Rent vs. Buy Myths? Not Really.

Jason Kottke links to a post purporting to expose the “rent vs. buy” myths that contributed to the housing bubble.  The claim seems to be that people who should have been renting bought instead, making the housing bubble worse:

Potential buyers bought into all sorts of rent vs. buy myths to justify buying houses that they could not afford during the boom. Now that the U.S. housing market is in shambles, people are starting to realize that renting may not be a dirty word after all.

It’s an interesting theory.  Unfortunately, most of the five “myths” aren’t really myths at all. First some parameters for our discussion — to compare renting and buying, the appropriate comparison should be renting a single family home vs. buying a single family home or renting an apartment vs. buying a condo.  It’s not really a fair comparison to examine a two bedroom apartment and a four bedroom house, and the options have entirely different cost-benefit analyses. Given that I have children, I’ll look at the single family home option, not the apartment/condo one.  We’ll also assume this house is being rented from a private landlord, as is the case with the vast majority of single-family detached homes available for rent.  These assumptions may skew the analysis, so YMMV.

On to the “myths”…

Myth #1: Renting is Like Throwing Your Money Away

Buyers throw their money away for the first five years they own a home, because they simply give money to the bank for the privilege of borrowing money. Renters, on the other hand, pay for one thing every month: shelter. They don’t pay interest to the bank, property taxes or maintenance fees. They pay rent.

There is a nugget of truth here.  The amortization schedule for a 30 year mortgage provides that you pay mostly interest in the early years.  For example, if you have a $300,000 mortgage at 6.0% interest, here’s how it breaks down:

• Year 1: 17% principal, 83% interest
• Year 2: 18.1% principal, 81.9% interest
• Year 3: 19.2% principal, 80.8% interest
• Year 4: 20.4% principal, 79.6% interest
• Year 5: 21.7% principal, 78.3% interest
• Cumulative years 1-5: 19.3% principal, 80.7% interest

Based solely on the principal payments and assuming no appreciation in housing prices and a 100% initial mortgage, you’d have equity of $20,836.86.  That’s not a lot, but it’s not zero.  The argument for home ownership is that you get something for your housing expenditure every month, not that you get wealthy. The return is low, however, and can’t the renter invest what he doesn’t spend on interest, maintenance costs or property taxes?  The problem is that renters do pay for property taxes, maintenance fees and insurance. They just don’t pay them to the government, homeowners association or bank.  Landlords aren’t charities, and the rent they charge is going to be equivalent to their mortgage payment, expected maintenance expenditure and some amount of margin.  If you’re saving money, it’s because the landlord either (a) has paid off their mortgage or (b) bought the house when housing costs were lower and therefore has a lower mortgage payment.  Given how quickly most landlords flip rental properties, the difference between renting and buying in this scenario isn’t that much.

Most renters do pay less in rent than they do when they buy, but a large part of the difference (at least around here) is that they buy a much nicer house than they were renting.

Myth #2: There are Tax Benefits to Owning

Contrary to popular belief, buyers do not get back the mortgage interest they paid throughout the year at tax time. Mortgage interest can only be deducted from taxable income. This essentially means that buyers pay a dollar just to save 30 cents.

Furthermore, deducting interest has no tax advantage unless a buyer pays so much in interest that the amount exceeds the standard deduction that everyone–including renters–is allowed to take.

When it comes to owning, the only guarantee is that buyers will be required to pay property taxes. Since renters are not required to pay any taxes on the property they rent, it seems downright foolish to factor the ‘tax benefits’ of owning into a buying decision.

If someone thinks they’re going to get back every penny they spend in interest, they’re an idiot.  It’s a deduction, not a tax credit.  And it, in and of itself, is not a reason to buy.  But it does factor into the equation.  Take the example above, for instance.  Our hypothetical buyer pays $1,798.65 each month.  In the first year, they pay $17,899.80 in interest.  Assuming a marginal tax rate of 28%, they’ll reduce their tax (or increase their refund) by $5,011.94, which means that for the first year, they are effectively paying $1,380.99 each month in principal and interest.  For most buyers, the tax deduction goes a long way in erasing any cost benefit to renting.  Plus, the landlord isn’t eating his interest expense; he’s passing it through to you and keeping the tax benefit for himself.

