.

        That’s ultimately the moral of the story… Do the math!

        I can’t for the life of me understand people who LIKE to move around, change neighborhoods, etc all the time… It’s nuts to me, but some people like it. The flipside of renting is that if you DON’T like that, and want to stay in the same place, you can’t control that. You can be booted out at any time, or simply get priced out in rapidly rising markets.

        Pros and cons as with everything in life!

        • David Pere

          Agreed, but sometimes it is inevitable. I, for example, am in the military, so at the very least I can expect to move ever 2-3 years haha.

    • Brendan LoCicero

      I wouldn’t have a problem renting in a tanking market if I had to move during such a time. I would be super careful about to live in an RV. New RV’s can exceed the the cost of a home in some markets. A 10 year old trailer in great shape for 10 grand fine. A 130k new Airstream no way. They’re about as good an investment as a car. I had a good friend who’s mom sold her townhouse in Huntington Beach at the top of the last market to buy a 100k+ motor home to see the country. To say she lost her a— is an understatement. Now living in a 5th wheel in her step daughters pasture. I guess whatever course any of us ultimately takes has to make sense.

      • David Pere

        Absolutely agree, I’m going to be looking at 3-15 year old Class A, or 5th-wheel RV’s in Missouri. Which I will then drive to San Diego (which means I’ll get it roughly 30% cheaper than buying in San Diego). I’m only giving myself a week to look at them. if I don’t find the perfect RV I will immediately ditch the idea and rent a house/apartment in San Diego instead.

    • David Pere

      I am hesitant to speak in absolutes, but I would definitely disagree that you should ALWAYS buy in markets like DC. If you move out, and the rent doesn’t cover the mortgage, that is a BIG liability. Can you buy in markets like DC successfully, absolutely…but that doesn’t mean it is always the answer.

  2. Tom Phelan

    A great debate and one that will probably rage on forever.

    A huge, pivotal factor is the location. If you live in NYC, San Francisco or LA and want to be in the pith of it all and not 45-miles away, unless you earn a bundle you’re pretty much relegated to renting.

    I have a daughter who is a doctor in San Francisco and just doesn’t want the obligation of a mortgage and home ownership with taxes, maintenance etc. She pays about $3,500 a month for a very modest 2-bedroom unit. But, instead of shelling out $6,000 a month on a mortgage plus another $1,000 for taxes etc., she puts away $10,000 per month in cash. She has accumulated in the mid 7-figures and now is considering retiring when she hits age 50.

    However, I also think of the story of the two twin sisters who live in a more affordable part of the US. One sister, Jane rents for 30-years during which time her rent has steadily increased.

    The other sister, Joyce purchased a home with a 30-year mortgage where the payment stay the same.

    During the 30-Years Jane has never had a mortgage deduction to offset her costs. Also, after 30-years Jane has much higher rent, no equity and is staring at the prospect of paying rent until she dies.

    Joyce meanwhile has a “Mortgage” burning party and knows she’ll never has a monthly payment again. Yes, she pay taxes based on 30-years ago and maintenance but she also has tremendous equity that if needed could be tapped into with a Reverse Mortgage with zero payments while she lived.

    I just can’t see renting for a lifetime.

  3. Mary Fielding

    Don’t forget to factor in demography and what will happen with respect to the baby boomer generation (eg selling big homes, buying smaller bedroom on the first floor or ranch homes). There isn’t a generation big enough under them (in the age range families tend to buy big homes) to absorb all those big houses that will be for sale (not to mention the McMansions will have a number of structural things near the end of their useful life so potentially expensive repairs) and some of those folks will be competing with first home buyers for the smaller, cheaper homes.

  4. William McGowen

    It’s more about a lifestyle choice than anything. Buying a home should not be thought of as in investment in most cases.

    But I think it’s a little more complex than this. When I buy property, I rent it out for more than it costs me to keep it up. That alone should mean that I can live in many properties cheaper than the rent, and that doesn’t take into account the growing equity. But then I don’t need a big down payment in the first place.

    For me I have 2 rental properties, and a house I am currently flipping. But I am still renting an apartment. I will continue to rent until my rents exceed any house payment I have.

    I will also take one of 2 actions when I am ready to purchase. Either buy a fixer upper, and treat it like a brrrr investment, but live in it after I fix it up. Or I would do the ever popular house hack. Possibly a combination of both. Find a triplex, fix it up, refi and live in it.

    But the whole idea does take a little math. I buy houses that will cashflow, so obviously the rent is more then my costs, so living in a property like that should be cheaper than renting the same property. But if I were to choose a property that wouldn’t cashflow, than I might be in a better position renting as opposed to buying. But then should I take into account how part of the mortgage is going toward the equity? How any increase in the price is is multiplied as a result of the leverage?

    One of the things I think about with the house hacking is if it is better to live there, or to rent and just get the income from renting the other unit out? Your income is reduced by the same as your rent, so while the effects seem the same, your tax return will be affected. This can cut your taxes as a result, but it could also tell the bank that you aren’t making much if anything from your rentals.

    • David Pere

      All valid points, but you clearly live in a market where cash flow is possible. There are many markets where the mortgage is nearing double what market rents are, and that is what I’m talking about. The point is that, it depends on the numbers, and the market…that is why there is no definitive answer to the buy/rent scenario, only “it depends.”

  5. Jonathan spaeth

    David, I completely agree with your premise that renting, for an active RE investor, makes more economic sense than buying a primary residence, especially in a large metro area where taxes are high. The additional capital saved while renting is more powerful invested in rentals with solid cash flow. Everyone’s market and situation is different but this has always made mathematical sense for me. I have a net worth > 1M and have chosen to do this for quite some time.

