Wednesday, December 12, 2007

Renting in Retirement

Does renting in retirement make sense? In some cases it does. In others it does not. However, from a purely financial standpoint, I think it does. But of course no financial decisions devoid of emotional value. So why does renting make sense?

Well for example a $300k home, would allow the owners assuming they pay cash for closing a $300k nest egg. Sure, they could live there and pay approximately $3k/year maintenance, $1500/year insurance, $3k/year insurance. So monthly they would be paying about $625. However there is lost opportunity cost on the $300k sitting in home equity. Assuming a very conservative 6%, that is $18k/year or $1500/month. So in actuality owning a home is costing the homeowners $2125/month.

But why sell? Well let's assume they invest the $300k in a Bond index fund. And only harvest 4%/year leaving 2-4% reinvested annually. They'd still have $1k/month to rent with. Now assuming they could rent a 2 bd/2ba apartment for that they'd come out ahead. But you're moving from a single family home to an apartment!

Well the truth is as you age, you will become unable to do home repairs yourself. You will rely more on hired help. It will be harder to mow the grass, weed, paint, repair shingles, etc. Things you might have done yourself a decade ago. So your maintenance costs on your house might easily double. Especially if you haven't been properly maintaining the house for 30 years and left a lot of it deferred. Hence it won't just cost you $625/month, it could be more like $1500/month to live in a house.

When you rent, as an elderly person you don't have to worry if the sink breaks, toilet floods, etc. You call the landlord and they deal with it. As an owner, you have to afford these repairs. So renting can make sense, especially for people who are disabled and unable to do any projects themselves.

But $1k/month isn't enough to live on. Well then why not harvest 8%? Assuming you invest it in a balanced fund at Vanguard getting 8% returns isn't hard. This would allow$2k of expenses month. Could you rent a place for that much? Likely yes.

The problem is the attachement people have to their home. It doesn't actually make financial sense to own as we age. Also if you forced into a care home/nursing facility, it's a lot easier to move out of a rented apartment versus trying to sell an ancient home.

As I write this, I think about how I'm still trying to convince my parents to stop taking our mortgages and buying home at 56 and 76. They have bought into this notion that real estate is wealth. When the truth is they are spending more buying than if they would just rent.

But growing older I wonder if we aren't more stuck in our ways due to habit rather than looking at the best financial options?


traineeinvestor said...

Good write up. I looked at this issue a few times and decided that owning was better than renting (at least for me) for the following reasons:

1.the house is a store of wealth. I can draw on it by selling and renting, trading down or taking out a reverse mortgage. In effect the house is a form of emergency fund

2. the emotional security of owning your own home is a significant factor for me

3. as people age, they tend to invest in more secure/stable investments like bonds, deposits and money market accounts. For the most part, these are not inflation indexed. In comparison rent will increase over time with inflation. This means that investing conservatively carries the risk that your income will eventually fall behind your cost of living. If you try and keep your income ahead of inflation by investing in stocks, you effectively expose yourself to gerater volatility risk. Evaluating which is the greater risk will often depend on your time horizon.

minimum wage said...

But $1k/month isn't enough to live on.

(Scratching head) (heartbreak of psoriasis)

I live on $1K/month and I'm not even retired.

Anonymous said...

Then there's the flip side of my grandparents renting the same house for...I'm not sure how long - I'd guess 40+ years and eventually the lot was worth more to the owner than the house and they had to move. So they were in their late 70's/early 80's and the house was torn down and the lot sold.

They had to find another home to rent that was in their budget and move from their home of 40+ years because they never bothered to actually buy anything.

A year or so later my grandfather died and my grandmother finally owned her own home - a single wide trailer purchased for something like $5,000-$6,000 and put in a mobile home park on a rented lot.

I'll buy, thank you.

Living Almost Large said...

Try living on $1k a month paying for medical care in your 70s and 80s. It costs a lot as you age to care for yourself. How much do you think a property tax costs? How much do you think someone doing the roof? I think even in cheap COLA cost quite a bit.

