Physician Finances

Your Parents Were Wrong – A House Is Not Your Best Investment

With every monthly rent payment, you think to yourself: “Why am I just throwing my money away when I could be building equity if I buy a house?” Indeed, home ownership is often considered a core part of the American dream. On the surface, it does seem like it is financially wiser to buy a home rather than rent. After all, house values rise with time and when you eventually sell your house, you get all of that appreciated value back as an investment return. Plus, you’ll get back a lot of the monthly mortgage payments you made before selling the house and you get to write off interest and property taxes from your income tax. Well… not so fast. Buying a house as a primary residence is usually not a good idea from purely an investment standpoint. When we bought our first house in 1988, the conventional wisdom was that you have to own a house for 3 years in order to break-even on the sale of your house. But that number was probably incorrect in 1988 and it is definitely incorrect in 2023.

This year, the median price of an existing home in the United States is currently $416,100. There is tremendous geographic variation, however – the median price in Ohio is $219,903 whereas the median price in California is $750,080. The average size of a house in both states is 1,630 sq ft and 2 bedrooms. Newly build homes are generally more expensive and larger. Houses lose value in some years and gain value in others but on average, homes appreciate at 3-4% per year. The average cost to rent a 2 bedroom house in Ohio is $1,250/month and in California is $2,795.

So, let’s use Columbus, Ohio as an example. We’ll use the following assumptions based on the current Columbus median costs and tax rates:

  • Purchase cost of a 3-bedroom house of $285,000
  • Rental cost of a 3-bedroom house of $1,745 per month.
  • Rental inflation rate 2.5% per year
  • Appreciated value of the house at 3% per year
  • Real estate sales commission of 6%
  • Property tax of 2% of appraised value per year
  • Down payment of 20% ($57,000)
  • Mortgage interest rate of 7% on a 30-year loan
  • Homeowner’s insurance rate 0.4% of appraised value per year
  • Closing costs of 1.5% when buying
  • Closing costs of 0.75% when selling
  • Standard federal income tax deduction (married filing jointly) of $27,700
  • Average home repair and upkeep costs of 2% of appraised value per year
  • Cost to prepare house for sale of 1%
  • Average annual return of mixed stock/bond mutual fund of 7%

There are many costs that most homebuyers do not consider when purchasing a house. Yard maintenance, landscaping, and home repairs. Homeowners insurance. Property tax. Realtor’s commission when selling. Closing costs when buying. Closing costs when selling. The cost of staging and preparing the house to be sold. All of these hidden costs add up, often unseen at the time of purchasing a house – and they significantly erode the return on the investment of the value of the house. Furthermore, as the appraised value of the house increases each year, so does the amount of property tax, homeowner’s insurance, upkeep/repair costs, realtor’s commission, and closing costs.  In addition, there is another hidden cost – the lost income had the amount of the down payment been invested in stocks or bonds instead of used to purchase a house.

The difference between buying and renting

Using the numbers for Columbus, Ohio above, let’s look at what happens when you buy your own home and then sell after different numbers of years versus renting for the same number of years. We will include all of the various costs associated with the initial purchase, annual homeowner expenses, and sale of the house after that number of years, minus the equity in the home at the time of sale. For rent, we will compare the total amount of rent paid over those years minus the investment income had the amount of the house down payment been invested in stocks and bonds.

Year 1. Selling the house after only one year of ownership is very costly with a net expense of $43,859 compared to a net rental expense of $17,474. By doing the math, this means that you would spend $26,115 more to buy a house rather than rent a similar house.

Year 3. Selling the house after 3 years results in a net expense of $77,448 compared to a net rental expense of $53,199. This means that you would spend $24,249 more to buy a house rather than rent a similar house.

Year 5. Selling the house after 5 years results in a net expense of $110,394 compared to a net rental expense of $89,908. This means that you would spend $20,487 more to buy a house rather than rent a similar house.

Year 10. Selling the house after 10 years results in a net expense of $187,525 compared to a net rental expense of $185,411. This means that you would spend $2,115 more to buy a house rather than rent a similar house.