    With that being said, I’m purchasing a modest primary residence and will be living with someone that will be paying rent and splitting a fraction of the cost of the residence. Factoring in rent and the mortgage interest return at the end of the year makes it close to the same monthly cost are I’m paying in rent, in the same area. I’m curious what your opinion would be on this move.

  6. Russ NA

    This is a very well-written article that goes over the fundamentals of investing, but applies it to Real Estate. The author is accurate about nearly everything in the article. Indeed, one has to figure in the cost of the investment when deciding whether to rent or buy. In some markets (like California), if you rent a house, you’re actually typically renting it below the actual carrying costs and you’re having the landlord subsidize your rent! I sold my first house before the crash and rented until prices came down. It was a no-brainer to rent a house for $3K that the landlord had bought not a month earlier for $850K. At the time, I estimated his mortgage to be about $6K a month. Yes, the house has appreciated since then, but it went through a large downturn first, where we then stopped renting and bought.

    As for the article, I read a piece in Bloomberg recently about Generation Z, and how their population is 10-20% less than the millennials, and this will affect college enrollment in the very near future (and probably college housing stock as well). This recent “college boom” is very driven by demographics, and they are shifting away at this moment.

  7. David Krulac

    David, great name and well thought out post.
    I agree with the premise and sometimes renting is better than buying. However there are several other factors involved. I have bought and sold well over 900 properties for my own inventory so I know a little bit about buying property.

    There’s more to the Detroit story than the decline of the automobile, a lot more.

    One factor not mentioned was bargain purchases. Even if the median price is high in an area, if you can buy a property below market price, you have much higher income results versus purchase price. For example I was able to buy a $330,000 house for $30,000 and the first tenant paid $2,050 a month in rent. So the rent was well under the 1% rule if you used the value of the property, but well above the 1% rule if you used the actual purchase price.

    One employer that is largely recession proof and economic cycle proof is governments. State capitals, county seats, as well as government installations tend to grow. And the adaptability of a city to adjust when there is a loss of employment factors into the equation. Pittsburgh, once heavily steel industry is now a medical, education, and financial center.

    I strongly agree with your perspective about not buying a property in every duty station. Some have profited from that move, but even with the no down VA financing, low graded enlisted can’t buy houses in high price areas like CA, HI, SF and DC.

    Keep up the good work and keep From Military to Millionaire going strong.

    David Krulac

    • David Pere

      Thank you David,

      I agree, there are exceptions to every rule…ultimately the best answer to the buy/rent question is “it depends.” Unfortunately, that answer doesn’t help anyone so I tried to expound. Buying bargain houses is a great way to hack the system!

  8. David Andrzejek

    Thought-provoking post!
    I guess it really comes down to looking at your purchase cost (PITI + some maintenance costs) and comparing it to the monthly rent.
    But for a fair comparison, you’d need to assume an interest-only loan (no payment of Principle), and then compare to rental cost plus a market return for the down payment you would have had to make on buying. Or estimate your principle pay-down plus market appreciation, and compare that to your renting cost plus the market return on principle.
    You probably should also factor in tax savings of your mortgage interest deduction as more ‘return’ from owning.

    It ends up being slightly more complicated to figure out apples to apples, but Pere’s concept is sound.

  9. Fred Maul

    I have been buying and renting homes across the country while in the military as well. We kept four of them since we started buying in 2003. I have had mixed results. In some markets, the home you buy for your family is not the home you should rent. In others, like you say, the rent costs are lower then the all-in cost to own a home and therefore you do not buy. Renting can be very attractive, especially when the cost of renting is less then what it cost for PITI and maintenance costs.

    One big factor in the long run for me was the equity build. I have been selling my homes and that has so far been the main factor that I consider this experiment a success. I am paying taxes on the gains since we depreciated the homes over the years on our taxes, but so far so good. I’m down to one home and it was purchased during 2006 peak market. I think it’ll get me around $20k after closing which is pretty sad considering the lengthy time I’ve owned it, but having broken roughly even in all that time, I think that’s better then nothing.

    For the newbies out there, results may vary. Do your analysis without emotion and look at alternative investments.

  10. Cody L.

    This shouldn’t be a “Wait what?” statement for anyone. Think about it: There are markets where if you buy a home, you’ll NOT cash flow. Because the mortgage is way more than rent.

    That means the inverse is true: In those markets, it’s silly to buy a home to live in. Might as well rent.

  11. John Murray

    The one lesson I learned from the military was how to work and succeed in chaotic conditions. Don’t sweat the little stuff, everything is little stuff if you are alive. Serving with Tropic Lightning when Mililani Town was being built a 4 bed 2 bath home brand new was about $38K. Inflation has been about 450% since then so the math is $38K X 4.5 = $160K. Today the same house sells for about $900K or so. As an E-4 I grossed about $4700 in 1977. This is how I became a multimillionaire, I always thought about Mililani Town and how I should have purchased in 1977. I have to settle for being a lifeguard on Waikiki, Fort DeRussy and Rec Services was a blast. Eat your heart out Millennials.

  12. Eric Carr

    Indeed, great points and I see you wrote it mostly through the lens of an investor, not just a home owner. It would not make sense to buy, and then sell when/if you were relocated – you’d likely not have the equity by means of principal payment or appreciation if you moved within a few years of buying. You’d have all the selling costs to deal with. You said it in so many words, buy where you live when it makes sense, rent where you live when makes sense. And when renting, buy investment property in other markets to subsidize the rental lifestyle! And when you move to another base, your rental in the Midwest stays where it’s at. Hindsight is always perfect, and you’ll likely hear contradictory stories from people who did it differently, all offer things to think about. You made excellent points here
    Right on

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here