New Tool To Help Determine If It Is Better To Buy Or Rent A Home

New Tool To Help Determine If It Is Better To Buy Or Rent A Home

Many homeowners have found the price-to-rent ratio isn’t deep enough to include all the costs and benefits incurred when purchasing and owning a home.

Two foundational factors home buyers are generally aware of include:

1) That homeownership is more financially advantageous than renting the longer one owns a home.

2) Homeowners are also generally aware that they shouldn’t buy a house if they aren’t going to live in for at least some period of time to recover costs

The length of time a homeowners plans to stay in the home determines if it is better to buy or rent. Because non-trivial transactional costs often add up faster than homeowners think, this point of consideration matters significantly. This suggests that there is some length of time at which the decision to buy versus rent hits a saturation point and the answer changes.

Zillow’s new Breakeven Horizon tool goes a nice way to help determine that length of time. The price-to-rent ratio, while helpful, cannot really determine this time frame. It instead gives an abstract ratio that must then be compared to some rule of thumb about the general level at which the decision flips from renting to owning as the optimal answer. Zillow says, “Seldom is there any recognition of the fact that the length of time the consumer plans to live in the home affects the threshold of the ratio that separates a buy decision from a rent decision.” Somebody planning to live in a home for two years and somebody else planning to live there a lengthy time frame, like fifteen years, will come up with different answers.

The real estate market needs comprehensiveness and comparison tools. As technologies continue to advance, the benefits of clearer metrics to sieve, sort and stack up buying versus renting costs, are welcomed.

Homeowners have a need to know two basic things about their place of residence:

1) the total they will spend when buying a home

2) and how this compares with how much they will spend if renting.

The real estate industry can do a better job of taking these considerations into account. Potential buyers must factor in property taxes, transactional costs, the opportunity costs of a down payment, mortgage interest deductions, and home maintenance. The conventional price-to-rent ratio doesn’t consider these pieces of information.

Zillow’s website says, “A particularly glaring omission in any price-to-rent ratio is home value appreciation which can make a home purchase a profitable investment after a certain number of years as opposed to renting the home. Hence, the number of years after which buying a house becomes financially beneficial compared to renting the house is a function of the number of years one plans to stay in the house. The price-to-rent ratio calculation does not take this into account.”

Overcoming these limitations, the Breakeven Horizon tool makes the buy versus rent decision-making process more accurate and intuitive.

Factors involved that make up how Breakeven Horizon works are:

1) Living in a home for a shorter period of time than the breakeven horizon, renting is more advantageous than buying.

2) Computing this number at the home level and then calculate the average and median breakeven horizons at the city and metro levels.

3) Incorporating costs and benefits associated with buying and owning a home such as the down payment, purchase costs, mortgage payments, property taxes, utilities costs, maintenance costs, tax benefit etc. as well as costs associated with renting the same home.

4) Including home value and rental price appreciation.

The Breakeven Horizon is a very useful metric for several reasons:

1) If a consumer knows that they want to buy, it allows them to target cities and metro areas that fit the length of time that they intend to live in the home.

2) If a home buyer is unsure whether they want to buy or rent, but they know where they would like to live and for how long, the Breakeven Horizon offers guidance on whether to buy or rent.

3) For real estate investors, the Breakeven Horizon is a more unbiased estimate of the number of years it will take to recoup the cost of buying the property from the lease income as opposed to the price-to-rent ratio.

4) For realtors, depending on which consumer sector, this metric will enable them to focus on areas where they find target consumers are likely to buy based on the average and median breakeven horizons at city and metro levels.