See that house over there? It’s an investment!

Few topics in personal finance and in the early retirement community stir up emotions as nicely as the pros and cons of homeownership. Some folks in the FIRE community are renters and swear by it and others are very happy homeowners and/or real estate investors. Neither side is wrong. Those with more nomadic lifestyles probably prefer renting and the those with kids in school and strong ties to the local community are apparently happy homeowners. Normally, the two sides just coexist peacefully but discussions normally get heated and sparks fly when one side accuses the other of doing something wrong. If I had to distill the arguments of the two sides into bumper stickers it would be:

  • Homeowners: Renting is just throwing away money!
  • Renters: A house is not an investment at all. Or it’s a terrible investment!

But of course, both claims are just that: bumper stickers. And both claims are demonstrably false and/or crude generalizations! Let’s look more into the math of the rent vs. own tradeoff…

Debunking the “Throwing Away Money” claim

This is a free country and a capitalist market economy (for the most part, at least) and consumers have the option of either buying goods and services in the marketplace or producing them themselves. Renting is no more throwing away money than buying eggs at the grocery store or paying for a haircut. Sure, I could have cut my own hair or set up a chicken coop in our apartment (might violate our condo rules, though), but I decided to spend my time and money more productively.

A rental property is clearly an investment

Probably even the most militant homeownership opponents would have to admit that rental properties are indeed investments. You put money in an asset that pays an income stream and has the potential for some capital gains on top of that. In fact, in many ways, rental real estate is a pretty attractive asset class, especially for early retirees. With an equity index portfolio, you get a measly 2% dividend yield and you have to worry about pretty substantial price swings. With bonds, you get a pathetic sub-3% yield and no potential for capital appreciation. In contrast, rental properties have the potential to generate relatively stable income without the need of liquidating principal, which is convenient considering the illiquidity of the asset. Stable income and not having to sell the principal reduces Sequence of Return Risk in retirement! Moreover, both the income flow and the property value will likely keep up with inflation. In fact, rental prices are a large chunk of the Consumer Price Index (CPI), so by construction, rental income is a hedge against inflation.

But even owner-occupied housing in an investment!

This is one is harder to swallow! After all, shouldn’t an investment pay some sort of a return? A dividend or interest payment? Let’s go back to that example buying a chicken as an “investment.” The amount of money we save every day by not having to buy an egg at the grocery store should be part of the return calculation. It’s a dividend, even though it’s paid in-kind and not in dollars. Therefore, an owner-occupied house pays rental income, too:

“My [primary residence] is an investment for the same reason a rental property is an investment. It generates a rental service flow. As a homeowner, I save the expenditure I would have otherwise spent on rent. As a landlord, I pocket the money.” (Quote from Big ERN in the ChooseFI Facebook Group)

A dollar saved is a dollar earned! In other words, I think of a primary residence as generating rental income. It saves me the cost of renting a house in the marketplace. And keep in mind that accounting for this income from owner-occupied housing is exactly what the experts do:

The implicit rental income is counted in GDP; to the tune of $1,500,000,000,000 per year!

Yup, you heard that right; according to the Bureau of Economic Analysis, Table 2.4.5U, homeowners are generating rental income, effectively renting properties to/from themselves for a total value of over $1.5 trillion dollars per year (trillion with a “t”!!!). That amount is …

  • … more than the entire annual GDP of Canada! Which is ironic because my favorite anti-homeownership bloggers are from Canada! 🙂
  • … three times the amount that all non-homeowners spend on rent,
  • … over five times the amount we spend on new motor vehicles (autos and light trucks),
  • … and 24 times the amount consumers spend on new computers.
BEA table 245U Part2a
Imputed rental of owner-occupied nonfarm housing. That’s “geek-lingo” for the $1.5 trillion (with a “t”!!!) of consumption of implicit rental income and it’s counted in GDP!

What does an actual expert say?

If you ask folks who actually understand real estate investing (for full disclosure, I don’t consider myself a member of that group) you’ll find that for the long-term real estate investors, income is king. For example, Coach Carson has an amazing post on how to run the numbers on real estate investments. Did you notice one thing almost completely missing from that post? Where does he factor in home price appreciation? He talks about the gross rent multiplier, net operating income, Cap Rate, etc. and none of these ever take into account the property appreciation. Income is the bread and butter of the (long-term) real estate investment. Price appreciation, because it’s mostly out of our control, is nice. It’s the cherry on top. But you don’t rely on it.

