The Daily - Should You Rent or Buy? The New Math.

Episode Date: December 1, 2023

For many millennials, buying a home has become almost entirely out of reach. Average 30-year mortgage rates are hovering around 7 percent — the highest they’ve been since 2007 — largely because of the Federal Reserve’s efforts to tame inflation.David Leonhardt, a senior writer for The New York Times, discusses whether it is time to change how we think about buying vs. renting.Guest: David Leonhardt, a senior writer for The New York Times. He writes The Morning, The Times’s flagship daily newsletter, and also writes for Sunday Review.Background reading: Are you ready to buy a home? Should you rent? Take our quiz.From Opinion: Millennials are hitting middle age — and it doesn’t look like what we were promised.The New York Times’ review of David Leonhardt’s book “Ours Was the Shining Future.”For more information on today’s episode, visit nytimes.com/thedaily. Transcripts of each episode will be made available by the next workday.

From The New York Times, I'm Michael Barbaro. This is The Daily. Today, for many millennials, purchasing a home has become almost entirely out of reach. So much so that we asked our colleague, David Leonhardt, whether it's time to change, once and for all, how we think about the wisdom of buying versus renting. It's Friday, December 1st. December 1st. David, on yesterday's Daily, we talked to our colleague, Gina Smilak, about why this economy has been so frustrating for younger Americans in particular. And a big reason for that, as Gina mentioned, is the cost of housing.

In particular, the cost of homeownership, which feels almost entirely out of reach for so many millennials because interest rates are so high right now and so are home prices. And I'll be transparent with you. Our team here at The Daily is made up of a lot of said millennials who live in big cities, spend a lot of time on Zillow, and have gotten very frustrated, and they really want to know, will they ever be able to afford to buy a home? So that got us thinking, can we help listeners think about whether buying a home really makes sense right now? And naturally, David, we thought of you. You've been writing about economics and housing for a very long time. You once helped create a calculator for people to use to determine if home ownership is right for them. And you just wrote an entire book about the American dream of which homeownership is so central. I did.

So if you're somebody thinking about buying a home right now, should you just pretty much give up on the idea? Give up on the idea that has been seen as a ticket to adulthood and a reliable path to creating wealth, and just accept that you're going to be a renter? Yes. For most people, the answer is yes. You should give up on the idea. You shouldn't feel bad about it. Renting has this unfair stigma in this country. It kind of does, doesn't it? It does. But giving up on it now doesn't mean you're giving up on it forever. mean you're giving up on it forever.

Hmm. Well, just very quickly, can you just give us, David, your shortest but most illuminating explanation for why these prices are so stubbornly high? Because from everything I know about economics, when the cost of buying a house goes up and up and up because of interest rates, then demand for those houses should go down, and therefore people selling houses should have to lower the price, therefore prices should start falling. But that hasn't happened. You're absolutely right about that, Michael. When interest rates go up, prices should come down. But housing isn't a normal market, and it doesn't adjust very quickly. Because people get in their heads, we're not willing to sell our house for less than this amount. So imagine a family that bought a house for $600,000 and put $100,000 into a new kitchen. They're just not willing to sell their

house for less than $700,000. And that's basically what has happened now. Sales have gone way down, the number of sales, but prices haven't adjusted that much. And so for any individual, you're really in a tricky spot because interest rates have gone way up in the last few years and house prices have not come down. And you put that combination together and the cost of buying a house for families in almost every market in the country is vastly higher than it was just a few years ago. Right. And especially for millennials, it's basically like lethally high. Yes, because millennials are by definition younger than baby boomers or Generation X. So millennials have not had decades to build up savings that can go toward a down payment. And younger people tend to make less money on average than older people in the job market.

