A Manifesto for Renting

One of my friends just e-mailed me this article by Jack Hough from Smart Money discussing the advantages of renting vs. buying (emphasis mine):

I have something un-American to confess: I rent an apartment, despite having enough money to buy a house. I plan to keep renting for as long as I can. I'm not just holding out for better prices. Renting will make me richer.

I normally write about stocks for SmartMoney.com, but the boss asked me to explain to readers my reason for renting. Here goes: Businesses are great investments while houses are poor ones, so I'd rather rent the latter and own the former.

Shares of businesses return 7% a year over long time periods. I'm subtracting for inflation, gradual price increases for everything from a can of beer to an ear exam. (After-inflation or "real" returns are the only ones that matter. The point of increasing wealth is to increase buying power, not numbers on an account statement.) Shares have been remarkably consistent over the past two centuries in their 7% real returns. In Jeremy Siegel's book, "Stocks for the Long Term," he finds that real returns averaged 7.0% over nearly seven decades ending 1870, then 6.6% through 1925 and then 6.9% through 2004.

The average real return for houses over long time periods might surprise you. It's zero.

The average pundit, planner, lender or broker making the case for ownership doesn't look at returns since 1890. Sometimes they reduce the matter to maxims about "building equity" and "paying yourself" instead of "throwing money down the drain." If they do look at returns they focus on recent ones. Those tell a different story.

So to sum up why I rent: Shares right now cost 16 times earnings and over long time periods return 7% a year after inflation. Houses right now cost 19 times their "earnings" and over long time periods return zero after inflation. And they look likely to return less than that for a while.

Hough then answers a few questions:

"What about the pride of home ownership?"

It's not for me. I define ownership as no longer having to pay for something and being able to do as I please with it. I own my coffee maker. House owners must pay taxes each year even when their mortgage payments are done. In certain markets they can't even make changes to the houses they've paid for without seeking the approval of others. Personally, I feel the pride of ownership for shares of businesses, and I'm proud to occupy a nice place while leaving the burden of poor returns and maintenance to someone else.

"Houses are bigger than apartments."

True, and both can be rented. A third of renters live in single-family houses. I prefer an apartment for now. I like not having to fill it with stuff. I like using a fifth of the energy of the average American. I like being 20 minutes from work and (this is unique to New Yorkers) not having owned a car in 10 years. I like not stressing over whether to get the marble countertops or the imported tiles or the 52-inch flat screen. I'm not especially frugal; I spend a teacher's salary each year on restaurants and travel. But I guess I'm too busy or lazy right now to bother with a big house and its innards.

"Renting is for poor people."

True. But it's for rich people, too. The average renter makes about $34,000 a year, but while the percentage of renters declines after incomes exceed $20,000 and rents exceed $600 a month, it jumps again once incomes top $150,000 and rents top $1,200 a month. In other words, poor people rent modest apartments for lack of choice. Middle-income people buy houses. High-income people, presumably with a dose of financial savvy, often rent nice apartments instead of buying.

"So you're never going to buy a house? What about raising a family?"

I might buy one eventually, but the longer I can put it off the more I'll get out of the shares I'll have to sell to afford it. I'm 34 now with a fiancée and a fish. I'm going to try to rent for at least 10 more years. If I have kids I'll probably move into a big apartment or a house once they reach running-around age. I'll rent, most likely.

My take:

I agree with Hough on many points with two caveats. First, you have to be careful reading too much into historical data. While it does seem like there has been a unprecedented increase in home values over the last decade, this is no guarantee that prices will suddenly drop. Having said that, my hunch is that there will be a reversion to the mean and that home prices will eventually come back down to historical norms, after adjusting for inflation. This may take quite a long time, which means houses may not appreciate like they have in the past for quite some time. This is only a hunch and I could be wrong on this.

Second, Hough is obviously better off than the average person. He seems to be looking at this from the standpoint of someone who has enough money to buy a house outright, something most of us do not have the luxury to do. Since most Americans can't/won't/shouldn't borrow hundreds of thousands to invest in the stock market, they aren't facing the same choice he is in regards to where to invest their money. Since they might borrow the same amount to buy a house, many are probably comparing imputed rent plus appreciation on a home vs. monthly investments into the stock market. This may change the calculus for most people a bit.

