Renting vs. buying a home (part 2) Factoring in appreciation and depreciation into the rent vs. buy decision.
Renting vs. buying a home (part 2)
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- Welcome back.
- I now want to play a little bit of devil's
- advocate with myself.
- I made this argument where I show that for the exact
- identical house, if these are the numbers -- I mean you'd
- have to work it out based on your market, and what the
- numbers are at the time.
- But if this is the comparable rent for a $1 million house, I
- showed you that for the $1 million house you're burning
- $40,000 a year.
- This is not money that is going to build equity.
- This not money that's going to the principal of your house.
- This is money that just going out of your pocket, you'll
- never see again.
- In a way, and actually not in a way, in reality, you can
- view this $40,000 as rent on the money that you borrowed.
- Interest is nothing but rent.
- So when you have an asset, if the asset is cash, the rent on
- it is interest. If the asset is a house, the rent on it is
- your monthly rent payment.
- So when you think of it this way, when people say home
- ownership, they really aren't homeowners yet.
- You're not a homeowner until you don't have debt.
- You are a money renter.
- So your choice is either to be a money renter here, or to be
- a house renter here.
- And I show that you are burning
- almost double the money.
- But then there's the argument of well, there are advantages,
- still, to buying this house.
- And what are they?
- Well one example is, in this situation, if I did get a
- fixed-rate mortgage -- and we learned, when you look at all
- those adjustable-rate mortgages, we know that a lot
- of people didn't.
- But if I have a fixed-rate mortgage, I know what my
- payment is for the foreseeable future, for the next 30 years.
- While my landlord, in this case, they could
- keep raising my rent.
- So this might look good right now, but what if my landlord
- raised the rent to, I don't know, $3,500 a month.
- Well then, out of your pocket, 0.5 times 12, you'd be
- spending $42,000 a year.
- And then of course you get the interest from the money that
- you put in the bank.
- Plus 10.
- Oh, minus 10 actually, sorry.
- So in that case, if the rent goes up, then out of your
- pocket is $32,000 every year.
- Or what if the interest that you get on your cash in the
- bank goes down?
- Then this $10,000 thousand will become lower.
- But as we can see, the rent would have to go up a lot to
- make up for $41,000, to make this a break-even situation.
- Let's figure out how much it would have to go up.
- So in this first scenario, in order for your net outflow to
- be $41,500, assuming you're getting $10,000 from the money
- in the bank, your rent would have to be $51,500.
- Because you're getting $10,000 from the bank.
- And so divided by 12, your rent would have to be $4,300
- in this situation to make this a break-even proposition.
- This is another way to view it.
- If I were to buy the house, and if I were to move, how
- much would I have to rent this house out for, in order to not
- be losing money every month?
- Well I would have to rent it out for $4,300 a month, even
- though maybe the market rents are only at $3,000.
- And there is another devil's advocate argument.
- And that's, well, housing -- and this is something that you
- heard a lot about three years ago.
- And a lot of these people aren't talking as much now.
- But they would say, housing has never -- housing has done
- nothing but gone up, and I will build equity just from
- housing appreciation.
- So how much does my house have to appreciate every year?
- Well, to make up this difference-- $41,500 minus
- 26-- so to make up that $15,500 difference every year,
- this is $15,500 favorable.
- My house would have to appreciate by a comparable
- amount, right?
- So how much appreciation is that on my house?
- Well that's a $1 million house, right?
- So $15,500 appreciation on a $1 million house.
- I'm doing everything in thousands, so 1,000 thousands
- is a million.
- So that's only 1.5% appreciation.
- So if my house appreciates by 1.5%, that's it-- 1.5%.
- If my house just appreciates by 1.5%, I'm going to make up
- this $15,500.
- And so it is worth it for me.
- It is worth it for me to blow this money by having kind of
- an increased -- by renting the money for more than I would
- have to pay to rent the house.
- And that might sound like a very reasonable proposition,
- that the house will appreciate by 1.5%.
- From 2001 to 2005, 2006, houses were appreciating like
- 10%, 15% a year.
- So it seemed -- and a real estate agent would often do
- this very math with you, and say, well, you're definitely
- going to get 1.5%.
- In fact, you're probably going to get 10% appreciation.
