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why pay rent?

 
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leaving boston



Joined: 26 Jul 2006
Posts: 11
Location: Rhode Island

PostPosted: Tue Jan 16, 2007 8:28 am GMT    Post subject: why pay rent? Reply with quote

My wife and I rent one side of a duplex. It's comfortable: we have room and we're saving money every month. We'll pay about $24,000 of rent this year. We have a reoccurring argument: why are we throwing away $24,000 a year, when we could be building equity.

Everyone in both of our families is busy "building equity." When this argument occurs, even when I'm surround by my own flesh and blood, I can count on no support: I am in fact an uncivilized savage idiot that can't understand the most basic economic concept: rent = waste and paying a mortgage = equity. Am I surrounded by happy homeowners who are in thier own world of blissful ignorance, or could I be in denial?

How did my wife and everyone around me suddenly become the spokes-person from Century 21? "The rates are still low." "Now is the time to buy." "We've reached a bottom."

So why am I sitting among the King's court: surrounded by wise counsel, and everyone is praising, "what an exquisite dress the King is wearing." Should I be worried that the King is naked, or should I be thinking that, "yes, he is naked, everyone knows he's naked too, but he has such clear complexion and superb personal hygiene."

Am I missing something in my understanding of what "equity" is? If all my friends are buying houses, shouldn't I? or "How I stopped worrying and learned to love the bomb."
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admin
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Joined: 14 Jul 2005
Posts: 1826
Location: Greater Boston

PostPosted: Fri Jan 19, 2007 3:30 pm GMT    Post subject: Reply with quote

Equity is just a fancy word for savings. Technically, it usually refers to ownership in property or a business, but the key point is that it isn't inherently more beneficial than savings in some other form. In fact, in some aspects equity in real estate is less beneficial than many other types of savings because you are taxed on it intermittently rather than just at the time of sale, it is very illiquid, and it goes directly against the principle of diversification. Other aspects can be more favorable (e.g., some potential tax advantages), so it's not a universally applicable choice as to what the best vehicle for savings for an individual's situation would be. Regardless, you could very feasibly accumulate more equity by renting and using the price difference between buying and renting to dollar cost average into stock indices - or use any other savings vehicle if you don't feel an overwhelming need to be able to call it "equity."

As for the belief that renting throws money away, what those who state this fail to consider is that owning can "throw" even more money away. I think that some people believe that renting throws money away because rent is a sunk cost and cannot be recovered (apart from the minor Massachusetts tax deduction), whereas with owning you presumably get some money back when you are done with the property and sell it. However, owning has its own set of sunk costs which cannot be recovered either, and I have started a list of these at http://www.bostonbubble.com/forums/viewtopic.php?t=29 The biggest (for an 80+% loan) and easiest to understand is probably the mortgage interest. When someone tells me that renting is throwing money away, I point out that so is mortgage interest and usually to a larger extent. Another big sunk cost, if your down payment is large, is opportunity cost. Also, at present while prices are higher than their historical relationship to incomes, the risk of negative appreciation is another way to throw money away by buying.

I would say run the numbers for your own situation and see what it would take to buy something equivalent to what you are renting, both in terms of space and location. If the numbers come out in favor of renting, then the next time somebody tells you that you are throwing money away on rent you can say that you ran the numbers and buying would throw more money away for your situation. You can also let them know that you are getting extra equity by renting because you have more money to put toward the S&P 500 (or whatever else you want).

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AgentGrn



Joined: 28 Sep 2006
Posts: 82

PostPosted: Tue Jan 23, 2007 6:42 pm GMT    Post subject: Re: why pay rent? Reply with quote

leaving boston wrote:
Everyone in both of our families is busy "building equity." When this argument occurs, even when I'm surround by my own flesh and blood, I can count on no support: I am in fact an uncivilized savage idiot that can't understand the most basic economic concept: rent = waste and paying a mortgage = equity. Am I surrounded by happy homeowners who are in thier own world of blissful ignorance, or could I be in denial?

The question I would ask either of your families is ... did they buy in an overheated market? I would venture to guess that they probably did not. Your side of the duplex probably would cost more than the $2k/mo you spend now if you were to buy it.

It doesn't matter how much equity you have built up unless you have enough to always be afloat no matter what happens with pricing. The latest information from The Warren Group points to a 5.8% price drop overall last year. Certainly, that's more once inflation is considered.

Once the ARM resets hit this year and next year, it'll put a further downward pressure on prices. The glut of empty housing should put a downward pressure on rents as well, or keep them mostly steady depending on the condition of your rental market.

It's anyone's guess what 2007 is going to bring, but I wouldn't make the mistake of calling it a "soft landing". Even with the current price drops, the housing stock is still unaffordable and that needs to correct itself. It always does.
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