Rent or Buy?

Whether you choose to rent or buy a home largely depends on your life situation, financial circumstances, and personal goals. For many first-time home buyers, this can be a challenging decision. While homeownership can bring a sense of stability and pride, it can also introduce a financial burden that might affect your future. Here, we analyze whether you should buy or rent a home from an economic perspective using a simple and representative case. Among all the factors influencing this decision, two key parameters are particularly important: the interest rate and home appreciation.

A Simple case

Let’s assume we have $500K in cash, which we could use to purchase a 10-year-old single-family home in the Triangle area, or we could rent the same home for $2,700 per month. We plan to stay in this home for at least three years. We assume that during these three years, the interest rate will remain at 5%, and the average home appreciation rate will also be 5%.

Choice 1

Rent the home for $2,700 per month

we will deposit the cash in the bank and earn 5% interest. At the same time, we will pay $2,700 in rent per month during the 3-year period. If we do not pay the rent, then at the end of the third year, our bank account will have $578,813. The total rent paid over the three years is $97,200, and the future value of this amount at the end of the third year is $104,722. This amount will be higher than the total rent due to the interest earned. Therefore, at the end of the third year, our bank account balance will be $474,091.

Choice 2

buy the home for $500,000 as residence,

then sell the home after three years

If we buy the home for $500,000, its value will increase to $578,813 due to appreciation. The home incurs the following average annual costs: real estate tax $4,500, HOA $1,000, home insurance $1,000, and maintenance and repairs $1,000. Therefore, the total costs over three years is $22,500. The future value of these costs at the end of third year is $23,644. If we sell the home at the end of the third year and assume that the transaction costs related to the purchase and sell are 8% of the home value, then we would have $578,813*0.92 - $23,644 = $508,864 after the transaction.

Conclusion

This simple case indicates that when the interest rate is comparable to the rate of home appreciation, purchasing a home as a residence might be more economically advantageous than renting, provided that we plan to live in the home for at least three years. However, if the interest rate is significantly larger than the rate of home appreciation, this may not hold true.

Extended Analysis

We can also estimate the expected return if we buy the house, then rent it out and sell it after three years. This can be used to compare with the interest rate and determine if the investment is profitable.

Choice 3

buy the home for $500,000 as rental investment, then sell the home after three years

If we buy the house then rent it out, we will receive rent income for three years. The future value of this income at the end of the third year is $104,722. The house incurs an average annual cost of $7,500. Additionally, we use a property management company to find tenants and manage the property. The company charges a fee equivalent to 1.75 months’ rent per year. The average vacancy rate is one month per year. At the end of the third year, the house is worth $578,813 and we sell it with an 8% transaction cost. After the transaction, we will have $578,813*0.92 - $23,644 + $104,722*0.77 = $589,500. This results in an annual return of 6%. Therefore, the return on this investment will be higher than the 5% interest earned by depositing $500,000 in the bank.