By Dr. Gary L. Deel
Faculty Director, Wallace E. Boston School of Business
and Dr. Karin Ford-Torres
Faculty Member, Wallace E. Boston School of Business
This is the eighth article in an ongoing series on sound tips for financial security and prosperity. Nothing in these articles is intended as formal legal or financial advice. Readers should consult with an attorney or licensed financial advisor before making any financial decisions.
In the last part of the Smart Finance 101 series, we introduced the benefits of home ownership over renting, and we discussed some of the common reasons people use to rationalize renting over buying. In this part, we’ll look at a real example from Dr. Deel’s own experience moving to Las Vegas several years ago to see how big a financial advantage buying over renting can really be, even when the ownership is for a relatively short period of time.
How Buying a Townhome Proved to Be a Smart Financial Decision
Back in 2013, Dr. Deel was accepted to the University of Nevada Las Vegas to complete his Ph.D. work, an undertaking that he knew would take him two to three years to complete. He was living in Orlando at the time, which meant he would have to relocate to Las Vegas.
Dr. Deel remembers a conversation with a friend back then who thought he should just rent an apartment in Las Vegas, since he would only be there for a short time. But Dr. Deel decided to buy a townhome, and that ended up being a much wiser decision.
Dr. Deel paid $125,000 for the property, and he ended up being in Vegas for almost exactly two years. The townhome had three bedrooms, and since he was alone, he rented the extra bedrooms to other college students. That helped cover his costs of the mortgage, interest, taxes and utilities. And after he returned to Orlando, Dr. Deel rented the entire home to various tenants for about five years before he ultimately sold it in 2020.
During all that time, Dr. Deel made the minimum monthly payments on the mortgage. And he invested what other remaining income he received in investment vehicles that were paying higher rates of return than what he was paying on the townhome mortgage. For more information on investment vehicles, see our article series on relative interest.
So Dr. Deel had a mortgage interest expense on the house. He also had expenses for taxes, insurance and major repairs during those years. But the rental income more than covered those costs. In fact, for the five years he rented the home, he often maintained a healthy profit margin on the rental each year.
Then, in 2020, Dr. Deel sold the home for $225,000 or $100,000 more than he paid for it. That’s the beauty of real estate properties. They are generally appreciating assets. And if you time your purchases and sales wisely, you can generally count on them being worth more when you sell them than when you buy them, sometimes a lot more.
In this case, Dr. Deel bought the townhome just a few years after the Great Recession. The housing market in Las Vegas had not yet recovered, so homes were relatively inexpensive. But seven years later when he sold it, home prices had increased quite a bit.
So how did Dr. Deel fare with the Las Vegas townhome after all? He made regular yearly income with his rentals, and then he sold the home at a profit of 80%. Of course, Dr. Deel had the yearly ownership costs of mortgage interest, insurance, taxes, utilities, repairs and so forth. He also had to pay federal income tax on the rental income and capital gains tax on the profit from the sale, which was 15%.
Dr. Deel also had closing costs to pay in both the purchase and sale. Closing costs generally aren’t too high for buyers. But sellers usually owe commissions to real estate agents on both sides of a transaction. These commissions are usually about 3% each. That means when he sold the townhome for $225,000 Dr. Deel paid almost $14,000 of his profit to realtors as commission — a cost of doing business.
Profiting from the Townhome Sale
But even after all costs are considered, the Las Vegas townhome still ended up netting more than $100,000 in profit for Dr. Deel. In other words, he walked away from owning that home with $100,000 more in his pocket than he would have had if he had never bought it.
Now let’s compare that to where Dr. Deel would have been if he had rented for the two years he was in Las Vegas. An average monthly rental for the townhome that he bought would have been about $1,300. So if he rented the same home in Vegas for two years, he would have spent $31,200 in rental costs and at the end, he would have had absolutely nothing to show for it. No home. No equity interest in the home. Not even a key chain. Just $31,000 in pure loss.
So comparing that with the purchase he did make, Dr. Deel’s real gain over the alternative of renting was actually $131,000. Because not only did he earn a $100,000 profit on the townhome, but he also saved the $31,000 in rental expenses that he would have otherwise had to pay for the alternative housing option.
So, for all the reasons above, we submit that people in many situations should never rent a home. In fact, there are many people renting right now who are throwing away potential equity for no good reason.
To be clear, this is not to say that no one should ever rent. There may be situations when renting does make limited sense. For example, if you were visiting Las Vegas for a month rather than for several years, it might make more sense to rent an apartment or even to simply rent a hotel room for that matter. That brief of a stay likely would not justify the investment of a home purchase.
Also, markets vary wildly. If Dr. Deel were to try to buy his current home in Orlando in a market like San Francisco or New York City, he would have to pay much more than he paid for his home in Florida. So the price premium on real estate might compel buyers to either a) reassess the size and type of home they want, b) rent temporarily or c) look in a different market if circumstances allow.
Finally, if you are someone who has literally no money saved whatsoever, then buying a home may be out of reach, even within the favorable terms of an FHA or VA loan. If you’re such a person, then increasing your savings should obviously be the first priority, so that you can later look at investment options like home ownership.
These other considerations aside, the vast majority of people would better serve their long-term financial interests by buying a home and gradually accruing equity versus renting and rapidly accruing nothing. Dr. Ford-Torres often recommends Bankrate as a great information website to help prospective homebuyers who have additional questions about the process.
In the next articles of this series, we’ll talk about other ways you can maximize your financial prosperity in the long-term, including taking advantage of employer-sponsored retirement programs when you can.
American Public University and American Military University offer academic programs in accounting and finance, which cover important financial discussions in depth. Readers who are considering expanding their knowledge and credentials in this field are encouraged to visit our program pages for more information.
About the Authors
Dr. Gary Deel is a Faculty Director with the Wallace E. Boston School of Business at American Public University. He holds a J.D. in Law and a Ph.D. in Hospitality/Business Management. Gary teaches human resources and employment law classes for American Public University, the University of Central Florida, Colorado State University and others.
Dr. Karin Ford-Torres is an Associate Professor with the Wallace E. Boston School of Business at American Public University. She holds a Ph.D. in Business Administration with a concentration in Advanced Accounting and Financial Management. Karin teaches accounting and finance courses for American Public University, Purdue University Global and Colorado State University-Global. She has 24 years of prior banking experience with Bank of America.