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Own vs. rent from a first-time buyer’s view

One of the nation’s top real estate consulting firms took a recent run at the Buy vs. Rent question, targeting “outdated” assumptions that have long been used when analyzing first-time homebuyers.

Erik Franks, manager at Irvine, California-based John Burns Consulting, found that homeownership costs more than renting in most areas of the country despite the fact that “many economists with calculators claim the opposite.”

Housing payments were based on a 5 percent down payment on a 30-year, fixed-rate mortgage plus property taxes, homeowners’ insurance and mortgage insurance. The study used 80 percent of a market’s detached, resale price and assumed no tax deduction. Apartment rents were based on a market’s average effective rate in a large complex.

Effective rent is the net amount after any incentives. For example, if an apartment is listed for $1,200 per month but the landlord offers one month’s free rent, that would take off $100 per month, arriving at an effective rent of $1,100 per month.

Given those parameters, the Burns study found that rent payments were 34 percent cheaper than owning in Seattle, a difference of approximately $537 a month.

“Don’t get me wrong,” Franks said. “We believe homeownership is a great long-term investment for those with stable employment. It is just not less expensive than renting.”

The study runs counter to a buy-rent piece produced by Seattle-based Zillow that found renters can expect to spend 30 percent of their income on rent while buyers can expect to spend 15 percent of their monthly income on a monthly mortgage payment.

The criteria for the Zillow study differed, especially with mortgage affordability. Zillow assumed a 20 percent down payment.

“There are good reasons to rent temporarily – when you move to a new city for example,” said Svenja Gudell, Zillow chief economist. “But from an affordability perspective, rents are crazy right now. If you can possibly come up with a down payment, then it’s a good time to buy a home and start putting your money toward a mortgage.”

Franks said that his company recently reviewed one highly publicized calculation that owning was cheaper than renting in almost all markets. He claimed that the calculation had a number of “outdated” assumptions, including:

Outdated assumption #1: Buyers have a 20 percent down payment. “In reality, own versus rent is a first-time buyer decision, and the vast majority of first-time buyers today make down payments of 10 percent or less,” Franks wrote.

Outdated assumption #2: Buyers are in a 25 percent tax bracket and thus save 25 percent of their interest payment in taxes. “Today, half of all homebuyers obtain a mortgage less than the median resale price of $236,000 and 100 percent of the annual interest on that mortgage is less than the standard itemized deduction of $12,000 per couple, so many entry-level buyers actually save zero dollars in taxes,” Franks said. “Those that itemize likely only save a small percentage of the interest payment in taxes.”

Outdated assumption #3: Future home price appreciation should be included in the own-versus-rent decision. “Most indices show that home prices have historically appreciated 1-2 percent faster than incomes, but over a 30-year period of falling mortgage rates,” Franks said. “Assuming you believe rates will rise or at least stay flat, price appreciation might be an aggressive assumption.”

The Burns study noted that the premium homeowners pay to own versus rent varies across all cities. While the average United States homeownership premium over renting is $146 per month, housing payments in San Francisco are more than $2,500 more per month to own an entry-level home than to rent an apartment.

In some markets in the Midwest and the Southeast, like Minneapolis and Tampa, the monthly payments (excluding maintenance) are currently cheaper to own than rent, according to the Burns study. These areas are still extremely affordable, thanks to mortgage rates and home prices that have increased over the past few years but not enough to return to their long-term average.

“Potential entry-level homebuyers focus on saving a small down payment and affording the homeownership costs,” Franks said. “They compare the monthly cost of renting to the monthly cost of owning, realizing that the owned home is usually much nicer than the rental and is thus more expensive.

“If owning were truly cheaper than renting, far more renters would be buying homes. Never forget that headlines can be misleading.”

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