Buy vs Rent and Invest: Planning for Financial Independence

Here’s how to analyze your own buy vs rent and invest scenario, deciding to invest in either needs to be part of your financial independence plan!

Reading Time: 11 minutes

I’d like to help you understand how to analyze the decision of buying a home vs renting and investing your downpayment. Living arrangements are an important part of your plan for financial independence. What are the costs of owning a home and how does that affect your plan for financial independence? What’s better: buy vs rent and invest your downpayment?

The final answer is almost certainly going to come with a dash of “it depends”, but I can at least teach you how to figure out how to create your own unique calculation.

Is the Best Investment You Can Make Buying a Home?

The townhouse we lived during my high school years pictured from behind. Jenni spent many after school afternoons tutoring me in chemistry here (no, really!).
The townhouse we lived during my high school years pictured from behind. Jenni spent many after school afternoons tutoring me in chemistry here (no, really!).

My parents moved into their current house in 2002. This month, they’re finishing up a significant bathroom renovation and intend to put their house on the market for sale relatively soon.

And, don’t worry—I haven’t tried to convince them to use one of my recommended websites to sell your stuff to facilitate that transaction. My dad happens to have a realtor license.

My parents worked hard to pay down their 30-year-mortgage early in the last 18 years and they’ve nearly done it. As I described recently, they answered the “pay off mortgage or invest” question by making lots of extra payments toward their debt over the years.

My dad is often flabbergasted at the value of the house and how it’s risen since they moved in all those years ago. They keep the place spotless and maintain it well.

He’ll often flippantly mention:

“This house is the best investment we’ve ever made!”

My dad

But I wanted to know: is that true? Is a house really an investment?

More importantly, how can you ask yourself the same question and figure out if buying or renting and investing makes better sense for you?

Buying vs Renting and Investing

At the end of this analysis I want to answer the question: were my parents better off buying their house with a 20% downpayment or renting the same home and investing the downpayment. I’d like to calculate the total cost of ownership and compare that to renting and investing.

Comparing the rate of return

Let’s start off with the easier, initial question. Is residential real estate or the stock market a better investment? We’ll take a look at my parents’ anecdotal experience and then bring in historical context.

My parents purchased their house in 2002 for just shy of $350K. Today it’s worth just under $666K. Just glancing at the numbers it’s easy to see how that $316K increase in value, or potential profit, would seem like an incredible investment.

Over the 18 year timeframe we’re analyzing, the compound annual growth rate (CAGR) is 3.64% for this house.

We’ll use the S&P 500 index to represent “stocks”—I like investing in index funds vs individual stocks. If we took the same ~$350K and invested in the S&P 500 when they purchased the home in 2002, would the resulting value today be more or less than $666K?

Make your own guess before we calculate this!

On the date of their mortgage opening, the S&P 500 was at 1,153 points.

The S&P 500 was at 3,363 points on the date of their most recent property value estimate in 2020.

If they purchased an S&P 500 index fund with $350K in March of 2002 and left the dividends reinvested it’d be worth about $1.37M today. That’s near 4x more! The CAGR for the S&P 500 investment is 7.88%!

I don’t think it’ll be a surprise to most people that the S&P 500 beat my parents’ house in terms of appreciation, but we needed to calculate this in order to set up the rest of our analysis.

Historical residential real estate return rate

How has my parents’ property compared to the average residential real estate CAGR in the US? The St. Louis Fed exposes the data for the S&P/Case-Shiller U.S. National Home Price Index to calculate CAGR easily.

For the same 18 year period, the average home earned a 3.51% CAGR which was just behind my parents’ house 3.64% return rate.

The CAGR for the same home price index (HPI) going back several decades suggests this is pretty close to average which is about 3.9%.

HPI varies around the country. Since they purchased their home, the US went through a massive housing crunch in 2008-2009.

This timeline video will give you a sense of house HPI varies around the country. Housing Price Index Source: CaseLogic & New York Fed.

You can easily calculate your own CAGR via Moneychimp’s CAGR calculator.

Of course, this is a very simplified comparison between index funds and a primary residence. We’ve ignored multiple key factors:

  1. Real estate often uses leverage
  2. Housing has additional expenses

Before diving into how additional housing expenses affect the primary residence vs stocks equation, let’s look at using debt—leverage.

Leverage in real estate investments

Simply put, a mortgage is by far the most common form of debt the average person will use to amplify an investment. This amplification through debt is leverage.