And so millennials just don't have the resources on average to buy homes that older people can. Okay, so let's return to the case that you started to make that renting is okay, maybe better than okay. It's good. And that we can collectively let go of home ownership as our gold standard for a life well lived. I am happy to. well-lived. I am happy to. The rap on renting is that you're throwing money away because you're writing a check to a landlord each month that doesn't build any equity in your home. And that's absolutely true. You are doing that when you rent. But it's important to think about all of the ways that when you buy a home, you are also throwing away money. In fact, you're throwing away more money when you buy a

home more quickly than when you rent. So I think there are four different ways to keep in mind that you're throwing money away when you buy a home. The first is the broker's fee, which is also known as the commission. And in a typical transaction, this fee is about 6% of the house price. On a $500,000 house, 6% equals $30,000. On a $1 million house, and a lot of homes, including modest homes in the Northeast in California, cost $1 million. That 6% fee equals $60,000. Now, technically, the seller and not the buyer pays this fee. But in reality, that difference doesn't matter. The fee comes out of the money that the buyer is paying, and the fee inflates the home's cost. So a broker's fee often amounts to tens of thousands of dollars that a buyer has to spend and never gets back. The second thing is you are paying interest on a mortgage when you buy a home.

And many people say, yes, but there's a tax deduction that reduces that interest. And it's true, there is, but it only reduces that interest. You're still paying the cost of interest that you never have to pay if you rent. And it's a really significant amount of money. Not only that, but in the first few years of paying a mortgage, the way mortgages are structured, you pay almost entirely interest. So what you really should think about is that in your first several years of living in a house, you are going to pay many tens of thousands of dollars to a combination of real estate agents and banks, almost none of which is actually home equity for you. Right. And the case you're making is that you may in fact be throwing away significantly

more money than you would be if you rented during those years. That's exactly right. Okay. That's meaningful. What are the other two ways in which you end up kind of throwing money away, even when you're buying a house, not renting? Things go wrong in houses all the time. Sometimes it's little repairs, like maybe a toilet breaks and you have to spend several hundred dollars on it. Sometimes it's really big repairs that just completely sneak up on you, like your roof needs to be repaired or else you're going to have rain coming in the roof that can be thousands of dollars. When you rent, you don't pay that. Right.

When you own, you do pay that. And over time, it ends up being a really significant amount of money. When we created this rent versus buy calculator for the New York Times years ago, we made this a specific factor, which was the amount of money a typical homeowner spends each year just on repairs. And what is that number? For a typical homeowner, it's often 1% of the purchase price of the house. So if you have a $500,000 home, it's often $5,000 a year when you add up everything. And so that's the third thing. Okay, what's the fourth? The fourth is when you buy a home, you make a down payment. It's often about 20% of a house price. So it's a significant

amount of money. Just to do the arithmetic here, a 20% down payment on a $500,000 home is $100,000. On a million-dollar home, it's $200,000. It's an enormous amount of money. If you rent a home, $200,000. It's an enormous amount of money. If you rent a home, you don't stick that money underneath your mattress. You can invest it. And while all investments bring risk, over time, most investments do just fine. They make a positive return. And so the comparison when you buy a house should not be to zero. It should be in part to what would happen to your down payment money if you invested it in the stock market or in bonds or in a basic index fund that over time tends to grow. And so people should think not only about these direct costs of home ownership, but of the opportunity cost of not being able to invest your down payment in another way that it could make a return.

Right. You're saying on top of all the costs associated with buying a house that may not ever represent a real return on the use of that money, you have to tie up the biggest chunk of cash you probably have in your life in a home when that money could be used, you know, in a Fidelity or a Vanguard or a TIA account that pretty reliably will, unless there's a giant stock market crash, yield returns and make you profits. That's right. And let's put a fine point on this. Over time, the stock market has risen substantially faster than house prices. That seems important. It is important. And it's a point that many people miss. The stock market is not guaranteed

to go up, and I don't want to suggest it is. But over history, the stock market has risen more quickly than housing prices have. So David, you are somewhat successfully crumbling the myth that homeownership is so great, renting is so problematic. But I want to be very skeptical. And here I have some ego, some skin in the game. I am a homeowner and I'm a New Yorker. And in a place like New York, you tend to think of housing as a long-term investment and kind of, if we're being honest, a can't-lose investment, right? You buy a home in a place like New York or Boston or Washington

