Why Renting Is Better Than Owning For Early FI

For many, owning a house and paying it off is part of the American Dream.  Growing up, my father’s three-bedroom house in the middle of nowhere was a symbol of stability for me.  When I started working for high tech companies, I saved for several years and bought a two-bedroom house in Seattle.  

I had fulfilled my own American Dream.  Or did I???

This house is where my partner, Jake, and I lived and was the first home of my two young children.  This house was leveraged to expand our portfolio with a HELOC.  This house is where I reached early FI.

Recently, I have grown restless about the idea of owning vs. renting.  I have been giving this topic a lot of thought and decided that perhaps we’d be better off renting instead of owning our primary home.  I know that renting, in some cases, is better than owning for financially savvy investors.  I have leveraged my primary house as a piggy bank for myself.  However, it wasn’t until I was finally settled in my dream FI life that I realized that perhaps it is time to let it go as a primary home.  

Here are a few thoughts I want to share with you on the intriguing topic of owning versus renting a primary home.

Myth 1: Owning Provides Security

Many people think that owning a house outright provides security and hence makes it easier for people who have reached financial independence to budget their expenses.  

Is it really? 

I have noticed this is not necessarily the case. Especially, you live somewhere desirable on the west coast.  The property tax and insurance costs go up year after year.  In King County, for example, property taxes have gone up 13.7% in the last year.  With the recent pandemic, cities are scraping for money due to county closures and the slowing down of many businesses due to strict lockdown policies.  The approach may be, if fewer people are paying taxes, then whoever can still pay needs to pony up more.  This could be the reason for many sharp increases in property taxes we see across the nation especially in states that have strict lockdown policies.  

My total for insurance and property taxes last year was around $15K.  That is $1250/month not including repairs and improvements.  The problem with property taxes and insurance is that you have no control over the increases.  So if you are an early retiree, you still have to budget for dramatic increases especially during lean years.  If your income isn’t increasing, how can you keep up?

Rents, on the other hand, are driven by the market.  So at least on a lean year, you can expect little to no increase in rent. 

Then there are the repairs and improvements to consider.  Appliances go out every 5-10 years. The roof needs repair or replacement every 15-20 years.  The water heater goes out every 10-30 years.  The HVAC system goes out every 10-20 years.  So a homeowner can be expecting roughly $3,000/year in expenses.  As much as we can budget for such repairs, we never know when the money will be necessary.  No one wants to sit in the freezing cold with no heater or in the sweltering heat with no AC.  Being prepared, financially, to fix what needs fixing quickly is ideal.  Some years, you can expect to pay $20K+ if the timing is at its worst.

Renters, on the other hand, do not need to worry about repairs.  Renters call the landlord for repair and replacement of both major and minor items. 

So basically you can burn $1,500/month on a free and clear property.  We are talking about just a tiny two-bedroom house in Seattle.  If I am to rent it out, I can barely make $2,400/month which leads to a return on investment of 1.7% annually.  If it is the average 3-4 bedroom house in Seattle for a family of four, that monthly cost can easily double.  With $3,000/month, there are many options to rent anywhere in the world. 

Now if you have mortgages, then you are still responsible for that.  If you missed payments due to unexpected hardship, you cannot just easily move somewhere cheaper and reduce your payment. In fact, you may lose your whole house if you are in foreclosure.  All these years of accumulated payments will be for naught. 

Still think owning equals security?  

Myth 2: Owning Provides Equity Gain

We’ve all heard someone say, “when I first bought this house 20 years ago it was $100K but now it is worth five times that!”  Owning in a desirable place provides huge equity gain, correct? 

First of all, the house has to be in an appreciating market to reach that kind of equity gain.  We all wish we had a crystal ball, the amount of appreciation mentioned above requires you to live in one of the hottest growth markets.  I looked at my tax appraisal.  Even living in Seattle, one of the fastest growing cities in America, you are looking at a growth of four times on an average home over 20 years of ownership.  That is an IRR (Internal Rate of Return) of about 16% using the standard 2% inflation rate and average growth of 20% over the span of 20 years, not accounting for inflation.  This is not counting for average cost of ownership as mentioned before and no improvements needed to maintain the property. 

