Renting vs. Buying
Is renting or buying the better investment decision in Phoenix Arizona? You can watch the video above or read the blog below. The property address I will use as an example to better illustrate this is on 8318 South 47th Lane Laveen, AZ 85339. This is an 1800 sq ft property that is currently worth about $240,000. The current market rent for this property is $1,590. I have created an excel spreadsheet for this property on a 10 year time span which assumes you will be selling the property after 10 years. Click the link “Owning vs. Renting” at the end of this sentence to open the spreadsheet Owning vs. Renting. Follow along the spreadsheet as I explain to you my analysis. There are three tabs on the excel spreadsheet with three different assumptions.
My first assumption is with a 30 year FHA loan, 4% interest rate and with a 3.5% down payment. FHA loans allow for a 3.5% down payment however, they require you to pay for mortgage insurance. The “actual monthly cost” to buy in yellow is $1,079 while the monthly rental cost is $1,820. When buying, we are factoring in HVAC and hot water heater replacement in 10 years. We also have a monthly maintenance and repair budget of $250 which is $30,000 after 10 years. This 10 year $30,000 budget is for landscaping, new fridge, oven range, dryer and washer, paint, bathroom, kitchen and flooring upgrades when selling. Owning a home can get expensive if you do not budget for HVAC, hot water heater, new appliances, landscaping as well as remodeling the bathroom, kitchen, flooring and paint when selling. I also did not add a budget for a new roof because the time span I chose is 10 years where as a roof can last 25-50 years depending on the material.
Keep in mind that certain upgrades to your house may not be necessary and can cost you more than you will gain depending on the type of upgrade, location of your house and if it’s a sellers or buyers market. I do not recommend getting a loan to upgrade your house unless the money is from refinancing or a HELOC. Huge remodels are almost never worth the cost and will cause a lot of stress and time.
Going back to the excel spreadsheet, the 10 year cost to own with an FHA loan is about $129,525 while the cost to rent after 10 years is $218,400. This is after factoring in 3% appreciation per year, loan pay down and deflation of the mortgage payment since you will be paying the same amount 10 years from now even though the value of the dollar will decrease which is a positive compared to renting because rents will increase in 10 years due to inflation. To summarize, after 10 years of living at this property, an FHA loan will result in you having $90,000 more in your pocket compared to renting. The longer you own a property, the more ahead you will get of renting a property for the same time period. Renting is best for short time periods and when you can invest the excess capital into higher producing investments such as stocks, real estate or starting a business.
The second assumption on the second tab of the excel spreadsheet uses a 15 year mortgage at a 4% interest rate and a 20% down payment. In this scenario, most of the numbers stay the same except for the down payment, monthly mortgage and loan pay down after 10 years. The actual monthly cost to own in this scenario is $810.88 compared to $1,820 to rent. The total cost of owning after 10 years is about $97,305 compared to $218,400 to rent. In 10 years, you will have $121,000 more in your bank compared to renting. If you wait 15 years instead of 10, you would own the home outright which would save you even more money compared to renting. 15 year mortgages have higher monthly payments compared to 30 year mortgages but you end up paying less interest in total and own the home much faster. The down side of 15 year mortgages to 30 year mortgages is that you could have used the excess capital to invest in something with a higher return such as stocks or rental properties which could have given you an 8-12% return per year while only paying a 4% interest rate on the mortgage. The difference between what you could have used the capital for to earn 8-12% and the 4% interest rate on the mortgage is referred to as opportunity cost. Paying with cash or with a 15 year loan is best for people who are risk averse, conservative and are not knowledgeable enough to invest in other assets such as stocks and real estate.
In this scenario as well, you will also come out on top after 10 years compared to renting. Renting is initially better than buying in the first 3-4 years but after about 3-4 years, you will come out ahead from owning the property unless you could use the excess capital of the down payment for more lucrative investments.
The third assumption on the third tab is similar to the second tab except it is with a 30 year mortgage. In this scenario, the 10 year cost to own is $111,038 while the total rental cost is still $218,400 which is a difference of about $107,000. I personally prefer 30 year mortgages compared to 15 year mortgages only because I would use the excess capital from the monthly mortgage payment to invest in either stocks or rental properties.
If you plan on living in this property longer than 3-4 years, then the best choice from an investment perspective would be to buy. If you plan on living in the property for less than 3-4 years, then the closing costs to buy, property taxes, home insurance, maintenance, repairs, hoa fees, water bill and eventually the cost to sell such as 5-6% Realtor fee are not worth it. Always remember that Realtor fees come out of the seller’s pocket when they are ready to sell. The seller provides the commission which is usually about 5-6% to their agent at closing and the seller’s agent splits the commission with the buyer’s agent. Even if a buyer does not have an agent, the seller’s agent will STILL keep the 5-6% so buyers have no reason NOT to use an agent. Purchasing a house is a long process that requires understanding purchase contracts, inspections, appraisals, lending guidelines, negotiations, closings and coordinating with everyone in the entire process that a full time dedicated agent can help guide you through.
Renting is ideal if you don’t have the funds to pay for the initial costs to buy, prefer to move frequently, can use the down payment for more lucrative investments such as stocks, real estate or starting a business and plan on staying there for less than 3-4 years.
- Pros to Renting:
- Less initial costs.
- Mobility and Flexibility to move.
- Can use down payment to invest in something more lucrative.
- Less chance of burglary in apartment complexes however, fire hazards increase due to more people.
- Ideal for short periods of time between 1-4 years.
2. Pros to Owning:
- Loan pay down also known as Amortization.
- A peace of mind and freedom to paint walls, hang pictures and anything else you want to do inside your own home without dealing with inspections from the landlord or property management company.
- Your monthly mortgage payment stays the same for 30 years which means you benefit from inflation where as rent may increase without you having any control.
- No landlord to evict you or sell the property to someone else.
- Long term increase in net worth.
- Ideal for 4+ years.
In conclusion, I would personally choose to save money as fast as possible to pay for the initial costs of a mortgage, obtain a 30 year mortgage and invest the rest of the money over the years into index funds(Stocks) and rental properties. If you are not educated about index funds(Stocks) or real estate investments and you are risk averse and prefer to be conservative, then paying cash or with a 15 year loan is the best decision for you. Renting in today’s economy is not the best financial decision long term unless you can use the down payment on the mortgage to invest into something that would produce higher returns such as stocks, real estate or your own business.
At the end of the day, outside of a strictly financial comparison, owning provides a peace of mind that renting does not. You have to constantly deal with landlords, property management companies, unfamiliar contractors, possible sale of the property, evictions etc. If the AC goes out in the middle of summer and it’s 120 degrees out, you are at the mercy of the landlord to have it repaired where as if you owned the home, you could have someone out the next day to repair it. If the hot water heater goes out, you will have to wait days or even weeks until the landlord decides to replace it. These are emotional factors that do not carry a monetary value.
If there is anything in the world you need help with or are looking to buy or sell in the future, save my number as “Realtor Lasker” at 480-779-8579 and my email at [email protected]. Good luck.