Many people believe that when you're retired, you need to own your own home, ideally without a mortgage. But there are instances where renting can make more sense, not just financially but for several other reasons.
In this episode, James discusses the pros and cons of owning versus renting and when it makes sense to rent instead of own.
In what instances does it make more financial sense to rent than own?
What other reasons might factor into the decision to rent?
3:33 Cost of rent rising
6:00 Less control
9:00 First issue: tax implications
11:49 Second issue: budget
18:44 Your health
23:20 Emotional factors
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What do you do when you're retired and you want to move out of your current home? Do you use the cash from the sale of your current home to buy something else, or do you rent and then live on the proceeds? That's the question we're going over together on today's episode of Ready for Retirement. This is another episode of Ready for Retirement. I'm your host, James Conole, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. There's this idea that once you're retired, you absolutely need to own your home, and not just own your home but not have a mortgage on that home. So when people bring up the question of does it ever make sense to rent and retirement, for a lot of people the initial instinct is to say no, absolutely not. You need to own that home. However, there are certainly cases where renting can make a lot of sense, not just financially, but for other reasons as well. So what we're going to do today is walk through the pros and cons of owning versus renting and helping you to understand the nuances of that decision that you need to be aware of so you can make the best decision for you. This episode comes from a listener question, and this listener's name is Diane. Diane says this. She says I'm recently retired and I'm recently widowed, and I'm 70 years old. I have no mortgage, but I have a desire to move to another location because my home is too much about my life with my husband and I need to start fresh. Once I sell my house, i'm tempted to rent a home instead of buying again. Buying a home puts me in a position of having to handle repairs and maintenance on my own, which, as I age, i would not be able to do. I would put the proceeds of this house out into my portfolio. So, other than rents going up, what are some of the other cons of doing this plan? PS, i listen to your YouTube presentations all the time and they are so valuable. Thank you, diane. Well, diane, thank you very much for that kind feedback and thank you for your question. I think it's an excellent question that we can help to unpack And, whether this is Diane listening for her specific situation or anyone else listening, what I want to do is share the pros and cons and the different nuances, like I said, that are involved with this, and many of these may be things you haven't quite thought of before. So that's what we have in store on today's episode, and before we do so, as always, i'd like to review the review of the week, or highlight the review of the week as a way of saying thank you to all of those of you who have taken the time to review the show. That ultimately helps more people find this and create better outcomes for their own retirement. So this review comes from username Triken09. Trikant09 gives the show five stars and says worth the time. I've listened to many retirement podcasts. Ready for retirement has become my favorite. James is clear, practical and concise, yet very informative. Thank you very much for that review. Trikant09 really appreciate that feedback. That's good to know and that's helpful for other people, as I mentioned, looking for good content. How do you cut through the noise and find the information that's practical and applicable so you can create a comfortable retirement and get the most out of life with your money? So let's go on to the episode. As I said, a lot of people find it weird to even consider renting a home in retirement, especially if they already own their home. Now, some people they do choose to rent in retirement for financial reasons, sometimes for personal reasons, but today we're going to discuss the pros and cons of each because, contrary to conventional wisdom, there are actually some cases where renting could make sense. Now let's start by considering all the potential downsides before you make this decision. So, as Diane mentioned, she says, hey, other than rent going up, what are some of the other cons of doing this plan? So let's start with that. Let's start with the downsides and then we can look at the upsides, the first of which, diane, is exactly what you mentioned Rent prices can and do go up over time, which certainly could eat into your retirement budget. Now, this is especially important to consider if you plan to stay in the same rental for a long period of time. I say that because if you're like Diane and you're wanting to make sure that you have some stability, you probably don't want to be moving every couple of few years, especially as you age. So if you're willing to move and be flexible, then you're not maybe as subject to rent price increases that you will certainly go up, but you can constantly be looking at what's the best city, best place, blessed area to rent in for a reasonable cost. However, if you want to stay in the same home or the same place, you're going to be even more impacted by rising rent. So here's just some basic data from the Federal Reserve from 1970 to 2020. So a 50 year time period. Over that time period, rents in US cities increased by about 4% per year. So that's a pretty significant increase when you compare what rents were at the beginning of that time period, so 1970, until what they were at 2020. Now, of course, inflation as a whole has also gone up and during that time period, cpi so the Consumer Price Index, which is a gauge of inflation it increased