Why To Keep Your Rental Lease & Invest In Stocks Instead Of A Home
You do pretty well for yourself, and you have some money put aside to invest..
. somewhere. You had originally planned to use that money to buy a home, with a nice little yard and a white picket fence. But you're feeling a little spooked by the housing market crash, and now you're wondering "what's a better investment, stocks or housing? Should I renew my rental lease and invest in stocks instead of buying a home?" Let's take a closer look at the actual data.
From 1944-2004, the average return on stock investments was 6.9% over inflation (inflation generally runs 2.5-3%/year). For a comparison, real estate prices have beat inflation by only 2% from 1945-2000, which means in a long-term perspective stocks beat real estate returns by roughly 5%/year.
Returns aren't the whole story, however. What about real estate-related tax benefits, such as deducting mortgage interest, that tenants on a rental lease don't receive? Stocks also have tax breaks: share margins for those borrowing money to invest in stocks (as opposed to real estate) is also tax-deductible. But both cost more money than they return: if you borrow money at 6.1% for a mortgage, and only receive a 5% boost in value, you've lost out. Further, most Americans don't even deduct their mortgage interest, opting instead for the Standard Deduction.
All right, but you can't live in stocks, right? You have to pay for housing, whether you buy or lease, after all. But here's the rub: you can earn more money on your stock investments, even subtracting a year's worth of rent, than you would save by using that money to buy real estate. Imagine, for a moment, that you have $300,000, to either buy a home or invest in the stock market, and you currently live in an apartment that costs $1,250. Incidentals, such as taxes, homeowner's insurance, and maintenance cost roughly 2%/year, or $6,000, compared to your $15,000/year paid towards your rent, for a savings of $9,000/year. At the average stock return, even after subtracting for inflation, on that same $300,000 will give you $21,000 in earnings for that year, $12,000 better than the money you saved by buying real estate instead of staying put with your rental lease.
Here's an interesting housing conundrum: many Americans have experienced satisfying returns on their real estate, over the last fifty years. Consider, for a moment, the rise of government-backed programs to increase the number of Americans who own instead of rent, including the initial drive for longer mortgages with lower down payments (oh yes - Uncle Sam was in fact the trailblazer here, despite politicians' current scapegoating of the mortgage industry). Before the Federal Housing Authority (FHA was formed in 1934), Americans were expected to put down 40% of a home's purchase price, and pay the mortgage back over 5-15 years. To boost the availability of home ownership, FHA insured mortgages with 20% down, for a 20 year term. Over the next fifty years, FHA's guidelines become more and more generous, reaching an all-time low in the housing bubble, by allowing homebuyers to put down 3% for a 30 year term. Because of the affordability of buying real estate, the percentage of homeowners in America jumped from 44% in 1940 to 65% in 2004, driving demand (and therefore prices) upward.
But here's the problem: that all came to a screeching halt in 2007-2008. Home prices will no longer be fueled by loosening lending standards, at least not for the foreseeable future of the next 10-20 years. Instead, the percentage of homeowners in America is shrinking, fueled by the foreclosure crisis, unemployment, and economic uncertainty. Today is the day of the tenant, frugally paying an inexpensive rental lease while saving money and investing shrewdly, not the days of grandiose mcmansions, rainforest hardwood, and scarlet-veined granite, and with the Great Recession coming to a close, now is a great time to start putting your money in the market.
by: Kevin Kiene
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