The “Rent versus Buy” dilemma: 12 important questions

You are at a crossroad in your life, and you need to decide whether to rent or buy a house (to live in). How do you make the best decision?

The “Rent versus Buy” dilemma

I have studied this question for the last few months in great detail, and in this post I will share the following with you:

  1. There’s not a single answer. It partially depends on your personal situation, and partially to some objective economic and math considerations.
  2. I believe it helps greatly to ask yourself this set of 12 questions on the subject. They will quickly inform you on pitfalls and common mistakes.
  3. For most, this is the biggest decision in your life. However, most people don’t think this through, especially if they want to buy, in which case ~10% of your home value is spent on the transaction (split somehow between buyer and seller). Take it slowly.

This might apply to real estate investment broadly, but I am focusing here on buying vs renting your primary residence. Let’s dive in.

There’s not a single answer.

If you google for “rent vs buy” or “rent vs own”, you will find hundreds of websites and online tools that supposedly can help you find the answer rather quickly.

The New York Times “rent vs buy” calculator (source)

Some of them are accessible and simple to understand.

Some are detailed and well known, like the ones offered by the New York Times, Nerd Wallet, or Aaron Staley (which correctly emphasizes how difficult it is to model non-financial trade-offs). Others are really, really detailed.

That’s precisely why there’s not a single answer, or to be more precise: part of the answer is subjective, and hard to model / measure.

Don’t overestimate how good these tools can be to inform you on the right decision to make.

12 important questions

Let me present you my “12 important questions” list, and then let’s dig into each of these with one or two quick examples for each, and why that’s an important question to consider.

Also, as one of our investors has pointed out, Question #7 is particularly important for a healthy financial planning.

  1. How much do you know, or care, about being a landlord?
  2. Can you find a great buying opportunity, as opposed to a great renting opportunity?
  3. How important is stability, as opposed to flexibility?
  4. Do you really know what a Black Swan event is?
  5. Is your area more landlord-friendly than renter-friendly?
  6. Can you get a great loan and easily provide a down payment?
  7. Is your portfolio in need of additional real estate assets?
  8. Is home ownership a good way to forcefully help you save money?
  9. Is your marriage or legal situation likely to affect your home ownership?
  10. How likely are you to live in the same house for a number of years?
  11. How much visibility you have on your housing needs, and how often and how soon they will change?
  12. Access or Possess?

Let’s start with the first!

1. How much do you know, or care, about being a landlord?

To be a homeowner, or a landlord, implies some skills and knowledge that you have to acquire to become effective. You might have these skills already, or you might need to invest time and effort to learn them: how mortgages work, what’s title insurance, what taxes advantage you have, learning about the market in which you want to buy (is now a good time?), etc.

Does it feel 2018 is the right moment to buy a house? Actually, the answer is not obvious. (source)

You can get as detailed as learning to use Poisson distribution for your forecasting models.
Being a GOOD real estate investor requires work and dedication.
If you don’t know, or don’t care, about the real estate market, you might be better off renting.

2. Can you find a great buying opportunity, as opposed to a great renting opportunity?

Do you know when a deal is a good deal? When you get in. If you buy a house BELOW market price, you have bought yourself some cushion / insurance against downturns, unexpected costs, etc. This is simply called Price Discount in economic terms. Other slightly more complex terms include ConC (Cash on Cash) return, NOI (Net Operating Income), NIAT (Net Income After Taxes), but I won’t cover these.
If you can find a GOOD buying deal, versus a GOOD renting deal, you might be better off buying.
To know if a deal is a good deal, you should do some market research, e.g. by taking a look at data offered by Zillow and others.

3. How important is stability, as opposed to flexibility?

Owning a house gives you stability. It reduces your chances of being evicted (no, they’re not zero — you still need to pay your mortgage every month, to avoid being “evicted” by the bank!), it allows you to customize your house, etc. 
If that’s important to you, as opposed to the flexibility of renting, and therefore being able to react quickly to evolving life situations, you might be better off buying. 
(see also question #11 on using AirBnB or similar to partially offset this problem).

4. Do you really know what a Black Swan event is?

A Black Swan is:
1. A very rare event (e.g. house loans to default)
2. unpredictable or unforeseen (house loans have never defaulted!)
3. with extreme consequences (global economic crisis)
4. predictable in retrospective (ten years later, several people claim to know why it happened, and how it should have been predictable).

If you decide to buy a house, you should consider the possibility of a Black Swan event which might vastly affect your equity. It’s very, very hard to predict a future Black Swan event. However, it is easier for you to predict what happens to your life, and your finances, if an event like that occurs (e.g. another 2008 financial crisis). If you don’t know what a Black Swan event is, you might be better off renting.

A different type of Black Swan

5. Is your area more landlord-friendly than renter-friendly?

Price/Rent ratio. That’s it. That’s why you should probably NOT buy right now in the San Francisco Bay Area
You are better off buying if the market offers a Price/Rent below the break-even.
If you’re interested in Price/Rent ratio, and in the “rent vs buy” dilemma in general, I recommend reading what Get Rich Slowly recently wrote about it.

