More Wealth in Renting Homes

Median-income households could generate more than 50% additional net wealth over the next 10 years by renting and investing instead of buying a home, according to “House of Cards,” a study from HelloWallet. The catch is that people have to invest to reap that extra money.

The report brings a new perspective to families’ unique decisions to buy or rent a home by analyzing the historical tax benefits and wealth-building opportunity costs of home ownership. The paper includes two analyses. The first examines historical home-purchase data from the Federal Reserve Board’s 2013 Survey of Consumer Finances and compares how much wealth Americans would have created had they rented a comparable home and invested any savings in a portfolio of stocks and bonds over the time they owned the home.

The second looks at two hypothetical households, one earning $50,000 a year and the other $100,000, living in 20 major cities to examine the effect of state and local tax structures on the buy-versus-rent decision.

The analysis finds there are two things prospective home buyers can do as they weigh all the factors. First, calculate their “rent-to-price” ratio, or the ratio of the annual rental costs of a home compared with its purchase price, to determine whether to buy a home or rent and invest. If the rent-to-price ratio is 5% or less, people may be better off renting and investing any savings. If the rent-to-price ratio is greater than that, they may be better off buying.

Second, beware of online calculators. Many free online “buy-or-rent” calculators inflate the benefits of home buying. The study shows that calculators provide inaccurate guidance to more than 90% of renters who are considering whether to buy a home by overestimating tax benefits and underestimating the returns an individual can earn by investing. One reason: Most renters take the standard deduction on their tax returns instead of itemizing, but the calculators always assume that users will itemize.

Another flaw in the calculators is that most inaccurately assume there are no alternative investments to home buying other than putting the money in a savings account earning low (and risk-free) returns when renters could invest in a wide-variety of other vehicles, including a tax-advantaged individual retirement account (IRA), 529 college savings plan, or a defined contribution plan such as a 401(k).

Among other findings:

• Median income homeowners realize no federal tax benefit in three out of four major cities;
• More than half of current homeowners (more than 40 million households) bought homes during periods when average homebuyers would have been better off renting and investing; and
• Americans should have access to advice that encourages them to consider investing in assets other than housing.