(for full disclosure: there are many other niches in the real estate investing business where capital gains are indeed king, i.e., flipping foreclosures, etc.)

An owner-occupied house can be a pretty good investment!

How much of a difference does it make when we recognize the implicit rental income from owning a house? A huge difference! Let’s take an average house in an average neighborhood in an average town in America: Omaha, Nebraska. You can’t get any more average than that! Here’s a Zillow listing I found:

Zillow Screenshot 01aZillow Screenshot 02a

Let’s run with a home value of $166,000 and assume that if we had rented this property it would have cost us $1,375 a month. Annualized that’s just under 10% of the purchase price, so probably a little less than what most of the pro-real estate investors would find attractive. But for most middle-class neighborhoods in moderately priced towns in the U.S., single-family homes will have a rental yield of somewhere between 8-10%.

Let’s also make some other pretty reasonable assumptions about the mortgage, property taxes, insurance, maintenance cost, transaction costs, a 10-year holding period, and a property appreciation of only 2% annually, i.e., just keeping up with average inflation over the last few decades:

Assumptions for IRR calculations

If you like to change any of the assumptions, please check out the Google Sheet. As always, you have to save your own copy first before you make any changes! Fields in orange are the ones you specify, the rest is calculated by the sheet!

The main results:

  • Despite the measly 2% property appreciation, the return numbers look quite attractive. The IRR over the entire 10-year period is almost 12%. And this is with zero tax advantage, i.e., assuming that interest and property taxes are not tax-deductible.
  • The year 1 net operating income is $8,200 which implies a Cap Rate of just under 5%. The Year 1 Cash-on-Cash return, which does take into account leverage and the moderate appreciation is slightly above 12% (for full disclosure: I’m counting the 2% appreciation in this calculation).

Of course, the results are highly dependent on the parameters:

  • Set the home price appreciation to 0% over the next ten years and your IRR drops to only 5.3%. But a 3% price appreciation would drive the IRR to above 14%!
  • Leverage makes a big difference. If you own the house outright (set LTV=0%, i.e., no mortgage) the IRR goes down to 6.4%. For an investment that pays a stable “dividend” of housing flows that’s still a very attractive return. Much higher than today’s bond yields!

OK, I can already hear one objection:

“my $300/month roommate deal would have been even better!”

Yes, and? That’s comparing apples and oranges. We have to make two decisions here:

  1. (Scale): do we live with roommates or in an efficiency or in a One Bedroom apartment or in a Three-Bedroom house with a yard, etc.?
  2. (ownership structure): the rent vs. own decision.

If you indeed think that a 1-BR is all you need, all the more power to you. But then you should compare renting a 1-BR vs. owning that exact same (or at least comparable) 1-BR. We should not compare renting a 1-BR apartment vs. owning a 3-BR house.

What about all the other disadvantages of owning a house?

Jim Collins had a nice post, a whole laundry list of reasons why real estate is such a terrible investment. To which I can only respond: All of that is factored into the rent! Thus, you will be paying the cost of real estate transactions, the illiquidity, real estate taxes, repairs, maintenance, etc. one way or another. As a homeowner, you’ll pay that directly and as a renter you’ll pay it indirectly through higher rental costs. In other words:

Thinking that as a renter you’ll be shielded from all the disadvantages of homeownership is just as wrong as thinking that a rising crude oil price doesn’t impact you because you only buy gasoline at the gas station!

So, if we don’t want to pay for all those inconveniences of real estate then renting is not the solution. We might have to move into a tent. Or live in our car! But, just to be really clear, here are a few costs that you will be paying as a renter that a homeowner doesn’t have to pay:

  • Your market rental rate will include a provision of at least 5%, maybe even 10% of the rent to account for vacancies.
  • A landlord will require a premium for the risk of the tenant trashing the place and/or becoming delinquent.
  • Included in the rent are all the other costs of running a business like advertising, property management, tax preparation fees, LLC setup, local business licenses, etc.
  • A landlord will have to pay income tax on the (net) rental income (though there are some ways of reducing and/or delaying the tax burden). Homeowners are never taxed on any of the implicit rental income. Imagine that: $1.5 trillion every year in untaxed implicit income!
  • A landlord has to pay capital gains when selling a property (though there are creative ways to defer those, e.g., 1031 exchanges). But a married couple can sell their primary residence and pocket up to $500,000 in capital gains tax-free!

