Renting vs. Buying in 2024

Reading this blog will help you understand the pro’s and con’s of buying a home, compared to renting + index investing.

This blog will break down the true costs of buying a home, compare annual returns of renting + index investing to buying, debunk myths about home appreciation, and highlight the flexibility of renting.

Words from the Author:

For five decades, when it comes to investing, there was no real alternative to buying a home to save for retirement.

Back then, there was not really any point in thinking of alternative investment strategies, as they were not available to the public. Stock picking on the weekend does not count, in my opinion, as this is a very active task.

However, things have changed. Now, you can buy the entire stock market with one index fund (example: the iShares All Country World Index, ~4.000 companies).

With this option available, purchasing a house and investing in a single index fund equalizes the time and effort required over the many years until retirement. You either pay off the house or buy an index fund.

However, the desire to own a home still exceeds the desire to own an index fund. Owning a house is a lifestyle choice. You can invite friends and family and make wonderful memories. But there is also a certain social pressure to go this route.

When you look around, it seems as if everyone buys a house, builds a house, or does something similar “for their future.” Family members may ask you directly when you will finally stop renting and start buying. However, there are a significant number of people who buy houses without questioning the feasibility of this financial adventure or their alternatives.

The general consensus is that owning is essential and never fails. Everyone seems delighted with their dream house, and after 35 years, you own the property.

The truth, however, is that 44% of all house owners still have debt on their home after they retire. The most common argument for buying is that it will be yours by the time you retire, but reality does not support this claim.

There is a 44% chance you won’t make it before retirement. Even if you succeed, your house will be over 35 years old by the time you retire. (NerdWallet: Finance).

I just briefly mention the drawbacks associated with divorce, illness, or expanding a family beyond your current living space.

Selling the house spontaneously is also challenging. The process usually takes 4–7 months if the market has a balanced seller/buyer ratio and will cost at least 10% of the houses current market value.

The true cost of buying a home

Let’s begin by listing the actual “running costs” associated with house ownership. Some are abvious, other may surpise you.

First, lenders typically require a substantial down payment, typically ranging from 10% to 20% of the purchase price. This down payment can amount to tens or hundreds of thousands of dollars, which remain inaccessible until the property sells.

Second, the current mortgage interest rates are the highest in over 20 years, at just over 7%, resulting in significant costs over the loan term.

Third, private Mortgage Insurance (PMI) is an additional cost, typically ranging from 0.5% to 2% of the mortgage balance per year, incurred if the down payment is less than 20%.

Next, property taxes are an unavoidable expense that is usually calculated based on the home’s appraised value and adjusted annually, ranging from 0.3% to 2.5% of the property’s value, which tends to increase over time.

The average cost of home insurance is approximately $1.428 per year, but underinsured homes may require approximately $2.200 annually for a proper policy, with costs expected to rise over time.

Given the available data, I recommend allocating 1-2% of the property’s value annually for repairs and maintenance to cover the inevitable expenses that arise over time.

Total costs of ownership

Below, you will find a calculated summary of the costs outlined. It may come as a surprise, but the true cost of ownership in this example, considering all factors, is $3,463.

Cost Breakdown of Buying a $400,000 Home
Expense	Monthly Cost
Mortgage Payment	$2,400
PMI	$150
Property Taxes	$383
Insurance	$200
Repairs and maintenance	$330
Total	$3,463

Renting vs. Buying: The Numbers Don’t Lie

In a recent blog post, we learned that the entire US real estate market made 9.5% annually over the last 55 years. However, a well-maintained single property only yielded a 3.9% annual return. (Norada Real Estate)

The difference stems from the fact that your house has been in existence for at least 30 years. The technology (construction, isolation, cables, pipes) has changed or is outdated.

Renting a similar home for $2.100 a month without tying up a substantial down payment offers a significant monthly savings of $1.363 compared to the total out-of-pocket cost of owning a $400,000 home.

