Even though our house is sold, Janice and I have only completed half the puzzle. We still have to figure out where to live. For us, and many other people approaching retirement, the decision to keep the family home, downsize to a smaller house or condo, or rid themselves of the stress and expense that can come with home ownership altogether is a difficult one. Let me give you a few things to chew on as you contemplate this decision…

Things to Think About

Keeping a few simple ideas in mind will help simplify the decision between renting and home ownership. Although this is an important choice for anyone contemplating downsizing, Janice and I think it is best to avoid the details of specific ownership and rental opportunities and examine this issue from a big-picture point of view. Keep the following points in mind as you weigh your options:
•    What is your budget for renting or ownership, net of taxes?
•    Do you view a house or condo as a potential investment opportunity or just another cost of living?
•    Have you thought about the risks associated with ownership in terms of unexpected costs? Can your budget tolerate them?
•    Create a “don’t/can’t” list. We do not want a lot of land, a house that needs a lot of work, it cannot be north of this or south of that…In our case this is being done through the process of elimination.
•    Is this move temporary or “permanent?”

After-Tax Expectations

The first step, in analyzing ownership versus renting, is to determine how much money you want to spend net of taxes. Since mortgage interest and property taxes on a primary residence are tax deductible, knowing after-tax cost is essential. Keep in mind that you need to foot the pre-tax bill until tax refund season. That being said, your cash flow situation needs to be taken into consideration as well.
 
Risks to Consider

Obviously, home ownership has a distinct advantage in that you can theoretically get more for your money. However, there is no free lunch as home ownership also entails substantial financial risks. Such issues as fluctuations in market value, expected/unexpected maintenance expenses, and insurance deductibles can comprise huge additional costs over and above renting. Once you have done the math above, simply go shopping for homes, mortgages, and rental properties that fit your budget. Do not forget to plan for inflation – rents, taxes, and insurance costs all go up over time.
 
An Investment Opportunity?

Even though homes and condos can be good investment opportunities, these assets should not be examined solely from that perspective. The fact of the matter is that housing is an unavoidable cost of living. From a conservative point of view, your home should be considered a cost of living as opposed to an investment asset. This is because investment assets should not involve finding another place to live as a means of providing liquidity. Therefore, from a retiree’s standpoint, it would be best to ignore the investment upside of ownership in your thought process. It will distract you from the real goal of appropriately planning for your retirement housing costs.
 
Recently, Janice and I met with Jeff Ivory, our financial planner, who advised us that “one of the biggest myths of home ownership is that it is an investment. It is not. Owning a home that you live in is an expense, not an investment. Actually, it is a depreciating asset because here in Michigan house prices are not increasing.” Nonetheless, if you see your home as an investment, a general rule is very simple: Buy low and sell high. This means buying and selling homes opportunistically, not emotionally. Keep in mind, however, that in some ways, renting can be considered the economic equivalent of shorting a stock. 

For example, if you believe that housing prices are headed lower, you would rent a home, wait for prices to fall and buy a home later. This strategy reaps the benefits of going short through lower housing costs. If you are wrong about the direction of housing prices and you end up paying a higher cost of housing when you do buy, this is similar to paying a higher price for a stock to cover your short position. This is the main thing you should be concerned about in using a primary residence as an investment. By selling your home, you take the chance of becoming priced out of the market if prices increase instead of decreasing. This should be a big concern if you are on a fixed budget and enjoy owning your own home or condo, as opposed to dealing with a landlord.
 
Maintenance Risk

Another major issue to examine is the maintenance risk associated with ownership. This is important because renting is similar to buying an insurance policy against maintenance. What this means is that renters have no liability for regular maintenance costs, equipment failures, or catastrophic occurrences such as a tree falling on your home or being hit by a storm. The beauty of renting is that the landlord has to worry about the unexpected financial costs of ownership. In our case, I have zero fix-it capabilities – the joke is that I have two tools in my toolbox, my phone book and my checkbook.

I favor renting for many reasons. High [home] prices with weak investment potential are the first reason. The second reason is the underestimated monthly costs of owning. Taxes, interest payments, insurance, water, electricity, sprinkler systems, planned and unplanned maintenance, and others add up to significant monthly payments that do not go towards building equity. Renting is often more cost efficient. However, there is a counter thought that in this model there will always be a monthly payment. In the previous generation, many retirees and downsizers have no monthly because they have paid off their home; again, this is both a mathematical and emotional decision.

Stay tuned to see how our downsizing journey ends!

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