Case Study: Renting vs Buying - which will let me retire earlier?

[speedystache]

UPDATE BELOW: With new idea of Purchase Vs. Renting (a co-op) All data below still applies to this new idea.  THANKS for the re-read!


Background
me (35), wife (30), daughter (3), baby on way

Here is a breakdown of our money situation. We feel we are on the right track, but are unsure of what steps to take next.

Income
$130,000 - my take home is about $80,000 (though we got back $13,000 in taxes last year, not sure if it will be the same this year). I also work overtime occasionally, though it's not reliable enough to account for.

Monthly Expenses
Rent/Parking: $1,550/month
Utilities: $100-$200 (was $236 in Feb - electricity was 29.9¢/kWh!!)
Car Insurance: $122
Internet/Cable: $95
Cell (2 lines): $160 (currently looking into Ting)
Gas: $100 (almost exclusively for commuting, though if we stay in the city I can possibly take a free shuttle most days)
Laundry: $20
Groceries: $400
Unexpected Expenses/Donations/Eating Out: $150
TOTAL EXPENSES: usually about $2,600

Assets
Checking: abt $3,000 (we usually keep only enough for the month)
Savings: $390,000 (since we don't know if we are going to buy or rent, we haven't wanted to tie up this money just yet. not sure if that's a mistake.)
Investment w/ bank: $106,000 (admittedly I have a lot to learn about investing - they have done our assets for us since we don't know much right now - 10% equities 90% mutual funds)
401K: $209,000 contributing max of $16,500, plus company match of 3% (I believe)
Roth IRA: $51,000
IRA: $56,000 (rolled over from my wife's old 401K)
529 account: $23,500 (we've contributed $10,000 for the last 2 years for max. tax deduction)
TOTAL ASSETS: $838,500

I would love nothing more than to retire early and spend my time with my family instead of at work. So! Here are my questions... First of all, we are currently in a 1 bedroom apartment and we will probably feel pretty cramped once the new baby comes. We are trying to decide between renting a 2 bedroom apartment in the area for about $2,000/month OR buying a house farther away (anything close to work is completely out of our price range) for about 450k, and property taxes at about 12k (closing costs of 30-40k). While we love the idea of a house for the outdoor space and not worrying about making noise with our kids, we are worried it is a step in the wrong direction! We are worried about sinking all this money in a house when we could be making money investing it.

The thing we're wondering is if it's really possible for me to retire early and move us closer to family (OH, IL, SC or FL), then we might be able to squeak out a few more years of tight and inconvenient living. Or, do you think it would be worth the investment to buy a house? Any advice or thoughts would be greatly appreciated!

[arebelspy]

I would love nothing more than to retire early and spend my time with my family instead of at work. So! Here are my questions... First of all, we are currently in a 1 bedroom apartment and we will probably feel pretty cramped once the new baby comes. We are trying to decide between renting a 2 bedroom apartment in the area for about $2,000/month OR buying a house farther away (anything close to work is completely out of our price range) for about 450k, and property taxes at about 12k (closing costs of 30-40k). While we love the idea of a house for the outdoor space and not worrying about making noise with our kids, we are worried it is a step in the wrong direction! We are worried about sinking all this money in a house when we could be making money investing it.

The thing we're wondering is if it's really possible for me to retire early and move us closer to family (OH, IL, SC or FL), then we might be able to squeak out a few more years of tight and inconvenient living. Or, do you think it would be worth the investment to buy a house? Any advice or thoughts would be greatly appreciated!

http://www.nytimes.com/interactive/business/buy-rent-calculator.html

Play around with it.

With a 2k monthly rent, 450k home price, 20% down, 3.5% mortgage rate, 2.67% property taxes (to get 12k annual, as you specified), and everything else left default, it would take 13 years to break even buying.

If you only lived there 4 years, your average annual savings renting would be $9,351 (or $37,404 total saved over those four years by renting). That doesn't count the extra (thousands?) in longer commutes.

In your situation, if you can stand to live in the smaller 2k rent place for a few years, do it.

It's a sacrifice, but it will save you tens of thousands of dollars.  Especially if you'll be moving in less than a decade.

[speedystache]

Thank you for the reply, arebelspy. That's a great tool to have! It seems like it probably is better to rent, especially since we would love to be able to move to a lower cost area and retire within 10 years.

[Baron235]

Another thing to factor is the tax savings.  If you are in 25% bracket you could have significant tax savings from buying and I don't see the NY Times calculator taking that into account. 

[arebelspy]

Another thing to factor is the tax savings.  If you are in 25% bracket you could have significant tax savings from buying and I don't see the NY Times calculator taking that into account.

That is taken into account.

