My life as a tenant is well known to my colleagues and friends. And while my previous attempts at rent negotiations (opens in a new tab) didn’t work out, I ended up moving to a different (and larger) unit in the same complex at a cheaper rate. However, as I watch my friends go through the home buying process, it makes me wonder if I am wasting my money and the wealth building potential of owning a home.
Personal finance experts have long argued that homeownership is a key step to creating lasting wealth. (opens in a new tab). A home is an asset that typically increases in value over time, and buyers also benefit from leverage: you can borrow up to 80% of a home’s value, or even more with a low-cost loan. downpayment.
Before individuals had access to low-cost mutual funds and brokerage accounts, the stock and bond markets were reserved for institutional investors and wealthy investors. For everyone else, buying a home was the primary way to invest, says Florida Atlantic University professor Ken Johnson, who specializes in rental housing and real estate market research. Johnson is also the co-creator of the Beracha, Hardin and Johnson Buy vs. Rent Index (opens in a new tab). The index analyzes 23 US metropolitan areas to determine whether market conditions favor renting or buying in terms of wealth accumulation.
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In early March, the index found that in 17 of 23 metro areas, including Atlanta, Los Angeles and, surprisingly, Detroit, consumers would be better off renting and investing the money they would have used for a down payment, fees closing and other housing expenses, even though rents have skyrocketed. The median U.S. home sale price reached around $429,000 in late April, and 30-year fixed mortgage rates recently hit 5.27%, the highest since the summer of 2009. Over the past 10 years of bullish returns, the S&P 500 Index rose 11.7% on an annualized basis, compared to a 7.9% annual rise in home values. (Data is as of May 6.)
How to lease strategically.
For renting to provide a higher return, you need to have enough money after paying your monthly rent to invest. And that is down to personal choice. For example, if you would be happy with a one-bedroom unit, choose that over the more expensive two-bedroom unit, or skip the pool complex.
Or, if you’re like me and live in an expensive metropolitan area, you can choose to save money by living out of town. Even though my rent went up $50 a month in August, it’s still cheaper than the rates for closer apartments in the Washington, DC area. I also gave up some amenities, like a pool, in-unit washer and dryer, and up-to-date appliances. That’s not to say I’m not comfortable in my apartment – I can entertain groups of friends and there’s plenty of sun for my plants – but the lack of these amenities keeps my costs in the range with which I am comfortable with.
Along with these types of trade-offs, tenants need to get into the habit of saving. Pay yourself first with automatic transfers from your check to your savings or brokerage account (opens in a new tab). If you have access to a 401(k) (opens in a new tab) or any other employer-sponsored retirement plan, contribute as much as you can. While I am currently focused on paying off some credit card debt (opens in a new tab), I have a nice amount of money invested in my retirement savings accounts. Once I have paid off my debts, I intend to increase the amount I invest in these accounts and will continue to review whether buying a home fits my long-term goals of heritage building.
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