The standard deduction argument is an almost completely irrelevant one.  The 2008 standard deduction for couples filing jointly is $10,900.  If you itemize, you’ll deduct not just mortgage interest, but property taxes and state/local income taxes as well.  The number of homeowners who can’t itemize is a number statistically indistinguishable from zero.

Myth #3: It Doesn’t Cost Any More to Buy Than It Does to Rent

People can usually rent a home by paying first month’s rent, last month’s rent and possibly a security deposit. All the money that is paid initially actually goes towards monthly payment obligations, with the exception of the security deposit, which is nearly always returned to the renter in the end.

When a person buys a home, the money that is paid upfront is more significant and may or may not be seen again. For example, a buyer must pay closing costs (typically five percent of the loan amount) and real estate agent commission (typically six percent of the loan amount) before being called a homeowner. This 11 percent ‘investment’ ensures that the home must appreciate by at least 11 percent before the buyer can hope to break even.

Initial costs aside, there are also other costs a buyer is responsible for that a renter is not, such as mortgage interest, property taxes, insurance and maintenance. These costs can add up and may even increase significantly over the years.

There’s actually a nugget of truth here.  The upfront costs of renting are generally cheaper than the upfront costs of buying.  Assume a $1,200 rental payment against our hypothetical $300,000 mortgage.  The renter is probably out $2,400 up front.  The buyer’s closing costs are going to depend on the loan, but will probably be around $4,000, assuming you’re not paying points (and if you are paying points, you get another tax deduction).

This is one of the places that “eFinanceDirectory” prints a blatant falsehood. The seller, not the buyer, pays the commission.  Further, the renter may not be directly responsible for mortgage interest, property taxes, insurance and maintenance, they are indirectly responsible for them, as the landlord will expect to recover those costs through the rent payment.

Myth #4: Buyers Have Assets, Renters Do Not

At best, buyers have depreciating assets. Home prices are falling in nearly every area of the country. An estimated 50 percent of the buyers whose loans were originated after 2002 now owe more than their homes are worth.

Homeowners who have been paying on their homes for ten years or more are seeing their equity disappear. This means that the ‘investment’ they made through mortgage payments is gone–dried up virtually overnight through no fault of their own.

Renters may not co-own a home with a lender, but this doesn’t mean that they don’t have assets. Many renters have a large and prosperous portfolio, Star Wars collectibles (just an example) and other assets that can be sold IMMEDIATELY for cash. The reason they own these things is because they haven’t been paying a lender to ‘rent’ money so that they could pretend like they own an asset.

In the current housing market, especially on the coasts, housing prices have certainly fallen.  There are borrowers who are upside down on their mortgage and will take a loss if they sell.  This is certainly not true everywhere, and unlikely to be true over time.  Here in Richmond, housing prices have continued to appreciate, albeit slowly.  In markets that went crazy over the last decade, prices have collapsed, although many of the people now taking a hit were both buyers and sellers during that period.  So the reality is that some buyers have equity and some don’t.  On the other hand, no renter has an asset they can pledge as collateral (just try to get a small business loan based on those Star Wars collectibles).

Myth #5: Houses are a Good Investment

During the housing boom, everyone thought that housing was a great investment. Many people bought under the assumption that home prices go up, not down. The result of this madness is the biggest foreclosure crisis in the history of the United States.

The reality is that housing is not an investment. It’s shelter. That is all housing has ever been. Self-serving organizations like the National Association of Realtors like to tell people that buying a home is a good way to build long-term wealth, but this statement couldn’t be further from the truth.

Again, there is a nugget of truth here.  If you have money to invest, you’re better off buying mutual funds than buying a house.  But that’s not really a proper comparison.  The issue isn’t homeownership vs. stock ownership; it’s homeownership vs. renting.  The former has a small return.  The latter has no return at all.

Essentially, these 5 myths boil down to this: renting is cheaper than buying, and if you invest what you save by renting, you’ll make up any benefit you get from buying.  That’s not necessarily the case, given that landlords have mortgages, too.  The money you save is mostly because renting a crappy house is cheaper than buying a nice one.  You can save money by renting an apartment instead of buying a house, and many people are better of renting an apartment instead of buying a condo.