If you put $70K down on a $350K house, you’ve only invested 20% to obtain the underlying asset and its growth. If the home value goes up 10% to $385K, your investment is worth $35K more whether you paid in full or not.

It’s the increase relative to your initial investment that matters.

You stand to have a 50% gain over your initial transaction cost in the leveraged scenario!

Of course, the risky part is that if the house were to lose just 10% in value, you’d stand to lose 50% of your initial investment!

Debt can increase rate of return

Let’s reanalyze our initial rate of return calculation for the house which suggested that it earned a $316K profit off of a $350K investment over 18 years.

If we only put $70K down but still earn the same $316K profit after paying the remaining $280K debt balance from our $666K sale, our CAGR rises to a whopping 8.73%!

That beats long term CAGR for the S&P 500 stocks.

Again, this is a simplified explanation with 0% debt interest.

While it’s not something I’d do, you can use leverage (margin) to invest in stocks as well.

Mortgage interest rates’ impact on rate of return

As you near paying off your mortgage, your rate of return will decrease as you have more of your money tied up in the asset but still earn the same growth on the asset.

Let’s make this quantified comparison of primary residence vs stocks a little more realistic by including the effects of leverage and the related interest on the debt. Let’s assume a 20% downpayment ($70K). In March of 2002, the average 30-year fixed-rate mortgage had an interest rate of about 7% which we’ll use.

YearDebt ($)Interest Paid ($)
Mar 2002280,0000
2003277,89314,651
2020183,890300,496
Sep 2020176,618309,983

We can see from the table above that while the home value nearly doubled over 18 years or so, almost $310K of interest would be paid with a 7% mortgage.

Meanwhile, just a bit over $100K of the original debt would be paid down.

Extra costs of real estate

So far, we’ve ignored these additional housing costs:

  • Realtor fees
  • Transaction fees (transfer taxes, title, etc.)
  • HOA fees
  • Maintenance, improvement
  • Property taxes
  • Insurance

These expenses can really add up as we’ve revealed in our own annual FIRE budget, making the actual principal and interest payment look small.

Not to mention the fact that interest rates these days are near historic lows. My parents have refinanced since their initial mortgage at 7%.

Let’s try to account for some of these larger expense factors and also add refinancing into the equation.

Refinancing to increase real estate returns

Let’s assume a refinance occurred about midway through the payoff period with a newly refreshed 30 year fixed rate mortgage at 4% in early 2012. The fee for the refinance itself would have been around $5,500 which we’ll include in the total interest paid column at the refinancing point.

Let’s take a look at our mortgage table again.

YearDebt ($)7% Loan ($)4% Refi Loan ($)
Mar 2002280,0000
2003277,89314,651
2013237,890179,63714,301
2020202,959179,63776,305
Sep 2020198,604179,63782,338

Our initial 7% mortgage sits at a total cost of $180K from the start of 2012 onward.

Getting rid of the higher interest loan at 7% really juices returns. The mortgage refinancing would cut their total interest paid so far from $310K to $262K.

Ongoing costs of real estate

But what about some of those housing expenses? Property taxes are probably the element most folks would like to see included.

Here’s the tax history for their property:

YearProperty Taxes ($)Tax Assessment ($)
20206,098589,140
20196,034577,450
20185,709526,150
20175,783514,030
20165,887518,080
20155,882512,420
20145,842505,760
20135,947493,550
20125,602453,600
20115,872457,000
20105,798451,300
20095,736441,900
20085,774457,500
20075,458527,300
20066,337612,200
20055,522533,500
20045,308512,800
20034,520436,700
20023,891375,900
Total107,000

That’s $107K worth of property taxes they’ve paid so far on their place!

What about HOA fees? Their current HOA fee is $119 per month. Over the course of their ownership, it has averaged $101 per month. That’s another $22,422.

Over the course of 18 years, their home insurance has run an average of $1,140 per year. Total cost: $20,520.

Real estate transaction costs

Transaction costs when selling a home will vary from person to person. I’m going to give our scenario the benefit of the doubt in the calculation.

We’ll assume my dad, with his realtor license, will sell the home himself to cut the 3% fee that is typical for a listing agent. They’ll still need to pay the buyer’s agent 3%.

If they were to sell around $666K, that’s another $19,998.