or San Francisco, and the argument has always been that prices creep up. Maybe it's slowly, but by the time you're ready to sell, you're going to make some real money. And the long-term value of that investment is so meaningful that it tilts all the scales away from renting toward owning. So what would you say to that? So the first thing I would say is I'm old enough to remember the housing bubble. It was less than 20 years ago. Prices fell in essentially every market in the country, including New York, including San Francisco, including all these markets. Nationwide, as an average, prices peaked in 2006 and did not return to that peak until 2017. And so prices really can fall in the housing market they fell quite rapidly in that post 2006 period and sure then they started rising but if you bought in 2006 it took a really long time

to get your money back so that's the first thing i would say prices really can fall the second thing here is i think inflation plays a lot of tricks on our minds because inflation can be really significant. And so the idea that a house price goes up over time is both true and less important than it sounds. The price of almost everything goes up over time. The price of lettuce at the grocery store goes up. And we tend to miss this with housing because we buy a house and then often don't sell it for many years and we think oh my goodness it went up so much in price but we get tricked into thinking it goes up a lot the thing i would compare it to is most items in our lives are like children that you live with and they're growing every day and so you don't really notice it. But a house is like that distant cousin that you see

at a wedding once every seven or ten years. And they have soared. You think, oh my goodness, she's so much taller than she used to be. And she is, but so are all the other children who are her age. And we shouldn't think that somehow she has some phenomenal qualities of growth that other human beings do not have. I never thought of my kids in those inflationary terms. David, given all of this, I think we have to accept the strength of the argument you're making here on behalf of renting. But I know something about you that leads me to question everything that you're saying.

You own a home. True or false? True. You know me well, Michael. I own a home. Right. So is this a case of, you know, do as I say, not as I do? That's a fair question, but I don't think it is. I would say there still are times

when buying can make sense. But the question for each person out there is, is this one of those times for you? person out there is, is this one of those times for you? We'll be right back. So, David, help us understand why, even in this moment, when renting clearly makes so much sense, buying still might feel like the right decision. I think you just used an important word there, Michael, which is feel. I think often buying feels like the right decision to people, even when it's not.

And I'm going to use myself as an example here. I'm a New York Times reporter who spent years writing about renting and buying, and specifically spent years writing articles saying people should not feel bad about renting. And about 15 years ago, when my wife and I were in our mid-30s, we looked around and we said, we're in our mid-30s. We're married. We have kids. We were moving from New York to Washington, D.C. for the New York Times. And we really wanted to own. We wanted to have that feeling of owning for the first time. But we couldn't afford the house that we wanted to live in. So we actually allowed that deep desire to own to guide us. And we

bought a perfectly nice house, but it wasn't a house that we wanted to live in for a very long time. And that was a mistake. It was not a ruinous decision. But in terms of the strict finances, we lived in that first house that we owned for four years. And if we had rented for those four years in the same neighborhood, it absolutely would have been a better financial decision for us. Because of all the fees you just talked about and the interest you were paying, the banks, basically it was a bit of a losing proposition for you, sounds like. That's exactly right. So I really get the idea that people feel this deep pull toward owning.

I've felt it myself. And I think the number one question that people should ask themselves when they're trying to decide whether to rent or buy is how long am I going to live in this house? And then how confident am I that I'm really going to live there that long? And if the answer is only a few years, renting almost always makes sense for all of the reasons that we've been talking about so far. Okay. So the flip side of that would seem to be, if you know you're going to be in a place for a long time, then buying makes more sense. That's exactly right.

