Rent Vs. Own

PITI = Principal + Interest + Taxes + Insurance

These are the four major components of "ownership" costs. I would also add a fifth category for maintenance but we'll get to that later.

However, when we compare ownership costs to rent costs, we have to remember that when renting you are paying nothing towards principal. So I would argue you should look at ITI vs rent and omit the P (Principal) component. I have argued this for a long time and you can go back and look at my old posts where I talked about looking at rent vs an interest only mortgage (hence, no principal).

To simplify, I'm going to look at what these numbers cost per $100k of purchase price.

You can get a 30 year fixed for under 4% but I will use 4% to be conservative. (You can also get 5/1 ARM money below 3% but we won't go there...).

Interest = $333
Taxes = $100
Insurance = $15

This comes to $448/month. However, interest and taxes are deductible on your taxes. Since we are talking about westside properties, you are most likely falling into at least a 28% if not 33% (or higher) tax bracket. I will be conservative and use 25% to account for some AMT and other restrictions.

This brings the net monthly payment down to $340. I will now add in a little under 1% cost for maintenance which brings us to a total net monthly cost of about $400. Assuming zero tax deductions, the gross cost comes out to $508.

Before the bubble ever burst we talked about how properties in desirable areas generally wouldn't get to or through rental parity even at the bottom of the cycle. However, I would argue that by using the numbers above you can find many examples where properties (more skewed towards entry level than the top of the market) are currently selling close to or at rental parity. I believe rents are firm and aren't going down. This puts in a good floor for prices and that is a big reason why you are seeing stability in the market right now.

Looking out more than just a year into the future you need to remember that your housing costs are fixed for the most part if you buy. However, the rental rates you use in these exercises are subject to increases. Over many years I think inflation will take its toll and help boost rents. Meanwhile those who buy are not subject to rental increases. Instead, they will accrue benefits of a lower fixed cost which will ultimately manifest itself in higher nominal property values over time.

I'm happy to hear some rebuttals to this way of viewing things but I think this is how to do it. In this case we have zero down payment. However in reality, a responsible buyer will put at least 20% down. Since your money is making less than 1% these days, you are actually benefiting as you will implicitly be earning the interest rate of your loan (4% in my example) instead of less than 1%. So you can't make an argument about opportunity cost of capital. Secondly, I think this continues on toward principal payments. I'm not including them here, but essentially you are earning the cost of the loan on that money when you pay down your principal. Granted, when you rent you aren't forced to pay any principal. But in my mind, being forced to pay principal isn't the worst thing in the world as you are essentially being forced to buy a bond paying 4% which enables you to gain all the future upside in the housing market.

So in real life, we are looking at $400/month net cost of owning per $100k of house. So does a $1mm property rent for $4,000/month? I would say that is about where rents are these days...We are close enough to parity that if you have a stable job and have the down payment saved up, you don't have much to gain at all by renting.