Cost Benefit Analysis
Wednesday, February 01, 2006
Invariably, the first question that comes to mind, or my In box, when a person starts shopping for a new home is: How much is this going to cost me?
That's a loaded question if I ever saw one. Almost as good the classic, "Have you stopped beating your wife?"
Anyway, the most important thing to understand is that there is no one true and final cost of buying and owning a home. At times owning and maintaining your home can "cost" you much more in actual dollars out of pocket than renting one would.
So why does anyone buy if it costs more money to own than to rent? We all have our reasons.
To understand, it helps to do what is referred to in the finance world as a cost benefit analysis to determine if it's really worth you owning your home. You and your neighbor might have completely different outlooks and feelings toward where you may spend 1/3 or more of your life; just one more reason I love working in real estate: no two people or homes are ever alike!
So let's drop four very different homeowners into the ring for a Battle Royale to compare their home ownership experiences. Then we can see if it actually pays off for them to be homeowners, or if they should stay as part of the 30% of people who spend their entire lives renting homes from others who own and maintain them.
In the first corner, we have Bob and Sally. They are two hard working, success driven professionals who enjoy going out to the theatre, dine at exclusive restaurants and frequent country clubs and golf courses across the country in their corporate jet. They both spend large amounts of cash to stay fashionable and trendy, drive the newest and flashiest cars, and sometimes work 10-12 hours a day, 6 days a week to bring in the financial wherewithal their high flying lifestyle requires. They paid cash for a high rise condo downtown and have no children or pets.
In the next corner we have Larry and Jane, another fictional couple who are Bob and Sally's virtual opposites. They live in a quiet established suburb in a 20 year old home on 3 acres and enjoy spending a majority of their time telecommuting or running their small businesses from home. They love and adore their 3 dogs and 2 cats like the children they plan to eventually have, entertain friends and associates at their home on weekends, dine out twice a week at most, subscribe to Netflix, and rarely go downtown to shop or catch a hockey game. They put down 20% on their home and carry no other debt.
Raising a ruckus in a nearby town, are Sid and Nancy, a couple of crazy 20 something's who went out and bought a house after they wrote a song about it. They aren't really sure what owning a home really means, or how much it actually costs them since their manager pays all their bills. They bought a 15,000 square foot mini mansion. As wild and independent rock stars, they have plenty of money to throw around and are only home when they aren't out on tour, which isn't often. They financed 100% of their home purchase using leverage from future album sales, and if they have any pets or children at home, they aren't aware of them or their actual mailing address.
Finally, Sara stands timidly in the last corner. She is a 25 year old single college graduate who completed her Masters in Accounting last month. She loves to read and has been in school since she was 5 years old. Thanks to Sarbanes-Oxley, she landed a secure high paying accounting job right out of school. She decided she was comfortable enough to use her entire summer job savings as a 10% downpayment on a large newer home near her college, financing the remaining $360,000 with a 30 year fixed loan. Sara is stretching a little to buy the 4 bedroom home, but intends to rent out the extra rooms to other students to help her pay the mortgage.
So how did our four contenders make out after the final bell? Are they Homeowners or Renters?
The Results:
Bob and Sally stand tall and proud. They bought their condo for the status it brings them, not as a residence or refuge. The value they perceive from their address and zip code is immeasurable in the world they exist in. Also, as a cash purchase, it was no different to them than buying a new suit or handbag and the maintenance costs of ownership are minimal compared to their overall income.
Rank: Home Owner
Larry and Jane gain the most tangible benefits from their homeownership, as nearly every experience in their life revolves around their home and the time they spend there. Since they own an older home, they may encounter more maintenance costs in the future than someone who purchased a new home, but with no other debt, they are well equipped to handle the expenses.
Rank: Home Owner
Sid and Nancy are the clear losers here, right? Actually, they were a red herring. Their manager actually bought the mansion in his name with a power of attorney and is using their money to pay the bills, so they're really just glorified tenants. Sid and Nancy's lifestyle is a dramatic exaggeration of your typical renter -- little respect, concern, or understanding of the place they call home. They would rather just pay someone else a fee each month and avoid any of the larger responsibilities of ownership.
Rank: Renter
Sara is a detail oriented strategist. She plans to own more than one home and hopes to ultimately derive an income stream from her portfolio of rental properties. She is organized enough to be her own property manager and has made a wise choice of having others pay her mortgage for her. Sara understands all the costs and benefits she will incur, both financial and social, by having roommates, and is willing to make sacrifices now in order to have greater choice and control over her life and finances long term.
Rank: Homeowner (and Landlord)
In the end, no one really wins or loses. It ultimately comes down to what each person or couple wants out of their experience of home ownership. The personal cost benefit analysis of money paid out of pocket and the perceived value gained from that expenditure determines their views of homeownership as good or bad.
For example, I went to Lowe's a few days ago and spent $250 on household items to redecorate a room in our house. I didn't think twice about it. The intangible value those items returned went far and above the actual cost of materials and time spent making another room in my home more useful and pleasing to me. Would someone else have rather spent that same $250 on a new outfit, nice meal, or night out on the town? I'm sure there are plenty of people who would line up to do so.
But don't take my word for it. Do your own cost benefit analysis before jumping into the ownership/rental ring. You may find that the costs out of your pocket objectively add up to be more substantial than renting, but the benefits are totally subjective and open to interpretation.
Your perception ultimately defines your reality of homeownership or rental being the best choice for you.