6. Can you get a great loan and easily provide a down payment?

This one partially refers to Question 2 (“can you find a great buying opportunity”). If you can get great loan conditions (e.g. my mortgage is a 7-year fixed 2.550% interest, which is almost unbelievable), and can easily afford the ~20% down payment, then you might consider buying instead of renting.

You might want to do some research, as there are plenty of good opportunities to reduce the barrier of entry here. A good example is Divvy, a smart and straightforward “rent to own” program that allows you to use part of your rent payments towards the eventual purchase of your house, effectively reducing the amount of down payment you need upfront (most young wannabe homebuyers don’t have the ~20% upfront).

The Divvy website

7. Is your portfolio in need of additional real estate assets?

Have you considered your portfolio allocation? Is it balanced? Do you want it to be balanced? (controversial detail: I don’t have a balanced one right now, by choice).
In any case, you should consider the impact of a real estate asset in your portfolio. Placing all your bets in one single asset class makes you heavily dependant on the financial outcome of that particular asset class.
You want to consider buying a home if it’s in tune with your portfolio strategy.
Learn more about Portfolio rebalancing here, as a start.

8. Is home ownership a good way to forcefully help you save money?

Are you the kind of person that NEED to have that big mortgage installment being taken away from you every month, in order to save money? Otherwise, you would likely spend it on frivolous things?
If you are, you should consider buying a house. And if you are, I also highly recommend you reading Mister Money Mustache, my favorite financial independence blog out there — besides, Peter Adeney is a really nice guy!

9. Is your marriage or legal situation likely to affect your home ownership?

If you are not single, how’s this decision going to affect your relationship with your partner? It’s common to see two people react differently to big financial decisions in life, ESPECIALLY when things don’t go as planned.
Imagine a worst case scenario: you bought a house in 2005 or 2006, and three years later you’re underwater. Are you and your spouse/partner able to cope with it with the same strength?
Even without considering extreme scenarios, is buying a home going to negatively effect your marriage?

How’s your marriage going to be affected by buying a home, or by renting one?

10. How likely are you to live in the same house for a number of years?

The more likely you are, the more it makes sense to buy, instead of renting. However, most people don’t have good visibility into the future. Jobs change. Marriages end. Kids happen. The more “stable” you feel, the more it might make sense to buy.

11. How much visibility you have on your housing needs, and how often and how soon they will change?

This is related to the previous one. If you buy a 3 bedroom home, and in two years your two kids go to college, you have “idle” capital. Remember: the house you bought gives you a service, called “shelter”. If you are not using it fully, you are wasting some of it, and therefore some of the benefits of having bought the house in the first place.
A corollary to this: how easily can you “rent out” the extra capacity? Can you AirBnB these two rooms easily? Do you want it to? And how it’s going to affect your marriage (question #9)?
The opposite is also important: you buy a 1-bedroom now, and in two years you have your first kid. Wow. You might need to move to a bigger house. Did it make sense to buy it then?

12. Access or Possess?

Millennials tend to prefer access, over possession. Car sharing, and temporary car renting, as opposed to car ownership. Besides age categories, a similar question should apply to your house.
Do you value “possess” a lot? Is it important for you to claim that this house is your turf? Or are you ok in simply being able to “use” the house you live in, irrespective of who owns it?

These 12 questions are heavily interconnected

As you realized by now, these 12 questions have a lot of overlaps. This probably means that you could get the same insight and clarity with less questions!

Some of these questions are very SUBJECTIVE. You are the only one who knows the right answer. Others are more OBJECTIVE (e.g. Is it a good time to buy real estate in this particular area?), but often the FORECAST is highly debatable.

All in all, I believe that these questions can stimulate the right kind of reasoning around whether it’s better (for you) to buy or rent, and help inform you on aspects that sometimes are taken for granted.

Conclusion: SLOW, especially if you want to buy

“I told you to take it slow!” — Warren Buffett

I hope this post was helpful, and that my 12 questions helped you realize how important it is to take this decision very, very slowly, especially if you are more inclined to buy a home.

In fact, buying or selling a home costs you on average ~10% of the home value, a combination of agent commission, mortgage origination fees, title insurance, etc. 
However, it’s fair to say that this cost is somewhat split between buyer and seller, even if indirectly; which means that the actual cost that YOU bear is closer to ~5%. Still, a large sum. On a $500,000 house, a 5% means $25,000!

Companies like Rexchange are building products and services to reduce that amount significantly, starting with the commissions you pay to your real estate agent (in their case, going from a 6% total, to a very attractive 2%).

Rexchange helps you sell your home for a 2% agent commission, instead of the usual 6%

Still, remember that buying or selling a home is a decision that, because of the high “transaction cost”, needs to be taken very carefully.

These 12 questions are only a starting point. They can be refined, improved, and “pruned” of unnecessary details. They should probably shrink in size over time!

Any suggestion, comment, feedback on how to improve these is super welcome!

Finally, I want to give a shout to Hacker News, as this post and the comments within helped me greatly.

If you are more into narrative, this long article on “My 10-year odyssey through America’s housing crisis” is also worth a read.

If you are interested in posts like this, I suggest you follow our company, Fabrica (we are building a software platform to digitize real estate assets, and transact on them quickly and efficiently using the Blockchain).