Having said all that, I still basically agree with Hough on many fronts. I have always rented and find that, for me, the benefits have outweighed the costs. Renting certainly gives more flexibility on many fronts. By renting, I've been able to keep my housing expenses to a fraction of what they would have been had I owned and had significantly more free time than I would have had otherwise. This has allowed me to contribute more money to charitable causes I care about, invest significant amounts into my 401k early in my career, have enough disposable income to travel to all 7 continents and all 50 states, and save up enough money to come back to school to work on my PhD and JD (I am blessed enough to stay debt-free so far). It also freed up my time enough to allow me to have volunteer significant time with my church and organizations like Give Kids the World (I volunteered there weekly with terminally ill kids in Orlando for over 7 years), spend extra time hanging out with friends and building relationships, gave me more time to read, and made it easier to pursue my MBA on a part-time basis while I was working for Mitsubishi (and make long business trips to Japan without having to worry about arranging home maintenance while I was gone). I wouldn't have been able to do many of these things if I had owned a home.

Additionally, as Tim Hartford recently pointed out in this article in Slate , renting also keeps you more mobile, making it easier to find interesting work:

English economist Andrew Oswald has shown that across European countries, and across U.S. states, high levels of home ownership are correlated with high levels of unemployment. More conventional factors such as generous welfare benefits or high levels of unionization don't explain unemployment nearly as well as the tendency to own houses. Renting your home and staying flexible do wonders for your chances of always finding an interesting job to do.

This has certainly been true for me. When I first got out of school, I got into a job that I didn't fully enjoy, but that paid me well enough that I could have afforded a home. I didn't buy because I didn't want to get stuck having to stay in that job just to pay my mortgage. Because I kept myself flexible, I was able to change companies twice, each time with a significant salary boost. Avoiding debt and keeping my living expenses low has given me tremendous freedom in job choices.

In addition, renting has given me tremendous flexibility both in terms of where I've lived and what I've lived in. I've rented rooms in houses, had my own 1- and 2-bedroom apartments, lived in 4 states since graduating college, and never had to live more than ~ 15 minutes from work (or school). Last year I was a resident advisor on campus which let me live for a year without paying rent of any kind. Moving around a lot also helped me avoid accumulating many things and got me in the habit of enjoying simplicity (and avoiding something like this). This has certainly made the transition to becoming a full-time student again much easier than it otherwise might have been.

On the downside, I did miss out on what could have been a six-figure increase in equity by not owning a home during the tremendous build up in home values over the past few years. While I sometimes lament not buying, what I really am lamenting is missing out on that financial gain. It is based on information known only after the fact and at no time do I really think buying a house would have been the right move for me. Despite missing out on this growth, I wouldn't give up what I've been able to experience in exchange for that growth.

Recent happiness research indicates money doesn't have a big impact on happiness, but keeping a short commute and making good use of leisure time go a long way towards increasing it. Could this a good argument for renting?

I do hope to one day get married some day and if/when I do and if we (hopefully) have kids, I'd want to have a home for them to grow up in. Until that time, I will probably keep myself perfectly content by renting and enjoying the flexibility that it brings.

For what it's worth, my 91-year-old Aunt Ruth and all of her elderly friends have told me I've been making the right decisions. They say I can always buy a house and recommend I wait to do so until after I get married. Until then, they recommend I enjoy my freedom and spend my time and money doing the things I enjoy. Sounds like good advice to me.

Overall, there is such uncertainty in the housing market (and stock market for that matter), whether to buy or rent should come down to deciding what type of living situation you prefer and can afford. I will admit I have an unusual penchant for travel and education, so what makes sense for me might not make sense for everyone.

To sum up, one of my finance profs in my MBA program once said:

"Deciding whether to rent or own is not a financial decision. It is a lifestyle decision."

I think he's right.

Related links:

• Watch this CNBC video debate about wheter to rent or own and this cool video showing changes in home prices as a roller-coaster ride.
• See some uber-cool apartments here, here, and here.