This comes off as a puff piece for home ownership, but it shouldn’t be.  Renting is right for some and wrong for others.  You certainly shouldn’t buy more house than you can afford based on some ephemeral tax advantage.  But there are benefits to home ownership, and there are reasons to buy other than the evil influence of the Realtor/banker/mortgage broker cabal.

House, Senate, Prez agree on economic stimulus package

After Senate Democrats dropped plans to expand unemployment benefits, Congress and the White House agreed on the terms of a final economic stimulus package, meaning that checks are likely to go out in May.  The bill passed by Congress (PDF) calls for a gradual phase-out of tax credits for higher-income taxpayers, but now includes a whole bunch of people who otherwise wouldn’t have qualified because they have no qualifying income.  Here’s some scenarios, assuming I read the text correctly:

Individuals

AGI	Children
	0	1	2	3	4
3000	300	600	900	1200	1500
6000-75000	600	900	1200	1500	1800
80000	350	650	950	1250	1550
90000	0	150	450	750	1050
100000	0	0	0	250	550
110000	0	0	0	0	50
111000+	0	0	0	0	0

 

Married Filing Jointly

AGI	Children
	0	1	2	3	4
3000	600	900	1200	1500	1800
12000-150000	1200	1500	1800	2100	2400
160000	700	1000	1300	1600	1900
170000	200	500	800	1100	1400
180000	0	0	300	600	900
190000	0	0	0	100	400
198000	0	0	0	0	0

 

Nothing changes my overall view that (a) a reduction in the tax rate is still better than a one-shot credit; (b) there’s no justification for providing tax relief to people who don’t pay taxes; and (c) there’s no justification for denying tax relief to “the rich” (defined in this case as a family of four with AGI above $180,000, which is certainly not rich).  But there it is anyway – I’ll enjoy my $1800. How will you spend yours?

If anyone’s interested, I created a little spreadsheet – leave a comment and I’ll post it.

Politicos agree on stimulus package (for some)

Update 2/8: Congress and the President have agreed on a revised package.  See here for more.

So House leaders and the Administration have reached a deal on an “economic stimulus” package, the centerpiece of which will be tax rebates to some workers.  The details haven’t really been released, but the Post describes it this way:

Under the deal, nearly everyone who earned a paycheck in 2007 would receive at least $300 from the Internal Revenue Service — $103 billion in total. Most people would receive rebates of $600 each, or $1,200 per couple. Families with children would receive an additional payment of $300 per child. Workers who earned at least $3,000 last year — but not enough to pay income taxes — would be eligible for $300.

The way it will actually work is that the tax rate on the first $6,000 of earnings for individuals and $12,000 for couples will be reduced from 10% to zero. In addition, families will be eligible for an additional $300 per child.  Individuals with Adjusted Gross Incomes above $75,000 and couples with AGIs above $150,000 will see their rebates phased out.  You’ll get a rebate even if you would otherwise pay no income tax (due to deductions).

Here’s a summary, as best I can figure out:

Individuals

AGI	Children
	0	1	2	3	4
$3,000	$300	$600	$900	$1,200	$1,500
$4,000	$400	$700	$1,000	$1,300	$1,600
$5,000	$500	$800	$1,100	$1,400	$1,700
$6,000	$600	$900	$1,200	$1,500	$1,800
$6,000 to $75,000	$600	$900	$1,200	$1,500	$1,800
$75,000 to $87,000	Unclear, but will be gradually reduced from above to $0 as incomes increase
Above $87,000	0	0	0	0	0

Couples

AGI	Children
	0	1	2	3	4
$3,000	$300	$600	$900	$1,200	$1,500
$6,000	$600	$900	$1,200	$1,500	$1,800
$9,000	$900	$1,200	$1,500	$1,800	$2,100
$12,000	$1,200	$1,500	$1,800	$2,100	$2,400
$12,000 to $150,000	$1,200	$1,500	$1,800	$2,100	$2,400
$150,000 to $174,000	Unclear, but will be gradually reduced from above to $0 as incomes increase
Above $174,000	0	0	0	0	0

