Rent vs. buy?

This appeared under my byline in reuters india in their personal finance section

I have a difficult time explaining to editors in their 20s why there is a gap between what I say in my columns, what I do and what others do.

The origins of this article can be traced to a meet with 5 television editors (to be fair, their boss was on my side) who were shocked when I mathematically proved it is better to hire, than to buy. This is true of cars, vacations, or homes! Here we are talking homes.

So let us see what I do which worries, surprises, shocks, my editor friends.

Even though I do write articles on portfolio planning, portfolio construction and occasionally even stock picking, my own money is with a portfolio manager – and he is urging me to index! It took me a long time to understand that ego of stock picking need not interfere in the more important task of wealth creation.

So the stock picking happens as a hobby and the money gets managed by an extremely competent and diligent portfolio manager – and to use today’s modern language he is “just a broker”. He has been handling our family portfolio for the past 30 years.

We attended each other’s wedding, and now his daughter is ready for marriage. No I do not call him my “relation-ship manager”.

I rent an apartment, despite having enough money to buy a house. I plan to keep renting for as long as I can. I’m not just holding out for better prices. Renting will make me richer. Businesses are great investments while houses are poor ones, so I’d rather rent the latter and own the former.

Shares of businesses return 7% a year over long time periods. I’m subtracting for inflation – gradual price increases for everything from a loaf of bread to a root canal surgery. (After-inflation or “real” returns are the only ones that matter.

The point of increasing wealth is to increase buying power, not numbers on an account statement. Shares have been remarkably consistent over the past two centuries in their 7% real returns.

In Jeremy Siegel’s book, “Stocks for the Long Term,” he finds that real returns averaged 7.0% over nearly seven decades ending 1870, then 6.6% through 1925 and then 6.9% through 2004.

The average real return for houses over long time periods might surprise you. It’s zero. Shares return 7% a year after inflation because that’s how fast companies tend to increase their profits. Houses have their own version of profits: rents.

Tenant-occupied houses generate actual rents while owner-occupied houses generate ones that are implied but no less real: the rents their owners don’t have to pay each year. House prices and rents have been closely linked throughout history – except for bouts of bull / bear runs- and related to inflation.

A house, after all, is an ordinary good. It can’t think up ways to drive profits like a company’s managers can. If land, cement, steel, and money are all commodities, how can a combination of all these not be a commodity?

Robert Shiller, a Yale economist and author of “Irrational Exuberance,” which predicted the stock price collapse in 2000, has recently turned his eye to house prices.

Between 1890 and 2004 he finds that real house returns would have been zero if not for two brief periods: one immediately following World War II and another since about 2000.

Even if we include these periods houses returned just 0.4% a year, he says.

The average pundit, planner, lender or broker making the case for ownership doesn’t look at returns over long periods of time – it is embarrassing to say the least! Sometimes they reduce the matter to maxims about “building equity” and “paying yourself” instead of “throwing money down the drain.” If they do look at returns they focus on recent ones. Those tell a different story!

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