When it comes to maximizing your lifestyle and net worth, the “should I rent or buy” question is one of the most debated. Even if you already have your own home or apartment, it’s a good idea to regularly think about whether living there is the optimal move.
Borrowing to buy is always a gamble. But if you go this route, your goal would be to use the debt to live a better life than you could afford if you had to pay in cash. The first few years after taking out a home equity loan are generally the riskiest.
In contrast, the return on the rent you pay is essentially zero. Yes, in exchange for paying rent, you get a place to live. However, you have little opportunity to generate capital.
BURL: The rest estate investing rule to follow
As a real estate investor, I always recommend using the “BURL” rule – which stands for “buy utility, rent luxury” – to avoid financial regret. See the article : Commercial real estate in mid-2022: the big slowdown.
Usability can be defined as something you absolutely need with very little unused space. Luxury is something that goes beyond what you need, such as a third spare bedroom, a huge terrace and a backyard with a pool.
BURL helps you realize that the true cost of living in the home you own isn’t just the money you spent living in it. This is the opportunity cost of not renting at market rate.
A case study for the BURL rule
I once knew a couple in San Francisco who decided to downsize when they realized they could rent out their 2,600-square-foot, four-bedroom, three-bathroom home for $7,500 a month. To see also : Indian car buyers are selling SUVs, technology like never before.
Before the pandemic, they bought a second, smaller house in a less central location that cost 40% less than what they paid for the first house. Their new house had a $3,000 mortgage and could be rented out for $4,500 a month.
For them, a smaller house with a rental value of $4,500 was more in line with their budget and household size. So they rented out their old house for $7,500 a month and increased their monthly cash flow by at least $3,000.
Following the BURL rule, they decided to buy — and live in — a slightly more functional three-bedroom, two-and-a-half-bath house and let someone else rent it out for luxury.
If you’ve been an owner for a while, it never hurts to do some research to find out how much rent your home could command in the current market. You might be surprised. As of June 2022, the average national rent price increased by 14.1%, according to data from the Housing List.
And thanks to inflation, population growth and demographics, rent is likely to continue to rise indefinitely.
What smart real estate investors do
In my experience, the “rent or buy” question boils down to this: See the article : Homebuyers are once again taking the lead in the cooling real estate market.
Smart real estate investors often don’t pay more than 100 times the monthly rent to buy a property. In the couple’s example above, an investor following the 100x monthly rent rule would not pay more than $750,000 because the monthly market rent was $7,500.
Spending $7,500 per month ($90,000 per year) on rent may sound expensive, but paying $7,500 per month is actually relatively good value, as you would have to spend about 360 times the monthly rent to buy this house at its market price valued at around $2.7 million at the time.
It may be more difficult to follow the BURL rule of investing in real estate in expensive cities like New York, Los Angeles and San Francisco. There are people who pay six figures a year in rent, but actually get ahead because of the BURL rule. These tenants invest in various properties in other parts of the country for higher rental returns.
A Honda Civic takes you around well, and some people like to drive Ferraris. The BURL rule says if you can afford it, buy a Honda Civic and rent a Ferrari for the weekend.
The other side of BURL
There are properties in the Midwest for around $200,000 that could be rented for $2,000 a month based on the 100x monthly rent rule. Amazing value for investors, but not so much for renters, even if the absolute dollar amount of rent is low.
If you were to buy such a home with a $40,000 down payment, a $160,000 mortgage and a 4% interest rate, your annual cost of ownership would be approximately:
Add in the $800 per year in opportunity costs of not earning a 2% risk-free return on a $40,000 down payment, and it only costs $13,800 per year to own, compared to $24,000 per year to rent.
Even if the owner could only charge $1,200 (compared to the expected $2,000) in monthly rent, making the purchase of a $200,000 property equal to 167 times the monthly rent, ownership is still a better value, especially if the property continues to grow. values.
If the area you live in or would like to live in has market rates that look like this, buy rather than rent because you could immediately be cash-flow positive if you rent out the property one day.
Ultimately, choosing where to live is a very personal decision. We all want to live close to friends and family. We also want to live in an area with great food, great entertainment and great weather.
But we can’t have everything! But we can choose the best options with the money we have.
Dogen himself spent 13 years in investment banking before launching Financial Samurai, his personal finance website. He has been featured in major publications such as The Wall Street Journal, The Sydney Herald, The Chicago Tribune and The L.A. Times. Sam’s new book “Buy This, Not That: How to Spend Your Way to Wealth and Financial Freedom” is out now.