Year 11. We finally break even. Selling the house after 11 years results in a net expense of $201,832 compared to a net rental expense of $205,040. This means that you would spend $3,208 less to buy a house rather than rent a similar house. In other words, it requires owning a house for 11 years before it is more financially advantageous to buy versus rent the house.

But you might ask “What about those tax write-offs?” The changes to the federal tax code in 2016 included a significant increase in the standard deduction. In 2023, if you file single, the standard deduction is $13,850 and if you are married and file jointly, the standard deduction is $27,700. You can only take a tax deduction on your mortgage interest and your property tax if you itemize your deductions and you can only itemize if your deductions total greater than the standard deduction amount. On a $285,000 house, the mortgage interest plus the property tax would be $20,616 in the first year, falling substantially below the standard deduction amount of $27,700. Itemizing deductions is only advantageous if you have a lot of other deductions (such as charitable deductions) or if you buy a more expensive house (with higher annual mortgage interest and higher property taxes). The bottom line is that most people cannot deduct their mortgage interest and property tax on a $285,000 house.

These calculations are based on today’s economy. If and when mortgage interest rates fall, it may take fewer than 11 years to break-even on owning a home versus renting. Also, if Congress changes the tax code and reduces the standard deduction it may take fewer than 11 years. If you live in a state where the average housing costs are more expensive (such as California or Hawaii), then it may take fewer than 11 years for home ownership to be financially advantageous compared to renting.

The value of home ownership can be more than just money

There are plenty of reasons to buy a house other than financial. Maybe you want to re-do the landscaping or put in a basketball pole by the driveway. Maybe you want to paint the walls a different color or replace the kitchen counters. Maybe the neighborhood you want to move into has a lot of houses for sale but few houses for rent. Maybe you worry that your landlord will terminate your lease after a year or two in order to sell the house that you have been renting. Maybe owning your own home is just psychologically important to you.

But buying a house has risks. In 2007, the housing market crashed and home prices plummeted. It took years for home prices to recover to their pre-2007 prices. Many people who sold their homes during these years lost a lot of money. No one can predict what the housing market will be in the future and it is possible that if we have another crash in the housing market 10 years from now, it could take even longer than 11 years for buying a house to be financially more advisable than renting. There is also the risk of unexpected major expenses such as a new roof, new furnace, repairing damage from a broken water pipe, etc. These expenses can be tens of thousands of dollars that if you rent, your landlord has to cover but if you own the home, you’ll be stuck with the bill.

Your “forever home” won’t be

In past generations, many people bought a house and then lived in it for their entire life. When you are in your 20’s or 30’s, it is easy to think that the house you are buying will be the one you will stay in forever. But life happens and things change. Maybe you have a kid or have more kids. Maybe you or your spouse get a new job in another city. Maybe your income goes up and you want something nicer.

The average American expects to live in the home that they buy for 15 years. However, reality is very different – the mean duration of home ownership in the U.S. is only 8 years. For first-time home owners, the duration of ownership is even shorter at 3-5 years. The duration of home ownership increased after 2010, largely due to the housing market crash that resulted in people holding onto their homes rather than selling them for less than they bought them for. Prior to 2010, the median duration of home ownership was only 5-6 years. The bottom line is that most people do not live in their home for as long as they think they will.

So, should I buy or should I rent?

Based on the current interest rates and tax laws, you are financially better off renting if you stay in an average sized house in Ohio for less than 11 years. This is especially true for residents or fellows who do not know where they will be practicing in 3-5 years, when they finish their training. For people who anticipate living in a house for less than 11 years, the decision to buy a house should be because of the non-financial reasons of home ownership but with the realization that that those reasons come at a monetary cost. Each person should decide for himself/herself whether home ownership for less than 11 years is worth it.

December 6, 2023

By James Allen, MD

I am a Professor Emeritus of Internal Medicine at the Ohio State University and former Medical Director of Ohio State University East Hospital