How "Rent vs. Buy" Shifted in 2023

Katie: Welcome back to The Money with Katie Show, Rich Girls and Boys. Fire up your engines because today, we are talking about shelter. That was a mixed metaphor, but we're gonna go with it, because when my husband and I moved from Dallas to Fort Collins, Colorado, I figured the cost of living was gonna be lower. I thought, surely this small mountain town I had never heard of would be less expensive than the sequined cowboy metropolis that I formerly inhabited. 

But approximately 14 minutes of Zillow stalking later, I realized that I had made a dire miscalculation. Not only was the Fort Collins housing more expensive, but it was a lot more expensive. I don't know if it's the proximity to the mountains or if it's the mass pandemic migration of other Texans and Californians (sorry) seeking cooler climates and an abundance of Subaru Foresters. But our new cost of living absolutely trounced our old one. Our rent, as a result, jumped from $1,741 per month to around $3,000 per month. And I lost a lot of sleep over it—though to be fair, we did upsize from a two-bedroom apartment to a single family home, but with two people, one of whom worked from home (yours truly), a 75-pound dog and a cat, we were basically on top of one another. So the extra space did make a lot of difference. And we had toyed with the idea of buying. We never really thought about it seriously because Colorado real estate was very expensive and we knew that we'd be moving again in a couple of years for Thomas's next military assignment. 

But then came late spring 2023, when we learned we'd be moving to the Sacramento area, and the rent versus buy question was back on the table. Now, the NorCal region—outside of the Bay Area, obviously—was, much to my surprise, actually a lot cheaper than Northern Colorado. So by now you've probably deduced at least two things. Number one, my intuition about real estate prices by region is clearly terrible. And number two, whether to rent or buy our primary residence has felt like this omnipresent financial dilemma. So that's what we're chatting through today, and our guest is Emily McDonald, a rentals communications manager at…da da da da…Zillow. I can hear all of your millennial ears perking up. And she's gonna weigh in on our choice to continue renting and provide a few other considerations. We'll be right back after a quick break.

All right, so first things first. Let's look at real estate in 2023 at a high level, because we've done deep dives in the past on this show about how to calculate housing numbers—we’ll link our most recent ones in the show notes. But the real estate environment in 2023 is interesting. We're on the other side of a huge runup in prices post-2020, and we are also facing some of the highest interest rates since the early 2000s, since the Fed was all like, “Oh shit, this sucker is running way too hot and we need to slow it down.” So as a result, housing affordability, it's at a historic low. I love that for us. 

A Redfin analysis looked at the hundred biggest US metropolitan areas and found a significant drop in affordable homes. Now, “affordable” is defined as the monthly mortgage payment being no more than 30% of median income in a county. And in 2013, half of homes met that criterion, and in 2022, only 21% of them did. You probably already know this, if you're a human who, I don't know, requires shelter to survive. But it's worth revisiting that broader economic context, because it illustrates why this rent versus own dilemma has shifted so dramatically over time. 

The conventional wisdom that owning is always financially beneficial, it was born in an era where homes were affordable on one median income, and the prices were basically guaranteed to go up, thanks to policies that helped to buffer home values like the 30-year fixed rate mortgage or zoning restrictions, or mortgage interest rate deductions.

But much like the college decision has shifted as the price of admission has gotten so much steeper, things like these evolve, and whether your results are going to be net positive or net negative typically comes down to the details. In that way, “you should always own your home” is a little bit like the advice to “always get a college degree.” These statements used to be true for nearly everyone regardless of the circumstances, but now it's a little more complicated. Their validity today is a little more nuanced, and I talked with Emily about how the pandemic changed people's preferences. 

Emily McDonald: To start off, I would say the housing market in general is very different than what we were seeing three, four years ago. The biggest call-out for the rentals market is that people are renting for longer. The cost of home ownership is so high. So people are starting to have families, you know, going through life events that used to trigger home-buying now staying renters for a bit longer, and that changes what they want in a rental. People are wanting more space. A lot of people that aren't starting families decided to ditch their roommates, live in a studio or a one-bedroom alone, instead of sharing a TV with three other people like I used to be doing. 