I’m not saying a house is always a good investment

Just to be clear, I don’t want to talk anyone into buying real estate. It’s a personal choice and only worthwhile if price-to-rent ratios are attractive and you are likely to stay in the same location for a while. The number one reason a house, even a one with very attractive price-to-rent multiples, can become a bad financial decision is that we extrapolate the calculations above to larger and larger houses. If that $166,000 modest house is a good investment, shouldn’t an $800,000 McMansion be an even better investment? No!

Don’t get high on your own (housing) supply!

Even if that $800k house still delivers roughly $7,000/month in housing services it’s a bad financial decision. Technically speaking, the house is still a good investment but we’re overconsuming the in-kind dividend. Of course, there is one remedy: House Hacking! Buy a larger house than we need and monetize the excess housing services by renting out the extra space. I have never done this so I will refer to the expert again, namely Coach Carson and his excellent topic on the topic of House Hacking.


I’m not dogmatic about homeownership. I have been a renter but have also owned two homes in my life and generally enjoyed the experience. After we sell our current home early next year and move to a lower-cost-of-living area we will certainly rent for a while. If we like the new surroundings and can see ourselves living there long-term we will certainly look for a permanent home.

For us, a house is most definitely an investment because it saves the rent we would otherwise pay. An in-kind dividend payment like that is even better than a cash dividend because it’s tax-free income!

I would never bank on outsized property appreciation. Quite the opposite, in my personal calculations, I assume that a home appreciates only in line with inflation and even that appreciation is only because we spend quite a bit of money to properly maintain and repair and regularly update the house. But even without any significant home price appreciation, a house can still be an awesome investment!

We hope you enjoyed today’s post! Please share your thoughts on the rent vs. own debate!

79 thoughts on “See that house over there? It’s an investment!

  1. Nice post! Lots of investments lack appreciation: Businesses buy computers, machines, trucks, airplanes, etc. and they are all investments (according to GDP tables) despite becoming worthless over time. Yet they can have astronomical IRRs!

  2. Awesome post!
    I have a (probably dumb) question – for the spreadsheet showing the housing IRR calculation, could you set it up so that users could enter the monthly rent rather than the rental yield? That seems a tiny bit more user friendly in terms of information that one could input directly from their local market. (I realize one could do the calculation outside the spreadsheet and enter the yield, but I’m lazy and want spreadsheets to do ALL the calculations 🙂 )
    Thanks for all your amazing posts – I LOVE reading them

  3. This is a great detailed post Ern. Most posts on this topic tend to try to sell you one way or another. Rent vs. buy is so clearly dependant on the situation. Thanks for putting this together. Can’t wait to mess around with the spreadsheet.

  4. Thank you for providing a balanced and objective view on this! I think a lot of bloggers are doing a disservice to their readers by only arguing one side (often dogmatically).

    Could you provide your thoughts on what a reasonable price-to-rent ratio threshold is for people who are making the decision using this logic (viewing the rent saved as an in-kind dividend, assuming the home value goes up with inflation, and assuming they will live in the property for a reasonable length of time).

    1. Thanks! Probably the best number to look at is the Cap Rate (= rental yield minus cost/hose price). That’s because, for houses in more expensive cities, the structure (which is what depreciates and needs a lot of repairs/maintenance) becomes a much smaller share of the home price. I would target a Cap rate of at least 3 to 3.5%.

  5. It is so nice to read a post on this that doesn’t say “I’m right and the other opinion is only held by idiots!”. Like most of life home ownership and renting are both full of gray areas and both can make sense depending on the host of variables you detailed. Add in the emotional attachment that often goes with a home and it is never going to be the kind of decision most people will make only using a spreadsheet. We bought our house decades ago and have never moved. Like our marriage it has lasted our family for almost 40 years and was the only house our three millennial kids ever lived in until they made their way off into the world on their own. It is just a possession I know, but it feels like more than that. It is home it is paid for and it is ours and to me at least that is a good feeling. It shouldn’t really matter when it comes to achieving FI whether you buy or rent, controlling lifestyle inflation, saving aggressively and maximizing income are all vastly more important choices. Very well researched and written post.

