Controversial Rent vs. Own Housing Calculator

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. Thank you for your support.

The Center for Economic and Policy Research (CEPR), a non-governmental economic think-tank, is very upfront about its views on the housing bubble. For a clue as to what they are, check out this article titled “The Menace of an Unchecked Housing Bubble”. They draw several parallels with the tech stock market crash of the late 90s. While there is a lot of other articles of note, I was drawn in by their Housing Cost Calculator:

This calculator compares the cost of owning a home relative to renting for a potential new homeowner. The Housing Cost Calculator reports the “Net Cost of Owning” — the expected amount of additional cash available to a renter compared to the amount available to a homebuyer who buys a home today and sells the home at a specified time in the future. The calculator takes into account the unprecedented run-up in real home prices since 1997.

In other words, it says that housing prices will revert back to its historical tendency to keep in step with inflation. Remember this chart?

Example Calculator Input
I put in that I am looking for a \$500,000 house in San Francisco/San Mateo, CA. I want to put down \$100,000 at a fixed-rate of 6.35% for 30 years. I am in the 25% tax bracket and plan to itemize deductions on my taxes.

This is the first calculator I’ve seen that automatically takes into the account the geographical area that you choose. So Provo, Utah is different than San Francisco, California.

Results

Your basic costs start at \$2,900 per month. However, if you can rent a similar home for less than \$6,300 per month, you may be better off renting.

Well, I can definitely rent that kind of house out for less than that. Let’s see what else they say. It tells me that the sell price in 5 years will be a mere \$222,000, a 56% decrease. If I sell in five years, I will not only lose \$116,700 when selling the house after commission, but I could have saved another \$94,700 on monthly housing costs. Total loss in 5 years: \$211,600. I’d have to keep the house for about 15 years to break even.

Screenshot:

A lot of simplifications were made to get these numbers. For instance, the calculator assumes that house prices will drop instantaneously by the amount that they have risen in excess of inflation. So no matter if I keep the house for 1 year or 30 years, the house price will forever be an inflation-adjusted \$222,000.

These numbers seem a bit drastic. But hey, I’m not a Nobel Laureate. As a current renter, I don’t know if I should be happy or depressed by this news either! Do I have the patience to wait it out and see if these guys are right? Probably not.

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

User Generated Content Disclosure: Comments and/or responses are not provided or commissioned by any advertiser. Comments and/or responses have not been reviewed, approved or otherwise endorsed by any advertiser. It is not any advertiser's responsibility to ensure all posts and/or questions are answered.

1. Nagel says:

What are the far reaching implications if this is true?

2. Martin says:

You also have to look at Mortgage Interest Rates. If the rates get lower, like say 5% when you plan on selling, you can probably sell your house for a lot more as people can afford to pay more.

I bought in August, but if I would have bought in February, I could have spent \$30,000 more for a house.

3. Ed says:

These numbers do seem extreme. I wonder if part of the extreme nature of these numbers is the area of the country. SF has extremely high real estate prices and last I look were trending down as the population ages and folks want more affordable housing elsewhere in the country.

I look at the housing investment like a long term stock investment. In the long run the price will increase because they don’t make land anymore and labor prices, etc. go up over the long haul. In the short term, like stocks fluctuation could be dramatic. Just pick a house and payment you can live with for 15-30 years, and you will not lose money if you are not forced to sell before you can realize gains.

There is also a hidden opportunity loss in renting. You cannot increase value with improvements – e.g. finish off an unfinished bonus room that increases the value of the house.

Regardless, both home ownership and renting is a liability. Home ownership has the potential to become an asset if you can sell it for more than you paid for it in the future.

4. Jake says:

While you may be right that the fundamentals of the housing market will return to a sustainable level eventually, I don’t think it is going to happen in 5 years, and I believe that in many markets we will have a soft landing that will take several times longer than 5 years to work through.

I did this exact evaluation 8 years ago — and it ended up costing me \$700K.

