Author Topic: Comparing two scenarios: FIRE and buy a property vs FIRE w. more money and rent  (Read 1290 times)

Padonak

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Hello MMM community. I'd like to hear your thoughts on comparing and backtesting the following two scenarios:

1. Fire and use part of your nest egg to buy a property outright. Spend less money because you're saving on rent.
2. Fire with a bigger nest egg and rent for the rest of your life.


I tried to use this tool https://ficalc.app/ to backtest both scenarios. Someone on youtube mentioned Ficalc and i really liked it for its simplicity, but the same kind of backtest can be done with other tools as well. I am not affiliated with this web site.

The numbers I used as inputs are just to simplify calculations, not anyone's actual numbers. If you feel they are too low, multiply all of them by 10 if you want.

I used the following assumptions: $1MM nest egg, 4% fixed withdrawal rate adjusted for inflation, 30 years retirement length. 

Scenario 1. Keep $700K in the stock market (Ficalc defaults to 80% US stocks, 15% US bonds, 5% cash). Use $300K to buy a property (yes, i know it's low for most places in the US but again, these numbers are used for simplicity). Then run a backtest with a 4% withdrawal rate, so that's $28K per year which is $40K per year minus the estimated rent you would be saving on a $300K property, which is $1K per month or $12K per year in this example.

Scenario 2. Keep renting and invest the entire $1MM nest egg in the same portfolio of 80% US stocks, 15% US bonds, 5% cash. Use the same 4% withdrawal rate for spending, so $40K per year adjusted for inflation. That includes the estimated $1K per month rent you would be paying in this case, also adjusted for inflation.

With these inputs, both back tests show a 95.9% success rate. Scenario 2 is what https://ficalc.app/ shows by default if you open it. To run Scenario 1, just reduce the nest egg to 700K and yearly spend to 28K and you will get the exact same success rate.

Questions and comments:

One assumption I made for this comparison is that the rental yield on the property is the same as planned withdrawal rate which is why the success rate is equal for both scenarios. So, 12K/300K = 4% gross rental yield on the property (the rent you wouldn't be paying, adjusted for inflation). Alternatively, investing that amount and withdrawing the same $12K per year infl. adj. at a 4% withdrawal rate gives you the same results. Question: what's the best way to stress test this assumption perhaps by using a range of different rental yields and different withdrawal rates as well?

I tried to model the same scenarios with estimated social security as additional income (ficalc has that option), so in that case, buying a property would reduce the failure rate because you're adding the same amount of SS in both scenarios while keeping expenses lower in Scenario 1.

This comparison doesn't account for the value of the property after you pass away so if someone wants to leave it to children or significant others, it's also an important consideration. For someone who doesn't have heirs or just doesn't care, a reverse mortgage is also an option increase income even though it's generally a bad deal.

Another assumption is that both rent and spend growth are tied to inflation but depending on where you are, these may be different. For example, if you want to stay in a gentrifying area or let's say a developing country on an upward trajectory, it may be better to buy a place before rents for similar places get out of control or the local currency appreciates vs the USD.

Then there are non-financial considerations such as being able to renovate and furnish your place as you please, not having to move when the landlord needs the place, etc.

This kind of comparison can be used before you FIRE but you can also use it at any point of your retirement if you're renting and want to buy or conversely, considering selling the property your own, investing the money and spending the extra income on rent. The only caveat is that if you use it later in retirement, you will have to account for the same kind of sequence of returns risk that recent retires face without the same ability to get back into the job market if things go wrong. So it's probably better to use a lower safe withdrawal rate in this case.

Anything I'm missing? Any additional thoughts or other examples?
« Last Edit: January 24, 2023, 08:07:07 PM by Padonak »

six-car-habit

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   I am usually amazed, and disheartened, when I do a mental "what-if ?"

Step 1 - Sell the house we've been living at and paying mortgage towards, for the past 10 years.

Step 2 - Collect equity, which would be substantial, as the house has doubled in value.