So one of the reasons is that a big cost of buying is that upfront realtor's fee. And so if you're buying a $500,000 home and $30,000 of it goes to realtors fees, but you're going to go live in that house for 20 years, that's just not that big a deal. If you're going to live in a house for only four years, the way my wife and I were back when we first bought, it's actually a lot of money. If we had instead taken the money we used on a down payment for that first house and invested it in other ways,

it would have kept growing. And we wouldn't have had to pay all those realtor fees and the mortgage interest and the repairs we put into that house. And we actually would have had more money for a down payment several years later than we did. Right. And I think you should be commended as a financial reporter for admitting to making financial mistakes. Thank you. Everyone makes mistakes. I guess the only question is whether you admit them and learn from them. Right. And admit them, you know, to millions of people. Okay. So, David, what are the other factors that might tip people into buying versus renting, even right now when prices are high and interest rates are high? Well, one's a little technical, but stick with me here. When you buy a house, you are buying it with

leverage, as people say, because you're getting a mortgage and you don't have to pay for the entire house. Let's use an example here. You buy a $500,000 house and you put down $100,000 down payment. And for the sake of this, let's just ignore all the fees and costs. Right. You have a $400,000 loan. $400,000 loan. Let's imagine a few years later, you go to sell that house and its price has gone down to $400,000. You've lost all your money because your down payment was just $100,000. But the flip side of that is that if the house price goes up to just $600,000, you've doubled your money because your down payment was just $100,000 and you pay off your

mortgage and you get $200,000. Now, by now you know this, you don't actually double your money because you spent a ton of it on fees and on interest and on house repairs. And you could have instead invested that money in the stock market. So in that example, actually, there's a decent chance if you lived in that house for a few years that buying was a bad decision. But the math holds no matter what, which is you're buying a house with leverage. And so it is the case that since there are government subsidies for mortgages, so it's easier to borrow money to buy a house than borrow money to invest in the stock market, so it's easier to borrow money to buy a house than borrow money to invest in the stock market. That leverage does tend to help people

over time who buy homes. Put very simply, when things go well, the fact that you're buying a house with other people's money tends to make the good outcome even better. Exactly. And so far, we've just been talking about finances, Michael, and life is about more than money.

Amen. And I actually think the biggest case for buying is not the financial case. Owning a home feels really good. You don't have to worry about things like the landlord raising the rents. And it's your space when you own a home. You can renovate the kitchen and make it the kitchen of your dreams.

You can paint every wall in the house. Right. Economists sometimes talk about the difference between investment and consumption. And I don't think people should feel bad about the fact that spending money to buy a house is a really good form of consumption in many cases. Right. It's not just an investment. If it was just an investment, then owning a home would be like owning a stock. And they're different. They're really different. I mean, if you own a stock for 20 years and you lost some money on it,

there's really no benefit. If you own a home for 20 years and you raised your children there and you met friends that you're going to have for your whole life, all that stuff matters more than whether you made a little bit of money or lost a little bit of money on it. Right. Stocks don't create memories. Not most of them. No, exactly. So here's a way I would think about it. If you found the place you want to live for 15 or 20 years, in that case, it is often the right decision to buy. And speaking of living in a home for 15 or 20 years or even longer, there's another point we haven't talked about, which is the reality that a home for many families is a place where multiple

generations end up living. A parent buys, a child grows up in the house, raises their kids in the house, and that house becomes a kind of intergenerational creator of wealth. That's exactly right. I'm curious when you think that the kind of market that favors homeownership might ever return. When interest rates might fall,

when prices might fall, so that people aren't feeling so locked out of buying, if they want to. Yeah. I mean, I can't predict the future, but I can offer people a benchmark to think about this so they can figure out when might be a good time to buy. There's this concept we've used in the times that I really like called the rent ratio, which we've run by a lot of experts. And it's just a simple index. But what it tries to do is capture the relative cost of buying and the relative cost of renting. It's actually quite simple. Take the price of a house that you're interested in buying and then find a somewhat similar house to rent and calculate the annual price of renting that house.