  6. Love the bumper sticker comment – I shall try and condense some of my posts into a bumper sticker!
    I always feel that house ownership is an easy way for the average Joe to get access to the illiquidity premium and some leverage. That provides some diversification that I value. [By average Joe I don’t mean a crazy cat who is taking advantage of put option premium skew and leverage!]
    I liked you comment about the math not scaling up. A mistake that I have made in the past

    1. Thanks AoF!!!
      One other thing I noticed about the math not scaling up: For the very fancy McMansions the rental yield is also lower, so that’s another reason to not go overboard with the house size!

  7. Great analysis! I always figured owning my home vs. paying rent was a wash or maybe I came out slightly ahead if you were to compare the actual cost of renting a 3 bed/2 bath house in my neighborhood – making an apples to apples comparison. However, I purchased the home 10 years ago so I have that lower price locked in. The math would not be as favorable with today’s prices even though rental rates have upward pressure. I’m curious to do the math and see the difference between the two and wonder if that might be a signal that the prices are a little frothy here.

    1. Well, frothy means that if buying over renting becomes profitable only if we have to factor in much higher than 2% housing inflation.
      One nice thing about expensive parts of the country where the rental yield is low is that the maintenance/repair cost should be applied only to the structure, not the land value. So, if you live in a very expensive area you’ll probably need a lot less than 2.75% maintenance cost. 🙂

  8. Like Charlie Munger has said…You should be able to give the arguments of the other side of your point better than they can.

    I feel many people have reasons on their side, but none have spelled it out for both sides. Thanks for sharing.

  9. It can be a good or a bad investment, but true it is a type of one. Still I don’t count it among investments in network since if I sell it I still have to pay your implicit rental fees to live. So I guess I’m somewhere in the middle. I fell most home purchases are unlikely to earn me a high return as a primary home. Then again it shouldn’t stop me from considering it as one part of purchasing.

    1. Again: it depends on how you define “return” – if it’s the Millenial Revolution definition I don’t expect much. But factoring in the true costs and benefits I expect as much as my portfolio return. Otherwise, I’d rent and invest the downpayment. 🙂

  10. “…you should compare renting a 1-BR vs. owning that exact same (or at least comparable) 1-BR. We should not compare renting a 1-BR apartment vs. owning a 3-BR house.”

    I’ve seen so many otherwise good sites make this lopsided comparison it’s maddening. Also, I’m a BIG fan of the Charlie Munger quote above. If you can’t see the other person’s viewpoint from their viewpoint, you’re in no position to argue!

  11. I’m a homeowner, but I still wonder if I made the right decision. First I took a big chunk of stock, and sold it to make the down payment and realtor fees. Now, every month I have to pay, not only interest on the mortgage, but also principal on top of that. Yes, on paper, the principal is an investment, but in the here-and-now it just seems like another fee I have to pay.

    Even if the house appreciates, how am I supposed to use that money? I could get a second mortgage, but then I’m stuck paying a higher bill each month. I could sell it and move somewhere cheaper, but I like living here. I could wait until I’m old and then get a reverse mortgage, but it seems crazy to spend my whole paying off the mortgage just to start borrowing from it again.

    All in all I feel like home ownership is a good deal on paper, but it’s hard to actually use that money for FIRE purposes. It works out best for people who only retire late in life, if ever, and then pass down all their money to heirs.

  12. This is a thoughtful review of a complex topic. Nice job!
    When starting out I’m glad I rented and apartment and then rented a house. I wasn’t settled and I didn’t want the mortgage and transaction costs. Later I bought and sold houses. I didn’t make a profit after factoring in all the costs. I had trouble selling one house and rented it out for a couple years. That actually worked well. I think of my primary residence as just a house to live in as opposed to an investment. I invest in REITs and commercial real estate but am looking into buying single family homes again. It is nice to own something “physical” rather than just paper money or numbers in an account somewhere. I admit that part may be more emotional than rational.

