Homeowners Get Rich, Renters Get Poor, But Rich Renters Get Rich, Too

Renting vs. Owning

We've all heard countless time that we should not be paying rent but we should instead buy a house or condo and substitute mortgate payments for rent payments and slowly acquire ownership of the property, for instance in The Automatic Millionaire (a very sound beginner's book in general). This is good advice for most people.

However, this rule doesn't apply to me and I'm tired of hearing about it. It doesn't apply because I'm a rich renter. If I were to buy a house or condo, I would just pay cash and buy it outright. A mortgage would be a senseless waste of money for me, and this makes buying a property much more directly an investment (instead of a forced-savings program). But, something ignored in most discussion of homeowning is “opportunity cost”—I can't invest that same money in anything else if it is tied up in a house or condo.

Time for a real-world example. I know a person who lives in a condo in Saint John, New Brunswick, Canada. She bought her condo for $50K in April 1995 and she is thinking about selling it it today, nearly 10 years later (116 months), for $75K-$80K ($77.5K average). Back in 1995 she paid $230 in condo fees and today she pays $280. In addition to condo fees, she also has to pay property tax of $1000 and insurance premiums of $150 per year. She did the whole mortgage thing, but we will assume for this discussion that she didn't. So, she invested $50K in 1995 and owns a $77.5K property today, for a gain of $27,500 but has spent approximately $40,697 in housing fees. Net loss: $13,197.

Now, suppose that she had rented for the past 10 years instead and invested her money in something else. An equivalent apartment in the same area would have cost $600 in 1995 and $850 today. Her housing fees would be $84,100. Suppose she had invested in a boring DOW Industrial Average indexed mutual fund (or equivalent) instead of a condo. The DOW was at 4200 in April 1995 and and is at 10,829 today (2004-12-29). So, her $50K investment would be worth $128,917 today, for a gain of $78,917. Net loss: $5,183 (61% less). The increased returns from the stock market pay for your rent.

So there you have it. The housing market is at a peak today and the stock market is still recovering from the dot-com meltdown, but over the last 10 years, the stock market has still substantially outperformed the housing market in her area and probably generally. The stock market has gone up a total of 158% or 9.93% compounded annually whereas her real estate has gone up a total of 55% or 4.64% compounded annually. Renting is not such a bad idea for the wealthy, and now is probably a bad time to invest in real estate since you want to buy in when a market is low. I would wildly guess that the stock market is at about “medium” today.

Caveat Mortgager

Also consider that most people get burned in mortgages. They take out a 25-year mortgage to get a lower monthly payment but then they decide to move somewhere else within 10 years. Mortgages are structured so that you pay all of the interest off for the remainder of the term for every dollar of equity you gain, so over the first 10 years of a 25-year mortgage, you only acquire 10% of the equity. Over the first four years, you only get 1% equity. IMHO, if you need to take out more than a 15-year mortgage, then you are in the habit of living beyond your means and you can ultimately expect financial ruin in your lifetime.

A better plan would be to pass up the “great” house and get a 10-year mortgage on an “okay” house. Then, after you have full ownership of the “okay” house, you can sell it and be able to afford the “great” house without giving the bank huge bushels of profit at your expense.

You want the “miracle” of compount interest to be working for you, not against you. If you take out a really long mortgage, then you will ultimately pay a huge ton of money more for your house that it is worth. The banks aren't stupid; they get rich off of you. Maybe a good investment for the principal of a rich renter is to lend his money in a mortgage arrangement to someone else, but apparently, the stock market is even better.

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