And I think one of the biggest things too, for renters and many people during the pandemic: A lot of people adopted pets. So Katie, I know you have pets. I have two cats of my own, one of which I adopted during the pandemic. And on Zillow, we're actually able to see what renters are specifically searching for. And “pets allowed” by far and away is the number one filter that renters search for. In most markets, it's number one. Some markets it's number two, behind in-unit washer/dryer, of course. But what people are looking for, they wanna make sure that their pets can go to their next rental. 

Katie: Really unusual circumstances of the pandemic shifted what people were interested in. I thought when all of that was starting that we'd see a bit of a quote unquote “return to normalcy” and that those more standard, if you will, preferences would kick back in after a certain period of time. Are we not seeing that? 

Emily McDonald: Right now, it really does depend on where you are looking. I would say, though, in some big cities like New York, San Francisco, those places where there was this quote unquote “return to cities, return to the office,” we are still seeing people feeling like they want to have their own space, live alone. People had got adjusted to what they were experiencing during the pandemic, and maybe having that extra money, being able to go and live alone, that it's then now driving prices back up because people still want that. People still want to be able to live on their own, live in a one-bedroom as opposed to sharing a space.

Katie: And then there are the factors I personally considered when facing this dilemma. So we're gonna walk through the numbers of our decision to continue renting in the hope that you'll be able to map my thought process on your own criteria and gauge what makes the most sense for you. So when I'm thinking about a decision this huge, there are four financial factors that I am weighing most heavily. 

Number one is transaction costs. So the up-front transaction costs to purchase a home are pretty tremendous. Rocket Mortgage estimates the average costs at closing will be between 3% and 6% of the loan’s value. So that means if you are purchasing a $500,000 home, you're gonna pay between $15,000 and $30,000 when you close. Now, this is the cost of merely completing the transaction, right? Because of this, how long you plan to stay in that home is one of the most impactful factors in your outcomes, because the costs to switch are so high. Emily's gonna cover that a little bit more later. 

Number two is property taxes and insurance in the area. So if you live in an area that's known for tornadoes, hail, hurricanes, other natural disasters, or if your insurance company just thinks that you do, your cost to insure may come as a bit of a surprise. So property taxes are another major factor I like to consider. In Fort Collins, property taxes are below the national average. They're around 0.65% of the home's value. So for a $500,000 home, this is gonna be about $3,200 per year, which I would consider very reasonable. And that was a major reason why we felt kind of compelled to consider buying, because it seemed like ehh, you know, it could be kind of a good area. But that was until I saw how expensive everything was, and I promptly curtailed the idea. Now, Henah's former place of residence, Jersey City, for example, has a property tax rate of 2.17%, meaning she would pay $10,850 per year, or three times as much in taxes, on the very same home.

Number three is interest rates. How expensive is it to borrow money? Now, just a few short years ago, borrowing money was pretty cheap. If you had good credit, you could get a 2.5% interest rate on your mortgage, which is basically free compared to what we have now. The average 30-year fixed rate is 6.96% as of today, July 12, 2023, which was basically the nail in the coffin for my consideration to buy this time around, because at that rate, the opportunity cost of my down payment and the cost of my debt long-term would be so high that it just became hard to justify when compared to the alternative, especially since we will not be living there for a long time.

And my last one—okay, this one's a little bit harder to quantify, and I would say it's far more personal to me and my easily flustered personality. But I was also concerned about the opportunity cost of the mental load. My primary source of income is my job, which I try to devote most of my brainpower and energy to. Now, our criteria for a home that we would buy would be pretty high, as it would need to be a spot that we could feasibly keep and rent out after leaving to cover our costs. So between the house-hunting for such a residence and the number-crunching for what would become the largest purchase of our lives, I started to realize that the process of buying and maintaining would be kind of time-consuming and onerous. And I was concerned about losing a few months of momentum at work. It just did not seem like the highest-leverage use of my time at this point in my life, given the way that I make money. 

So at this point, it looks like I'm painting a pretty bleak picture of buying a home in 2023. And that's not too far from the truth. Historically, it's not a great time to buy, but as with all things, real estate and interest rates are cyclical. So it doesn't mean that that's always going to be the case. It's also hyper, hyperlocal and very specific to how long you plan to stay in the house. So despite the headwinds, if your area is on the more affordable side of overvalued and you plan to live there for the next 20 years, your timeline is probably gonna smooth out just about all of the gnarly factors that we are highlighting. And of course, you get to have a house to live in for the next two decades, which…kind of cool. I also asked Emily to weigh in on what she thinks is the key when deciding whether it's time to buy or better to keep renting. 