The stimulus package uses AGI, not taxable income. This means that only a select few deductions from income are included.  401(k) contributions are excluded entirely from taxable wages. Standard and itemized deductions don’t reduce AGI.  The IRS defines it as:

AGI is defined as your taxable income from all sources including wages, salaries, tips, taxable interest, ordinary dividends, taxable refunds, credits, or offsets of state and local income taxes, alimony received, business income or loss, capital gains or losses, other gains or losses, taxable IRA distributions, taxable pensions and annuities, rental real estate, royalties, farm income or losses, unemployment compensation, taxable social security benefits, and other income minus specific deductions including educator expenses, the IRA deduction, student loan interest deduction, tuition and fees deduction, Archer MSA deduction, moving expenses, one-half of self-employment tax, self-employed health insurance deduction, self-employed SEP, SIMPLE, and qualified plans, penalty on early withdrawal of savings, and alimony paid by you. Do not deduct your standard or itemized deductions.

The assumption behind the stimulus package is that people will take the money they don’t have to pay the government and spend it, putting money into the economy.  If that is indeed the assumption, why the one-shot rebate check? Why not just cut the overall marginal tax rate, so that people have more to spend all the time?  It’s not at all clear that the tax relief will go into consumer goods instead of savings against catastrophe.  After all, once the money is received, it’s not going to come again.

The stimulus package as proposed also suffers from Washington’s typical class warfareism.  Why exclude those with incomes above $87,000/$174,000 altogether? Why phase out the relief for those above $75,000/$150,000?  If the justification for including those with income but no tax liability is to get money into the economy (after all, in that case it’s a cash handout, not a tax rebate), there is no justification for excluding higher incomes.  A family with two professionals earning $178,000 puts money into the economy just as much as one earning $149,000.  The political reality is we can’t ever be seen as “benefiting the rich,” even though they pay the vast majority of all federal taxes (and yes, this is true even if you include FICA).  And we can’t ever be seen as not helping the poor, even if they pay no taxes.  So we end up with a stimulus package that stimulates less, just so we can say we’ve appropriately soaked the rich.

Again, while anything that takes money out of the government’s greedy mitts and returns it to the people is a Good Thing, a tax cut would be better.

Check Your Wallet: Here Come the New Urbanists

The new General Assembly session starts today, which means its time to beat Virginians over the head about transportation. Last time around, it was about how to pay for new construction, which led to the despised Don’t Drive Like an Idiot fees and the probably-unconstitutional regional taxation transportation authorities.  This year, we’ve largely moved on from your wallet, so it’s back to the old standard of beating middle-class suburbanites over the head for their lifestyle choices.

First up was perennial lifestyle nag the Southern Environmental Law Center, whose Land and Community Program director Trip Pollard was featured in yesterday’s T-D op-ed pages, arguing that “development and transportation decisions are influenced by a host of governmental incentives and regulations that promote sprawl and offer few alternatives to driving.”  Pollard claims that this eats up natural resources and contributes to global warming.  His solution is, of course, more government:

Innovative, practical steps are needed at the state and local levels to fundamentally change our development, transportation, and energy policies and patterns. These steps include the following:

Revitalize communities and promote more compact neighborhoods and town centers that include affordable housing and transportation alternatives to solo driving;

Provide incentives for greener building to make new and existing structures healthier, cleaner, and more energy-efficient;

Protect and enhance rural and natural areas, and promote agricultural vitality;

Provide greater transportation choices, including increasing funding for transit, rail, pedestrian and bicycling paths, and improved local street networks;

Provide incentives for more efficient, cleaner vehicles and cleaner fuels; and

Make reducing greenhouse gas pollution a priority in all energy and transportation plans and projects.