I lived in San Francisco in 1998 – 2002. While I was there, I rented a 1400 sq. foot apartment for \$3100 per month. In 1999, the apartment below mine sold for \$420,000 (it had the same floorplan as mine) — which I thought was outrageous at the time. I decided not to buy that apartment since I thought there’s no way that 1400 sq. feet with 5 windows (3 of which were in window wells) could be worth anywhere near that.

Well — I was wrong. That same apartment that I had previously rented sold for \$1.1M. Now I probably wouldn’t buy in an extremely heated market right now — but I was wrong in the past on that, and just as likely could be wrong on that now.

5. Julie says:

I really think that each area has to be viewed individually in order to make any type of accurate analysis:

As a caveat, however, I think this article is several months old. I live in Boise, which is at the top of the “bubble-proof” list. Since this article was published, Boise has experienced a decrease in home sales prices, but so far its thought to be a “healthy correction” rather than signs of a deflating bubble.

Perhaps you could make your own graph with locality-specific information (based on where you are interested in living)? That might give you a better picture. At least it would give you a better “worst case scenario” picture.

6. Heather says:

While I’m a bear on housing (I HAVE to be, renting in California), I agree that the housing drop at this calculator is pretty severe. It’s nice to run the numbers when I pay my rent though! If you want to plug in a smaller drop in (real) appreciation, try plugging in Anderson SC (-5%) or Akron OH (-10%). This change doesn’t seem to affect the other numbers (like property tax), and if property prices flatten, it’s not a bad estimation. But the calculator has some other good points; if you click on “See Details” under Net Savings, they ballpark various housing costs for you, and you can double check them with your own estimations (taxes, closing costs, insurance, etc.)

7. Winston says:

They’re are better calculators out there to be sure.

However, people need to do the math and figure out which option works better for them. When people think about the benefits of owning a house, they don’t often think about:

1) The tax benefits are incurred by spending money on mortgage interest. I’ve been told to spend the typical \$550-\$650k for a house in the Seattle area, so I can get the tax deduction over the \$1,300/month I pay in rent (It would cost me \$400k at minimum to buy a similar condo) for my apartment. Um, how does paying \$2,400 in interest, which after the tax deduction is about \$1,800 help me come out ahead over paying \$1,300 in rent?

2) Realtor Commissions

3) Costs involved in maintaining a house

4) The fact that the run-up in prices over the past couple of years isn’t sustainable. Additionally, as Baby Boomers are the largest segment of the population (along with their parents) – they poured a lot of money into the market and drove up prices. As they retire, pass away, etc – they’re going to downsize to smaller homes, putting a lot of homes on the market, which will depress prices, as there aren’t enough of us in the younger generations to buy-up their homes.

Plus, many of us already own homes anyway. You’d just get an arbitrage situation, there would still be more homes on the market.

This is not to stay that you can’t find a housing situation that’s better than renting or that one is always better than the other, just do the math for your financial situation and metropolitan area.

For me, looking at a condo or townhome that’s equal to my apartment – I’d have to pay about \$400-\$500k to get the same space, similar layout and live in the same area. I’d then need that house to appreciate at 15%/yr to match what my surplus cash from renting will bring me if I invest it/save it and earn 7% a year.

So I rent for now.

Still, owning a house is nice – so I may do it anyway if I find a good deal.

Either way, just do the math and make a solid decision.

-Winston

8. hayhehes says:

This is in a very interesting topic Jonathan. I think that the CEPR calculator is a little off base in assuming that the the value of any given home will immediately plummet to get inline with inflation, but presumably there are balance points regarding de/appreciation rates, length of ownership, and similar rental opportunities when buying a house actually wouldn’t be the best thing you could do with your money. I’d really like to see you delve more into this in the future.

9. The calculator does allow you to choose your geographic area.

One thing I was thinking of was how fast the houses revert back. Actual house prices could stay still until inflation rises enough to catch up.

I think in inflation-adjusted terms there were areas in California that stayed about stagnant for 8 years or so. So this scenario may happen, but drawn out over a longer period of time.

Interesting the many hidden costs and opportunities in both renting and owning.

