Don’t buy a house in high cost of living areas!

Don’t buy a house in high cost of living areas!
In high cost of living areas (HCL) and very high cost of living areas (VHCL) it may make more sense to rent than purchase your home. If you rent in places where it is cheaper to rent than own, there is substantial money saved each money, that money can be plowed into investments.
Some of that mortgage payment a home owner is paying is going toward the principle on the house. After 30 years, the homeowner will have the house paid off and that essentially becomes a sort of nest egg. Therefore, if you are renting and not paying a mortgage, you need to be putting extra money aside anyways towards retirement because you are not paying a house off.
For it to make sense to rent instead of purchasing a house, you must be saving money from renting. I would suggest this amount of money you save from rent needs to meet or exceed the amount of principle you would be paying off by being a homeowner. However, this is overly simplified and there are other costs to consider in the calculation. Let’s assume a theoretical mortgage with $550 going towards principle, $700 going towards interest, and $700 going towards escrow which is going to over things like insurance and taxes. I would say that if I’m going to rent a place, it needs to be less than $1,400 which is the interest plus the escrow. Then I would put the $550 I’m saving form principle into the stock market. Now this is over simplified and I know I will get downvoted and picked apart in the comments. However, this is just a ballpark to kind of lay out some of the considerations.
In a previous video, we explored the price-to-rent ratio which helps determine if it is better to buy or rent. If we look at this ratio, some of the largest cities, and most expensive cities in the United States have high price to rent ratios which would indicate that you want to be a renter, not a home owner. These cities include San Francisco, Oakland, New York City, San Jose, Los Angeles, Seattle, Washing DC, San Diego, and Boston.
When you first purchase a house, your leverage is the highest, and thus your potential returns on your investment are the highest. For example, imagine you purchase a $500,000 house with a downpayment of $25,000 downpayment which is equivalent to 5%. Now assume the house increased by 10% in the first year. The house is now worth $550,000. You had a return of $50,000. You had to take out a mortgage and let’s assume the interest rate is 5%, so that is $25,000. So the house appreciated by 10%, about 5% of that is eaten up by your interest payment, you have 5% of that return you are capturing which is $25,000. So your downpayment was $25,000 and your return was $25,000. So that is about a 100% return in the first year. Then you have to consider you are living in that house, which means you aren’t spending money on rent. Also, any money you are putting down as a downpayment or paying on the principle is paying off the price of an asset. That is equity that increases your wealth and is yours to keep assuming the market price of the house is stable.
The issue is that a house does not always increase in value year over year. For the majority of US history, housing prices have increased only slightly more than the level of inflation in the economy. The stock market has beter overall returns than the housing market. Only during a period called the Great Moderation between 1990 and 2006 did the returns from real estate rival the stock market.
One line of argument is that if you are in your 20s or 30s, you may make more money from a total market ETF or S&P 500 ETF that you would putting the same amount int real estate.
So it is complicated whether to own or rent, but the more expensive owning is versus renting, the more sense it makes to just rent and invest whatever money you are saving into the stock market. The decision is ultimately highly personal and depends on you and your family, and their needs and wants.
Works Cited:
https://www.investopedia.com/ask/answers/052015/which-has-performed-better-historically-stock-market-or-real-estate.asp
https://www.stessa.com/blog/price-to-rent-ratio/
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