Emily McDonald: So I think the biggest piece that people do not consider when they are on the fence about renting versus buying is the length of time that they're going to be in that next home. You know, what that break-even point is where you'll have more money in your pocket for renting versus you'll have more money in your pocket from buying. So yes, buying a home is a good investment, but only if you plan to stay in it for a certain amount of time. And there are a lot of tools that can help you calculate your break-even horizon. But you do need to know a few things, like what your budget is, how much homes are going for in your area, what your rental budget would be. 

Katie: So let's explore the actual numbers and parameters my husband and I looked at, because when we considered buying a home, we noticed a few things. So according to Zillow, the median home value in Sacramento, the city of Sacramento, is currently $466,942, which is actually down 5.7% year over year. But we noticed the homes in the suburb north of the city closer to the base were going for anywhere between the mid-$500,000 range and mid-$900,000 range. So we set a tentative budget right in the middle, at $750,000, because we decided we could tolerate, if necessary, a 20% down payment on that amount, or $150,000. I estimated that would mean between $22,500 and $45,000 in closing costs. So out the door, we're looking at between $172,500 and $195k in up-front costs just to get the keys. And that is, of course, assuming we can score something great for that price.

With the property tax rates in our new town, we were looking at an annual tax bill of about $8,100 on a home of that value, and estimated annual insurance costs of around $3,000 on average, according to the online calculator I found. So lots of iron-clad research happening here. 

And finally the big one, the mortgage. My credit score is in the 700s, last I checked, and we would be avoiding PMI with that 20% down payment. So Google spit out 6.74% as the estimated interest rate, which, not gonna lie, seemed kind of high to me, but I didn't wanna pad it just in case that was accurate. So this means our all-in monthly payment was looking like it was gonna clock in around $4,821 per month after our up-front costs of between $172,000 and $195,000.

Not great. I didn't feel super optimistic about these estimates, because I also knew that they represented the absolute minimum we were gonna be on the hook for as owners of the property. And at $57,852 total per year, that meant our cash input over years one through five would be $461,760 at the low end. A little fast math, i.e., an amortization calculator, told me that that meant if we sold after the last month of year five, we would have $563,234 on the loan left to pay back. In order to break even, we’d need to make back our cash input that we've already had, $461,760, and we'd have to have enough to pay back the $563,234 on the loan, which means the home would need to net $1,024,994 after broker fees for a sale price of approximately $1,090,000, or just shy of $1.1 million, if you assume 3% fees from both the seller's agent and the buyer's agent. This means our hypothetical home would need to appreciate by around 8% per year every year in order for us to break even, assuming no maintenance, no renovation costs.

The average annual appreciation in the area since 2000 was 4.15%, and as we've noted, it's down 5% year over year right now. So I didn't feel super comfortable banking on that, given the expected timeline of our ownership that seemed most reasonable. And like I said, we also considered the idea of renting out the house in the event we wanna leave after two years when my husband Thomas retires from his four-year commitment to the Air Force. But in looking at market rents, we didn't think we could realistically get $4,800 per month for a $750,000 home.

I spent a lot of time exhaustively clicking between the “rent” and “buy” options in Zillow in that area. And anecdotally, it started to seem to me like the homes that were renting for that $4,800 to $5,200 a month range that we would be looking for to feel comfortable were worth well over a million dollars. So I didn't feel super confident that in two years from now, we were gonna be able to cover our housing costs and the cost of property management, since we probably would not wanna be out-of-state property managers with the rent that we'd be able to get for that type of home.

And finally, I asked friends who invest in real estate for their opinion, and they kind of cautioned me about investing in rental property in California, because the laws around rental property investing are a little more stringent there than in other parts of the US. 

So to wrap this up, in other words, I was really hoping for my first home purchase to just look like a slam dunk, at least on paper, right? And nothing about the way this situation was shaping up screamed, “this is a great deal” to me. 

