Friday, March 8, 2024

Have interest rates made renting more affordable than owning?

Back a few years ago when we had all time lows for mortgage interest rates it was absolutely more affordable to own than rent. The numbers were very convincing, but now with interest rates in the 7s is it still the more affordable approach?

I have spent some time on the rental websites looking at rental properties advertised locally and have found very recent sales of similar homes in the same neighborhoods to see if I can tackle that question. Affordability comes down to more than just the monthly payment. Renters generally do not have to pay for repairs and upkeep whereas homeowners do. These are expenses that should be calculated in to be fair. But homeowners also have the benefit of building equity through a combination of reducing the monthly principle on the loan and through market appreciation over time.

The number one advantage of renting is mobility. Typical lease commitments are one year. When choosing to buy a home you should be committed to at least four years. The disadvantage to renting is you run the risk of not getting a new lease at the end of your current lease. The owner may choose to sell the property. With apartments, this is rare, but with houses it happens fairly often. 

So operating under the notion that we are committed to staying in the property long term and we have a small to medium sized dog. Let's crunch some data.
The first property is a rental house about 25 years old and nicely updated in NE Vancouver. The home is a very common house that many builders built in that time period. It has 2080 SF with four beds and 2.5 baths. It sits on a typical 6000-7000 foot lot. It is listed for rent at $2850 per month. The upfront cost is two months rent and a security deposit. Pets are allowed but with a larger deposit of an extra $500 and an extra $100 per month.  So we have to come in with $6200 and our monthly payment is $2950. This home has a classic 1990s two story floor plan with the living room up front, kitchen, dining and family room in back with a 1/2 bath down and all four beds and both full baths up. Renters insurance will run between $50-$100 depending on how much coverage for loss you choose. Total monthly expense is $3000

The comparable home to purchase closed late last year at $475,000 and the seller paid $7000 in buyers closing costs. This home was also updated but not quite as nice on the inside as the rental house. The exterior is a little nicer and it is located just a few blocks away in the same neighborhood. Its floor plan is a near clone of the rental but with slightly less space at 1960 SF and four beds with 2.5 baths on a 6000-7000 foot lot. For the sake of comparison I'll assume an FHA buyer with 720 credit score, 3.5% down, and $7000 in closing costs. Buyer will need to come in with $16,625 and will have a $3887 monthly payment including taxes and insurance. I found several similar homes currently for sale a little further away but less than 2 miles in this general price range. This home had a newer furnace and newer roof.

It is quite evident that the cost to buy a single family detached home is substantially higher than the cost to rent it at the moment. But let's fast forward ten years. Trends in rental properties over the last several years have shown increases of roughly 2-3% annually but are tracking a bit less lately so I'll operate at 1.5% annually so rent would be roughly $3500. Property taxes will fluctuate based at least partly on the market. Vancouver is currently experiencing very modest price appreciation and will likely remain flat over the next couple of years. The historical post war (WWII) appreciation over a ten year period has been about 70%. Since we are currently trending lower than the historical average I'll run the next 3 years flat and then historical average for the remaining 7 years. That would yield a 50% price appreciation over ten years for the owned home which is conservative barring a recession with the severity of 2009-2012. The only likely increase in the mortgage payment would be in taxes so that payment would look like $4100. Home value at $712k with equity at about $280k. Repairs and maintenance costs would run about 1% annually on this house as most of the expensive bits are new. Much of that could be performed by the homeowner to save money, yard work, minor repairs, light painting, etc. Over tens years assuming half of maintenance DIY would be $25,000 so net equity is still more than $250,000. If interest rates were to drop during that decade a refinance could lower the payment and eliminate mortgage insurance. The payment after six years if rates are 5% could be lowered to $3000. Obviously there is no way to know if rates will go back down or go the other way. If they do the latter then the homeowner is sitting pretty with a sub market rate.

The moral of the story is that long term home ownership will benefit the buyer immensely but for short term, renting is often the superior option. I have lived in my home since 2002. I paid $200k for it with $40,000 down. I could sell it now for $600k. Over the 22 years I have put roughly $50,000 into the house for maintenance and upgrades including a roof, furnace, and kitchen remodel. All told I have paid into the house including said maintenance, upgrades, and principle, interest, taxes and insurance, $441k. This includes three refinances one of which had cash out to clear a home equity line I used to pay for some upgrades. My first loan was at 7.5%, the second loan was at 5% the final was a rate and term refi at 2.9%. All those payments including my down payment over the 22 years and the maintenance costs adds up to $441,000. If I sell the house today I would walk away with $274,000. That means I lived for 22 years in this house for a total real cost of $167,000 and that works out to $632 per month. This is why long term, buying is the only way to go. It's not all peaches and cream, as the market can be volatile at times and early on in your homeownership, it can be expensive to move. Sometimes you can feel trapped in the house when the market is soft or when rates are much higher than your current rate. If I sold my home for $600k and used the 274k as a down payment on a smaller house at say $450k my payment would be about the same because the smaller mortgage at a higher rate works out about the same as my current larger mortgage. So I am staying put, for now. 

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