Transfer taxes vary as well, but we’ll lump them in with title insurance, escrow fees, attorney fees, and prorated property taxes. 1% is a common rule of thumb, which is $6,659.

Ongoing home maintenance and improvement costs

Consider that the average maintenance and improvement cost for a home is 2% per year. You can cut some maintenance and improvement costs by not being fearful of DIY projects. Nonetheless, home maintenance and improvement costs are estimated at $126K in this scenario!

I know they’re working on a bathroom renovation right now I suspect will ring in at $20-30K!

Homeownership tax deductions

Back in 2002 the standard income deduction every married couple gets on their federal taxes was $7,850. People without itemized deductions would claim this standard deduction. In that year, they were certainly paying more on their property taxes, mortgage interest, and state income tax so they would have itemized their taxes. These state and local taxes (SALT) would have been deducted from their income to reduce their tax liability.

The value of tax deductions for owning a home are highest in the beginning of ownership because you’re paying the most interest at the start of the mortgage. For example, we know that by 2003 my parents paid about $15K in interest on their loan. This along with the property taxes for the year ($3,891) would have resulted in an itemized deduction of about $19K. That’s about $11K more than the standard deduction.

If we assume their federal and state tax rate combined was about 32%, the tax deduction was worth about $3.5K in year one!

However, this number would have shrunk when they refinanced since they were paying less interest and the standard deduction has kept increasing.

Let’s use 2013 as another snapshot to test the tax deduction value. With the newly refinanced loan at 4%, they would have paid $9,435 in interest. Their property taxes were $5,947. The standard deduction in 2013 for them was $12,200. Without any other deductions, their itemized deduction would be $3,182 over the standard deduction. If we assume the same ~32% effective tax rate, the tax deduction on their house was worth $1,018.

With the Tax Cuts and Jobs Act of 2017, the standard deduction is now $24K for married couples. SALT deductions are also limited to $10K! Like many couples who own a single home and don’t have many itemized deductions, they’ve taken the standard deduction since at least 2018.

Overall, I’ve estimated their tax deduction for owning their home as worth $36K.

Downpayment opportunity cost

Lastly, we need to account for the opportunity cost of the original downpayment. The 20% they put down on the loan to secure it would otherwise be invested over their 18 years of ownership.

We know from our earlier discussion about this home’s price appreciation vs the stock market that an S&P 500 index fund would have increased more than four fold. In fact $70K invested then would be worth $274K today with dividends reinvested!

The growth, $204K, is the opportunity cost of the downpayment being locked away in this house for 18 years.

Adding opportunity cost into their homeownership cost calculation treats the analysis like it happens in a vacuum—as if alternatively, they could have lived at some other place free of charge.

True Cost of Homeownership

What has been the true total cost of home ownership in my parents’ scenario?

DescriptionValue ($)
Home Sale665,941
Income tax deduction36,144
Debt(280,000)
7% Loan Interest(179,637)
4% Refi Interest + Fee(82,338)
Property Taxes(107,000)
HOA Fees(22,422)
Home Insurance(20,520)
Buyer’s Agent(19,998)
Closing Costs(6,659)
Maintenance & Improvement(126,000)
Initial Downpayment (20%)(70,000)
Downpayment Opportunity Cost(203,727)
Total homeownership cost(416,216)
In our specific analysis, my father is a realtor which absolves them from the typical 3% (another ~$20K) seller’s agent fees. Be sure to include that expense in your own analysis, though!

It’s incredible to look at this real estate investment that has increased in value from $350K to nearly double at $666K yet because of all the expenses associated with owning your own home, it can be a pretty bad investment.

But the truth is, my parents didn’t buy their primary residence with an eye for it to be strictly an investment.

Assuming the sale goes through at the price they expect and without any last-minute repair needs, it’s cost them $416K to live there for 18 years. Over 222 months, that’s $1,875 per month on average.

Really, I don’t think that’s a bad deal! But, is it an investment? No. Their asset has cost them money, it’s not something they were able to rent out to produce cash flow and the appreciation wasn’t enough to overtake the expenses.

Someone looking to retire early through real estate investing would analyze the situation from a perspective of rental rates, my parents just wanted a place to live that would increase in value, too.

Rent and invest or buy?

Let’s come back to my original question: would they have been better off, financially, to rent and invest their downpayment or to have purchased their home as they did? We’ll analyze that opportunity cost of the downpayment as an actual second scenario.