10. big says:

I am no economist, but the simple notion that rent is better than owning is probably wrong. Here is why. Real estate bubble is clearly there, and most homes today are over priced. But the market correction of real estate is not likely to be the same as that of the stock bubble. In stock market, price of a share can change from \$400 to \$10 in a couple of months. This is rather unlikely to the housing market simply because people are living in them and they can?t sell them like a piece of paper (considering most stocks are not even tangible papers but a figure on your computer screen.)

The real estate market is filled with investors, but not all investors. This is another major difference. I believe the way to adjust housing price is through inflation only, which means the absolute price of houses will still be the same, but the buying power represented by the total amount is going to be lowered. Inflation, on the other hand, affects everything else in our life including your rent. So you can?t expect your rent remain the same while your money losing value fast. The only thing that still keep inflation relatively low right now is the cheap goods shipped from China. Once the US forced China to correct its currency value, you will see prices on consumer products go up quickly (unless Wal-mart finds another country with the same industrial capacity with a huge and cheap labor force right away.) Once that happens, your rent will go up fast while most mortgages are locked in..

If buying a house is a losing bet, renting only gives you the chance to escape hardship but definitely not giving you a winning chance. On top of that, owning a house feels different. The reward (or punishment) you get from home ownership is a kind of experience you won?t get else where, very much like the experience of having children. Many people opt not to have children, and they can?t use any scientific reasoning to say that?s a better choice.

My suggestion in your case is don?t wait. Most economic successful individuals got into real estate as soon as they have enough capital. Time the market in both real estate and stock market is hard and unscientific.

11. Nick says:

the problem is inflation is vastly understated. I mean inflation is supposedly 2-3% over the past few years but anyone with a brain knows what they are paying with food, utilities, transportation, education, medical, etc. is much higher. So home prices aren’t really that inflated, a small dip maybe but nothing more.

12. Julie says:

I didn’t mean to just figure the Housing Cost Calculator with locality, I meant do a local graph with a specific area’s population growth, building cost index, and home price index over the same period of time (if such information is available). That will give a better picture of the extent of a bubble.

13. Brian says:

The calculator assumes a sudden drop, which is unrealistic. However, historically housing prices have dropped over long periods, particularly in Japan from 1990 onward. And in Japan this drop has been substantial and devastating, even with 0% interest rates. The US has had extended drops in particular locations (such as LA in the 90s) for many years after large run-ups in price as well. And the drop in Florida in the 1920s was historic.

But I guess this time it’s different, prices never go down! I find it amusing that suddenly so many people think of their own housing as an “investment” rather than an expense, as Ed says. Oh, and I love this argument from Big:

“On top of that, owning a house feels different. The reward (or punishment) you get from home ownership is a kind of experience you won?t get else where, very much like the experience of having children.”

It sounds like you are defining yourself by your house! I have found no better “feeling” of owning my house, versus when I rented, it has its benefits and its drawbacks. It adds more stress to mylife with maintaining the property and paying all of the expenses and taxes. It also gives my family more space to live, and overall I agree that it is a quality of life improvement which to me outweighs the hassle of apartment living. But I can see how renting a house could give equivalent benefits, without the stress of owning one. I have never rented a house so with regards to this point I can only speculate.

Housing, historically has barely beat inflation. It is generally profitable as a long-term “investment” because it is leveraged, and if you own for 15 years, then your 6% “expense ratio” and high “maintenance fees” are negated by the effect of leveraging. But it is not a stock. Would you ever buy a leveraged stock with 6% front-end load and 2% expense ratio and a huge monthly payment and that has a historically overvalued P/E? That is where we are with housing: the price is overvalued compared to incomes, as incomes have not risen over the past 6 years, and yet housing in some areas has increased hundreds of percent. It doesn’t make sense economically, and as we know from all prior history, the economy has a way of correcting itself. Since I don’t see incomes increasing 100% (without some kind of huge inflationary episode, which would be speculation), I can only come to one conclusion. Long-term bond yields of under 5% tell me that inflation isn’t expected, otherwise, they would be much higher.

With a house, the primary benefit used to be that it was generally cheaper than renting, and as an added bonus, you would eventually pay it off! Just imagine not having ANY house payment and being able to retire, the income that you would need to live would be reduced drastically. But I guess this is the new paradigm, buying a house to make money, instead of to live in. Just like dot com stocks were the new paradigm in 2000. Or in any other bubble in history.

