Diversify Your Portfolio by Renting
At the most basic level of financial investment, there are two maxims that can often be mutually exclusive. The first is to hedge your bets by diversifying your portfolio and spreading out your risk. The second is to invest in where you live; more specifically, if you are going to be paying a large percentage of your income towards your home, then it makes a lot of sense to be making payments towards something that you will someday own and may also, if all goes according to plan, appreciate in value.
The problem with all this great advice is that it can be difficult to diversify your portfolio when all your money is going towards a mortgage. This rings especially true during a turbulent market when people's adjustable mortgage rates are increasing and forecasted appreciation is suspect; it is making more and more sense, from an investment perspective, to rent an apartment rather than buy a house.
This strategy is buttressed by a study done by three Federal Reserve economists, who looked at the long-term relationship between home prices and rents. They found that from 1960 through 1995 annual rents averaged from 5 to 5.25 percent of home prices. Then the figure started falling dramatically after 1995, reaching 3.5 percent at the end of 2006. In other words, rents are unusually low relative to home prices, and to get back to normal, apartment rents would have to soar or prices to plummet.
Check out this video from CNBC, which features a contentious conversation between R. Donahue Peebles, Chairman and CEO of The Peebles Corporation and Wall Street Journal Editor David Crook concerning the pros and cons of buying a house as an investment. The two debate the potential returns over both the short and long term in the housing market versus alternative investing options.
Net, net, if you're on the fence as to whether to own or rent your next place, try to focus as much on the economics as on the excitement of having your own white picket fence. Be sure to research adequately and explore and compare your options by using internet resources such as MyNewPlace so that you know that you are making an informed choice that will meet your needs.
Let us know about your experiences on making decisions on whether to buy or rent from an investment perspective. Have you found that buying a home has put all of your investment eggs in one basket?
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February 20th, 2008 at 1:43 pm
An important and eloquently expressed insight. Certain economists and housing experts have been building upon this research in recent years. Among the more recent and specific evidence is a report by Craig Somerville and colleagues (titled something to the effect of “Do Renters Miss the Boat?" and published in a volume from last year called “Household Credit Usage"), in which the authors compare the wealth generated by owning versus renting and buying stocks in Canadian cities. The result: in 7 of the 9 cities, households did in fact do better for themselves by renting and investing instead of purchasing their homes.
Im sure you guys are aware that the Harvard Joint Center for Housing Studies has also looked at this (see, for example, Belsky, Retsinas, and Dudas 2005 report, The Financial Returns to Low-Income Homeownership ). These guys recently edited a book published by the Brookings Institution on rental housing policy, which may be worth checking out: http://www.brookings.edu/press/Books/2007/revisitingrentalhousing.aspx.
Its a highly relevant question that seems to finally be descending from the ivory towers, as it gets increasingly pondered by consumers and policymakers alike. What's unfortunate is that it took an economic crisis before most people took notice. Hats off to you guys for staying current with/ahead of the popular paradigm.
February 21st, 2008 at 2:09 pm
As we wait for the housing market to “bottom out", renting may be the best investment opportunity available. It is predicted my most economist that our recession will be shallow and will last no more than 18 months, however, they all seem to feel the housing market will bottom out sometime late Q2 ‘08. With the corresponding rate reduction already in place (with more anticipated)sitting on your cash and waiting for the final market correction may turn out to be the best investment you can make. Obviously this is a nationwide problem, however, there are some markets that seem to be harder hit than others and may take longer to “bottom out" or “rebound". Places like Florida, Nevada, Arizona, California come to mind. The New England states seem to have avoided the wild ride so far and most don't see much opportunity in that part of the country. So hold on while the wild ride continues, sit on your cash, and in the meantime rent!!
February 25th, 2008 at 3:53 pm
thanks for the detailed feedback, gertrude and ricardo. it certainly is an interesting question.
glad to see we are in good company with the Brookings Institution.
These links, are helpful quantitative devices:
http://finance.move.com/homefinance/Calculators/RentBuy.asp?poe=homestore and http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html#
They are from move.com and the http://www.nytimes.com respectively, are helpful starting points for investigating options and analyzing data.