  13. I had not seen this topic broken down like this. Very nice job!

    I am all about the math. When the math tells you to do something, it is usually correct.

    However, there are some variables involved that can be more important than the math. A home can be something more than just the cost and return. It can be a sense of security for a family with kids. It makes for a solid community. A community that can provide a good education. Yes, you may be able to fine this while renting but you are not in control in that situation. If your landlord decides not to renew your lease, your family would be forced to move and possible to a new community and a new school and new neighbors. When you own a home, you can make the choices on selling or staying based on what is best for your family.

    I guess the point is there may be more to deciding to rent or buy than the math. Call it what you want but there is something to establishing a “home”. Less important without children or after they leave the nest.

  14. There are another copule other things to consider, just like as if you were living in Venezuela, homeownership would be the capital preservation king. In high inflation, homeownership would be nice. I think it as a hedge. Beyond that, there is a legal protection of your home in some countries, i.e. If you / your company were sued, all of your assets could be “arrested”, but not your single home….
    There is any kind of this legal aspects of home ownership in US?

    1. Really great point! We haven’t had the worries like that in a long time. In the U.S. one could actually spin the legal argument in the opposite direction: A house is a legal liability risk. If someone slips and falls on the sidewalk in front of your house you can be liable. Definitely something to consider!

  15. This is an interesting take on home ownership and renting. LOL @ your jab at Canadians leading the way when it comes to arguing that renting trumps buying. I experienced that first-hand and pretty much just convinced myself when we finally bought a house that we were doing it because that was what we wanted – didn’t have to make financial sense. I will take a stab at the spreadsheet and see what the numbers say.

  16. Very good post, thank you. A few notes: appreciation is somewhat suspect as it really applies to the land, not the building. The house requires maintenance and upgrading to keep its value. Check out properties where the house hasn’t been touched for a few decades, they sell for the land value, not much more. The flip-side is owning the house has lower cash flow requirements (needs, not wants). Usually the property tax, utilities, and insurance are way below rents, but doesn’t allow for maintenance (1%?) and upgrades. The only other factors driving appreciation are increasing replacement costs (labour and materials to rebuild) and market sentiment. Another consideration is the transaction costs. As your personal situation changes (kids move out, stairs become an issue, etc.) you may want to move. There is a high frictional cost to this if you own (over renting). Thanks Ern!

    1. In my calculations, I assume that the appreciation applies to both land and structure. With the maintenance and repairs category (2.75%) I mean that you keep up and renovate periodically. Bathrooms/kitchens every 20-30 years, roof every 10-20 years (depends on location), etc. So, if the structure is kept that way I can very well assume that it, too, appreciates at the general rate of inflation.

  17. Well done big ERN! Now I have a post to reference for a logical approach to the argument any time it comes up. Like you, I’m not dogmatic one way or the other on this debate. I am very high on real estate investing, but I recognize there for many people, owning real estate doesn’t make a good emotional fit. But what I like about your formulas is that it reduces it down that emotional decision. But the numbers can speak for themselves.

    Something else I always point out in this debate is that adding other smart home ownership tools like house hacking (renting spare bedrooms or onsite apartment units) improves the equation dramatically because you’re bringing in extra income. Where would that income go in the equation?

    1. Thanks, Coach Carson!
      About the house hacking: In the example from Omaha, NE, if I rent the entire house from myself for $1,375 or keep 1/2 of the house for myself and rent out the half for $687.50 to a roommate, the IRR of the asset would be the same.
      But, I think the beauty of house hacking is that you can probably rent out the sum of smaller units for more than the entire house. You are the expert, but I would suspect that the rent per sqft is probably higher for most duplexes and most roommate arrangements. So, who knows, probably one could keep one bedroom in the 3BR-2bath for myself and rent out the other two BRs for $500 each and drive up the rental yield to $1,500 total (by assuming a $500/month implicit rent for myself for the own bedroom). That way, house-hacking is even more profitable.
      But again: I have never done this. If I were 20years younger I would certainly look into that! 🙂

  18. Big ERN:

    Thanks for another informative and highly useful post. You are far and away my favourite FIRE blogger, and I voted as such for the Plutus Awards a couple months back!