Housing or other real estate purchases can be a good investment if you want to use it as rental property in certain locations. I own a house, I have nothing against owning, or renting. But I hate seeing people attempt to convince people to “buy” because of reasons like “it feels better” or “they don’t make any more land” or “because you’ll be priced out forever.” The house that you live in is not an investment, and expecting to make money on it is pure speculation, unless you will live there for a long time. It is a personal decision and if this calculator helps people make that decision then more power to it.

14. Tony says:

Yeah, the inflation indexes seem to be way too general. The things that I buy have risen a lot more in cost than 2-3%.

The calculator is way too simplified. It seems to just assign a percentage adjustment over a fixed time period. Nearly all real estate investors agree that real estate markets are local and while there are national trends, local markets can be working in a completely different manner.

The long term goal is wealth and most people don’t ride out their 30 year mortgage. They swap houses. You really need to gauge your local market as to if you were going to buy a house, when would you sell it and where would the market be. Calculate the return on that investment vs renting with the extra going to a different investment.

15. Wes says:

LOL!

Come on people! I’m reading each of the above comments and I can replace “2002” with “1982”. Or, for the younger folks, replace “real estate” with “.com “. You guys are too funny! Can you say “denial”?

“Soft landing”! Soft or not, the plane is still smoking and the landing gear is stuck.

Is every reader on this board younger than 30?

16. Money VS Debt says:

Haha I definitly agree with Wes. I’ve gotta add I may be 20 pushing 21 in a couple months, but wow this is entertaining watching a ton of statistical nerds verbally fight it out 😀

Does Fight, Fight, FIGHT! Work in a situation like this or would that only be on the play ground?

Personally I love the growing bubble! Heck I plan on purchasing a house here soon just so I can play the enormous bubble lottery and while everyone else is sweating I’m going to be making 18-20% per year from investing the over sized mortgage balance into a group of none U.S Dividend stocks 😉

Happy hunting and please make the bubble grow so I can pick up a couple foreclosure houses that much easier…

17. Bigfoot says:

You lose a lot of credibility when you say “it’s” instead of “its.”

18. The thing is, real estate doesn’t always increase in value. My parents live in a city where there is so much open land that whenever there’s a demand for more housing, people just build more houses. In the 25 years that my parents have lived in their house, they have certainly come out ahead over renting, but the inflation-adjusted value of their house hasn’t gone up at all. I think it may actually be worth less today than when they bought it even though they’ve redone almost the entire interior, including the kitchen and bathrooms.
Also, while buying a house and having it go up in value may increase your net worth on paper, you can’t actually do anything with that cash unless you sell your house and buy something cheaper, which isn’t likely to happen unless you’re moving to a significantly less expensive city or have found a less expensive up-and-coming neighborhood to move to within your same city. As another commenter said, once someone owns a house, they usually don’t want to go back to renting. So if your house increases in value and you sell it, chances are most other houses in the area you want to live have increased too, and whatever extra cash you might get when you sell your house will just go into the next house.
I know that some people would want to use the increase in their home’s value to take out a home equity loan and buy more property, but I probably wouldn’t be able to sleep at night with that kind of financial obligation hanging over me even though I know this strategy works very well for some folks.

19. Wes says:

Bigfoot – are you referring to Julie’s post? That is the only misuse of it/it’s I’ve found.

20. Gabe Halsmer says:

I’ve yet to find an honest housing calculator, which is why I had to create me own. Faced with the decision of rent or buy, I needed answer the most basic question: “What is the monthly cost to living in house.”

I agree, that the historical average of housing is not much higher then inflation. Studies of housing costs over the past 200 years have shown this to be the case. But I think, even if you ignore premonitions of a severe correction, owning a house is much more expensive then most people have been led to believe. Take a look at my calculator to see what I mean…

http://www.gabehalsmer.com/HousingCalc.htm

21. Mike Thorn says:

I have been searching the net to find a worthwhile aid to calculating the numbers on our situation here in the UK and havn’t found anything yet.I have chosen this site to make comment because there a some smart people looking at it.