Step 3 - Rent an similar house - {size, neighborhood, age, land} -  drawing down the equity which is kept in a 'safe' investment @ 3% or 4%

Step 4 - Need to move in less than 10 years, because the equity money has depleted to zero, since todays rental prices have almost doubled as well.

   

Paper Chaser

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I think that reducing the number of variable parameters in the post-retirement formula is always preferred. Stability and predictability in expenses has value. Stable or expected increases in expenses are easy to plan for. It's the uncontrolled or unexpected changes in expenses that are probably most likely to lead to portfolio failures.

Investment returns will always be variable and out of your control. If you rent, then housing costs are also variable and out of your control. However, if your housing costs are more or less locked in via mortgage or outright ownership, then the only thing you need to concern yourself with is the variability of investment returns. The confidence interval improves, even if the success/failure rate may not.

Metalcat

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Renting vs owning is both a financial and a lifestyle decision.

If your entire analysis is based on living in a specific type of home in a specific location indefinitely, then yeah, it's highly likely that owning is going to be the more rational option.

But life doesn't exist in that kind of vacuum. Where renting really shines is when you are downsizing and want the flexibility to move around. So say you retire, kids move out, and you sell and downsize, but also move every few years trying out different, interesting LCOL regions.

It also depends on your market. In a lot of a markets I've lived in, small apartments are cheaper to rent than to own. This is because small apartments for rent are often in large rental buildings and apartments to own are condos. Plus everywhere I've lived has strict rent control. So if you retire, kids move out, and you sell your house and downsize to a rent controlled apartment in a rental building where you cannot be evicted at will by an owner who wants to move in their niece, then you can lock in rent waaaaaayyyyyy below market value over a long period of time.

Renting is always a investment in flexibility, so if your plan doesn't require flexibility, then you're losing a lot of the benefit.

I personally can't fathom staying in one house indefinitely. I get antsy after 2 years, so ostensibly renting would be ideal for me. Except, for various reasons I just ended up buying in a few different locations, and I'll move around between those locations for the next decade. But that's only because DH is still working.

Once he's retired, we'll likely rent out our properties and live largely nomadically, renting for ourselves as we go.

My point is, the calculus on rent vs buy hinges so much more on how long you want to stay in one place than anything else. Then it comes down to your specific market and what kind of housing you want in that market.

Laura33

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I'm not sure a general analysis is particularly helpful, because so much of real estate is local.  What is the cost to rent a house comparable to what you would buy, or vice-versa -- and do those comparable units even exist?  IME, most rent vs. purchase decisions are driven by both affordability and preference for the type of units available (e.g., if you want a SFH, you generally need to buy).  Also, do not forget the very significant cost of ongoing maintenance for a house, which is covered when you rent.  OTOH, buying allows you to pay off the purchase over time when you have a higher income stream, so that by the time you quit, you have paid off the mortgage and can enjoy the lower costs.  OTOH again, though, assuming a purchased home is more expensive than a rental apartment (which is the case in my area), perhaps you'd have been better off investing the difference instead of putting it toward a mortgage.

IMO, this kind of analysis is much more helpful when you're considering two specific options.  For example:

Purchase 1:  we bought when we moved for DH's job because we planned to settle in forever, built our dream home, etc.  Terrible, terrible idea:  first tech crash hit barely 2 years later, he worked for a Kozlowski company that was being jiggered financially and shut down for reasons that became apparent only several years later, we had to move out of state for a new job (I was pregnant when his job went away so not in a position to carry us financially -- it was truly a black swan event for us personally in terms of everything coinciding), ended up carrying two mortgages for over a year and lost about $100K on the house. 

