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Owning Versus Renting A Home
Tuesday, August 25, 2009
There has long been a strong ideological bias in the United States that has pushed families toward becoming homeowners. Instead of resisting this bias, many people in the policy and advocacy community unthinkingly echoed this ideological refrain, joining the push toward homeownership.
This would have been problematic at any time, but pushing homeownership at the peak of a housing bubble was a recipe for disaster. In the wake of the collapse of the bubble, it would be great if we could promote some clearer thinking on the relative merits of ownership and renting.
At the most basic level, it is important to recognize that ownership will not always be desirable for every family at all times. First and foremost, homeownership will typically only make economic sense when families can expect to stay in a home for a substantial period of time. If there are family or employment reasons that make long-term tenure unlikely, then homeownership is probably a losing proposition.
The arithmetic on this is fairly straightforward. As a long-run average, house sale prices equal roughly 15 times annual rent. This means that a unit that rents for $1,000 a month can be expected to sell for roughly $180,000 (15 times the $12,000 annual rent). The combined buying side and selling side transaction costs average roughly ten percent of the sale price. In other words, the roundtrip transaction costs will typically be equal to one and a half years of rent. In this example, the transaction costs associated with buying and selling the home would be equal to $18,000, which is one and a half times the annual rent of $12,000.
The high transactions costs associated with buying and selling a home mean that anyone who does not stay in a home for a substantial period of time is likely to end up losing as a result of owning rather than renting. In an examination of the length of tenure of moderate-income families who bought homes in the 80s and early 90s, before the housing bubble, the median tenure was just over four years. At this length of tenure, the transaction costs effectively add an amount that is more than 35 percent of the annual rent to the cost of owning a home.
Assuming that there is no unusual appreciation in the market or an extraordinarily low price-to-rent ratio, a family will almost certainly be losing by owning under such circumstances. Unless the transaction costs can be averaged over a considerably longer period of time, renting is likely to prove a better economic decision than owning.
There are other important cost factors that are often ignored by those pushing the case for homeownership, most notably the inaccurate accounting of the mortgage interest and property tax deductions. While these deductions can be valuable to upper middle-class households who are in upper tax brackets and have other deductions, the mortgage interest and property tax deductions are likely to be of little or no value to most low- and moderate-income families who already have minimal tax liability.
Even in the cases where families are paying income taxes, it is easy to overestimate the benefit from these deductions. The value to the homeowner is the difference between their total deductions when itemizing and the standard deduction. In many cases this gap will be trivial.
Taking the example above, suppose that a family has a $150,000 mortgage at six percent interest. If they also pay property taxes equal to one percent of the house price, their housing-related deductions will total $10,800 ($9,000 mortgage interest, plus $1,800 property tax). With a standard deduction for a couple of $11,400, this family needs $600 in other deductions just to break even. In the event that their other deductions totaled $4,000, then the net reduction in taxable income associated with home ownership would be just $3,600. If this family is in the ten percent bracket, the benefit comes to $360 a year. If they are in the 15 percent bracket, then the benefit comes to $490 a year, less than half of one month's rent.
While there are low- and moderate-income families that can see more benefit from home ownership-related tax deductions, these are likely to be the exception. For the vast majority of low- and moderate-income families, these tax deductions are likely to be of little consequence.
By Dean Baker