The Decision Strategist

This post is a follow up on the financial cost-benefit analysis of buying or renting a house in an earlier post titled Buy A House Or Rent. There I considered the different factors that affect the financial decision and posted a spreadsheet that I had used to calculate net worth (linked at the end of this post as well).

But the reasons we want to own a house go beyond financial prudence. Things like home, status, the american dream, family and location all come in to play. To help navigate those factors, there’s a slightly more quantitative version of the Pros-Cons-Fix method that I discussed in the What am I Doing With My Life? post called PMI (Plus, Minus, Interesting). The format is fairly similar, except that instead of a column for fixes for the negatives, there is a column for interesting ones that can be either negative or positive. Also, rate each plus, minus, or interesting item on a scale (-5 to 5). Then add everything together to get a score for each option.

Buy A House

PMI: Buy A House

Being a young male with a good job and no family, my values my differ substantially from yours. Even so, I think most other people would agree that the sense of owning your own home is important (+3), but I also added that the mortgages forces you to invest (+1), that you have complete control of your space (+1), and that you get tax breaks (+2). The reason I gave forced investment and control such low values is that I am almost out of debt and feel that I won’t have any trouble continuing to keep expenses low, so the forced investment is almost a negative for me, since I could make a better investment elsewhere. I also gave control a low value because I’ve never had control issues in a place I’ve rented, and from what I hear housing associations can severely limit and control what you can do to your own home.

The biggest minus for me is that I, as most people do now, fully believe that the housing market is in full bubble bursting mode, and that the market won’t recover for at least three years. I think it may take as many as 8 to 10 years for prices to return to their current levels in some parts of the country. This is a really strong negative factor for me (-5). I also put lower net equity, since buying a house gives you a lower net worth than renting in most places (given certain assumptions about interest rates). This is probably double counting a little bit, but the bad market factor is different for me in that I’ll suffer a lot more anguish if my house drops in value than I would if buying a house just resulted in lower net worth (-3). Property taxes are a negative, but since they are built into my cost-benefit spreadsheets, it doesn’t seem like they should be included here (-1). The last negative is repairs, which can be fairly costly and not very much fun (-2).

Of course, the market is always unpredictable, and it could happen that the values in my neighborhood increase substantially even while the rest of the country is declining. I think the chances of this happening are pretty small though (-1). Do-it-yourself projects, expanding or updating the house, are fun and can add value, though they also cost money, so most of their value for me would be the fun of actually doing the project (+2).

Rent

PMI: Rent

Renting for me is a more attractive option largely because of the flexibility involved. I’m still fairly early in my career, and will almost certainly change jobs and probably fields several times (+3).

On the other hand, moving really sucks. It costs money, takes a whole lot of time, and always leaves you freaked out for at least a month while you search for and then move in to a new place. In the long term though, this is a minor pain (-1). Similarly, unscrupulous landlords seem abundant. I just got back slightly over half of the value of the deposit on my last place, and for charges that I specifically addressed before I left. I’ll be taking them to court, which is just more of a hassle. Again though, in the scope of things, this is a relatively small amount of time and cost (-1).

I put investing in other markets down even though the returns to the market are included in the cost-benefit analysis, but made them small (+1). Here I’m only considering the fun and excitement of investing, not the higher value of the money.

Results

The grand total for buying a house is -1, while the total for renting is 2. Not a wide spread, but certainly reinforces the conclusions I’ve reached from looking at the financial part of it.

I expect that most people would come up with a positive for buying a house using this method, especially if they have family or know where they want to settle down. This creates a conflict between the lower financial return and the greater “value” return (for lack of a better word) that I’ll discuss in a later post. For me though, the flexibility of renting combined with the additional costs of buying a house makes renting a better choice for now.

Here is the spreadsheet again:
Buy vs Rent.ods (Openoffice)
Buy vs Rent.xls (Excel)

A better post given the current housing market might be to look at the decision between holding the house and selling. Hopefully I can get to that another time.

-zot

Popularity: 11%

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I’ve been thinking a lot about buying a house. It’s a testament to the power of metaphors for life planning that it seems good in such a bad market. I’ve worked out a spreadsheet for calculating my net equity after buying versus renting a house and thought I would share it with you.

There are several sites out there discussing the imploding housing market. I particularly like Patrick.net, which has a blog and a housing crash page that posts updates to other articles. It also has a real estate “dating service”. Dr. Housing Bubble is another great site, and gives a lot of data and in-depth discussion. The “Real Homes of Genius” articles are both funny and sad.

With all the doom and gloom, there is a still a lot of enthusiasm locally about the idea of buying a house. Although a lot of people know that the market isn’t as good, they are still caught up in the dream of owning their own home and having it’s value skyrocket. The crazy adjustable-rate mortgages and other sub-prime lending is disappearing, so the large majority of people can’t afford to buy a house now anyway, but the dream is still there.

The spreadsheet allows you do designate all the necessary rates so that you can do as many projections as you want. These numbers are specially tailored to the Albuquerque housing market, since I was considering purchasing a house there. These are the important assumptions:

• Rent is $320/month
• Mortgage Rate is 6%, 30 years
• Cost of rent increases 3% per year
• Return on investment is 7%
• Cost of house is $200,000

Housing Appreciates 0%, Sell at 5 years

Housing Appreciates 5%, Sell at 5 years

Housing Appreciates -5%, Sell at 5 years

Housing Appreciates 5%, Sell at 30 years

In this scenario, buying a house rarely as profitable as investing. The results are strongly dependent on rates of appreciation, so different locations will have different returns. It could be that investing wouldn’t earn you 7% in the long term, or that housing will go up in your market by more than 5% a year. In fact, if your house appreciates at 8% per year, you will be better off buying a house (It seems obvious, since 8% is higher than 7%, but there are other costs associated with buying and selling a house).

It’s interesting to me that buying a house is so obviously a worse decision. I think most people buy houses because they want the metaphor, not because it’s a sound financial investment.

That’s not to say it’s a bad decision. Sometimes the immaterial things are more important than the finances. I know I still want to buy a house some day, despite these numbers. Having a family would really increase that desire, even if it meant taking a hit financially.

The spreadsheet lets you adjust property tax rates, expected growth rates of investment and housing, mortgage rates, length and rate of mortgage, when you sell, annual extra expenses, rent costs, the benefit of having a roommate, the rate you pay to a Realtor as a buyer and as a seller and…I think that’s it.

If you spot an error let me know, and if you find this sheet useful please consider donating. Thank you.

(Updated to reflect information from Jon Daley).

Buy vs Rent (openoffice)

Buy vs Rent (excel)

Values based decision in Buy Or Rent Part II: Non-Money Reasons.

-zot

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