Should I Rent or Buy in Today’s Housing Market? The 0.5% Rule. (2023 Update) By Ashley Wilson

I wrote this article a few years back, but I think it is worth updating.

Being in real estate these days, it seems like the only question people want to ask me about single family housing is “are we still in a bubble?” The problem with that question is that there are great arguments on both sides. Anyone can pick a graph and quote things like historical trends or current supply vs demand, and make a very convincing argument. While I don’t have a crystal ball, I do have concerns that we have approached the top of the cycle. With the drastic increase in Mortgage Rates, I see people that I know stretching their budget just to get a name on a deed. So I have to ask: Is now the right time to be doing this?

The beauty and the curse of owning a home in this country is that it is the American Dream. Buying that first home has become synonymous with “making it” in life, and therefore at the top of the list of things to aspire. My husband and I have owned plenty of personal homes over the years and currently live in our potential “forever home”. At the same time, I know people who are very smart and are very successful investors who swear that renting a home is the way to go. Which brings me back to the current state of the market. If I believe that annual price appreciation is going to slow significantly or even stop, can I argue that these renters are wrong?

As always when it comes to real estate, we decided to crunch the numbers. While we love our forever home, we are lucky enough to have access to investments that return 10-20% on our money, so the equity in our home could be doing a lot more. Obviously everyone’s situation is different, and the numbers can vary widely in different parts of the country, but we tried to use averages and historical data as much as we could. I will try not to overcomplicate it with things like tax deductions etc, since once again that is situation specific.

For easy numbers, let’s look at a $500,000 home.

Expenses:

Your biggest expense is obviously your mortgage. At a 6% interest rate, your payment would be about $2,400. Contrary to the popular argument of a mortgage “paying yourself instead of the landlord”, about $2,000 of that is going to interest payments in the beginning. So disregarding principal payoff, your mortgage costs you about $2,000 a month.

Property insurance. Based on our experience with houses in this price range insurance is about $150 a month.

Property Taxes. Now here is the huge swing. A $500,000 house in our area costs you about $10,000 in taxes a year. If you live somewhere in the south you may be paying maybe half of that. In our experience with rental properties, the tax man is going to get you one way or another, but for this example to be fair we will go on the lower end and use $6,000 a year for property taxes. That gives us another $500 monthly expense.

That’s everything right? All the rental property owners just chuckled because they know that the constantly overlooked house expenses are repairs and capital expenditures. There are plenty of articles you can read about how much to set aside for these numbers, but for repairs, reserves for major capex items, ongoing maintenance and other expenses it is usually 1-2% of the value of the home per year. Therefore a $500,000 home would cost you another $500 a month on average in upkeep and repairs.

Adding it up we get: $2,000 mortgage interest, $150 insurance, $500 property taxes, and $500 for house expenses. This gives us a monthly total of about $3,150.  

Now, if we compare that to a couple of years ago when interest rates were 4% the numbers were quite different.  Your mortgage payment was only $1,900, and only $1,300 was being paid in interest.  That brought your total down to $2,500 a month instead of $3,150.

Back when I first looked at these numbers I noted how funny real estate numbers can be. While many of us like to use the 1% rule as a guideline on when to buy a rental property, at 4% interest rates, a 0.5% rule may be pretty close to the tipping point when you should rent vs. buy. In other words, if you could find a house that rents for less than 0.5% (for this example, less than $2,500) of it’s value per month, then expense-wise you were most likely coming out ahead. Right now with 6, 7, 8% mortgage rates renting seems even more tempting, and with us living in the Northeast, double the property taxes make it even worse.  Instead of a 0.5% rule, it might be more like 0.6% or 0.7%.

So the question is, what did we decide? Looking at rentals in our area, it was easy to find comparable properties to our current home that are renting for less than 0.5% of the value. Plus if we sell, we could invest all of the equity in our home and get returns much higher than we believe our home appreciation will get us. We both agreed that it made the most financial sense for us to sell our home and rent. Will we actually do it? Probably not. I love our house, and I really can see our kids growing up in it. While the numbers determine most of the decisions we make in our lives, what is the point in being successful if you can’t enjoy it a little?