From the website:

*Property taxes, the interest part of the mortgage payment, and in some cases, a portion of the common charges, are tax deductible. The resulting tax savings is accounted for in each item’s totals.

[Baron235]

Another thing to factor is the tax savings.  If you are in 25% bracket you could have significant tax savings from buying and I don't see the NY Times calculator taking that into account.

It does, but you have to go to the advanced settings panel.

Thanks for pointing that out.  Makes it much more useful than I initially thought. 

[hybrid]

I'd go here, rent a house for a year and see how you like being in a house without the hassles of fixing the faucet when it breaks. Seems to me like you are talking more about a lifestyle choice than a financial one.

[speedystache]

Well I guess I'm trying to decide if it's realistic to think I could retire within 5 years or so. That's still a bit of scary concept to us, though it's incredibly appealing. If we can save roughly $50,000 a year (which we've been doing so far, though at a lower rent) for the next 4 years, we'll have almost $700,000 in an investment fund. If we buy a house, we wouldn't be able to save that much, plus the added cost of other maintenance that comes up. However, reselling the house/renting it out once we do save up enough (still not sure what that number would be!), could maybe be an option? And we would have freelance work, though we'd have to build that up more than we have going right now.

I know that overall the choice is a lifestyle one - if we really just want to be in a house then we should try to make that work. We're just going back and forth in our heads so much we don't know what we want to do. That's what we really need to figure out, but easier said than done!

Thank you for the replies!

[payitoff]

one Mustachian here did this wonderful spreadsheet, i forgot who it was, maybe this helps:

[ZMonet]

Is your wife going to continue to work when you have the second child?  If you moved closer to family, would your costs go down?  Just running the numbers, you have done VERY well at such a relatively young age.  If you moved the savings into investments, and figuring a 4% withdrawal rate, you would be throwing off $33,000/year already.  You need to figure out how much having the second will drive up expenses, but you may be in a position where your wife can retire and you could afford a paycut.

Congrats on doing so well and keep up the good work.

[speedystache]

2wakefulFlea - Thank you for that spreadsheet! I'm going to play around with it now.

ZMonet - My wife is currently home with our daughter, though she does do occasional freelance work from home. The $33,000/year you're mentioning is from all of our assets, right? Including the school fund and the retirement accounts?

[Prairie Stash]

kudos to arebelspy, that's some accurate advice.

Just curious, what are your plans for the savings? if you follow the advice here.

I'm also curious about the bank investments, how well do they work out?  i.e. what kind of annual returns do you get? The advice given only applies if you can hit FI within 10 years, I hope it happens for you.

[speedystache]

Well first we have some reading to do because neither of us knows anything about investing, which is why our money has been foolishly sitting in a savings account. We moved 100k to an investment account at our bank in July of 2013, and I just checked and it's at 107,883. It's 10% equities 88% mutual funds and 2% cash. Again, we have a lot of learning to know what exactly that all means. Our 529 has earned 15% in the last 2 years which seems good, though I know it won't always be that high I'm sure. I'm not sure how the retirement funds are doing, though. That's something to look into.

We plan on saving up about 50k a year if we rent, which we have been doing that or a little higher for a while now, so I feel pretty confident that we will be able to keep it up. That savings will also be invested.

So basically if we rent, we will invest almost all of our savings (except an emergency stash of some kind). We just don't know how we'll invest it yet. Time to get to the library!

Any advice or cautions would be appreciated since we are clearly beginners!

[ZMonet]

Time to get to the library!

Any advice or cautions would be appreciated since we are clearly beginners!

I'd start with JLCOLLINSNH stock series.  I think he makes a compelling argument to go into the Vanguard Admiral Fund Total Stock Market index.  I'm betting you're paying WAY too much in in fees at your bank for management.

http://jlcollinsnh.com/stock-series/

[Melody]

The only thing I would add is, it sounds like you already know where "retirement home" might be. Is it worth buying an "investment" property there already and continuing to rent (are there tax advantages in doing so in the US, compared to shares?) This could outperform the stock market due to leverage. For example buy $200k property,put down 20% (40k), borrow $160k. If prices go up 5% you make $10k. If you invest $40k  in shares, you need 25% growth to get $10k return. You could then subsequently move into this house, having had your tenants help you pay it down. Obviously this only works if the area you plan to retire to has sound investment fundamentals.
Ideally I'd go for a balance if you can as it will spread the risk - a property plus index funds would be a great mix :)

[speedystache]

Thanks for the advice. The idea of buying a place where we might be sounds interesting, but we don't actually know exactly where it will be, unfortunately. We're still deciding between 2 or 3 places, and we probably won't know for sure until a few years from now. That did make us think about where we're at right now, though.

