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Rent or buy

Chris Farrell Jun 4, 2010

Question: My wife and I purchased a house in 2006 for about $130k, with the mortgage currently at $90k. We are planning on moving someplace warmer for 3-5 years, then eventually returning to Michigan to raise a family. My business will move with me. We have $60k in savings and are financially comfortable making the move. We know we will take a loss on our current house, though shouldn’t be underwater. Is it better to buy or rent wherever we move to, knowing it will only be for a few years? If we buy and stay in the market, it seems we could gain equity in the new house as the economy recovers, potentially offsetting any losses on our current house. With renting, we would be leaving the housing market, forgoing any potential upswing/recovery, though doesn’t have the transaction costs of buying and selling a house. Eric, Kalamazoo, MI

Answer: It’s clear from your note that you’re definitely intrigued by the idea of making a speculative bet on a rebound in home prices over the next several years. Considering the sharp price declines in home values it seems like a reasonable bet. But, as Yogi Berra put it, “It’s tough to make predictions, especially about the future.”

That’s why I agree with the legendary investor Benjamin Graham who wrote in 1949 that when challenged “to distill the secret of sound investment into three words, we venture the motto, Margin of Safety.” Those are wise words for all seasons.

In practical terms, the key financial question when it comes to managing our money is this: “What is the downside? What could go wrong?” It’s a simple, but profound approach to managing risk. That’s why I’m always talking about diversifying, hedging, and saving. This way the consequences of being wrong may be financially painful, but never catastrophic.

Owning offers a speculative opportunity, but renting a margin of safety.

What I would think through is what if you buy a home in a warmer state and five years from now home prices are lower and not higher? Right now, you’re financially comfortable and that’s an envious position to be in. Would you be financially strapped if the housing market down south deteriorates some more? Would your plans to move back to Michigan have to be postponed? Would you still have a margin of safety–in other words, the financial freedom to comfortably move back to Michigan if that’s still what you want to do?

Another concern to think about is a change in a traditional real estate rule of thumb. It used to be that most people would say renting is always better than owning if you plan on staying in a place for three years or less. The costs of buying and selling are usually too great to be recouped in such a short period of time. That rule of thumb has now been extended to at least 5 years. I agree with the more conservative approach (probably no surprise there!)

So, as you can see I definitely lean toward renting and keeping a margin of safety. I think that is the main lesson of the financial turmoil of the past several years. You’re taking on a lot of risk if you buy.

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