So there you have it. We decided to keep renting. It probably goes without saying that we are not “breaking even” over the next five years anyway; we're going to be spending money that we're not gonna get back by renting. We used Zillow to find our spot, and I am excited to move in because I gotta tell you, I am pretty relieved that I'm not gonna have to worry about repairing a roof or replacing an HVAC system in my time in California. Emily had some additional thoughts on how best to describe the rental markets right now. 

Emily McDonald: Right now the rentals market is actually on its way back toward normal. So we are shifting toward a quote unquote “normal” market right now. The rentals market is super seasonal every year. I mean, during the pandemic, things got a little wonky and a little crazy. But in a typical year, summertime is when demand really rises. We see those prices start rising, and that's exactly what's happening now. Last year in 2022, Zillow saw the fastest rate of rent growth of all time that we have ever seen. So it peaked in February 2022, and the rates started coming back down. Rent prices even started to cool last winter and now they are ticking back up. But that is what we expect to see in a typical summer season. And that record pace of growth from last year, we really, our economists do think that was a one-time event based on the return to work and the return to office people again looking to live on their own or ditching their roommates. So really we think that was a one-time event. While rents are rising again, which isn't the greatest news for renters, it is quote unquote “normal.” And that is good news for renters. 

My hot take is winter. I rented in the winter and there are fewer options, but landlords and apartment buildings are more willing to negotiate with you, I found, at that time. So while you have fewer options, what you're gonna end up paying and the concessions on your lease might be a little bit better. 

Katie: And we'll be right back after a quick break.

Okay, so we're back to the conundrum that we're all facing, because the other frustrating thing about 2023 is that while it is not historically a great time to buy, rent is also expensive. So while I feel like I'm choosing the lesser of two evils, at least at this point in time, renting is probably not gonna be a financial walk in the park either. Still, renting is in my comfort zone. It is so much simpler, because the sticker price is what you pay for that year. There's no surprises, within reason, obviously. Rent increases can and do happen, but you're dealing with fewer variables and shorter timelines and all-around known quantities.

So I have a bit of a renting paradox that I'd like to share. My paradoxical view of renting is that I am personally a little more willing to splurge on a luxurious place as a renter than as a buyer. And that might seem counterintuitive because you might be like, wait, wouldn't you rather splurge on the thing that you're gonna be paying off for the next 30 years? But that timeline is precisely the reason. With rent, I am dealing with those aforementioned limited quantities. The monthly cost will be X for the next 12 months. Should something happen between now and then, I know the time period of my commitment is limited and it is flexible and I'm pretty confident about how my income will shake out over the next 12 months. Whereas my income three years, five years, 10 years from now, that is a lot more uncertain and a lot more unknowable. So please keep listening to this podcast. Love ya. 

I don't wanna make permanent decisions about a five-times-leveraged purchase, aka a home with a 20% down payment, based on my income and lifestyle right now, because in a few years, who really knows? The amount of house that the online calculators will tell you that you can quote unquote “afford” is outrageous. So as a result, the estimates are gonna be based on best-case scenarios, that your income is gonna stay the same or go up; you're not gonna have any major repairs or renovations; you don't have any other debt coming into the picture. And of course, you can always sell and move, but if you're doing so because of a major change in income or lifestyle, you might find yourself selling at an inopportune time. And as we've probably all noticed in the last couple years, timing the housing market is kind of a huge factor in your outcomes. That said, the long-term ramifications of buying conservatively will almost always trump renting luxuriously if you plan to stay in the same spot for many years. But in our case, our move is temporary. 

So let's talk about what I call the total cost of leasing equation, because before I sign a lease, I like to run a quick calculation. What is the all-in cost of this lease to me? In other words, for the 12 months that I am gonna live here, what amount will I be legally on the hook for? Now, this is a different calculus than what we typically run with renting, which tells us to look at our monthly income to decide how much we can comfortably afford. And I'd still consider that a very necessary first step as part of that 30% rule. Figuring out the all-in cost of the lease is a necessary second one, because while the answer to the former question works out well as long as your income stays the same, the answer to the second one is gonna ensure that you are capable of fulfilling the legally binding contract you are signing, no matter what. This is a bit of a worst-case scenario-style equation because it's gonna help you contextualize your annual housing costs against your current cash cushion. So for example, if you're considering rent that's $3,000 a month, your total cost of leasing a year will be $36,000. And if you have $10,000 in cash savings, you have no other liquid assets—in other words, no assets outside of retirement accounts that you can't touch—you may consider renting something less expensive or prioritizing building up that savings amount. The intent with annualizing this number is to make sure you could fulfill that lease even if you were to experience a total loss of income. So it's a bit of a peace of mind check.