    I’m having trouble resolving one aspect of this post. You refer to JL Collins’ “laundry list” of housing costs, and you state that they are all factored into the rent. Doesn’t this imply that the landlord is: (1) making financially sound decisions, and more importantly (2) able to set the rate independent of the market?

    In my current rental we are paying ~ $1300 per month to rent a house that would sell for ~ $ 600,000. The house is quite old (higher than average repair costs) and in an established inner-city neighbourhood (high property taxes). I can’t imagine that — at our current rental rate — all of the costs our landlord is taking on are “baked into” our rent. Instead, it just seems like a poor investment partly because he is under charging us and partly because the rental market in our city tends to favor tenants due to an abundance of supply.

    Thanks so much for your HUGE contribution to the FIRE community!


    1. Wow, good for you! In many places, the $1300/m doesn’t even pay the property taxes and insurance. Is this a rent-controlled unit?
      So, obviously, a landlord who’s not following a profit motive or other barriers (like $500/month rent-controlled units in Manhattan!!!) change the equation. Plug in those numbers in the spreadsheet and you’ll find that you’re better off renting. Most people I know will rent from a profit-maximizing landlord, though. 🙂
      Thanks for your support!!!

  19. Excellent article, balanced and well thought out. We’re currently playing with the idea of buying a home, and based on the very helpful NYT buy vs. rent calculator ( it seems to favor buying for us. One consideration that I did not see mentioned is the fact that a home is inherently a much more volatile investment than a diversified portfolio of stocks, and changes in the local area can drastically affect your home’s value (foreclosed neighbors, decreasing quality of schools, flood zone changes, etc). People who do not wish to stomach that risk would benefit from renting, even though on average they would save money buying a home.

    Oh and you have a typo in one of your headers, “But even owner-occupied housing in an investment!” I believe should be “is” instead of “in”.

    1. Good point. I would still argue that on a month-to-month or year-over-year basis, stocks are vastly more volatile than real estate. But you are right: there is the risk that your particular neighborhood or even the entire city will go down the drain (think Detroit). That is certainly a risk to weigh and it’s a risk that not everybody wants to stomach. It’s also another reason to keep the value of our primary residence as small as possible.

  20. Prepaid consumption is not an investment. Almost everything durable you buy can be rented. If the imputed saving on rental fees is seen as the return, then everything that can be rented is an investment. Your car is an investment so you don’t have to lease it. Your furnitures are an investment so you don’t have to rent from CORT. Your laser printer is an investment so you don’t have to pay by the page printing at Staples. Your TV is an investment so you don’t have to rent one from Rent-A-Center. Investment loses its meaning when everything you can rent becomes an investment after you buy it.

    1. Yup, and don’t forget a washer& dryer that save me the hassle of going to the laundromat. Pretty much all durable goods that a business would buy (airplanes, vehicles, commercial structures, computers etc.) are all considered investments. Don’t blame me, that’s the way economics, accounting, and finance professionals (maybe even buffs?) have defined it.
      The buy vs. rent decision of all those will take into account how much it would have cost to rent/lease the same item, then calculate an IRR of the differential cash flow.
      Now, you can decide for yourself that in your personal finance dealings you don’t obey the principles of finance and economics. But I do run my personal finances no different from running my business.
      But just for the record, I’m making the same distinction here again: There are two decisions 1) how much house you need, 2) rent vs. buy. If you decide on a house that’s too large (=over-consumption) it’s a bad deal. But it would be a bad deal if you rent that same house or buy that same house. Despite a high IRR, owning a house can still be a bad decision. This fine disticntion doesn’t fit on a bumper sticker. Hence, I wrote a 2,000 word blog post about it. 🙂

      1. Businesses buy durable goods to make money. We as consumers buy durable goods for our own consumption. A more economical way to consume something doesn’t make it an investment. It has nothing to do with a house versus a 1BR. After you decide 1BR is what you need, buying it is still not an investment. Buying the 1BR or renting it are just different ways to consume housing. It’s not like anything durable you buy is an investment and anything you rent is consumption.