If you had invested in apartment syndications passively or some other investment vehicle, you could have matched or even beat this IRR.

We know Seattle was a good city to invest 20 years ago, but did you know that Seattle was still a “sleepy town” 20 years ago?  

Hindsight is always 20/20.  Equity gain is not guaranteed.  If you are buying in the coastal area, you have a better chance of appreciation. 

If the property is your primary home, you most likely live there.  Unless you sell your home, your equity gain is “dead equity.”  Dead Equity is just something to brag about instead of actually realizing the gain.  When I travel to Vancouver, Canada, I often see houses that are in really bad shape, piled with junk.  It is so sad to see that and hear people talking about how that house may be worth $2 million due to land value.  I can’t help but wonder, “Did the owner know what they could do with $2 million dollars in terms of improving their lifestyle? 

Most of us want to retire in style versus retire clipping coupons and pinching pennies, worried about if our budget is tight enough. 

Now, imagine if you sold your property.  Even if you are 25% leveraged on the mortgage, this provides a chunk of money to otherwise live on or invest.  Renting can help you free up all your lazy equity and really treat it as money that you can generate standard returns on. 

Could you generate 5% or higher return on money you freed up from your primary home?  Turns out that is about $150K of equity with an example mortgage of $450K with a 25% down payment.  Chances are that you could generate $625/month positive cashflow if you freed that up.  If you invested wisely, you could generate an 8% return on your money in cash flow and total >13% IRR.  That is $1,000/month cash flow.  That could go a long way in improving your FI lifestyle. 

Myth 3: Paying the Mortgage is like Paying Yourself

My engineer father always said, “Renting is throwing money away.”  For a while I believed that the sooner I bought a home, the sooner that I would be paying myself.  

After talking with many investors, it seems that this is a rather common lesson that our parents taught us. 

In our example above, we know that buying a home is not necessarily paying ourselves from the expenses that homeownership can present.  We are instead paying the government, the insurance company and various vendors and contractors for repairs.  Now let’s take a look at paying mortgage companies vs. paying yourself.

When you are renting a home, you pay your landlord and perhaps the utility companies.  You are definitely not paying yourself. 

When you get a $450K mortgage, you will pay $277,452.39 interest on a 30-year mortgage with a 3.5% interest rate.  This does not account for the typical 1% origination fee for the loan and expenses to close the property.  I love low interest mortgages when it is used for investments.  It can be used as a hedge for inflation and many other great things.  However, if you are just paying for your primary home, that is still an expense and a liability, not an asset or investment. Investments should generate positive cashflow or gains directly to you.  Your primary home is not accomplishing any of this.

In fact, when we submit personal financial statements to our commercial lender, they insist on excluding the value of our primary home from the asset category. 

Same with evaluating whether you are an Accredited Investor or not.  You have to exclude your personal home from that calculation. 

So clearly, in the eyes of the government and lenders, your primary home is not an asset but rather a liability. 

Myth 4: I Have a Place to Call Home

This one is going to be a 50/50 split depending on your definition of “home.”  This is what we believed when we first reached our financial freedom.  Our two-bedroom house was where we raised our two little kids.  This home was the beginning of our investing journey.  This was our first home.  When one property holds so many “firsts”in someone’s life, its more difficult to let go.

As early FI-ers, we have goals to travel more as a family.  The world has too much to offer than just staying in one place.  After being on the road for three months at the end of 2020 and into 2021, staying at different Airbnbs, we slowly realized that the city we call “home” is, in fact, not ideal for us to stay at least five to six months out of a year.  It is grey and dark for more than half the year in Seattle.  It is cold and wet.  At times, we won’t see the sun for a couple of weeks.  We just recently stayed for one month in Los Cabos, Mexico.  We really loved it there so much that we wanted to repeat this in winter months in the future. 

