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Why Buying Is Not Always Better Than Renting

2022-05-26 · Long video (solo, talking head or whiteboard) · Ali · recording, 19:01 · watch on YouTube

Topic: Money and investing · mode: Explanation and tutorial · tags: His own numbers, Family, His medical past

In a Money Club episode, Ali argues that renting is not simply money down the drain: he weighs buying against renting with his SMORES rule (sunk, maintenance and opportunity costs; roots versus wings, easiness, savings), runs the numbers in Causal's rent-versus-buy model, and concludes that the answer depends on your own numbers and assumptions.

What is said

The parts of the video and what is said in each (★ — how much it matters to the video).

00:00:00 — The renting-is-money-down-the-drain myth, his own buying and renting, and the plan of the episode

  • ★★★ The common advice that renting is money down the drain and you should get on the property ladder is much more complicated, Ali says: buying and renting both carry financial and psychological costs. — 00:00:00
  • ★★ For a long time, Ali says, he also bought into the idea that buying is better than renting and followed the get-on-the-property-ladder advice pretty religiously. — 00:00:29
  • ★★★ When he started working as a doctor, Ali sold Bitcoin at a loss of about $35,000 to buy a house in Cambridge with his brother Taimur. — 00:00:29 · Cambridge, Taimur Abdaal
  • ★★★ Ali has recently bought two flats in Manchester as buy-to-let rental properties. — 00:00:29

00:01:27 — Why most people have a home-buying bias

  • ★★ The home-buying bias is partly economic, Ali says: house prices have historically tended to rise while renting gives nothing back, so people see buying as an investment and renting as burning cash. — 00:01:27
  • ★★ A friend of Ali's who grew up in Cambridge says his mother bought the family house in central Cambridge for £80,000 in the 1980s; it is now worth over £800,000, a tenfold rise. — 00:01:27 · Cambridge

00:02:27 — Buying versus renting as an investment decision, and the SMORES rule

  • ★★★ Buying versus renting is an investment decision with two sides, Ali says: a financial side, getting the most return, and a psychological side, making the choice that makes you happiest, such as avoiding an extra hour's commute. — 00:02:27

  • ★★★ Ali weighs buying against renting with his own SMORES rule: three financial costs (sunk, maintenance, opportunity) and three psychological factors (roots versus wings, easiness, savings). — 00:02:57

    “which I'm gonna call the SMORES rule.”

00:03:15 — Sunk costs and maintenance costs of buying and renting

  • ★★ The real sunk costs of buying a house, Ali says, are the fees paid on top of the price that you never get back: property taxes, lawyer fees, the valuation fee and minor fees such as mortgage arrangement and surveyor's fees. — 00:03:44
  • ★★ Property tax on buying a home is usually 0% to 5% for most people as stamp duty in the UK, and 0.2% to 2% as general property tax paid to the state in the US, Ali says. — 00:03:44
  • ★★ In the UK, a solicitor's fees for the legal work of buying a house usually cost £1,000 to £1,500, depending on the price of the property, Ali says. — 00:04:43
  • ★★ The valuation the mortgage lender makes of a property costs between £150 and £1,500, depending on the property and the type of mortgage, Ali says. — 00:04:43
  • ★★★ With property tax of up to 5% in the UK on homes above £250,000, Ali estimates that buyers pay more than 5% of the home's value in sunk costs once lawyer and valuation fees are added. (hedged) — 00:05:12
  • ★★ For renters, Ali says, the main sunk costs are simpler: the rent, about £1,400 a month for a one-bedroom flat in London, and the cost of moving in. — 00:05:12 · London
  • ★★ Homeowners should budget about 1% of the house price a year for repairs and maintenance, the "1% rule" Ali cites, so £3,000 a year for a £300,000 house, as a rough estimate. — 00:05:41
  • ★★ For renters, maintenance costs are low or nil because upkeep is the landlord's job, one of the main perks of renting, Ali says, though renters pay a security deposit. — 00:06:10

00:06:40 — Opportunity costs: the down payment, the mortgage, Bitcoin and the S&P 500

  • ★★★ Opportunity costs, the benefits you miss by choosing one thing over another, are hidden and often ignored, Ali says: money used to buy a house cannot go to anything else, such as travel or business school. — 00:06:40
  • ★ Jamie, a friend on Ali's team, is thinking of buying a house but would have to sell all his Tesla shares, which he does not want to do as he expects Tesla to soar over the next ten years. — 00:07:09 · Tesla
  • ★★ A house down payment is usually roughly 20% of its value, Ali says, though some mortgages need 25%, 10% or 5%; the bank lends the rest, on which you pay interest. — 00:07:38
  • ★★ In Ali's example, a $1 million house with a 20% down payment needs $200,000 up front; at 5% interest over ten years the mortgage costs $8,485 a month, over $1 million in all, $218,000 of it interest. — 00:08:07
  • ★★ In most decent cities a house is a safe bet to grow in value, so buying is a pretty decent investment, Ali says, but the down payment and mortgage payments give up the chance to invest that money elsewhere. — 00:08:36
  • ★★★ Ali calls selling £35,000 of Bitcoin in 2018 to buy a house a really bad move in hindsight: kept in Bitcoin, it would be worth £175,000 today, £140,000 in profit. — 00:09:06
  • ★★ Ali's Cambridge flat has grown in value since 2018 by somewhere between maybe £5,000 and £20,000, he says. (hedged) — 00:09:06 · Cambridge
  • ★★ £200,000 put into an S&P 500 index tracker at a 7% average yearly growth would become over £283,000 in five years, a profit of over £83,000, Ali calculates. — 00:09:35 · S&P 500
  • ★★ A buyer pays no rent, Ali notes, only mortgage payments, which gradually add to net worth by paying off the principal. — 00:09:35