Right now we're at a 1 bedroom apartment for $1600 (with our new lease, including parking). We're thinking of staying here, but honestly we're not sure if it's something we want to do with our soon to be 2 kiddos. So we're starting to look at 2 bedroom apartments ($1700-$1900) in the area. Melody, your comment made us think more about buying, though. We were thinking of buying into a co-op in town for about $220,000 with maintenance fees of $950/month (half of that being property tax, the other half building maintenance and heat/hot water). It's 2 bedrooms, 1 bathroom, small balcony, laundry in basement still (unfortunately!). It would probably be somewhat easy to rent due to it's location (though applicants would have to go through board approval), and would rent for about $2,000-$2,200/month. We were thinking we could live there until we're ready to move on, and then be able to rent it out (hopefully!) or sell it if we had to.

What would you do in this situation? Does it make any sense to buy? Does it make any sense to rent?

[speedystache]

Bumping this thread. :/

Sorry to do so.  However, my family and have an option to exit our current lease in TWO weeks, without cash penalty. 

If anyone has any tips, or suggested research we could do to help us make a decision on the new situation described in this thread, it would be as greatly appreciated as all the previous advice!

Thanks again, all!

[arebelspy]

As before: http://www.nytimes.com/interactive/business/buy-rent-calculator.html

That aside...

You don't know where you will be in a few years, you don't know if you want to move or not.

I don't see how any of the situation has substantially changed.

Rent.

[speedystache]

@ arebelspy Sorry about that, and thanks again for your link, i have been using it quite frequently!  I'm looking for a little additional guidance to go along with the numbers :)

I was considering the idea to purchase a co-op, live in it now, and then when we make up our mind as to where to go, keep it, and use it as rental income.  Since the purchase prices are far lower than homes, and in our area, these types of units seem to rent more easily.  Also if any of the Landlords out there have any comments at all, it would be helpful! :)

I don't want to later find out this type of an idea is a bad one, and break even with the rent I can afford to charge vs. the monthly expenses, etc.

And if the idea to buy it outright ($200,000) would be better than 20% down, and paying the interest for the next 30 years. (the difference in rent paid per month would be $1,000 (if paid in full) and about $2,000 (for 20% down)

That along side the amount of money we could save for paying it off out-right, vs. putting that same money into stocks...
Thinking, $200,000 into stocks at 7% =  14,000 a year, (before taxes), or %4 after taking out the money at $8,000
or
Thinking, paid in full, at 1,000 a month to live, saves us $12,000, while WE are the occupants, but later on, with a tenant, that $12,000 would then get taxes as income.
or if we buy at  20% down, our mortgage would be around 2,000, similar to how much we would have to spend either way.

So, we're not really sure if this type of investment scheme is worth it or not.

Also, a (new) question.  Rental income, is that taxes the exact same as any other income? higher? lower?

Thanks again all!

[arebelspy]

@ arebelspy Sorry about that, and thanks again for your link, i have been using it quite frequently!  I'm looking for a little additional guidance to go along with the numbers :)

I was considering the idea to purchase a co-op, live in it now, and then when we make up our mind as to where to go, keep it, and use it as rental income.  Since the purchase prices are far lower than homes, and in our area, these types of units seem to rent more easily.  Also if any of the Landlords out there have any comments at all, it would be helpful! :)

We were thinking of buying into a co-op in town for about $220,000 with maintenance fees of $950/month (half of that being property tax, the other half building maintenance and heat/hot water). It's 2 bedrooms, 1 bathroom, small balcony, laundry in basement still (unfortunately!). It would probably be somewhat easy to rent due to it's location (though applicants would have to go through board approval), and would rent for about $2,000-$2,200/month.

This is not a good rental.

[speedystache]

You mean it wouldn't be a good place to buy because our profit after expenses wouldn't be large enough to make it worth it?

[ender]

You mean it wouldn't be a good place to buy because our profit after expenses wouldn't be large enough to make it worth it?

Do the math. You are maybe getting $1k rent a month for a price of $220k. This also doesn't include any additional non-mortgage/condo expenses such as vacancies, etc

That's not even close to the target 1% rent/price target (which some would say is not even a "good rental" anyways).

[arebelspy]

You mean it wouldn't be a good place to buy because our profit after expenses wouldn't be large enough to make it worth it?

Yes.  It is a poor rental based on the numbers.

So trying to rationalize a buy in order to make it a rental is a bad idea.

You seem to really want to buy.  If that's the case, go for it.  But just know it probably won't be the best financial move, especially because you may move in just a few years.

