Should You Buy A House Or Just Rent and Invest The Rest?

May 16, 2011 10:17 am

This is an important question many of us face in our lives: does it make sense to buy a house, or to rent one (in which case some cash can be used for investing in stocks, bonds and what not). We have written about the Rent Vs Buy decision before. (Remember: the definition of rent ratio: A rent ratio is the sale price of a house divided by the annual cost of renting an equivalent house). we arrived at two conclusions:

1. If the sale price of houses in your area is not more than 15 times your annual rent, you should go ahead and buy a house.
2. As a rule of thumb, a ratio above roughly 20 means that a monthly mortgage bill is higher than rent for a similar house.

And invariably, in most places it will be more than 20 – that means the mortgage bill, in general, will be more than the rent for a similar house. This is the premium we pay for owning the place, and towards wealth accumulation in the future. But this wealth accumulation – is this a fact? A recent paper by Jordan Rapaport has some in-depth analysis of this issue. Here are the conclusions:

1. While homeownership often builds more household wealth than renting and investing the saved cash flow, it also often does not. More specifically, for most ten-year occupancies beginning during the 1970s and 1990s, homeownership unambiguously built more wealth. In contrast, for most occupancies beginning during the 1980s, renting and investing unambiguously built more wealth.

2. Renting and investing is also likely to build more wealth than homeownership for many of the occupancies that started in 2000 through 2009.

3. These results suggest that either homeownership or renting and investing can be reasonable strategies for building household wealth. In other words, the conventional wisdom that homeownership is usually the better strategy is probably too strong.

4. For many households in many years, renting and investing the saved cash flow has built more wealth than homeownership. On the other hand, about half of the time, homeownership has built more wealth than renting.

How do we conclude this? with the magic number 15 of course – if your rent ratio is less than 15, go ahead and buy a house. i.e. , If the sale price of houses in your area is not more than 15 times your annual rent, you should go ahead and buy a house.

Statistics Source: Kansas City Fed

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1 Comment for “Should You Buy A House Or Just Rent and Invest The Rest?”

  1. Ramesh

    I agree somewhat with you. However, I do not agree with the number 15. The problem is, you refering to a statistics that was done on an western country where the population density is quite different than in India. As we know, the value (and also price) of anything would depend on supply and demand. Since the supply and demand of land/realestate is quite different in India from western world, if the number 15 was achieved based on analysis on a western country, it would not be the same in India.
    If a similar kind of analysis can be done only in Indian market, we would get more conclusive numbers.

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