00:10:04 — Running the numbers in Causal's rent-versus-buy model, including his own London case

  • ★★★ To weigh opportunity costs, Ali says, ask what you would do with the down-payment money if you did not buy, or with your money if you did not rent, and which option leaves you richer in two, five or ten years. — 00:10:04
  • ★★ Ali recommends the rent-versus-buy model built by Causal, his brother Taimur's company, which calculates whether you will be wealthier in 30 years by buying or renting; he says it is not sponsored. — 00:10:04 · Taimur Abdaal
  • ★★ In Causal's demo case ($1 million house, 25% down, 3.5% interest, 1–2% yearly appreciation, against $2,000 a month in rent and stocks returning −2% to 8%), a renter would be about twice as wealthy as a buyer by 2049. (hypothetical) — 00:11:32
  • ★★ If house prices rise 3% to 10% a year, as Ali assumes for the south of England, Causal's model makes buying far better: a buyer's wealth reaches 3.5 to 15 million against a renter's 400,000 to 2.8 million. (hypothetical) — 00:12:30
  • ★★★ Ali is genuinely deciding whether to buy or rent a place in London. — 00:12:30 · London
  • ★★ With his own London assumptions (20% down, 2–4% interest, 1–5% appreciation, £4,000 a month rent, S&P 500 returning −2% to 8%), Ali's model shows little difference for ten years, then a buyer's wealth of 2.5 to 6 million against a renter's 600,000 to 4 million. (hypothetical) — 00:13:29 · London, S&P 500
  • ★ Ali likes that Causal shows the uncertainty in a calculation, as inflation or S&P 500 performance may change. — 00:13:29 · S&P 500
  • ★★★ Renting is not always money down the drain, Ali says: in his London model buying and renting are basically equivalent for the first ten years, and only compounding over time makes a difference. — 00:13:58 · London

  • ★★★ On the financial side, Ali says, do not believe the myth that buying is simply better than renting: in every case run the numbers for yourself, since the answer depends on your assumptions. — 00:13:58

    “don't believe the myth that buying is just better than renting.”

  • ★★★ A big benefit of buying is putting down roots, Ali says: the security and stability of a roof over your head, no landlord, and a proper home. — 00:13:58

00:14:18 — Psychological factors: roots versus wings, easiness, savings

  • ★★ Ali had not appreciated how much stability matters: moving house turns out to be one of the more stressful experiences people go through. — 00:14:48

  • ★★★ Buying gives roots but can cost you your wings, Ali says: with most of your money sunk into a house, you lose the ability to take off elsewhere, which matters if you want to move every two or three years. — 00:14:48

    “we can lose our wings”

  • ★★★ Owning his Cambridge flat kept Ali living there longer than he needed to; he wishes he had moved to London earlier, but owning it made staying feel like the better financial decision. — 00:15:17 · Cambridge, London

  • ★★ Renting a decent place is easier, Ali says: a broken toilet, boiler or ventilation means an email or text to the landlord rather than finding a plumber yourself, though this matters little to people who fix things themselves. — 00:15:46
  • ★★ Owning has its own conveniences, Ali says: you can make structural changes, paint and decorate without a landlord or a security deposit to worry about, and you know you will not have to move for a while. — 00:16:15
  • ★★ Renting a fully furnished place, with sofa, beds, towels and cutlery already there, made Ali's move to London very easy compared with buying. — 00:16:45 · London
  • ★★★ Buying a house works as what some economists call a saving commitment device, Ali says: monthly mortgage payments force you to save, the interest part being lost and the principal part repaying the loan. — 00:16:45
  • ★★★ For people who struggle to commit to saving and investing, Ali says, buying a house can be a reasonable forced-saving device that keeps spending in check and builds net worth over time. — 00:17:43
  • ★★ In theory a renter could save as much by investing the surplus, but without a commitment like a mortgage most people will never save the equivalent of a down payment and monthly payments, Ali says, lacking a goal and a deadline. — 00:17:43

00:18:12 — Conclusion and a pointer to his beginner's guide to investing

Threads in this video

Where the stories that moved here went next

Mentioned

Central: Causal · Opportunity cost · roots versus wings · SMORES rule

Also: People: Jamie · Taimur Abdaal

Organizations: Tesla

Concepts: index fund

Places: Cambridge · England · London · Manchester

Products: Bitcoin · S&P 500

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