We realized that the memories, love and people make up the concept of “home” for us.  We can feel at home everywhere we go because we have each other and new friends that we make. The thought that we might be able to take our friends on a trip if we had a few extra bucks made the full picture complete. 

It is so much fun to explore new homes to stay in and see what fits us the best without the commitment of being there for life. 

I have learned the wonder of living the minimalist and digital nomad lifestyle.  It actually made my life fuller and happier.  Read my article about minimalism here. 

During this time, I was painfully aware that I was still paying a big bill at home for a place that is simply vacant.  We are not clipping coupons and being thrifty, but gosh I wish that I had a few thousand bucks extra a month to cover those costs.  I have crunched the numbers on renting out on Airbnb.  I think we would barely break even just paying our ever-growing property taxes and insurance.  There is at least $10K that I have to invest to make them Airbnb-ready which makes the return of investment even less. 

If I was renting a place, I could just hand in my notice and vacate any time I wanted to.  I could rent a place that had good schools, a big yard that allows our kids to run around and floor plans that best suit our needs. 

We bought our house in our twenties.  Over the course of ten years, we had our two kids and accumulated a lot of material items that we arguably did not need any more.  A lot has changed, and our needs for amenities has changed.  What once were fantastic homes for us now feels tight and like the bare minimum.  We chose to live near downtown so that we could hang out with our friends back then, but now they have all moved further outside of the city.  The distance to our friends didn’t really matter that much anymore.  

A standard mortgage is 30 years.  If you saved a lot, you could get it paid off in 10 - 15 years. But what happens once you reach your FI and realize that the home you loved before is no longer sufficient? 

If I was renting, I could just terminate my lease and move to a place that is more suitable and use my accumulated savings to invest and generate more monthly income to make up for that rent difference. 

Summary of Benefits of Renting

So here is a conclusion on a few reasons why renting may have more benefits than owning. 

1. Saving up for a hefty down payment takes time.  If you are buying in West Coast cities, this could be even more.  Assuming you are putting 25% down for a house worth $500K, that is $125K.  This usually takes a couple years of saving for couples who are both earning an income. 

2. You don’t have to deal with increasing taxes, insurance, home association fees or repairs. 

3. Your credit is not affected by missing mortgages or forbearances.

4. Shorter commitments and the freedom of living where you want if you have sufficient cash flow.

5. It supports the lifestyle of seeing more of the world after reaching financial independence early. 

6. You don’t have to keep a reserve just in case something happens to your house like a homeowner.  Reserves are lazy cash that needs to lay around to be available to draw at any time.  This allows you the ability to invest more of your lazy cash. 

When does it make more sense to own than rent? 

Is there a time when owning makes more sense to rent? I think there is. 

If we evaluate our primary home as an investment instead of personal residence and achieve a situation where you can live for free or make positive cash flow, then it would make sense to own.  A lot of young people use their home to househack, or rent out a room to cover a portion of the cost.  I still think it is a fantastic way to launch your investment career.  

You can see my interview with Craig Curelop, an expert househacker to learn how to do so. An alternative way to househack and still have the comfort of your own space is to leverage multiplexes or split-level houses. 

If you are using your primary home to flip and save capital gains every two years, it would make financial sense.  As you can get up to $250K capital gains tax exemptions if filed individually or $500K if you file jointly after two years of residency at the place as your primary home. This is a good way to accelerate your FI journey as well. 

If you are a homebody, who just wants to live in a single place and focus on hobbies such as gardening and painting, or if your home gives you a huge amount of joy and you recognize that is what you pay for, then it makes sense to own your home for personal enjoyment as you will have control over where you live for decades. 

This leads me to conclude that owning a primary home in places like the west coast for personal enjoyment rarely makes more sense than renting for people who are striving for or have reached early financial independence.

To reach financial independence or making your FI more enjoyable, it may be a good idea to take a second look at your primary home and see if it is working hard enough for you.