Welcome back to the second part of our two-part series on owning versus renting. On last week’s show, I discussed the immediate and short-term benefits of homeownership, and this week we’ll explore the longer-term benefits. Granted, as a Twitter-loving, text-sending, YouTube-watching culture, we put a low and ever-decreasing premium on long-term planning. We prefer instant gratification over investing. This trend will only widen the chasm between the rich and the poor, and the choices you make today will determine which group you belong to in the future.
You’ll recall from my November 7th show (“The Generational Parade”) that the prosperity of a country is determined primarily by demographic factors. Every generation is a different size, has different values, behaves a certain way, and so on. The size and values of a generation determine economic output, consumption, and savings rates among many other things. For example, the economic boom of the 1980s and 1990s was, essentially, the result of the Baby Boomers reaching their productive peaks. And since then, as the Boomers retire, the diminutive size of Generation X has prevented them from replacing the outgoing Boomers.
The productive output of the Boomers will not be replaced, let alone exceeded, until the maturity of the Millennials beginning around 2020. In that sense, ‘the fuse has been lit,’ which is to say the conditions necessary for an explosion in economic output are in place, and like a lit fuse it cannot be stopped. The Millennials are being educated; they’re starting careers; they’re forming families; and beginning in 2020 they will begin reaching their productive peaks.
One thing Millennials are not doing—at least not yet—is purchasing homes. Among Millennials, there is a slight preference toward renting instead of owning, informed by articles such as the one discussed last week. That article, and last week’s show, focused only on the short-term consequences of renting versus owning, of which there were few, if any, good reasons to rent instead of own.
One confusing aspect of a home is that it can be both a commodity and an investment. Everybody needs a place to live, so like food budgets people consider their monthly rent as a necessary cost of living. It’s a sunk cost, they reason, so there’s little difference in how it’s sunk. But, of course, if you own your home then very little of your monthly housing budget is sunk. Yes, a lot can go to interest if you choose a 30-year mortgage. And, yes, you are responsible for repair and upgrade costs to your residence. But these costs are baked into rent, too. The cost of your landlord’s mortgage is cooked into cost of rent. He is making his money back unless he’s a fool. And the odds of finding a foolish landlord are narrow. Unscrupulous, sure—but not foolish.
If you choose a 10- or 15-year mortgage, comparatively little of your housing budget will go toward interest. The majority will go to principle. Instead of losing money to your landlord, you are building equity. This, coupled with rising home values, ensures your money is going toward an asset that both holds and increases in value. In ten years, a homeowner will have an asset worth, well, the value of their home; a renter, meanwhile, will have nothing. Once the homeowner owns the property, he can buy a new one and rent out the old. Ten years later, he’ll have two homes—one of which provides a positive cash flow through rents—while the renter still has nothing. And so on. Eventually the homeowner’s rental properties are entirely self-sustaining and contributing to his retirement account.
Such an arrangement requires years of planning and execution. That’s why it’s imperative to begin as soon as possible. This year is especially great to begin since it will probably be the last year in which owning a home is less expensive than renting in the short-term—that is, your monthly mortgage payment is less than rent. As interest rates increase, mortgages will be slightly more expensive and by 2015 or 2016 the net cost of owning will exceed renting. But, of course, that does not consider the long-term opportunity cost of owning versus renting, which always favors ownership. All in all, 2014 may be the last golden year for new homeowners. If you’ve considered purchasing a home, or purchasing a rental property, now is the time to do so. At the very least, you should be consulting with your mortgage broker to assess your options and begin planning.
1-11-14 The Fuse is Lit: Renting vs. Owning Part II