Purchase 2:  bought our current house at a relative bargain c. 2004 in the middle of real estate market craziness.  Knew price was going to be offset by major remodel (old house), but chose for lifestyle reasons (short commute, good schools, close to mom, nice neighbors, kids can walk to school/library/etc.).  It was not the most financially beneficial choice, given how the market has roared since we bought, and the remodel/upkeep were more expensive than we originally planned.  OTOH, I love my house, loved giving my kids that kind of childhood, and as a lifestyle splurge, it was well worth it.  We also benefited by being able to pay the mortgage during our high-cash-flow years, and the payoff date coincides with our planned retirement date, which allows us to decrease risk going into retirement with significantly lower housing costs.  We also benefit by caps on real estate tax increases for homeowners.

Side note:  added benefit/point of comparison:  house fire has displaced us for a year.  As a result, we know the local rental market very well, because we did an exhaustive search for everything in our school district.  We ended up paying $1K/mo. more in rent for an apartment that is 1/3 the size of our house, so it's clear in retrospect that we truly benefited by locking in a mortgage at under 3%.  Unexpected blessing-and-curse:  house fire means that the house will have completely new everything -- electric, plumbing, lighting, insulation, HVAC, kitchens/baths, roof, appliances, paint, you name it -- all paid by insurance.  So we are hopeful that all the new systems will help with our long-term maintenance costs (not to mention electric bills, given that we finally have insulation!). 

But just as we never could have predicted the tech crash that cost us so badly on that first house, we also couldn't predict that a house fire would basically give us a brand-new house 2 yrs before our anticipated FIRE date.  In both cases, we made the best decision we could at the time.  The fact that one worked in our favor and one didn't was due to forces that were completely beyond our control -- man plans, God laughs, all that stuff.  So IME, looking for larger rules/principles that will consistently point the way to the most financially-optimal future is a waste of time.  Better to acknowledge that you have no clue what's going to happen, do the best analysis you can when a specific option is in front of you, and just make sure you spend a lot less than you can afford so you have flexibility to handle whatever comes.

And pay for good insurance.  ;-)

ChpBstrd

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1) If you can rent a $300k house for $1k a month, you should definitely do so. A quick mortgage calculation shows that with a typical $2,400/y property tax, $1k/y insurance, no PMI, no HOA, and today's prevailing interest rates, the payment for a 30y loan would be $1,832, not $1,000. So the way this comparison is set up, the rent vs. buy decision is heavily tilted toward renting, and that's before we account for repairs and maintenance. See what happens when you plug in $2,500 or $2,750 as the amount of monthly rent. It's a more reasonable number that a landlord speculating on appreciation might take on a sustained basis.

2) Buying a home also involves closing costs, even if you pay cash. Deduct at least $5k from the stache for closing, utility deposits, termite contract, unforeseen issues, etc.

Must_ache

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I'd be more inclined to own, up until the point when I'm frail and need simplicity in my life - a building that suits me without the task of maintenance.
If you rent, you are at the whim of a landlord. If they raise prices you may want/need to move - I have no desire to move around, it is a hassle.

Metalcat

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I'd be more inclined to own, up until the point when I'm frail and need simplicity in my life - a building that suits me without the task of maintenance.
If you rent, you are at the whim of a landlord. If they raise prices you may want/need to move - I have no desire to move around, it is a hassle.

Yes, as has been said, the more someone wants to stay put in one home, the more the balance tips towards owning. No question.

As for rents being raised, this depends on your region and local laws, which are obviously a major factor.

Where I live, if you rent an apartment from a rental building, they can never evict you and rent controls are strict and don't necessarily keep up with inflation. My aunt and uncle rent a 2 bedroom apartment that they've had for 25 years in a city where housing prices have exploded. To buy the equivalent at the time would have been quite expensive compared to renting and now the equivalent apartment to buy would be 1.5M and I think they pay $1200.

The longer they rent there, the better a deal it becomes. So in certain regions, for certain properties, renting long term can actually be very beneficial. They miss out on the equity of owning, but they wouldn't want to have to sell to cash out because they live in their ideal location. The property taxes alone on an equivalent condo would be more than they currently pay.