Anonymous said...

You're giving away your youth by saying that someone age 56 is old!! That is middle-aged. Even 76 is not ancient these days when more and more people live until mid- to late-80s or 90s.

Having a paid-for home makes the most sense for most people, especially if one retires to a community with lower property taxes. Cutting one's fixed expenses is just as important as having a good income stream. Paying off your home and staying in it is a good financial decision. And let's be real, most of us maintain our homes as we live in them, we don't put off maintenance for 30 years. If you're speaking of your own parents, believe me, they re the exception and not the rule.


Living Almost Large said...

LOL, I guess I am young. I don't consider 56 old though. Old isn't until you hit 90! But seriously I wonder if maintenance of homes is the major problem with ownership later in life.

Anonymous said...

When maintenance becomes an issue, one can always move to a condo. Renting isn't the smartest option.


Jim ~ said...

To the person making only $1k a month, that is pretty close to poverty status.

I think owning a house is an accomplishment in ones life. Some elderly people who have lived in their home for decades cannot let it go. Even if they have 300k in equity, their house becomes priceless. My great grandparents lived in their house until they passed in their 90s. When the house was sold it was very hard on my grandma as it was her childhood home. This is where emotions counteract the financial advantage.

I intend to retire with control over most of the things in my life that I can control. It is my intention to have a paid for home, enough money to retire, and the ability to enjoy the golden years. Traveling the world is something I would like to do later in life.

Anonymous said...

I'm with anon & Jim. I'm 55 years young. I'm just getting started. Already downsized into a new paid-for home, invest and travel. You still have to keep some $$ coming in, so we work part time. Inflation and poor returns that don't keep up can kill your retirement's best-laid plans.
It's a good feeling to be living and enjoying your 'golden years' in your own home. Who said the landlord is going to fix or do anything in a timely fashion anyway?

No thanks. I'm sticking here. Money is NOT everything. Peace of mind and security is. Priceless.

Anonymous said...

I think there are a couple of dynamics going on. As we have become a more mobile and urban society, some middle aged folks tend to downsize or move into condos to give them greater flexibility toward freedom.

But as either generation ages, there tends to be reluctance toward giving up the homestead. I think that stems from the thinking that if I admit that the house has become to big to maintain then I am admitting I'm dying.

That becomes more of an issue as we advance in age. I'm one of those "old" 50 year olds. The things that I used to shake my head in amazement at when I was in my 20's are now either issues or things I've thought about. While not having to do with a home for retirement, I have began to ponder how much time I have left to enjoy hiking, other outdoor activities or even travel. I may live in a healthy old ripe age, or I could be ill and unable to take care of myself beginning tomorrow and continuing for the next 30 years. 20 years ago, that wouldn't have even been a thought.

I remember people looking so forward to retirement, yet as the day approached, you could see them digging their heels in. I asked one person why the change of heart. They responded felt "that retirement meant they were too old to contribute any longer."


minimum wage said...

Try living on $1k a month paying for medical care in your 70s and 80s. It costs a lot as you age to care for yourself. How much do you think a property tax costs? How much do you think someone doing the roof? I think even in cheap COLA cost quite a bit.

Yes, since I see little upside to my income, I expect to live on $1k a month in my 70s. Which is to say, I expect that I will have to work as long as I can, and will become destitute when I can no longer work.

Many states extend property tax reductions or deferrals to low income elderly homeowners. Which is to say that the poor elderly homeowner won't be taxed out of their home, but the poor elderly renter gets no such protection, plus rental prop in most states is taxed higher than owner-occ homes of equal value.

Living Almost Large said...

I believe $1k is not poverty for an elderly couple now. My grandparents used to make $1200 and were not considered poverty. They did not get help for medications, etc. They made small social security and pensions. So because they made a tad too much, they did not qualify for help.

Why not ask them how useful it was to be barely above poverty and not able to manage?

There is no way they could have afforded home ownership.