The decision between renting and buying a home, Ben Felix introduces a different perspective from the common notion that buying is a good decision if the mortgage payment is equal to or lower than rent. The key points of the discussion are:
Renting vs. Buying a Home: The 5% Rule
Flawed Comparison: Comparing mortgage payments to rent isn't a direct comparison due to the different components involved in owning a home.
Unrecoverable Costs: To accurately evaluate the rent vs. buy decision, the total unrecoverable costs of renting and owning must be compared. Unrecoverable costs are expenses without associated residual value.
Components of Homeowner Costs: Unrecoverable costs for homeowners include property taxes, maintenance costs, and the cost of capital.
Property Taxes: Homeowners pay property taxes as an unrecoverable cost, usually around 1% of the home's value. This constitutes a part of the total unrecoverable costs.
Maintenance Costs: Maintenance costs can range from major expenses like roof replacement to smaller tasks. An estimate of 1% of the property's value per year is commonly used.
Cost of Capital: This cost is divided into the cost of debt (mortgage interest) and the cost of equity (opportunity cost). The cost of debt is relatively straightforward, while the cost of equity depends on expected returns for real estate and stocks.
Expected Returns: Historical data indicates that real estate has had a global real return of 1.3%, while stocks returned 5.2% (both net of inflation). The speaker points out that high recent returns might not persist, and expected returns should be based on risk premiums.
The 5% Rule: The key concept is the 5% rule, which helps assess the unrecoverable costs of renting and owning on an apples-to-apples basis. This rule involves calculating 5% of the home's value and dividing it by 12 to get a monthly figure.
Financial Comparison: By comparing this calculated monthly figure to the rent amount, you can make a financial assessment. If renting costs less, it may be a sensible financial decision. Conversely, if the rental cost is higher, it might be equivalent to owning a more expensive home.
Adjusting the Rule: The speaker acknowledges that this rule is a simplification and might need adjustments based on factors like tax rates, portfolio mix, and personal circumstances.
Opportunity Cost: The opportunity cost of equity capital, representing the difference in expected returns between real estate and stocks, is a significant consideration for homeowners.
Conclusion: For aggressive investors who haven't maximized their registered accounts, the 5% rule can be a useful tool. More conservative investors might adjust the rule to around 4%. The rule simplifies the financial side of the rent vs. buy decision.
Overall, the video provides a comprehensive breakdown of the factors to consider when evaluating the financial implications of renting vs. buying a home, emphasizing the importance of accounting for all relevant costs and opportunity costs.
If you enjoyed this, checkout Why Buying Makes 0 Financial Sense