When renting makes more sense than buying

A growing number of people, instead of buying homes, opt to put their money in a bank and pay rent from the returns.

Pakistanis would not usually be open to the idea of not owning any asset that we happen to be utilising if we can help it. It is generally assumed that those who rent their homes, for example, do so because they cannot yet afford to buy their own house.

Nonetheless, there appears to be an emerging class of people who seem to have done away with the need to own the home they live in, despite having enough money to purchase the property from its current owners. These folks have made their decision based on a single number: the opportunity cost of buying a home.

Opportunity cost is one of the most basic economic concepts which suggests that the true cost of something is not just what you pay to acquire it, but also the benefit of the next best alternative forgone.

There seems to be a growing number of people who, instead of buying homes, opt to put their money in a bank (or elsewhere) and pay rent from the returns instead.

Take the case of a colleague, Nadeem (name changed to protect identity). Nadeem lives in a house worth approximately Rs40 million in an high-income neighbourhood in Karachi and pays a monthly rent of Rs120,000 on it. The odd thing, though, is that Nadeem has more than the value of his house in fixed income investments. So why does he choose to not buy a house of an equal value to the one he is renting now?

Taking the annual aggregate, he pays Rs1.44 million in rent a year. On a Rs40 million investment in government bonds, he is currently making Rs5.2 million a year (at the current 13 per cent yield that he receives from a fixed income mutual fund invested in government securities).

In monthly terms, while he is paying Rs120,000 in rent, he is getting Rs430,000 in income from his investments. Not only does that cover his rent, but also much (if not most) of his household expenses.

“I also have the advantage of being able to switch houses on a much shorter notice than if I had owned my own place,” says Nadeem. “If I grow tired of a place, I can just rent a new one.”

To be sure, there are not a lot of people as well off as Nadeem. But his experience illustrates an important point: ownership is not always the best strategy. Sometimes renting can be more financially beneficial. In Nadeem’s case, he does not plan on living in Karachi permanently and so it makes little sense for him to buy property. He is not yet sure where he plans to spend the remainder of his career and retirement and renting helps keep him mobile.

This problem has become evident through the US financial crisis. As housing prices collapsed, millions of people ended up with mortgages greater than the new, lower value of their homes. People who lost their jobs cannot afford to sell their house and move. The immobility of the labour force is seen as one of the key drivers of high unemployment in the United States.

In the long term, of course, owning one’s own home can be important. It can be a valuable tangible asset to hold, particularly in rough economic times. It also helps to have the stability of knowing that one can never be kicked out of their current place of residence. But sometimes, mobility is a more important factor. If that is the case with you, it is recommended that you rent.

The writer is a financial and management consultant based out of Karachi

Published in The Express Tribune, October 18^th, 2010.