In the next chapters, you will see that investing the down payment and the monthly savings from renting provides an outperforming alternative to homeownership.

Comparison of 30-Year Investments

Enough said; we have all the information required to run the calculation. What would happen if we buy the before mentioned house and keep it for 30 years versus we rent a place and invest the downpayment as well as the monthly difference?

House Investment:

• Initial Purchase Price: $400,000
• Downpayment: $40,000
• Loan: $360,000
• Annual return: 3.9%
• Duration: 30 years
  
• Future value: $1,134,407.08

Renting + Investing:

• Initial Investment: $40,000 
• Monthly contribution: $1,363 
• Annual return: 10.2% 
• Duration: 30 years
  
• Future value: $3,679,270.63

If you are in disbelieve, I suggest you do your own calculation: Compound Interest Calculator

It may come as a surprise to everyone that the outperformance of renting + investing is 3x the house investment. To put it clearly, the outperformance exceeds $2,500,000!

Put another way, this equates to the purchase of two more houses that are 30 years old.

If your goal is to retire with the most money possible (more money, more flexibility), this is truly impressive and cannot be ignored.

However, there are other hard facts that need to be considered as well in this comparison.

When Renting is ‘Better’

1. The minimal responsibility and upfront cost associated with renting, as landlords are responsible for property tax, insurance increases, and major repairs, make it an attractive option for those seeking a hassle-free living arrangement.

2. Renting offers unmatched flexibility, allowing individuals to easily relocate once the rental agreement expires and providing leverage in negotiating favorable rental terms, especially in a competitive rental market.

3. If you want to have a family, you can move to a house or apartment that fits your needs. You can go bigger or smaller, depending on the total number of heads in the house. This in-and-out is difficult to do with an already-bought house.

Long-Term Advantages of Buying

1. Having a home allows individuals to secure their monthly expenses until they fully pay off the property, offering stability in the face of potential fluctuations in property taxes, insurance rates, and maintenance expenses.

2. The psychological satisfaction of homeownership, the freedom to personalize and make decisions about one’s property, and the absence of landlord dependency are significant advantages of buying a home.

Long-Term Disadvantages of Buying

• The value of your house goes along the value of the area your house is in. You cannot predict the “right” area 30 years upfront. There is a risk that you neigbourhood will not develop as good as you would like and you cannot do much about it.

• With the above argument goes along the second downside. You put all your eggs in one basket. After retirement, you still live in the house and it cannot be taken away, but it way not be worth what it once was.
  
  In the end, the value of anything is defined by the amount of others willing to buy it at a certain price. If there is no buyer for the asked price, you have to lower the price until there are enough buyers again.

Conclusion

Alright, so what do we do with all this knowledge now? First, we have to realize that buying a house is not the best option, both on money return and overall flexibility.

Second, making a mind about these things can compound to completly different outcomes.

Third, don’t do anything for your family, friends or out of FOMO. Make up your own mind and follow what fits you best.

I really hope to have brought some clarity to this rather complex topic. Hit the comment section if you have a question.

Yours,
Stephan

FAQ

Where can I read more about index investing?

Look at this: Index Funds: The Zen Way to $1.000.000+.

What if I only invest in a home but never in index funds?

In such a scenario, buying is definitely better than not doing anything at all. However, the asset class you invest in doesn’t matter as long as the risk-to-return ratio is good and ethical. For many people, real estate appears to be a better choice due to its tangible nature. Still, I recommend learning more about index investing and then you make the final decision.

Book Recommendations

• “Rent vs. Own: A Real Estate Reality Check for Navigating Booms, Busts, and Bad Advice” by Jane Hodges Amazon 
• “The Rent vs. Buy Debate: Navigating the 2024 Housing Market” by Melissa Rothschild Amazon
• “The Truth About Renting vs. Buying: An In-Depth Look at the Financial Realities” by Michael Bluejay Amazon