If they were renting a condo, the owners could evict them at any time to occupy the unit themselves or with a family member, and then a few months later rent it out again at a jacked up rate, which is what people here do to get around rent control. But the rental buildings have no way to remove people who are good tenants. They just have to hope they don't get too many lifers.

Rental laws certainly play a major role in assessing the pros and cons of renting.

This is another reason there are no universal rules on this front. It really comes down to the individual's needs and the very specific market they live in and what the local laws are.

Villanelle

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I plan to rent once we fully retire and settle, at least until we need assistance of some kind.

But that's for almost entirely non-financial reasons.  Face punch all you want, but I want to be able to paint the walls colors that bring me joy, and maybe even redo a kitchen so it perfectly suits me.  I want to know I never have to move if I don't want to.  No landlord can sell a property out from me, or raise the rent to untenable amounts, regardless of what the market is doing.  I want to get to know neighbors, which is rough for me as an introvert so I want it to be worthwhile. 

I think that this decision is about far more than finances, especially if one is looking at the possibility of a very long term house.  (vs. something like knowing that kids will be leaving the nest and in 5-6 years you think it's very likely you will want to downsize or move to a place without stairs, or if you are looking at something suitable for two 20-somethings but you plan to have children in a few years and will likely want to upgrade a few years after that ).

If it's a planned shorter term thing, I think the finances become the most important factor.  If it is expected to be long-term/forever, and if you have enough money that you don't need to maximize every financial decision, then they other factors can become more important. 

Finances_With_Purpose

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As usual, I agree wholeheartedly with @Laura33 .  She puts it perfectly into context.

It's a highly personal decision: no way around it.

I'll add this: you've omitted the potentially high costs of maintenance/carrying costs of a house.  But as others noted, over the long term, owning a house can save you money.  It also depends upon other things: do you want to be in one place, or are you going to want to move around/work in a field that requires moves in order to advance?  A house can become a problem even if all you need to do is move from one side of a metro area to another, or one school to another. 

As others mentioned, a house does lock in a lot of your costs (and thus protect against inflation). 

We own as well and love it, but it's definitely a lifestyle choice as much as a financial one. 

Ron Scott

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2 thoughts:

A) the New York Times has a good rent vs. buy piece for your consideration: https://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html

B) Firecalc looks cool and professional but suffers the typical fatal flaw of assuming past performance is a reliable indicator of future returns. Would I bet my last 30+ years of life on it, in retirement? HELL no!

PDXTabs

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Renting vs owning is both a financial and a lifestyle decision.

If your entire analysis is based on living in a specific type of home in a specific location indefinitely, then yeah, it's highly likely that owning is going to be the more rational option.

Yes, I'm on team rent but owning gives you different advantages. If you own in the US you mostly lock in your housing costs and you probably won't be forced to move. So you can argue that owning your primary residence is a hedge against increases in the cost of housing. But nothing is guaranteed. You could face eminent domain, huge increases in property taxes, or civil war.

Metalcat

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Renting vs owning is both a financial and a lifestyle decision.

If your entire analysis is based on living in a specific type of home in a specific location indefinitely, then yeah, it's highly likely that owning is going to be the more rational option.

Yes, I'm on team rent but owning gives you different advantages. If you own in the US you mostly lock in your housing costs and you probably won't be forced to move. So you can argue that owning your primary residence is a hedge against increases in the cost of housing. But nothing is guaranteed. You could face eminent domain, huge increases in property taxes, or civil war.

There really are pros and cons to everything. One of the biggest pros to owning: housing permanency, is also a con because it financially tethers you to an asset that can be expensive and difficult to offload when life demands it.

Everything is a trade off, and when it comes to housing, none of those trades are inherently superior, it entirely depends on what the circumstances are at the time.

This is why I personally only own properties that are cheap to maintain and easy to rent out. My family has been in the horrible position of having to sell in serious suboptimal circumstances a few times. So my personal bias leans quite heavily away from having my home be a large financial albatross.

But that's just me and my personal experience shaping my particular priorities. Someone who has dealt with multiple horrible landlords and being evicted for no reason may put far more value on the control and security that ownership provides.

