The New Math on Homeownership Bends Towards Renting

Thursday, July 12, 2018

Norm Miller, Hahn Chair of Real Estate Finance

Most economists have homeownership rates going up, based partially on long-term history and on the assumption that everyone really wants to own a home once they enter marriage, albeit on a delayed basis compared to prior generations. But our recent tax law changes make the own versus rent decision much less compelling, and when you factor in demographic trends and student debt, it is entirely likely our homeownership rate will fall.

The reasons are quite simple. The new household standard deduction of $24,000 means that the average or below-average income U.S. family will find that deductions for mortgage interest and property taxes are not likely to matter. Consider the math on a typical existing home resale price as of June 2018 (Federal Reserve Bank of St. Louis data) of $265,000 and an 80 percent loan to value mortgage at 5 percent, property taxes at 1.25 percent of the home value, maintenance and repair at one percent of the home value and property insurance at half a percent of the home value. The approximate cash flow cost would be $17,888 per year and the opportunity cost on the down payment at three percent to be conservative, would bring the total cost to own up to $19,478 a year. There would be little use in taking the mortgage interest or property tax deductions for federal tax purposes and other expenses could not be written off.

 Adding in the principal repaid to the cash flow and we get something akin to the cash actually required to own.  There would be investment benefits over time and the certainty of budgeting if using a fixed-rate mortgage, but mobility (selling and moving costs) would run at least six percent of the home value and as much as 30 percent of the equity. If the household is not certain about wanting to stay in the same home for several years, renting becomes compelling for several reasons. 

An investor in a home you occupy gets to deduct all the expenses required to own the home, even maintenance and repairs. They also get depreciation on the home. Using the same down payment assumption, and we easily can achieve an after-tax cash flow on equity return of five to six percent with rents set just above the $19,478 figure above and mobility would be much cheaper. In fact, if we increase the home value to the point that it clearly becomes worth owning rather than renting, we need to get all the way to $457,200, well above the median home value in the U.S. Of course, owning will still make sense for many households when they feel it is a good investment, but the propensity and desire to own will not be as high as for earlier generations.

It is no wonder that one-third of all rental properties are now owned by investors, and that they continue to buy single family property.  With a number of new rental formats now emerging and some offering greater mobility and flexibility for occupants, it is not clear that we should assume home ownership rates will return to long-term “normal.” The new normal could be headed down.


Kimberly Malasky
(619) 260-4786