I and my partner are contemplating selling our 2 properies in the UK and renting.We have a combined equity of about ?300,000 and are thinking of investing all that in balanced investments with an estimated return of 4% capital growth and 4% income.I know we can do better than that but this is a long term strategy so best be conservative.Now that investment performance should cover inflation and provide an income sufficient to cover the rent of ?11,000 a year. The incentive for us is that we can rent a property for ?11,000 that would cost us ?400000 to buy.This means the landlord is getting just over 2.5% return on his investment plus capital growth which has averaged 7.5% pa here for the last 20 years.We are getting a much better home to live in than our combined properties offer without the need to borrow ?100,000 to buy the same thing.A ?100000 mortgage will cost around the same as renting.In the UK the is no tax deduction for interest on a home mortgage so the figures are not tax implicated.
It is actually seems to be an easy decision.Get a much better home without a greater monthly expense and invest money wisely to hope fully keep pace with inflation and maybe even the housing market if we want to buy back in again which is much easier here if you dont have homes to sell.
Is there anything I have missed?

22. Vic says:

It looks as though this thread is winding down, but I have been reading it with great interest as my husband and I have been discussing this very topic. We are nearly empty nesters, living in a small town in the midwest in a 2600 sq. ft. home that we purchased 5 years ago for \$150,000. Our housing market is so depressed, we would be lucky to sell it for \$150,000 today. Our mortgage balance is \$100,000. The housing market here is not expected to improve in the next few years.

We have seriously been considering selling the home and becoming renters. There are some nice rental properties in our area (villas, duplexes, townhomes, lake cottages). We would eventually like to move to a warmer climate, but need to stay here for a few more years until our son is out of college (in-state tuition).

Our home is 35 years old. If we stay here for 3 more years, we will need to replace the siding, central air-conditioning, and fencing around the pool. We estimate they will cost at least \$20,000.

It seems that we would be better off selling the home now, avoiding the costly repairs that are looming, invest our equity, and live as renters for a few years until we can make our move south.

Does this seem reasonable??

23. For us, buying our first house was a step out of debt. If you’re batting around the difference between renting and buying, ask yourself if you’re likely to be staying in the area long enough to build up some equity in the home you’re currently in. If the answer is yes, you’re probably better off buying than renting. If it’s up in the air, however, you might want to continue signing that lease for a little bit longer.

24. Jim says:

Wow some good reading here. i see this is a pretty old thread but very informative. I stumbled upon this because I am finding myself in the same situation of rent vs buy. I am a single guy with about 55K in cash and have access to another 50K in my 401K for a first time home purchase penalty free. I have 30years to pay this loan back but will still have the shares working for me in my account if the market rebounds. So in short it’s a loan against my 401K.

I am currently free approved for 450K with 90K down at 5.7%(may be a little lower now)..2350ish a month and that with home owners insurance, less taxes, and possible flood insurance. I live in NY(queens). Home shave come down quite a bit but I really don’t see them going higher, just trading sideways so to speak. If not I am considering renting an APT for 1250-1450 a month with utilities. I am still on the fence if this is the right move. Do I deplete all my savings and take a loan out on my retirement plan, or just have a stress free, but zero potential growth, renting payment? Taxes in my area would add about 300 dollars per month so I’m looking at 2600-2700 a month payment for a home, not counting ANY utilities. I have considered getting a renter in the home for 1K a month to make this worth while. My brother LOL. Thoughts and opinions much appreciated for a newbie buyer 🙂

25. Jennifer says:

Jim,

If the house you’re buying would rent for enough to cover the mortgage + insurance + taxes then I would say it’s a pretty good deal. Also, make sure you’re not planning to move in the next five years. The rent test is a good way to give yourself extra financial security in case a major negative event happens (like you get laid off and can’t find a job for a year) and it also is a good way to gauge if the price is good or not.

Also, don’t commit to a house payment that is more than 33% of your gross or 25% of your net income. New york is not really a buyers market unless you’re rich and you don’t care how much your housing costs.