[GregO]

TOTAL EXPENSES: usually about $2,600

TOTAL ASSETS: $838,500

The thing we're wondering is if it's really possible for me to retire early and move us closer to family (OH, IL, SC or FL)

To second what everyone else has said, I agree you should rent because you plan on moving soon.  BUT, according to the information you provided, you have the assets to move and retire early right now.

http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/

Your current assets (minus the checking and 529), if invested, could provide $32,000 income ($812,000 * 4%).  You list that you have about $2,600/month in expenses, which is $31,200.  So your assets could cover your living expenses today.   I don't suggest doing that because you need to learn how to handle your money first and make a plan for early retirement.  But you should absolutely make that a priority!

You have done a great job of saving, but you need to put that money to work for you.  You got one great suggestion already, I suggest you check it out:

http://jlcollinsnh.com/stock-series/

There are lots of great blogs out there that can help you learn how to do this.  There are also several great books that MMM suggests that you should read.  I also learned about a PBS documentary called "The Retirement Gamble" from other people on this forum.  These are all things that'll help you start learning. 

But as most of those things will tell you, it doesn't have to be complicated to invest.  You could go read JLCollinsnh and start investing some of your money tomorrow!  What are you waiting for?

And just to give you a little more incentive:

Our 529 has earned 15% in the last 2 years which seems good, though I know it won't always be that high I'm sure. I'm not sure how the retirement funds are doing, though. That's something to look into.

That is not a good return, at all.  Over the last two years, the stock market has gained ~35%.  That means that whatever you are invested in got less than half the return of the stock market.  And you don't even know what your $100,000s in your retirement accounts earned.

[CanuckExpat]

Hi speedystache,

I'm glad you found alternatives to increasing your commute time. Staying where you or the co-op should both be better choices than paying more money to buy a larger house that is further away from you want to be. As for the choice between the two, you will have to decide what you want and compare the alternatives with the best estimates you can make (the calculator is very helpful for that). With you thinking that you might move sometime soon, it is tempting to say that renting is the better choice, but life can be unexpected and sometimes you find yourself living where you are for much longer than you would have anticipated (or life can change again and you wish you had the flexibility to move on a moments notice that renting affords you).

Have you considered making a more specific post with details about where you live and options you are considering? There are people on the board from all over, and people in your local area might chime in with lower cost neighborhoods or options that you had not even considered.

Finally, as people have mentioned, you do need to get a handle on your investments. The JL Collins series is a great explanation, as is the Bogleheads wiki and forum: http://www.bogleheads.org/wiki/Bogleheads%C2%AE_investing_start-up_kit

Goodluck!

[speedystache]

Thank you again, everyone for all of your replies. I really, really appreciate it. I've been reading through the JL Collins series and am waiting on a few books that have been recommended on the MMM blog (I'm on the "hold" list). We just started reading MMM a couple months ago, so we're still reading through a lot of the articles, so I appreciate the extra help along the way.

I didn't know about the 1% guideline for buying a rental property, thanks for sharing that.

CanukExpat: Thanks for that advice. I think I will make a specific post as you suggested to get some more ideas of areas where we could live. Thank you for the link, too!

I think the main thing we're starting to realize is actually that we don't know if this whole thing is actually really the best for our kids. It seems like it on the surface, but it's different from MMM in that he was able to sacrifice things and live cheaply when it was just him and his wife, and was able to retire when his son was born. We already have a toddler and a baby on the way, and I worry sometimes that us sacrificing things now in order to give more to them in 4 years or so is pretty much the same as working so hard all the time trying to make a better life, instead of just being with them and spending time with them. It's definitely to a lesser extent, because we do still spend as much time together as we can... but we can't help but wonder if we're not quite doing the right thing.

In 4 years our kids will be in school, which makes me feel like this whole early retirement thing is really just for us, when originally, we wanted to retire early so that we could spend time with our kids as a family. If we don't retire until they're in school, I'll only see them a few hours more than I do right now - not that that wouldn't be awesome still, but it makes me wonder if sacrificing some of their childhood experiences isn't worth it. If it were just me and my wife, we really wouldn't care if we didn't have any outdoor space, or lived in a studio apartment to save the money. However, with our kids, the idea of raising them in their earliest years without green space available to them, makes me so sad. I've never cared much about houses (how big, how fancy), but the idea of having land for our kids to explore and wander through always struck me as important. And the fact that we're sacrificing that for them makes me wonder if we're doing the right thing... Of course children are resilient and can thrive in a multitude of environments, and a lot of this is probably based on what my wife and I had growing up. I'm most likely putting too much weight on this, but as we're going through all these decisions, it seems like it continues to be something that's worth more to me than the mindset of "what is the least we can possibly spend on things"

Maybe I'll just make a separate post since I feel like I'm getting to the root of the problem, and see if any other parents of young children can relate or have advice for us.