The estimated rent for their home currently is $2,900 per month. There happens to be a very similar house available nearby that this rate so we’ll assume it’s accurate. Rental history for homes in the area back in 2002 shows monthly rent rates around $1,950 per month. We’ll estimate that as an average of $2,425/month over the same 222 month period.

We know that had they invested $70K in the S&P 500 (or even better, a total US stock market fund like VTSAX or VTI), they would have earned $203,727 over the initial $70K. Typically, renting a home requires 1-month of rent as a security deposit, so we’ll subtract that from our $70K investment. $68,050 invested would be worth $266,102 (earnings of $198,052).

Rent & InvestBuy
Initial cost ($)(1,950)(70,000)
222-month cost ($)(538,350)(537,917)
Investment earnings, stocks198,0520
Investment earnings, home10395,428
Security deposit return1,9500
Net(340,298)(212,489)
1) Investment value, home = sale price + tax deduction value – debt – buyer’s agent – closing costs

Note: Under the “true cost of homeownership” section above, we declared the total cost at $416K. That’s much more than our net cost to “buy” in the table above ($212K). That’s because opportunity cost shows itself on the other side of the equation as investment earnings for “rent & invest”. There’s some great discussion about this in the comments below if you find it confusing.

Strictly financially speaking, given rental rates for similar homes, buying was the smart move for them.

The decision to buy their home instead of rent and invest their downpayment put them ahead by about $128K over their 18 years of homeownership.

Buy vs Rent Pros and Cons

As an investment, your primary residence is very unlikely to produce a positive return once figuring in all the expenses related to homeownership. On top of that, unless you rent out a portion of your primary residence, you can only rely on appreciation (which tends to be 3-4%/year in the US) to increase your total investment value.

The story is much less clear when you begin to analyze buying property to rent out versus investing in the stock market, but that’s an analysis for another time.

Your primary residence is almost certainly a liability. Nonetheless, as the old saying goes, you need to live somewhere. Even with all the expenses associated with homeownership, it may be smart to include it in your plan for financial independence. That’s extremely dependent on the myriad variables involved with your decision between renting or buying. If you’re quantitatively analyzing that decision, NYT has an excellent comparative rent vs buy calculator.

In tighter housing markets, rental rates should reflect the underlying costs of homeownership pretty well. In that case, consider the pros of renting vs the pros of owning. Perhaps that’s more relevant to your decision that the strict financial costs.

Renting pros:

  • Housing flexibility
  • Less responsibility for maintenance
  • More liquid assets

Owning pros:

  • Housing security
  • Easier to mold your home to your liking
  • Asset appreciation possibility

There are many more detailed differences between the two approaches.

I think that for most people, much of the decision simply comes down to housing availability within a particular location. Many want to live in a particular place or neighborhood and the availability of rental units or purchasable units may be limited in that location.

Ultimately, the most important thing you can do to help yourself to achieve financial independence is to run your own analysis and create a plan. For your own specific criteria, renting may be the smarter choice. For others, buying could be the ticket. It’s not a one size fits all question. Use the buy vs rent and invest criteria outlined in this post to help make your own smart decision on the path to financial independence.


What do you think drives people to decide to rent or buy? Which is healthier for those on a path to financial independence?
Let us know in the comments!

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By Chris

Chris began his financial independence pursuit in 2007 as he learned basic personal finance from Get Rich Slowly as an aspiring web designer and novice investor. After several missteps, he learned the secrets of financial independence and began his pursuit of freedom.

He reached financial independence in 2018 with $1.2M and two businesses. He began the process of transitioning to early retirement in 2020.

Learn more: Meet Chris.

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Backpack Finance
20 days ago

Great analysis. I think buying your primary residence makes sense if you know exactly where you are going to live in the next 10-20 years. I don’t see buying a home as an investment. It’s an emotional decision and it gives you peace of mind. Valid enough reasons to fork out the funds if it fits your budget.

Noel@HappilyDisengaged

My dad says the same thing about his home being the best investment he’s ever made.

As for us, we bought our house in 2015. It’s currently appreciated about 100k in those 5 years. But I don’t see us ever selling to reap the appreciation. We’ll rent it out when we move, and that’s the day I’ll call my home an investment.

