The rent or buy decision is one that almost everyone faces at one point in their life or another. While this may seem like a complex decision, in many ways it is not as complex as it may at first appear. There are lots of resources on the web and in common home financial software programs that make doing the pretax/after-tax adjustments on the cashflows easy to analyze. The thing that many people miss are the more basic, common sense issues that often aren’t easily captured on a basic financial program. If you are facing a buy or rent decision, be sure you consider the following points in addition to your more basic tax and cashflow analysis.

How long will you live there? Many people consider buying starter homes with the goal of trading up in a few years. While this may be a useful strategy when housing prices are rapidly rising, it’s not always a good idea because the high transaction costs associated with buying and selling a property can eat away at your equity. For example, if a young couple buys a $300,000 house with a down payment of $30,000 and sells it less than two years later, they may loose close to their entire down payment, even if they sell the house for what they paid for it. Paying a realtor their usual 5-6% commission, fix up expenses like freshening the paint or putting in a new carpet, moving expenses, and assorted closing costs and taxes could easily total $20-25,000 in this example. If you plan on only owning the home for a couple of years, adding in that $1,000 or so monthly "hidden" cost may suggest you rent. In the example above, this couple would have been happier if they just left their down payment in a CD for two years and waited. But what if the property appreciated? Unfortunately, since they have owned the house for less than two years, that gain, if there is any after the transactions costs, is fully taxable. You must live in your house for at least two years to get the home gain tax exclusion. The message here is don’t forget the transaction costs if you’re planning on owning a property for a short period of time, they can add up.

How much will I use it? If it’s a vacation home then this is an obvious question to ask. If you are paying substantial after tax costs you might be better off spending the same money to rent and have the flexibility to rent different places. Keep in mind that if you plan on renting your property to others you are limited to using it just two weeks a year if you want to retain the rental property income tax treatment. If you need that rent to help cover expenses you may find it costly to carve out your two weeks in the prime rental season. Also, don’t forget about the maintenance costs on a property that is often too far away for you to tend to little problems yourself. How long you own the property rule applies here too. It’s not unusual for parents of small children to discover that they can’t really use their vacation home as much as they’d like as their children grow and develop their own, different interests and commitments. Be realistic about how much you’ll use a property and don’t overvalue the pride of ownership. Annual vacation home expenditures of $10,000 or so can buy some pretty nice vacations.

Will I want to live there in the future? Perhaps the hardest factor to evaluate but also the one that can really swing the balance in the rent or buy decision is your long term use expectation. If your goal is to eventually live in a property in retirement then the decision will more that likely swing in favor of owning, even if the numbers suggest otherwise. By definition, retirement suggests a long term ownership. In addition, retiring to a property you own outright (or nearly so) makes very sound financial sense. If this is your long term plan, and you can afford it, then buying a property is frequently the best alternative. While over the long term housing tends to appreciate slightly above the rate of inflation, certain sectors can do much better. If you are a baby boomer in your 50s starting to think about where you will retire, chances are your dream retirement home will be much more expensive in fifteen years as other baby boomers like you try to all buy the same types of properties. In the long run you’ll almost certainly be better off owning even if the costs are much higher today. The moral here is don’t let the numbers dissuade you from using your common sense.

Will I be able to maintain the property? One of the advantages of being a renter is if something in the building goes wrong, it’s generally the landlord’s problem. If you are buying a property do you have the time and inclination, or if not, the money, to fix the inevitable maintenance issues that will appear. Protecting the value of your property necessitates that timely maintenance be performed. This is especially important on older, fixer uppers that appeal to many buyers. Once again, the key here is to be realistic. Ask yourself, do you have the time, inclination and/or money to make sure that you can keep up with the maintenance. If not, you’ll likely be better served by continuing to rent, at least for the time being.

Owning real estate is often times a great investment and a pleasurable experience. However, don’t be fooled into thinking that you can do a basic financial analysis to determine what is best for you. More often than not, it’s the bigger picture, more common sense issues that should drive the decision.

As always, please feel free to call if you have any questions.

Randy Gridley

October, 2003