Step back and take a hard look. It might surprise you what side you end up on.
That's a loaded question if I ever saw one. Almost as good the classic, "Have you stopped beating your wife?"
Anyway, the most important thing to understand is that there is no one true and final cost of buying and owning a home. At times owning and maintaining your home can "cost" you much more in actual dollars out of pocket than renting one would.
So why does anyone buy if it costs more money to own than to rent? We all have our reasons.
To understand, it helps to do what is referred to in the finance world as a cost benefit analysis to determine if it's really worth you owning your home. You and your neighbor might have completely different outlooks and feelings toward where you may spend 1/3 or more of your life; just one more reason I love working in real estate: no two people or homes are ever alike!
So let's drop four very different homeowners into the ring for a Battle Royale to compare their home ownership experiences. Then we can see if it actually pays off for them to be homeowners, or if they should stay as part of the 30% of people who spend their entire lives renting homes from others who own and maintain them.
In the first corner, we have Bob and Sally. They are two hard working, success driven professionals who enjoy going out to the theatre, dine at exclusive restaurants and frequent country clubs and golf courses across the country in their corporate jet. They both spend large amounts of cash to stay fashionable and trendy, drive the newest and flashiest cars, and sometimes work 10-12 hours a day, 6 days a week to bring in the financial wherewithal their high flying lifestyle requires. They paid cash for a high rise condo downtown and have no children or pets.
In the next corner we have Larry and Jane, another fictional couple who are Bob and Sally's virtual opposites. They live in a quiet established suburb in a 20 year old home on 3 acres and enjoy spending a majority of their time telecommuting or running their small businesses from home. They love and adore their 3 dogs and 2 cats like the children they plan to eventually have, entertain friends and associates at their home on weekends, dine out twice a week at most, subscribe to Netflix, and rarely go downtown to shop or catch a hockey game. They put down 20% on their home and carry no other debt.
Raising a ruckus in a nearby town, are Sid and Nancy, a couple of crazy 20 something's who went out and bought a house after they wrote a song about it. They aren't really sure what owning a home really means, or how much it actually costs them since their manager pays all their bills. They bought a 15,000 square foot mini mansion. As wild and independent rock stars, they have plenty of money to throw around and are only home when they aren't out on tour, which isn't often. They financed 100% of their home purchase using leverage from future album sales, and if they have any pets or children at home, they aren't aware of them or their actual mailing address.
Finally, Sara stands timidly in the last corner. She is a 25 year old single college graduate who completed her Masters in Accounting last month. She loves to read and has been in school since she was 5 years old. Thanks to Sarbanes-Oxley, she landed a secure high paying accounting job right out of school. She decided she was comfortable enough to use her entire summer job savings as a 10% downpayment on a large newer home near her college, financing the remaining $360,000 with a 30 year fixed loan. Sara is stretching a little to buy the 4 bedroom home, but intends to rent out the extra rooms to other students to help her pay the mortgage.
So how did our four contenders make out after the final bell? Are they Homeowners or Renters?
The Results:
Bob and Sally stand tall and proud. They bought their condo for the status it brings them, not as a residence or refuge. The value they perceive from their address and zip code is immeasurable in the world they exist in. Also, as a cash purchase, it was no different to them than buying a new suit or handbag and the maintenance costs of ownership are minimal compared to their overall income.
Rank: Home Owner
Larry and Jane gain the most tangible benefits from their homeownership, as nearly every experience in their life revolves around their home and the time they spend there. Since they own an older home, they may encounter more maintenance costs in the future than someone who purchased a new home, but with no other debt, they are well equipped to handle the expenses.
Rank: Home Owner
Sid and Nancy are the clear losers here, right? Actually, they were a red herring. Their manager actually bought the mansion in his name with a power of attorney and is using their money to pay the bills, so they're really just glorified tenants. Sid and Nancy's lifestyle is a dramatic exaggeration of your typical renter -- little respect, concern, or understanding of the place they call home. They would rather just pay someone else a fee each month and avoid any of the larger responsibilities of ownership.
Rank: Renter
Sara is a detail oriented strategist. She plans to own more than one home and hopes to ultimately derive an income stream from her portfolio of rental properties. She is organized enough to be her own property manager and has made a wise choice of having others pay her mortgage for her. Sara understands all the costs and benefits she will incur, both financial and social, by having roommates, and is willing to make sacrifices now in order to have greater choice and control over her life and finances long term.
Rank: Homeowner (and Landlord)
In the end, no one really wins or loses. It ultimately comes down to what each person or couple wants out of their experience of home ownership. The personal cost benefit analysis of money paid out of pocket and the perceived value gained from that expenditure determines their views of homeownership as good or bad.
For example, I went to Lowe's a few days ago and spent $250 on household items to redecorate a room in our house. I didn't think twice about it. The intangible value those items returned went far and above the actual cost of materials and time spent making another room in my home more useful and pleasing to me. Would someone else have rather spent that same $250 on a new outfit, nice meal, or night out on the town? I'm sure there are plenty of people who would line up to do so.
But don't take my word for it. Do your own cost benefit analysis before jumping into the ownership/rental ring. You may find that the costs out of your pocket objectively add up to be more substantial than renting, but the benefits are totally subjective and open to interpretation.
Your perception ultimately defines your reality of homeownership or rental being the best choice for you.
Step back and take a hard look. It might surprise you what side you end up on.
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