When Renting Makes More Sense Than Owning

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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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The Dream

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.

The Reality

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.

The Plan

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!

Vacation Homes

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.

Shared Housing

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

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!”

Photo: tanjila

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

18 Comments

  1. I’m in the same boat, kids grown sold my house gave them my furniture. I bought and RV and down sized. It hurts my debt ratio over renting but it’s a tax write-off. I’m not one to move furniture around every year or have a landlord tell me what I can’t do or kick me out. IMHO, money isn’’t everything peace of mind is worth more.

  2. We were thinking of purchasing a vacation home, but then decided not too. We like to go to different places and we would be forced to go to the same place every year if we owned a vacation home. We decided its much smarter to rent a place on the beach for a week in different places than to buy a less desirable home not on the beach.

  3. Dave –

    This is a great example of thinking outside the box. I’m sure it’s going to make a lot of people think about renting vs owning property. Sometimes it just makes more sense to rent especially when you have that much money to invest to “make money”.

    Sharon

  4. Hi Dave,
    Thank you so much for this. How do you invest in notes to get 18% ROI? Can I do this? What are the risks and duration of the committed funds? I would love to do that vs. buying property !! I would love to hear about this Dave and I am sure many others would to. Thank you so much for imparting your wisdom.

    sri

    • Hi Sri,

      Glad you liked the article! Anyone can invest in notes, now what types of notes all depend on you, your risk tolerance, and how much you would like to invest (or the amount of money you’d want to raise to invest).

      There are multiple types of notes as well, so it depends on your interest as well. There are private 1st mortgages you could do for rehabbers where you can make a solid 15% and you can find people looking for these at any local REIA meeting. There’s also a site I love recommending for people without much capital called Lending Club (www.lendingclub.com) where you can invest in unsecured notes for as little as $25, and you can buy these with any type of term (from days to years), and when buying in bulk especially I’ve seen investors average a 15% or so return.

      What I was mostly referring to in the article though was performing residential notes. I manage a company called PPR that sells these types of notes and the average return is 15%-20%, and they also come with a warranty so if they go bad we’ll give you another note of equal value or a note credit. I like these types of notes because they’re secured by property and you don’t have to deal with tenants, maintenance, etc. The average price of these is about $15K but I’ve seen that vary depending on the type of note you buy, if it has equity, etc.

      If you have any questions or want to learn more, feel free to message me here on BP.

      Best,
      Dave

  5. Timely article, Dave, as my girlfriend and I were discussing this very issue over the weekend. We happen to live in San Francisco and are debating a move out to the East Bay (Oakland) for cheaper living. I think we have our mind’s set on moving East but there is still much debate on whether to rent or buy – especially now with the crazy low inventory here in the Bay area. Appreciate the “devil’s advocate” side you played here as most people (family included) think I’m crazy for renting still.

  6. Okay, you left the other shoe dangling . . . how can you justify investment in properties? Isn’t the landlord you rent from better off doing the same thing (assuming s/he can sell)? Is the difference in the financial details (taxes…?)

    • John-Christopher

      My landlord wasn’t an investor, he was a guy who got stuck with the house. The property was a bad investment, and it was not a good rental property to begin with in terms of market rent and HOA fees. He was a homeowner who got relocated to South America. He was essentially paying the full mortgage payment for 8 months while it was empty. He wanted top dollar because he was stuck on what he payed for the place (when it was brand new or almost brand new) and then the value fell. I guess he couldn’t justify (at least emotionally) selling it at less then what he paid for.

      As far as justifying investing in properties, I’m a bit confused by your question. How could I not justify it? I’m cash-flowing so much investing in properties that it pays my rent, living expenses, and for my new investments. That’s how I justify it! I can also justify it for the tax write offs, appreciation, depreciation (to offset earned income), etc. Most of the properties I own aren’t high end rentals (aside from commercial) because in my current situation I can’t justify owning them. I’d rather invest my money, than put it down on a high end property. That’s what this article is all about.

  7. Great article!
    My wife and I did this several years ago.
    Bought our first place near the top of the market and wanted to move after the biggest drop of the crash. Would have lost a ton of money to sell.
    It became our first rental and we got slightly more to rent it than we paid to rent a bigger place in a much higher end city.
    We did that about 1.5yr then bought an undervalued fixer in the good town, while still holding the rental.

    We actually were looking at doing it again since said fixer would get us a fat profit that would be tax free since it is our primary. Figure we would cash in on the mini bubble and would maybe buy back in when it pops.
    Unfortunately we bought so well that it looks like are cost of living will go up at least $500 a month for a smaller dated place. Not sure it will work unless we can happen upon a real undervalued gem.

  8. Man, it’s great to see someone else who advocates renting rather than owning! My entrepreneur/investor/inventor grandfather tried to tell me when I was young that owning a house wasn’t an investment and I didn’t believe him, my dad tried to tell me the same thing and I didn’t believe him, and I eventually heard at a Rich Dad Poor Dad seminar yet again the same thing. Evennnntually, after getting into real estate investing myself, I get it now! They were all right! I try to explain why to people and pretty much know one buys it. Oh well, that’s their deal. One good thing you mention as to the costs of owning a house that I didn’t think about as a huge expense is lost opportunities. You’re dead-on with that one!

    Excellent article and I’m going to bookmark it to use to help me when I’m trying to defend the idea again in the future!

  9. This is a really great article and something that I have been struggling with recently. My original goal was to buy a 2-4 unit, live in one of the units and rent the rest out. After reading this article and thinking about it a little more, I can totally see the other side.

    Say I can find an apartment that I can rent for $550 a month, still buy the multifamily property, and as long as the gross rental income is higher than $550 per month per unit in the multi I would come out ahead. Even though I wouldn’t be living in my own property and paying for somebody else’s cashflow, I also wouldn’t be robbing myself of cashflow from my property from the unit I would have been living in.

    • Nick,

      The only thing that would be beneficial in your original situation, would be the financing. You can usually get better financing if a multi-unit is owner occupied. But on the flip side, if you lived in a rental that you paid for with cash flow you don’t have to live with your tenants! I lived in a duplex when I first got married, the tenants bothered me obsessively but it’s still one of my best rentals! So it’s a judgement call, owner occupied lender requirements generally require you to live in the property for a year before moving but there could be some creative scenarios to get around that.

      Best of luck,
      Dave

  10. Hi Dave,

    Thanks for the article, I enjoyed reading it. In the section about High-End Primary residences you mention the option of placing 800K in notes yielding 15%-18%. I’m curious which notes you’re referring to that have such high yields?

    Thanks,
    gsw

    • Dave Van Horn

      Hi Phil,
      You are correct that rates have declined in the marketplace in recent years due to increased demand, although we still occasionally see similar returns, especially in private money. Keep in mind: all notes are not equal. Second liens have higher returns than firsts, and sometimes private money is higher, especially when you factor in the points.
      Best,
      Dave

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