Once upon a time, there was a Canadian computer programmer who hated her job. So she put her head down, saved and invested any extra money she could find, and ended up retiring at the ripe old age of 31. Here is a little of her story…
She graduated (in her words, “quietly slipped through the cracks when the Dean wasn’t looking”) with a computer engineering degree in 2006. After a brief vacation to recharge, she and her husband (also an engineer) launched their careers.
The two of them lived a fairly normal 20-something lifestyle at first, except that with two solid incomes, no kids, and no debt, they started to be able to put aside a significant amount in savings. At first, they weren’t really trying to live an extremely frugal lifestyle, and certainly knew nothing about investing and retiring early. But they had several very important qualities: a strong work ethic, some sturdy math skills, and a solid dose of common sense. That last (and maybe most important) quality helped them avoid a few common financial pitfalls that plague many people. Fast forwarding to age 31, they had amassed a 7-figure portfolio, quit their jobs, and were traveling the world full-time as Canada’s youngest early retirees.
Now, how much do you suppose that buying a house contributed to their net worth? Bear in mind that they lived in Toronto, one of the hottest real estate markets in North America. Surely they bought something at the bottom of the market and rode it to financial freedom, right?
In FIREcracker’s words (that’s her pseudonym from her blog, millennial-revolution.com)…
The vast majority of people walk into an open house, look around for 10 minutes, coo at the granite countertops and fancy faucets and say “Wow, I could really see myself living here.” And then promptly get into a bidding war for more money than they’ll ever earn in their lifetime. In other words, most people bring feelings to a math fight.
FIREcracker goes on to detail, in her inimitable style, all the costs that would have derailed their early retirement plans. You can read her breakdown here.
Millennials Take a Different Path
As a generation, Millennials are often characterized as valuing experiences over material things. This is the explanation for why, we are told, they are more likely to spend money on eating out with friends or travel than on saving up for a down payment on a home.
It makes sense; just as Millennials were focused on college or starting their careers, they saw how quickly the financial world could crumble around them. And those that focused on building wealth in real estate (mainly their parents) often lost even their own homes.
(Of course, it wasn’t just real estate that was affected by the downturn, stocks also plummeted in the Recession, which probably also explains their reticence to invest in the stock market as well.)
But back to homeownership, many in the financial media worry about the fact that many Millennials still choose to rent in the aftermath of this experience, even though many could technically “afford” to buy. They see it as irresponsible or self-indulgent and fret about the future financial security of a generation that already has to deal with high student loan debt and a slow career start due to the Great Recession.
And so when the statistics emerge about low levels of home-buying among the young, the hand-wringing in the media comes out in earnest. My favorite example of this was a headline MSN Money ran chastising Millennials for their love of avocado toast more than owning their own home. Apparently, some Australian real estate mogul knows better. (Nevermind that he’s benefitted from a historic real estate boom in the “Land Down Under.”)
The Guardian also worries that Millennials will never start buying houses (actually, they do want to buy a home eventually), while the Wall Street Journal complains that they are “shut out” of homeownership.
But maybe FIREcracker has a point, and delaying the purchase of a home is not as dumb as we all thought? Sure, real estate can be a good investment, but it’s not a guarantee to get ahead (as we all saw in 2008). In fact, given the realities of today’s world, I would argue that for many young professionals, sticking to renting is just fine. Further, as I’ve already argued, homeownership can be a trap that hinders wealth-building for many.
So without further ado, here are five reasons why it’s ok to wait to buy a home:
Home Values Don’t Always Go Up
Owning a home is no guarantee of wealth, or even that you will eventually have enough money to retire someday.
While it’s true that real estate investing can be one good way to build wealth, buying a home to live in (i.e. a primary residence) is not real estate investing — it’s a lifestyle decision, not an investment. Sure, it can in some circumstances also make money, but it’s almost always less than you think.
To back that up, consider this research from economist Robert Shiller:
What this chart shows is that once you factor out inflation, you get a return on real estate of basically nothing since 1890. (About 3%/year price increase, but that’s the same amount as inflation over that period. The two cancel each other out.)
Not confident in data from the 19th and early 20th centuries? Fair enough, let’s take a look at more recent times. Since 1975, prices in the U.S. have appreciated about 5%/year with inflation just a hair under that at about 4%/year. Again, you have a real return of about 1%/year — nothing to get excited about.
Compare this with the average real (after inflation) return for stocks of about 7.5%/year over the same period.
How can this be, you ask? Simple, stocks are companies filled with people, plants, and machines that actually produce things (goods or services). (Read more on why you can expect stocks to go up over time.) Real estate (unless it’s a rental property) generally does not.
And yet, clearly, buying has some distinct financial advantages over renting, such as the fact that a portion of your mortgage payment goes to pay down principal on your mortgage and that you get a tax deduction on the interest. These advantages are certainly real, but as you will see next, there are also a lot of financial disadvantages to consider as well.
Homeownership Costs More Than You Think
With renting, you have a fixed housing expense. It’s easy to plan and budget your finances around that cost, because it stays the same over the life of the lease, and includes almost everything — the taxes, insurance, maintenance, and repairs. For a homeowner, these costs can vary from year to year, and can sometimes catch the homeowner by surprise.