        1. How about a limousine or jet that a company buys for the executives? That’s not an investment? Again, you can define investments any way you want but I use the way the folks who know economics, accounting, and finance have defined it.
          Thanks for stopping by! 🙂

  21. Great article.
    I’m very firmly in the Buy rather than Rent based on my own personal experienced. A year ago, I did a post comparing my 40 years of buying a house versus renting. It was a no-brainer. However, it is also very dependent on the house you buy, and where it is located. The housing market in Edinburgh, Scotland is pretty sound and housing values have appreciated considerably in that time. If I lived in a less stable area, I might not have been so fortunate.
    I know people who have been able to retire early because of rental income from a portfolio of apartments / houses. Again Edinburgh has a solid rental market, so location helps.
    Rental has its place. It depends on your lifestyle, whether you want to check out the area before you buy, have to move frequently for your work etc, want to make the cash you have invested in your home work for you.
    So ultimately, it is a very personal decision.There really is no right or wrong answer

    1. Exactly! Thanks for sharing. This is really a personal choice. If you know you are going to stay in one area/neighborhood for an extended period then owning looks like a good choice. But even the most successful real estate investors will always concede that renting is best in some cases!

  22. Big ERN,
    One other potential source of imputed income from owning a house is for parents in the US with students in college. To apply for student loans and need-based financial aid, you are required to submit a FAFSA (Free Application for Federal Student Aid) that legally compels you to report your financial assets. Assets such as taxable brokerage accounts must be reported. Retirement assets in 401k’s/IRAs/etc are not reported. Interestingly, equity in your primary residence is NOT reported on your FAFSA whether you live in a $10,000 shack or a $1,000,000+ McMansion.

    Filing a FAFSA results in a number called the EFC (Expected Family Contribution). The EFC is the amount in $$$ that a student’s family is expected to contribute toward college expenses on a yearly basis. Have a low enough EFC (i.e., ER to reduce your taxable income, have most/all of your taxable assets in your primary residence, and tap your home equity through a HELOC for living expenses) and your student qualifies for student loans subsidized by the US government or event grants of free money for college expenses. Additionally, the EFC is used by colleges/universities to determine the amount of nonfederal need-based financial aid that is awarded to a student. Some private universities have additional asset disclosure requirements via the CSS Profile filing, so YMMV.

    How much can this be worth? Possibly tens of thousands, even considering the tradeoffs since a more expensive house will have a larger property tax bill and other expenses.

  23. The rental yields here are unrealistically high for many FIREers in coastal cities. The yield is actually much closer to 5-6% in places like San Francisco, bringing the cap rate to 0-1% on many mortgage terms. Of course the appreciation returns here have been much better recently, probably making up for it. The cap rates are much better in the midwest, because appreciation is much lower and less incentive to buy to chase appreciation.

    Another downside to buying early in life is that a huge part of your net worth will be in exactly one investment in exactly one housing market that can be destroyed by one disaster, whereas other assets will have a far more efficient diversification profile from a purely financial perspective. Buying a $500K house with $125K down and spending almost all your post-tax assets for that down payment will significantly affect your portfolio and accumulation

    1. Thanks for sharing! A few things I disagree with:
      The Cap Rate is always independent of mortgage terms. It’s calculated with the unleveraged asset only.
      In very expensive cities (NYC, SF, LA) more of the value is tied up in the land rather than the structure. Hence, you have less depreciation/maintenance as a % of the home value. So, even in expensive cities you can get decent IRRs with only moderate home price appreciation.
      That $500k house might be a bad decision. But renting that same house for $30k is just as bad or worse. So, again, we should separate the the two decisions: 1) how much house and 2) rent vs. own. A house may still be a good investment. It’s overconsumption for some people, I agree with that. But still a good investment if you can afford that house.

  24. Any reason you did not include opportunity cost for your down payment? Also another factor to cheaper housing is it’s most likely further from your job, which should account for higher commuting / time costs.

    Just my 0.02

    1. Two very good points:
      1: I prefer to calculate the differential cash flow between rental and owning first. And the IRR of owning over renting. If you then want to calculate the IRR of an equity investment, that’s fine. This will make sure that we consider the opportunity cost of the downpayment but also the opportunity cost of renting because the cost of renting is higher than owning from months 2 to T.

      2: Again, we don’t want to fall into the trap of comparing apples and oranges. Don’t compare renting the small rental unit in the city close to work with the 3 bedroom house in the suburbs. I like to compare the IRR of renting vs. owning the same house or at least very similar house in the same neighborhood.