A case can be made for substantial benefits for either, but it all comes down to what particular risks the individual is wanting to hedge against.

We also should never assume that the comparison of rent vs buy is always for the same kind of property. I'm personally willing to rent very different properties than I'm willing to buy. That can throw a lot of nuance into the considerations as well.

Padonak

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Is there a reliable source of information on rental yields for different cities in the US and also international cities? Ideally split by type of property (house vs condo). In my initial analysis, I am assuming a 4% gross rental yield and 4% safe withdrawal rate, so that makes the comparison of financial benefits of buying vs renting neutral.

I found this comparison online but not sure how accurate or reliable it is https://www.numbeo.com/property-investment/rankings_current.jsp


vand

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Buy. Preferably with a massive mortgage where you let inflation erode it over 25-30 years.

Paper Chaser

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Is there a reliable source of information on rental yields for different cities in the US and also international cities? Ideally split by type of property (house vs condo). In my initial analysis, I am assuming a 4% gross rental yield and 4% safe withdrawal rate, so that makes the comparison of financial benefits of buying vs renting neutral.

I found this comparison online but not sure how accurate or reliable it is https://www.numbeo.com/property-investment/rankings_current.jsp

I don't think there's any way to get truly useful data on rental yields because so much is property specific. It's heavily influenced by purchase price, leverage (if any), and clientele. A high end rental might thrive in some markets where low end rentals struggle or vice versa. So you might be able to determine a general average value, but there's so much variability that I'm not sure that general average would be very useful for planning purposes.

Zamboni

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@Laura33 I'm so sorry to read about your house fire. I'm glad you had good insurance and you are getting all new everything. A house fire is extremely traumatic even in the "best case" where no one is hurt and you can salvage important papers and some sentimental items.

I've helped someone dig through the wet, charred, rubble looking for old photos and jewelry and the smell alone is horrifying. I've sat in a laundromat washing "undamaged" clothing 7 times to get the smell out. This are not experiences I would wish on anyone.

It is more common than people realize. Not counting you, I personally know 5 friends who have had massive house fires where entire rooms were burned and almost all belongings ruined. In one case pets died in the fire. I can't even imagine how upsetting that would be.

All of this is to say that I second Laura33's recommendation to have good insurance. I would especially encourage renters to be sure to get decent renter's insurance. One of the fires I helped with the person rented and didn't have a policy, so the event was financially ruinous as well.

wageslave23

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Is there a reliable source of information on rental yields for different cities in the US and also international cities? Ideally split by type of property (house vs condo). In my initial analysis, I am assuming a 4% gross rental yield and 4% safe withdrawal rate, so that makes the comparison of financial benefits of buying vs renting neutral.

I found this comparison online but not sure how accurate or reliable it is https://www.numbeo.com/property-investment/rankings_current.jsp

You need to post specific numbers, all other discussion on this hypothetical is pointless until you do.

Laura33

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@Laura33 I'm so sorry to read about your house fire. I'm glad you had good insurance and you are getting all new everything. A house fire is extremely traumatic even in the "best case" where no one is hurt and you can salvage important papers and some sentimental items.

I've helped someone dig through the wet, charred, rubble looking for old photos and jewelry and the smell alone is horrifying. I've sat in a laundromat washing "undamaged" clothing 7 times to get the smell out. This are not experiences I would wish on anyone.

It is more common than people realize. Not counting you, I personally know 5 friends who have had massive house fires where entire rooms were burned and almost all belongings ruined. In one case pets died in the fire. I can't even imagine how upsetting that would be.

All of this is to say that I second Laura33's recommendation to have good insurance. I would especially encourage renters to be sure to get decent renter's insurance. One of the fires I helped with the person rented and didn't have a policy, so the event was financially ruinous as well.

