The trouble with rent vs. buy calculations

Last Updated on September 6, 2019 at 11:49 pm

‘Should I buy a house/apartment now’ or ‘should I continue to stay in a rented accommodation?’  I am sure you would agree that this is a common dilemma faced by many youngsters.

In fact, although there are several decent ‘rent’ vs. ‘buy’ calculators available, I continue to receive requests to make one.  For a variety of reasons, I am not motivated to make one although from a mathematical point of view it is reasonably interesting.

In this post, I would like to jot down the reasons for my lack of enthusiasm for making one and why in general ‘rent’ vs. ‘buy’ calculators may not be as useful as other calculators.

• ‘rent’ vs. ‘buy’ calculations need to take into account several inputs: rent paid, annual increase in rent, cost of house, annual increase in property prices, tax deductions on renting, tax deductions on buying, maintenance charges etc. and arrive at a table or graph which tells the user when it is beneficial to ‘buy’ – right now or a few years later
• This is definitely a challenge and many people have successfully tacked this.  Although this – the fact that I will have to reinvent the wheel to a large extent – is enough to dissuade me from making one, I am disturbed by the fact that, although there are several inputs, a single input dominates the entire calculation. To makes things worse, there is no proper method available to even reasonably estimate that input!
• I am talking about the rate at which property price increases.  Take any rent vs. buy calculator and change this input randomly.  You will immediately notice that the results change dramatically.
• If property prices are increasing at a rate much higher than renting costs, then buying asap is always better.  Do you really need a calculator to determine this?
• Well, if you don’t have a property of your own and feel desperate to get one for a host or emotional and psychological reasons, the answer to rent or buy is naturally buy. The question is of course, when.
• Buy asap is one answer. Buy after 3/4/ years as these calculators cough up is another answer. The question is, are these calculators and the typical reasoning associated with this issue adequate to arrive at the answer to when to buy a property?
• Easy enough to guess my answer: No (why else would I write this post?!). No, because most people are swayed by the increase in property prices whether they use such calculator or not. They look at the high returns from real estate and believe that it is best to buy asap as postponing can make buying unaffordable.
• While this is indeed true, a more considered decision is necessary. Here is a list of factors one should take into account before buying a house. I am convinced that many of these factors cannot be taken into account in rent vs. buy calculations.

1. Have I planned for retirement?  Most people take a home loan in the hope that they would pay it off asap and then focus on retirement planning. This is dangerous in more ways than one. A person must recognise the investment needed (immediate and rate at which it should grow) for retirement. I think one must consider buying a house only after at least 60% of the investment needed for retirement is in place and will not be affected by the purchase and subsequent home loan EMI.
2. This implies postponing the purchase for at least 3-5 years. As Ashal Jauhari points out, postponing can be beneficial is other ways too: “At the start of a career if one can prolong his/her house buying, more money can be there in the pocket to pay as a down payment. More than the money, in next few years in the career, there’ll be more clarity on where I want to settle for a house, city as well as area in that city”.
3. These are key points. One factor that is most crucial is in which city should I buy?  Most people who migrate because of work, plan to buy a house in their native town/city if you ask them immediately after they start work. After a few years they change their mind because they become used to life in the new city. So waiting a while can prove beneficial.
4. Another key factor: The area of purchase. A rented accommodation in the heart of the city cannot/should not be compared  with a house in the suburbs. Most of us can afford to buy only in the suburbs of a major city today. Therefore, relocating to a very different milieu can be painful and expensive in terms of transport. It can also affect the personality of children.  Logistics, proximity of shops, hospitals, hygiene (open sewers), adequate clean water etc. should be considered before you buy.
5. Emotional factors. There is a lot of emotional baggage attached with rent vs. buy! A  calculation which says, ‘buy after 7 years’, can never understand the difficulties associated with renting – lack of freedom, difficult landlords, frequent shifting etc. Therefore, most people decide to get their own place and handle other issues ‘later’.  Fair enough. A calculation cannot help much in such circumstances. I am sure this point will find universal acceptance!

• What if I can never afford a house?  Yes this is indeed a major factor to consider. However, more importantly, one should also consider the following: It is all well to own a house, however if I do so,
  • Can I still manage to invest enough for retirement?
  • Can I afford to pay for my children’s education and not burden them with an education loan?
  • What if I face the danger of becoming asset-rich, but cash-poor?
• Reverse mortgage is a load of crap Many think that a self-occupied property is valuable in retirement as it can reversed mortgaged to fund retirement. This is true only when the property is purchased only if the property is purchased in ones middle-age (45-50) and not ones 30s – the property would become too old to be worth anything.
• Invest for a retirement home  Why not buy a retirement home (when eligible) and relocate there when convenient. This is not only a cheaper option but also a prudent one in many ways.  Most importantly, it allows your children to do what they without having to tend to you.

To conclude, I strongly believe that instead of a rent vs. buy calculation, one should at least consider rent vs. buy vs. retire calculaton to understand the impact of buying or renting on ones retirement goal. One such illustration can be found here: Calculator: Prepay Home Loan or Invest?

However, I am still not convinced that it will improve anything. The rate of increase in real estate prices will still control everything.

So Why not use some thumb rules instead?

• Well qualified individuals with a steady income (if not job!) could consider buying asap provided they focus on investments immediately after purchase and not after prepaying the loan!
• Those staying in rent in a logistically well connected place with a decent landlord with whom they are likely to have a long term relationship, can afford to postpone buy until they fortify their cash flow and investments.
• What about those in between?  Tough call! I think postponing until the fiscal ship is as steady as possible is a decent idea applicable to everyone.

Is buying overrated? So you got a house on your own. Congratulations! What of it? Means nothing if

• you don’t have funds to meet your financial goals,
• don’t control your expenses,
• live a healthy and meaningful lifestyle.

At the same time, are the difficulties associated with renting often underrated? To stop living in rent may be the number one goal for a family. They choose that and wish to take a chance wrt financial independence in old age. Who are we to judge!

Articles

• Ashals article using the P/E concept
• Arthyantras report on Buy vs. Rent

What do you think?

When do you think about rent vs. buy calculations? Are useful?

What is your take on renting/buying?