  25. I bought my home on a whim (which I don’t recommend) and it turned out to be a good financial decision thus far. I love the nuance with which you approach this issue because no one wants to be told, “you’re doing it wrong.” I too did the href=””>Buy vs Rent calculator with a few different inputs and I think that it’s a good starting point for figuring out affordability and the right price point and down payment for coming out ahead with primary residence purchase. Ultimately, you’re very right that everyone’s numbers will look different depending on the markets for purchasing and rental. Also totally agree with you on making apples to apples comparisons. Great post and such a useful tool you’ve created,

  26. Interesting read. I love math so it was good to see how the numbers work. Started blogging recently, just last year December and decided to educate myself on Real Estate Investing and came across your post and was excited to see it! This is what I am doing so far to learn:

    In your opinion, is it better to learn by actually investing in a property, of-course after due diligence and some idea of what cash flow you need? Or making sure I understand everything then start the investment. What are your thoughts?

  27. This is yet another fantastic article that gets me brainstorming. The point you make about leverage making a big difference is very interesting. My husband and I own 2 rentals and our home that are all paid off. At the same time, I’ve been trying to come up with a way to get more money out of our IRAs before age 70.5, and still keep our Obamacare subsidies under the 64K tax “cliff”. We really don’t like debt, but I think I may have to reconsider. I used your google sheet to play around with IRR and you are so correct. Now I’m thinking that if we got mortgages on our 2 rentals, those not increase our IRR, but could zero out our income from Schedule E. Then we could withdraw that amount from IRAs each year instead. I will enter these in TurboTax to try it out, although there is probably a much more favorable situation now in 2018 with the new rates.

    Thank you so much for all the details you provide. You are an “asset” to our FI community. Can I count you in our net worth, ha ha?

    1. All, right! I love it! Rentals are such a great retirement plan. And tax efficient, both for income taxes and estate planning!You’re doing everything right!
      And you should count me as a $1 “other asset” in Personal Capital, how about that? That compliment made my day! 🙂

  28. Thanks for the clarity ERN. I agree that we should look at with eyes wide open and often times the generalizations are out of control. A quick question on another thing I have been thinking: What about the idea of investing my retirement (tax-advantaged) accounts in real estate (through a self-directed IRA and business entity; LLC or S-Corp) and keep my taxable in stocks so that they are somewhat liquid. Any thoughts on this strategy?

    1. I haven’t explored that strategy yet. This might be ideal (if it’s legal) for the home speculators and flippers to defer taxes. But for the buy and hold investor who buys a house and rents it long-term and holds it forever there are already some tax advantages: depreciation to offset ordinary income. And resetting the cost base when your heirs inherit the property. Why “waste” the space in your tax-deferred accounts for real estate then?

      1. I should clarify. This would be for someone who wants to chase appreciation in fantastic markets (think coastal or cities). Probably not for those chasing cash-flow. I have only chased cashflow, but could be persuaded to chase appreciation if I couldn’t touch the money for 20-30+ years.

              1. Ya, I own a commercial building with 2 buddies and they want to buy more under our LLC. I am thinking of making my portion of the down payments through a self-directed IRA.

  29. Thank you for a very interesting post.

    1. I remember reading somewhere (in one of Bill Bernstein’s books or in Jeremy Seigel’s “Stocks for the Long Term” that the real appreciation on housing over a long period (nearly a 100 years) is zero. So, do you think your assumption that housing values increase in line with inflation is fine?

    2. I see your point about increasing both the rental values and the house value at the same rate. But whether they do increase at the same rate depends on the prevailing interest rate, doesn’t it? If rates fall, shouldn’t the rental yield also should fall; and vice versa?

    1. Thanks!
      1: values increasing “in line with inflation” is equivalent to “real appreciation on housing […] is zero” so, yes, I think that’s a fine assumption.
      2: There is a strong connection between interest rates vs. inflation vs. rental inflation, true. Also, don’t mix up the rental yield vs. rental inflation. But I’m getting distracted. Your point in #1 applies here again: Over long horizons (30+ years, don’t even have to go to 100 years), rental inflation stays roughly in line with overall inflation. Over short horizons, very true, you can have some deviations of rental vs. CPI overall

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.