Today it’s Ford Weber, executive director of something called the Virginia Local Initiatives Support Corporation (here’s a list of the Top 25 Donors all-time to VLISC’s parent entity, a creation of the Ford Foundation).  Weber also says we should take money away from roads and give it to mass transit:

A comprehensive regional mass transit system is critical to our future growth and prosperity. Many of us have traditionally viewed public transportation as a costly social burden and mass transit as an expensive boondoggle. However, across the country, including Northern Virginia and Hampton Roads, many thriving metropolitan areas are realizing mass transit is a strategic investment in economic development and regional attractiveness that simultaneously enhances environmental quality, public health, social justice, and other aspects of a high quality of life.

Putting aside Weber’s use of meaningless euphemisms like “public justice,” which generally just means “give me your money,” it’s clear that his big beef is also sprawl:

That process has identified the importance of maintaining and expanding the traditional urban model of walkable neighborhoods linked with trolley service as key components for downtown revitalization. It recognizes our current dependence on automobiles, but notes that multi-modal transportation can help stimulate vibrant mixed-use revitalization in the downtown area where the streets, sidewalks, and utilities already exist. In the suburbs, growth was a major factor in the recent elections, reflecting citizen concerns about the sprawling manner in which our region is growing. With every new subdivision and shopping center, new roads and other infrastructure must be built and maintained at taxpayer expense, while farms and forests are lost forever.

We have a greater appreciation of how our auto dependence is creating sprawl — and how that sprawl is negatively affecting our quality of life. Other regions with viable mass transit are showing us how we can direct and encourage redevelopment and growth in targeted areas. Mass transit converts vacant and under-utilized real estate into valuable locations for higher density development, creating vibrant central city neighborhoods and facilitating downtown revitalization. The benefits include increasing local tax bases, reduced pressure for suburban sprawl, and a higher quality of life.

Both of these op-ed pieces come straight out of the New Urbanist handbook – note the lovely phrases like “more compact neighborhoods” and “higher density development.” Weber even goes so far as to argue that the Richmond regional transportation authority should ignore reality in developing transportation plans; reading his column makes you want to wipe the spittle off your face every time he dismisses current proposals as “data-driven.” New Urbanists live in a fantasy world where “sprawl” is the enemy of the pristine cities we’d all live in were it not for evil governmental incentives that drove the population to the suburbs (presumably foisted on us by the usual cabal of greedy Big Oil and car manufacturers).

This is a nice story, and there may be a tiny little bit of truth to it.  But the real reason we live in the suburbs isn’t bad government, it’s bad cities.  It may have made sense once to cram people on top of one another in urban centers, but it doesn’t any more.  We don’t work in factories; we work in data centers and office parks, which can be located anywhere there’s electricity and broadband.  In addition, many of the modern conveniences we’ve come to want work better in the suburbs – backyard playsets have supplanted the need for city playgrounds, but increased the need for a yard.  Home theater systems work a whole lot better in a 2,000 square foot house than in a 600 square foot apartment.  Modern supermarkets are full of things not available from the butcher where Alice shopped for the Bradys.  All of these things are bigger drivers of people from Richmond to Short Pump than is the taxpayer-funded interstate highway system.

A bigger reason for sprawl, of course, is that cities have higher crime rates and substantially inferior school systems.  Check out the overall Grade 3 SOL scores for 2007:

District     English  Math  History  Science

Richmond      76       84      89      81 Henrico       84       90      96      91

Chesterfield  87       92      95      92

The reality for the city schools are even worse, as the scores for Henrico include underperforming schools in the East End and closer to the city center.  For the elementary school my kids attend in the West End, the difference is even more dramatic.  Pemberton’s Grade 3 SOL scores for 2006-2007 were 96 in English and 100 in Math, Science and History. It’s possible to do almost as well in the city, but only if you can get into Mary Munford, and good luck with that.

Sprawl is not inherently bad, although I’ve been known to curse it while sitting in traffic at Pump Road and Broad Street.  Sprawl gave us strip malls and cookie-cutter, treeless subdivisions, but it also gave us good schools and affordable houses with yards.  People weren’t forced to the suburbs by oil executives wielding torches; they made a perfectly-understandable market-based decision to accept the strip malls as the price of good schools and safe neighborhoods.  Most suburbanites like the decision they made, and nogoodniks like Weber and Pollard shouldn’t try to reverse those choices with carrots of transportation boondoggles or the stick of overzealous zoning.