So for most houses, the obvious price is a monthly rent. So just multiply it by 12. And so you've got the annual cost of renting and you've got the price of buying that home forever. And you divide the home price by the annual cost of renting, and you've got the price of buying that home forever. And you divide the home price by the annual cost of renting. So divide the home price by the annual cost of renting. Okay. Exactly. So let's imagine, again, a $500,000 house you're buying, and you found a similar place to rent that would have cost $25,000 to rent for one year. You divide $500,000, the price of the home, by $25,000. Okay. I'm literally doing that with a calculator. Okay.

Okay. So what'd you get? I got 20. Yes. 20 is the rent ratio there. And when you get a rent ratio that high, it means that it's going to be very hard for you to make a decent return on buying a house in anything less than a decade or more. I was interviewing Mark Zandi, who's an economist who's been looking at housing for many, many years. And he said right now, with current interest rates, he thinks the break-even point is about 18. If you can find a rent ratio of 18 or lower, it will often make sense to buy. Now, spoiler alert, you're not

going to find a rent ratio of 18 in just about any housing market in the country because housing is so expensive right now. And that's part of the reason why for so many people, it really does make sense to rent right now. Right. But I think the service you have really done here, David, beyond telling us whether to rent or buy, is you have effectively liberated, I suspect, a lot of us from this paradigm where renting is somehow not enough and represents any kind of shortcoming. I mean, it just feels like we need to let go of that. And maybe we should have let go of it a long time ago. And this housing market has really helped us understand why it's okay to do that. I think that's exactly right, Michael. Don't beat yourself up if you're renting. Don't think you're making a bad financial choice. In many cases, you're making a really smart financial choice and you're not

wasting tens of thousands of dollars, particularly in a housing market like this. And so the first thing I would say is you should feel fine about renting, particularly right now, better than fine. You should feel good about it in most places. If I could do it again, I would have run in for my entire 20s and 30s. I think it would have been a better financial decision to do so. And it really wasn't until I was almost 40 that my wife and I found a house

that we really wanted to live in and could afford and thought we would be there for many years. And in fact, we have. We've lived in that house for more than a decade. It's where I'm sitting right now talking to you. And we love it. And buying that house was the right decision. I completely understand why most people want to own. And just because you don't buy right now or don't buy for the next few years doesn't mean that you're never going to own a home.

And in fact, one of the ways to take a step toward owning a home in the future is to avoid making a bad financial decision in buying a house now. And instead, building up the down payment so that in the future, you can in fact be the homeowner that you want to be. Well, David, thank you very much. We appreciate it. Thank you very much. We appreciate it. Thank you, Michael.

We'll be right back. Here's what else you need to know today. Israel has agreed to a plan to minimize civilian deaths when its ceasefire with Hamas comes to an end, according to U.S. Secretary of State Antony Blinken, who pushed for the plan during a trip to U.S. Secretary of State Antony Blinken, who pushed for the plan during a trip to Israel. We made clear the imperative that before any operations go forward in southern Gaza, that there be a clear plan in place that puts a premium on protecting civilians, and the Israeli government agreed with that approach. During a news conference on Thursday, Blinken did not specify Israel's plan to protect civilians,

but said he had pushed Israel for safe zones for Palestinians to gather in Gaza and had asked Israel to spare critical Gazan infrastructure, such as hospitals. There are concrete steps that we know and we heard can ensure to the best of anyone's ability that that happens. The ceasefire, which involved the release of Israelis taken hostage by Hamas and the release of Palestinians held in Israeli prisons, has lasted for a week but is scheduled to expire today. Today's episode was produced by Ricky Nowitzki and Alex Stern, with help from Jessica Chung.

It was edited by Mark George and Liz O'Balin, with help from Lisa Chow, was fact-checked by Susan Lee, contains original music by Rowan Emisto, Dan Powell, and Marion Lozano, and was engineered by Alyssa Moxley. Our theme music is by Jim Brunberg and Ben Landsberg of Wonderly. That's it for The Daily. I'm Michael Barbaro. See you on Monday.