I would also recommend checking the lease agreement for the language around early termination fees, because at the bare, bare-ass minimum, you want to be able to cover those costs easily out of pocket in the event you suddenly need to move or lose your income, whether voluntarily or involuntarily, and for whatever reason, don't anticipate it coming back. And there are other reasons you may realize a lease isn't working out for you. 

Which brings me to my next point: Is it worth it to sign a longer lease to lock in lower rent? So when we signed the lease for our new place, we had the option to sign for 24 months instead of 12. And that was tempting, but we decided to start with 12 months for a few reasons. And it can be helpful to calculate what I'll call the flexibility premium that you are willing to pay. The first reason is that we're totally new to this area, right? We wanna allow for changes if something does not work out as expected. Maybe Thomas's commute will be too long or the neighbors will have a teenager who plays the drums or our income is gonna unexpectedly change. You don't know what's gonna happen. So we wanna give ourselves that full flexibility. Number two, our rent is going up by about $2,000 a month, which is mostly offset by the increase in Thomas's basic housing allowance, which is provided by the Air Force, because it's scaled to the cost of living in the area that surrounds the base. That said, we're not really sure how it's gonna feel to pay a higher price, and we wanna allow ourselves the flexibility to downsize again after a year in the event that it's really not a great fit. 

And lastly, number three: The cost to break a lease is typically one month of rent, but your lease will specify. So in our case, we knew terminating before the one-year mark would mean paying about $5,000 in early termination fees. So that works out to about $416 per month if you amortize it over the duration of a 12-month lease. So in my mind, I'm thinking, as long as our rent in year two goes up by less than $416 per month, the price of flexibility is less than the potential cost of breaking a lease if we were to lock in that rate at 24 months and then needed to break it for some reason. So in order to come out ahead by choosing the shorter term and risking it, the annual increase in costs would have to be less than $5,000 in year two. So if you think it's reasonable to expect that your rent would increase by more than the early termination fee amount divided by 12 months, it might make sense to choose the longer term, the 24 month term as opposed to 12, and risk the penalty fee if it doesn't work out. 

Okay, finally, let's talk about deposits, because anytime you're signing a new lease, you gotta remember there's a bit of a mini-down payment required, often in the form of security deposits, your first and last month's rent, or any applicable pet deposits. And if you're lucky, you'll get a combo of all three. So depending on your monthly rent, this can add up pretty quickly, sometimes as high as three months’ worth of rent up front, though the deposit is hopefully going to be refunded to you. And getting a security deposit back from your former landlord may help offset some of this in the medium term. But just remember, you'll likely be paying deposits for your new spot before the old one has returned your deposit to you. So another reason to keep a healthy amount in savings. Now if you plan for this, it's not too painful, especially because some of it is gonna come back to you at the end of the lease and the rest goes toward your regular cost of renting. But it can be a pretty large sum up front, which takes people by surprise sometimes.

And of course there are a few harder-to-quantify considerations that played into my decision, that are likely going to play into yours, too. While our new lease is affordable in relative terms, I think in absolute terms, it's still way more than I expected we would ever spend. But where we live matters quite a bit to me, for a couple of lifestyle reasons. Number one is, I work from home, which means I spend the vast, vast majority of my time in my house. If I worked from an office five days a week, I'd probably feel a lot less strongly about my surroundings, because I don't mind living in a less-than-ideal apartment when I barely spend any time in it. And we looked at some of the more affordable homes in the newer subdivisions, but the surrounding area had very few trees or green spaces, which in the Sacramento area means you're gonna have a lot of heat. And I kind of worried about the middle of nowhere subdivision vibe and that that would start to feel a little isolating over time, because I spend most of my time in my house, and when I do leave the house, it's usually to go on walks, especially with the dog. So proximity to nature makes a really big difference to me. Same with proximity to a grocery store, because I now cook most of my meals at home. What up? One of the homes that we looked at was beautiful, but it was 20 minutes from the nearest store and I knew that inconvenience was really gonna compound over time.