- And you're going to make much more than this.
- But think about, in the presentation of the balance
- sheet and leverage, what happens if housing prices go
- down by 1.5%?
- What happens if it's minus 1.5%?
- Well, then you're going to spend this much to rent the
- money, right?
- And you're not going to gain this much.
- You're going to lose this much every year.
- And so the proposition becomes even worse.
- So this is a big deal.
- Now that, I think, on a nationwide basis, a lot of the
- housing indices show that housing prices have gone down,
- I think by 6%.
- That's what the Case-Shiller index says.
- 6% is a lot.
- Especially on a $1 million house, that's $60,000 a year
- that's just evaporating.
- That's wealth that someone thought they had, that's just
- disappearing out of their equity.
- So this rationale of pay more to rent the money for a
- house than to rent the house is justified if
- housing prices go up.
- It becomes 10 times worse when housing prices are flat.
- Or, God forbid, if housing prices actually go down.
- And now we see that housing prices actually go down.
- In the last couple of years especially, in the areas
- where, like the Bay Area, or Florida, or California,
- especially Southern California,
- where this is happening.
- And back even two or three years ago, when people used to
- make this argument.
- People used to make the argument, well you know, my
- house just has to go up 1% or 2%, and I'm going to
- make up the difference.
- I'd say well, why is your house going to
- go up 1% or 2%?
- I mean, there has to be some reason why next year someone's
- willing to pay 2% more for that house.
- Is it because rents are going up 2% a year, so the income
- stream is going to be 2% higher?
- And actually in the Bay Area, from 2001 to roughly 2003,
- rents were going down.
- And there were actually people moving out.
- All the tech workers were getting laid off.
- You had a lot of programming jobs being outsourced to India
- and wherever else.
- So you had this whole situation where the population
- was actually decreasing.
- Demand for housing was going down.
- But for some reason housing prices were going up.
- So people said well, they've been going up for the last
- five years, so they'll continue.
- And they've never gone down, et cetera, et cetera.
- But it didn't make an economic argument.
- And I'll show in a future video that the only reason why
- housing prices did go up is that it just became easier and
- easier and easier to buy a house.
- The standards that banks used for giving out a loan became
- lower and lower and lower.
- There are actually examples in Southern California, and in
- San Jose and some of the suburbs, where people who had
- incomes of $30,000 or $40,000 a year.
- The bank actually gave them a $1 million loan to buy a $1
- million house, based on stated income.
- There's things called stated income loans, where you just
- tell the bank what you earn.
- You don't have to prove it to them.
- And so every year that went by, it just became easier and
- easier and easier.
- More and more people just thought that housing always
- So that's why they want to pay more and more to essentially
- rent the money for a house.
- And this became a self-fulfilling prophecy.
- But as we see on the way down, it works
- completely against you.
- So in the situation where we are now, where nationwide
- housing prices are actually declining-- and actually they
- will decline until this rent-versus-buy equation
- starts to make a little bit more sense-- it really hurts
- the home buyer.
- And what's even worse, and this is kind of adding insult
- to injury, is that this guy, if I bought this house, and
- all of a sudden I lose my job, and I can't pay the house
- back, I might lose my entire $250,000 down payment because
- maybe I can't sell the house, or the house
- is selling for less.
- Or maybe I want to move, and there's no one out there who
- can buy a house because the banks all of a sudden got
- smart again, and realized that they should become more
- serious in terms of who they give money to.
- And so I'm stuck holding this house, and my flexibility in
- terms of where I can move is limited.
- Actually a friend of mine was telling me that they've
- actually done studies.
- And there's a correlation between
- unemployment and home ownership.
- Because when you own a home, you have less flexibility in
- looking for a job.
- If I have a house in San Jose but there's a job in LA, I
- might not be able to take that job because I
- can't sell my house.
- Or I might not even want to look for a job in LA.
- While the renter, of course, my lease ends and I leave.
- So this is just a rough sense of the rent versus buy.
- And I know I get very impassioned about this.
- But that's just because I explain this a lot.
- And when I'm at parties and I start talking about the
- calculations, people's eyes glaze over.
- But I made this video now and I'll just tell
- people to watch it.
- See you in the next video.
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