Buying vs. Renting a Home: Studies Show Buying Wins

by admin on February 22, 2012

The KCM blog published an article by Ken H. Johnson, Ph.D. — Florida International University (FIU) and Editor of the Journal of Housing Research, titled Creating Wealth Through Homeownership – The Proof.  We thought you might find it interesting in case you are considering of purchasing a home or continuing to rent. Here is Ken’s article:

Several real estate economists have shown that the average homeowner accumulates more overall wealth than the average renter.[i]  However, it is not clear how this is done.  Is it that owned property usually appreciates at such a rate that, after considering leverage, returns to ownership are extraordinarily high?  Said another way, might homeowners accumulate more overall wealth because ownership is a great levered equity creator through property appreciation?  Or, is it that owners acquire greater wealth, on average, because they are systematically paying down a mortgage thereby creating equity thanks to loan amortization?  In other words, paying off property creates wealth.

Capella Casona, Pedregal Cabo San Lucas

In ongoing research being conducted by Beracha and Johnson,[ii] these and other questions concerning homeownership and the accumulation of wealth are being investigated.  In earlier research, Beracha and Johnson show that renting is the superior investment strategy; however, in this earlier strict horserace between buying and renting, a very bold assumption is made.  Specifically, it is assumed that any rent savings (from lower rent versus mortgage payments) are reinvested without fail. Thereby, after balancing all of the costs and benefits from ownership and comparing them to renters’ portfolios from reinvesting rent savings, renting wins.

The question, however, very quickly becomes that, in a setting where Americans generally save less than 5% of their disposable income, is this assumption realistic and how might the removal of this reinvestment decision alter the outcome of the horserace between buying and renting?  As part of their current research, this question is directly addressed.  In particular, Beracha and Johnson find that after allowing renters to spend any rent savings on consumption (beer, cookies, healthcare, education, etc.), ownership leads to greater wealth accumulation, on average.  The graph below highlights this finding.

The graph looks at the ratio of renters’ portfolio values to owners’ proceeds from sale for the entire U.S. between 1978 and 2010 both with strict reinvestment of rent savings and without reinvestment of rent savings.[iii]  Clearly, numbers greater than 1 indicate that renting leads to greater wealth accumulations, while numbers less than 1 indicate that homeownership creates greater wealth, on average.

When renters are forced to reinvest (top line in the graph), the results confirm the earlier findings of Beracha and Johnson (2012).  That is, in a strict horserace between buying and renting, renting wins in the vast majority of cases.  However, when renters are allowed to spend rent savings on consumption (i.e. economically act like the typical American consumer), homeownership wins in virtually all instances.  Notice that in the bottom line of the graph (no reinvestment), the renters’ portfolio values divided by owners’ sale proceeds is great than 1 for only four of the 32 years of the study.  Thus, when renters are allowed to spend rent savings, homeownership is the clear winner in the wealth accumulation horserace.

Finally, in the same current research, Beracha and Johnson find that allowing for property appreciation rates to increase as much as 20% over their actual historic values results in virtually no change in the outcomes concerning wealth accumulation.  That is, property appreciation contributes only marginally to wealth accumulation.

Luxury residence in Pedregal Cabo San Lucas

Implications

Without proof many have speculated about this outcome for years.  However, there is now actual quantifiable evidence that homeownership is not the great levered equity creator that it has so often been touted to be.  Instead, it appears that homeownership creates extra wealth mainly through its ability to force owners to save rather than through property appreciation.  Thus, homeownership appears to be a self-imposed savings plan, which through time leads to greater wealth accumulation as compared to comparable renters.  In short, buying a home makes Americans save.

Who says that Americans are horrible savers?  Apparently, we are not.  We have simply been saving through our homes rather than putting our savings in the bank.

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In addition to the article above read also an article published by CNN Money, “Buying vs. Rent: These Days, Buying Wins”, which adds:

First, rents, though mostly stagnant the past few years, are expected to head higher as more people bitten by the housing bust turn to renting. Rents could rise 7% in each of the next two years, according to Peggy Alford, president of Rent.com.

Second, home prices have finally dropped enough to create a buying opportunity. Nationally, prices are down 32% from their peak, set in 2006.

Pedregal de Cabo San Lucas is the only luxury residential development located just steps away from the world class Cabo San Lucas marina, downtown and popular landmark Land's End.

Owning in Mexico today is easier and safer than ever before. Read more about it here, and check the available properties in for sale (homes and homesites) in Pedregal de Cabo San Lucas, Pedregal de La Paz, or see the directory of listings by Coldwell Banker Riveras in all the towns across Baja California Sur.  350 sunny days per year, proximity to the US and affordable living makes Baja a very desired place to live.

 

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Endnotes
[i] Homeownership is the most viable path to wealth creation for the majority of Americans.  See Engelhardt (1994), Haurin, Hendershott and Wachter (1996), and Rohe, Van Zandt and McCarhty (2002), among others.
[ii] Eli Beracha and Ken H. Johnson, 2012, Beer and Cookies Impact on Homeowners’ Wealth Accumulation, ongoing research.
[iii] The research assumes 8-year holding periods.  When the holding period is allowed to vary between four and twelve years, the results change only marginally.  Thus, holding period has very little to do with the results.

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