Thanks @Zamboni -- we're fine, it really was that best-case scenario.  But yeah, I'm somewhat overly sensitive on insurance now (as you can tell from my post on another topic a couple of days ago), because looking back not even a year later, I cannot believe how absolutely stupid I was, even though I thought I was very calm and rational.  Like, dude, I was standing barefoot in the street and turned down a neighbor's offer of shoes!  After standing there and rationally thinking through, well, it's mid-60s, I'm really comfortable, I don't want to be a burden, so in my head it made absolute sense to say no.  To shoes! In March!  I mean, I know that you shouldn't make decisions when you're emotional from a big loss and all.  But I wasn't emotional!  I was very calm and rational the whole time, and for months after; it really was just "stuff," and I never even cried about it (and I can totally be a drama queen, so not crying actually says something).  And yet the trauma of the major life event apparently shut down some part of my brain, so even though I felt like my normal, rational self, in retrospect, I was absolutely not.  When you're in the middle of something like that, it is a whole new world, with so many things that you need to know right now that you've never dealt with before, and you don't know what you don't know, nor do you know who you can trust to help you learn it -- and, oh, btw, you're now dealing with this massive life-altering event that itself will take months to process in your brain.  And now you can't even trust that brain, even if you feel completely normal!

You know what my saving grace was?  Having my insurance agent walk up the sidewalk to my neighbor's porch we were sitting on within 15 minute of when I called in the claim to make sure I had a place to stay and his card.  Having him show up the next morning with, literally, a blank check for immediate expenses, and to walk me through all of the details of the policy.  Having my neighbor share not only his porch and his scotch (The Macallan!), but the name of a public adjustor he could recommend; we hired them within the week and handed it all over to them (relevant because they get paid out of the insurance proceeds).   

This board is all about self-sufficiency and optimization, and I 100% approve of that.  But there are also some times in life when you can't do it alone -- where trying to be self-sufficient and save the most money will likely lead you to making poor decisions that cost you in the end, because you don't know what you're doing and are overwhelmed by all the damn emotion stuff that hits at the worst time.  I watched my mom lose my stepdad, and this hugely-competent woman with a Ph.D, who runs her own consulting company, somehow lost the ability to manage a phone tree.  It took her at least a year to be even close to back on her feet, and during that time I had to be her right-hand woman for so many basic things that it scared me at times.  I'm now 10 months post-fire -- which was far less traumatic -- and only now do I feel like I've gotten some perspective and rationality back (leading to the "WTF was I thinking?!?!" moments).  So by far the best thing that happened was having enough insurance that I didn't actually have to manage everything myself or worry about finances.

Oh:  and FWIW, a combination of baking soda and Oxyclean gets the smoke smell out better than the professional treatment did.  Doesn't always work 100%, but we saved a LOT of stuff that way.

Sorry for the frolic and detour.  ;-)  I now return you to your regularly-scheduled program.

Zamboni

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I was shocked by how much stuff has the nasty fire smell. Glassware that was in kitchen cupboards, far from the actual flames, for example, smell like ashes. Just really weird to me.

Back on topic:
I am honestly not sure about the buy v. rent thing. I am selling my home right now and just signed an 18 month lease. Rent is about half what my mortgage was per month, but the rental home is on the same street as the home I owned. It's literally within about 100 yards, but it's costing me half to live here. That doesn't make sense to me. The rental house is a little smaller but nice and well maintained. It has a nicer, more updated kitchen than the home I'm selling.

I was feeling really bad about "not being a homeowner." Then I realized I could rent this house for 10 years for less money that I will likely be getting from the home sale. I can invest the proceeds from the home sale conservative (like in a CD or treasury bonds) at current interest rates and the annual interest alone almost covers my entire rent for the year. That's wild to me. The renter who lived here before me was in this home for 8 years. It's a nice place. I never used to understand why people were lifetime renters, but honestly if I can stay here at the 3% annual rent increase that is codified in my lease, then who knows how long I will be here? The biggest possible hurdle to my plan is the landlord dies and his heirs decide to sell out from under me . . . so hopefully he has a long and healthy life.