And my third reason is that we don't know many people in the area, as in, we know four people total. So it's likely we are gonna be frequently coercing family and friends to come visit. And our home in Colorado did not have a guest bedroom. So it was actually kind of hard for people to visit us without having to spend money to stay in a hotel. So we really wanted our new home to have a guest room so we could host out-of-towners more easily.

And so I give you all of these reasons to highlight that depending on your lifestyle concerns, your priorities could be the polar opposite of mine. You might be an avid restaurant-goer who works in an office who would much rather get a cool studio apartment in the middle of downtown that's gonna be walking distance to your place of employment and the nearest bar, and I won't lie—finding all of this on Zillow definitely did make the search easier for me, which is why I was excited that we could get someone from their rentals team to join us today. And I intentionally tried to find homes that were being rented by their owners rather than a property management conglomerate, because I have had far better experiences that way. Here's what Emily shared about ways that you can use tech to your advantage when you are beginning the search for yourself. 

Emily McDonald: I live in Jersey City just outside of New York City, a city full of renters. And when I talk to my friends about my job and they ask me advice when they're renting, I'm so surprised about how little they know about the technology available to them to help them make the rental process just so much smoother.

So I think the greatest asset a renter has is time. The time that you have, especially in a competitive market like it is right now, you wanna be one of the first people to apply to that space. And using tech tools like the touring options available to you online can really help you save that time of needing to go to 10 apartments on a Saturday and look at them. If you're using 3D tours like we have on Zillow, you can even see a full property map of an apartment building to know exactly where your unit is going to be, so what your view is like, and if you're near the busy elevator or the garbage room. There are ways that you can cross apartments off your list without needing to go visit them in person instead of wasting time going to tour that space. So I think that is a big one. And then on The Money with Katie Show, I think we're all looking to save both time and money. Katie, I think you might have mentioned that you used this tool; there's actually a universal application that renters can pay a one-time fee over the course of 30 days and apply to as many applicable apartments as they like. So that saves you money because it's a $35 one-time fee, and then it's also saving you time. I'm filling out form after form. If you wanna apply to five different apartments, that's a lot of filling out the same information about yourself. So this one-time form really just helps you keep things moving and also saves you money in the long run.

Katie: We've used that twice now, both for our house in Colorado and our house in California. But I'm curious, these are both the markets that I'm in, they're mid-tier, smallish towns. Are there any rental markets where that's less common to find, where you are probably not gonna see that as much? Or is it kind of hit or miss? 

Emily McDonald: That's a good question. It is hit or miss because the universal application applies to smaller landlords. So the people that can opt in for their renters to use the application fee and the universal Zillow application are smaller landlords that own one unit to let's say even up to 20 units.

Katie: My favorite. 

Emily McDonald: Same, same here. 

Katie: Small landlords. I'm like, I wanna rent your primary residence. I don't wanna talk to a property management company, ever. 

Emily McDonald: Yeah, I totally get it. There are total trade-offs to renting from a big apartment building to renting from a very small landlord that you have a direct relationship with. So I totally get that. I would say it is available in every market across the country. If this is something that you are dead set on wanting to use and you say, I wanna spend the $35 and find an apartment that way, you can even filter on Zillow for apartments that take the universal applications.

Katie: Overall, I have long believed that our environment has a major impact on our mood and our mental health. So in my opinion, for me personally, it is worthwhile to pay a premium for the things that'll be most conducive to the lifestyle I want to live. And in this case, it is living in a home that's near nature and has a guest bedroom. For some people, the premium they're willing to pay for is stability. They may want to buy a home despite it being net more expensive, because they want the stability of knowing that they're gonna be in the same place for a long time. And I fully support that, assuming you can afford it, of course, because I wouldn't be a personal finance podcaster unless I said that.

But we wanna hear from you. What are your considerations when you're picking a place to live? Anything that came up for you today listening to this that maybe you didn't even realize was important to you? And how are you making the rent versus buy decision in 2023? Send us an email at moneywithkatie@morningbrew.com. All, right y'all. That is all for this week. I will see you next week, same time, same place, on The Money with Katie Show. Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin, with our audio engineering and sound sign from Nick Torres. Devin Emery is our chief content officer, and additional fact checking comes from Kate Brandt.