Norbert Michel and Jerome Famularo
It is a mistake for policymakers to push homeownership as an investment strategy. The long-term, wealth-building effect of homeownership is often less than that of renting and investing in the diversified market. Increasing homeownership rates, nevertheless, has been federal policy for nearly a century.
Whether buying or renting and investing is a better strategy for long-term net worth is dependent on many factors. In particular, it depends on the price-to-rent ratio (the ratio of a home’s selling price to its renting price), future house price appreciation, future rent inflation, future market returns, and mortgage rates.
In general, renting is almost always a better decision for short-term residency (under 10 years) due to the lack of closing costs or high-interest payments that are only associated with buying. Still, a longtime homeowner may enjoy higher net worth relative to renting and investing, especially if house price appreciation and rental inflation are both high relative to market returns. If, however, market returns are high and house price appreciation and rental inflation are low, renting and investing would likely lead to higher net worth even for longer-term residencies.
The New York Times has built a great tool for estimating whether buying or renting is a better deal, depending on various adjustable parameters. Table 1 uses the latest data from Zillow to show the amount of time it would take for buying to pay off versus renting across several market scenarios, using median home price and rent for the US average, San Jose, and New Orleans, respectively. As these results demonstrate, depending on the location and combination of market returns, rent inflation, house price appreciation, and mortgage rates, it could take as little as three years for buying to pay off versus renting—or it could take more than 40 years.
It is, of course, impossible to know the future trajectory of these measures, thus the decision poses a financial risk even before considering an individual’s future ability to earn income.
As far as the decision to rent or buy is concerned, other factors are worth considering besides net worth. Renting has the advantage of flexibility. Rental contracts are relatively easy to initiate or break. Investments in the market or savings accounts are quite liquid, particularly compared to selling a house. Taking out a home mortgage also effectively requires many people to invest everything they have in a single, undiversified asset. Moreover, the value of that asset, a home, is often subject to change based on local characteristics. For anyone with volatile or slow-growing income, taking on a home mortgage in this manner prevents the homeowner from diversifying their investments, thus magnifying their financial risk.
Of course, many benefits come with owning a home. For instance, the resident homeowner has much more ability to customize their home to their liking. Many people like the idea of certainty, hoping that buying will allow them to live in the same place for many years. These factors are all subjective though, and potential buyers should carefully weigh them against their (also subjective) financial risks.
It is high time for policymakers to stop pushing millions of Americans into risky financial decisions that distort housing markets and needlessly expose them to financial turmoil. Policymakers do not have objective reasons for tilting the market in favor of buying versus renting. They should allow people to decide for themselves whether and when they wish to buy or rent.
The authors would like to thank Ram Kannoju for his research assistance.