We’ve recently crossed over to the renting is better camp. There’s so many big and small expenses that go with owning a home, like you mentioned in your piece, that it can get frustrating after a while. Seems like every month we’re spending more than we budgeted just for upkeep–money that could have gone into the stock market. Not to forget the “time” it takes to keep the place looking good. Funny thing is these home expenses weren’t a big deal till we “financially awoke”. Once FIRE was on the table we could definitely see the drag home ownership is on our savings rate.

Nice break down.

Joe
Joe
18 days ago

A home is a good investment for many regular people because it’s a form of saving. If they don’t put money into the house, they’d just spend it.

For investors, it makes a lot more sense to invest instead of paying down the mortgage. Historically, the stock market is a better bet.

Max @ Max Out of Pocket

Great overview – I love case studies. You covered the tax deduction piece well and the Tax Cuts and Job Act you mentioned is certainly an even bigger consideration going forward. Opportunity cost is also often overlooked, so I like seeing that.

I was talking to my friend in Chicago last week and he was telling me he bought a new place for about 525k. I looked it up and property taxes are $8,700. I sometimes consider that “rent” to own a property.

My actual rent is $12,000 annually in a different market. To be fair, his place is bigger and nicer (different priorities), but property taxes alone are a big deal.

Again, I like to oversimplify things, but the fact that he is willing to pay 72% of my rent in taxes alone is uncanny to me.

Take care,

Max

Robert - Stop Ironing Shirts

This is good stuff, most of my financial mistakes revolve around housing as someone who owned four homes during the span of this analysis.

Many want to live in a particular place or neighborhood and the availability of rental units or purchasable units may be limited in that location.”

That statement is really the only reason I might buy a house again, now that I’m an early retiree, I am choosing to live in places that have a “paradise tax” and almost everything is either owner occupied or a short term vacation rental. Rental inventory is tough to come by.

Sandy
Sandy
13 days ago

Great analysis but you lost me at the argument of RENT vs BUY. The total cost of home ownership was just determined to be $416,216. Immediately following, you calculate the cost to be $212,489 over preceding the 222 months. Also, its seems that you excluded the cost of the seller’s agent in the total cost of home ownership as well, would I estimate to be the same $19998.

Please let me know if I’m missing something in my interpretation. Alternatively, would you consider updating your analysis after any necessary corrections? It’s such a great analysis!

Sandy
Sandy
13 days ago
Reply to  Chris

thanks so much for responding so thoroughly and quickly.

One other point I think worth emphasizing is that real estate is rather illiquid and that you may find yourself needing to sell in a down market, carrying 2 mortgages, dealing with vacant periods if you do opt to rent your home waiting for a real estate market recovery, along with the lack of diversification relative to what you can achieve in the stock market.

Speaking from personal experience, the home that I built in 2001 has not appreciated significantly, if any since the economy of my town has declined. This lack of appreciation has been relatively consistent year to year. In REAL terms, my home has lost value. I am glad I didn’t pay it off early and instead invested more heavily in the stock market.

If your parents shared the same misfortune as I do with respect to “location, location, location”, their monthly expense of home ownership would have gone up considerably…if my calculation is correct, up to $3298 per month!

Unlike the stock market, where one is generally not required to sell a large value of assets at a time when they may have depreciated, one may find themselves needing to sell their home do to unforeseen life circumstances (relocation due to loss of job or transfer, divorce, death, illness, retirement). No one can predict when the stock market will outperform real estate during a specific period of time. I think it is important to consider your home a place to live and not necessarily an investment (unless perhaps you live in California).

Lynne
Lynne
13 days ago

I’m currently in the throes of future planning and the thought of selling my place and buying another fills me with dread – because of the maintenance.

The best thing about homeownership, for me, is that your landlord can’t just up one day and terminate your lease agreement and force you to move. And as an owner, you have more control over getting the repairs done. Some landlords aren’t too swift on getting repairs done in a timely fashion. It’s more than inconvenient to go several days without a working refrigerator, water heater, actual running water or air conditioning/heat.

Those are the things that kind of scare me away from renting. They also give me ideas of questions to ask of a prospective landlord; how they handle repairs and how old their unit’s components are.

Impersonal Finances
10 days ago

As many other commenters have pointed out, for most people a home will be their greatest investment because it will be their only investment. In my view it really has to be a rental property for it to fall in the category of an investment. But, you do have to live somewhere, and having a mortgage payment as opposed to cutting a rent check each month means you are contributing toward the eventual ownership of an asset. Enjoyed the detailed breakdown!