It’s easy to look at just the mortgage payment by itself, compare it with your rent payment, and think you are getting a good deal. Unfortunately, it’s not that simple. Take a look here at a typical breakdown of the costs included in a monthly rent or mortgage payment:
|Expense||Rent Payment||Mortgage Payment|
|Repairs (new roof, etc)||Included||Not Included|
|Maintenance and Updates (carpet, paint)||Sometimes||Not Included|
To really compare apples to apples, I suggest that a would-be homeowner create a monthly line-item in the budget to account for these additional expenses. Unfortunately, it’s rare to find homeowners who actually do that. Instead, a recent poll reveals that almost 60% of Americans don’t even have $500 in ready cash available for an emergency.
But if one did have such an account set aside for all kinds of home maintenance and repairs, how much would that monthly amount be? Would buying a home still be as attractive?
Transaction Costs Are So Dang High!
Some of the objectives above can be overcome in certain circumstances. For example, for couples that stay in their homes for decades, buying almost always comes out ahead. And we’ve all heard the stories of those that got rich because they happened to buy a house in San Francisco/New York City/DC or some other hot market 20-30 years ago.
However, research shows that young people are generally more mobile now than previous generations. They have to be to retain the flexibility to pursue job opportunities as they come along.
The reason that matters is that the up-front transaction costs are so high with homeownership versus renting, and it’s not just the Realtor’s fees. When you add it all up, these costs can easily average 10% on each transaction. (Remember, you have to include all the costs of buying that you wouldn’t have if renting, including agent commissions, state transaction taxes (some states), title searches, attorney’s fees, mortgage origination fees (buyers), repairs to prep the property for sale (sellers), improvements that you can’t recoup, possibly a home warranty, etc.)
Therefore, if the house appreciates, after inflation, only 1-2% per year, then in five years your property should have appreciated about 5-10%. If you hold the property for a short time period, you will probably come out in the hole or maybe just barely breaking even.
Flexibility Favors Renting
On that note, the job market has changed over the last few decades, and it is no longer frowned upon for employees to switch jobs every 3-4 years. In fact, some research shows that frequent job-switchers actually make 50% or more over their lifetime than those who remain with the same company.
Instead of it being a negative to see frequent job changes on a resume, many companies now see it as a positive. Patty McCord, the innovative former chief talent officer for Netflix, says that “you build skills faster when changing companies because of the learning curve.” And employees with higher skills can usually command higher salaries.
In addition, the death of pension plans and a switch to 401k plans means that most retirement benefits can be taken with you when you leave a job. This fact even further reduces the incentive to stay with the same company for a long time period.
With all this job switching going on, much (if not most) of the time a relocation will be required. And with all the extensive fixed costs that go into buying a home, this favors renting over buying.
Tax Benefits are Better in a Retirement Plan
There is a lot of hype around the tax benefits of homeownership. Sure, you do get to write off the mortgage interest you pay, and there is no doubt that is a nice perk. But on the other hand, you typically have to sink 20% into the property up front to get into it. (There are some special programs for first-time homebuyers, veterans, and some others, that sometimes allow lower down payments. But outside of these exceptions, typically you need 20% down to avoid private mortgage insurance).
Saving up that kind of money is no easy task, especially in some markets where 20% can easily be $50,000 or more. That may take years of saving to accomplish, especially if you have to pay taxes on it first. To be used for a down payment, the funds have to be saved up outside a retirement plan.
That means that you forfeit the tax benefits of an IRA, Roth IRA, or 401k in the meantime on the dollars you put away for the down payment. Then, once you purchase the house, the 20% downpayment (aka, your equity) sits in the property and earns nothing. Even if the house goes up in value, the equity is still sitting there earning nothing, because the house would have gone up in value whether you have 0% in equity, 50%, or no mortgage at all.
But what if, instead, you saved that $50,000 in a Roth IRA? If you invested that in stock mutual funds and earned the historic market average of about 10%/year, you would have almost $900,000 in 30 years! (Read more about what kind of return you can expect by investing in stocks here.) The point is that you can certainly plan for retirement and build wealth without ever owning a home. (For more on this, check out how much you need to save to retire.)
The Bottom Line
I want to be careful to say that I’m not against homeownership. It can be a wonderful lifestyle, and also have some financial benefits as well. As I mentioned above, I’ve owned several properties, and both made and lost money on them. But I think the key to success is generally to avoid buying too much house, and then to have a plan to hold the property for the long term (the ideal holding period is forever). This means that you want to keep in mind that if your circumstances change and you have to relocate or maybe lose your job, you want to make sure you can rent out the place to augment your income. So check the community bylaws to make sure there aren’t restrictions against renting. (I’ve personally been burned by that one!)
Beyond that, the main reason for writing this is to encourage millennials not to feel bad if they just want to rent for awhile and enjoy their avocado toast. Don’t let the homeownership-obsessed media guilt you into something you aren’t ready for. It’s completely possible to build wealth without owning a home; in fact, in some instances it can even be an advantage.
Let me know what you think about this in the comments below!