Renting VS. Buying and Net Worth Potential

Over the past 8 years working with many different clients, unfortunately, I have seen many clients who have rented for years and have trouble accumulating substantial wealth.

On the other hand, I’ve seen many clients build the majority of their wealth through homeownership.

My Experience With Real Estate

• We bought our first home in Indianapolis, IN in December 2017 for $198,000.

• Fast forward to today, the value of the Indianapolis home has appreciated to an estimated $315,000, and I have netted approximately $15,000 (7.8%)/year from owning it (even after $40,000 of combined expenses!).

• Additionally, I rent out the property for a gross income of $18,000/year, which we were able to use towards the purchase of our next home in Mesa, AZ.

Our decision to purchase a home in our early 20s has been one of the best financial moves we made.

5-7 Year Rule

It is very important to have a time horizon of 5-7+ years when buying a home. You'll need this time to ride out any market fluctuations, pay down your mortgage, and increase the wealth gap of asset price and amount due to the bank (home equity).

HomeOwnership Advantages

There are several advantages to owning a home that many renters miss out on.

• Mortgages are the only way to really leverage your investments long-term with minimal risk.

• Forced to, “pay yourself first” by paying your mortgage every month

• Unlike renting, homeowners have the ability to personalize their home and invest in your own asset versus someone else's business or fund. This move is an entrepreneurial move that can result in many unforeseen long-term benefits.

• One of the significant advantages of owning a home is access to home equity.

  • You can use your home equity for various purposes, including paying for your child's education, investing in a new business, or consolidating debt.

• Furthermore, locked-in mortgage payments offer stability and predictability compared to the ever-increasing rental rates.

• According to the Federal Reserve's Survey of Consumer Finances, the average homeowner's net worth is 40 times higher than the average renter's net worth.

• First-time homebuyers benefit from lower mortgage rates and property taxes.

• Additionally, the interest paid on your mortgage is tax-deductible, which lowers your taxable income.

• Homeowners experience a wealth gap over time as they have a fixed payment and an increasing real estate market value.

  • As an example, even during the 2008 financial crisis, homeowners who never refinanced their homes experienced positive equity after seven years, despite buying at the market's peak.

“Location, Location, Location”

The famous words of any good real estate investor. You want to buy in a growing area that does not have inflated prices. Avoid over hyped markets that may only be around due to the covid-era of, “work-from-home” freedom. Also, avoid places that the population is decreasing or the economy is heavily dependent on a single industry. Look at the old steel mill towns like Gary, IN. They did not end up being good long-term real estate holds due to the steel industry dying out.

Scarcity, improvements, permanence of investment, and location or area preference are all economic characteristics that impact the value of land.

• Scarcity: It’s true what they say—you can’t make more land. In addition, not all land is suitable or available for building. If land is scarce, its value will likely be greater than if it is plentiful.

• Improvements: Usually, the term "improvement" refers to making something better. In the real estate world, improvements are structures, such as buildings, sheds, barns, fences, etc., that are placed on land. The condition and types of improvements on a property can impact value either positively or negatively. Improvements can also positively or negatively impact the value of surrounding properties or an entire community. For example, something as simple as a rundown house in a neighborhood can have an adverse impact on the value of neighboring properties. Proximity to commercial or industrial properties can adversely impact the value of entire neighborhoods or communities.

• Permanence of investment: The cost and nature of infrastructure improvements (roads, underground water, wastewater, natural gas, or electric installations) are sizeable and can't be easily reversed, and these infrastructure investments have relatively stable returns over time. Thus, these types of improvements represent "permanence."

• Location or area preference: A property's value is in large part dependent on its situs (location). For example, land on one side of a river may be perceived to be more valuable than land directly across the same river.

Avoid These Markets:

• New/hot market areas with year-over-year growth of more than 15% over the last decade are what I call "unforeseeable markets." These markets lack sufficient history to predict future values. However, buying in these areas may be lucrative, but one should be cautious and exercise due diligence to avoid making a costly mistake.

• Markets with low to no growth/ stagnant or decreasing population.

• Markets heavily dependent on a single industry for the town's growth.

Lastly, renting may seem like a cheaper option, but it comes with many hidden costs. The average renter spends around 30% of their income on rent and does not build equity.

What's Your Vision?

If you are a single person who has a low cost of rent compared to the local area and plan to invest the difference, thus don’t believe real estate is for you, ask yourself these questions:

1. Do you plan to have a family?

2. Would your current living conditions be suitable for a spouse or child?

3. How do you take advantage of leverage and tax deductions?

4. What is your plan for constantly increasing rental rates?

5. Do you pay yourself first before anything else? If yes, how?

6. Do you have any assets outside of retirement plans?

Renting may seem like an easy and affordable option, but it can be detrimental to your net worth potential.

What you’ll find is most people run out of space and need to upgrade to a bigger space as their family grows. But if you never hop onto the equity train then you’ll have no help with the increased cost of living. Rather your rates and rules will constantly be defined by a landlord.

Building equity early on is the only way for it to be usable by the time you need it.

Owning a home provides stability, predictability, and access to home equity, which can be leveraged for other investments. Homeownership is not just a place to live but also an investment in your future.

If you're seeking advice on home ownership, renting, or how to finance your purchases, Plan With John can help! Schedule Your Review Today by clicking the button below.

Schedule Review With Johnathon Lawson, CFP®

Examples given are for illustrative purposes only, actual results may differ substantially.

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