by 3.9%. So, as you look at it, do rents go up? Yes, but rents go up about the same as inflation. So the real cost of renting from that time period essentially stayed the same. Yes, it went up, but it went up in line with inflation. So if you're looking at your situation now, here's what that might look like going forward, and I'm going to assume an inflation rate of 3% over the next several years. Obviously it's been much higher the last couple of years, but if it normalizes, let's just call it 3%. If you could rent a place today for $2,000 per month and inflation increases by 3% per year and rents increase in line with inflation. What that means is in 10 years your rent would now cost $2,700 per month. In 20 years your rent would now be $3,600 per month and in 30 years your rent would be about $4,800 per month if rents increase in line with inflation. So that is one of the downsides of renting Your expenses, the cost of renting, has doubled, and more over the course of your retirement most likely. So you need to make sure that you factor that into your retirement budget. So that's the first downside of renting is the rising cost of rent. The second downside is potentially less control of your living situation. So as a renter, you're gonna have less control over where you live, what you do with where you live, than if you owned your home. For example, your landlord could always sell the property and force you to move, or your landlord could do something to the home or apartment or a complex you live in that you don't necessarily want done. So, as we're talking about this, especially in the context of retiring and trying to age in place, this could be disruptive, especially if you have health problems or other challenges that make it difficult to move, if that's forced upon you. So if you wanna age in place and you don't want to hold a lot of disruption. You probably don't want to be forced to move every so often. Now there's different ways that I would kind of gauge or measure this risk. For example, if you're renting a single family home from a family, there's probably a lot less certainty there, because that family could change their mind about how they view that home. Do they move back into it? Do they sell it because it becomes part of their plan, or they need the proceeds to buy their home. So that probably presents a little bit more risk. It definitely presents more risk than if you are renting in, say, a senior living community where the goal is for you to be able to age in place and not be forced out of that. So this isn't a universal principle the fact that you have less control of your living situation, but it is true depending upon the context in which you're renting. Another downside is no equity. So as a renter, you're not building equity in your home, which means that you won't have an asset to sell if you need that money in the future, and this could become a problem if you outlive your savings. Now the fact that you're not building equity isn't entirely true because, as we mentioned, especially in Diane's example, she still has the equity. She has the proceeds from the sale of her home. So that's just now doing something else for her. That equity is no longer being built in a residence or a home but if invested or if you use that correctly, it still can be growing for you. So more on that later. But you don't have that built-in default equity in a property. And I say that because for a lot of people their home kind of becomes their plan B, especially if they don't have any type of long-term care insurance. They look at their home and say, okay, if I did run out of portfolio assets or if expenses did go way up, say because of a long-term care event, well, i could access the equity value in my home to fund that. So more on this later. Because again, this isn't entirely true. You do have the lump sum proceeds that if invested properly, you could absolutely keep doing what you need to do from them. But you wouldn't have that principal equity, like many people would. All right. So those are some of the downsides. If you're looking at renting versus owning and retirement, those are some of the very apparent downsides and potential risks to doing so. Now let's look at the different issues I'd want you to consider so that you can make the right decision for you. So these issues are things that could be positive or could be negative, depending upon your potential or your specific situation, but let's go through them so you can apply that to yourself. So the first issue that you want to consider before making this type of a decision for yourself is what would the tax implications be of doing this? If you lived in your home a long time and you then decide to sell, you could be paying a pretty big chunk of the proceeds from the sale of your home in taxes. Now, in Diane's particular situation, this would come down to what state she lives in, and here's what I mean by that. When you sell a home, there's two different types of things that we want to look at, at least in Diane's situation. Number one is capital gains exclusions, but number two is a potential step up in basis not a potential step up in basis, but an actual step up in basis. But the way in which that works depends upon Diane's state. For example, if Diane lives in a community property state so I'm in California California is a community property state If two spouses jointly own a home and one spouse passes away, then there's a step up in basis on the entire property. For example, what if Diane and her spouse purchased this home 40 years ago for $100,000? And today it's worth $1 million, for example? Well then, on the date of Diane's husband's passing, the new cost basis of that home would become $1 million. It's community property and there's a step-up in basis on the entirety of the process or on the entirety of the property. I should say So. If Diane then continues to live in the home for some time and then she ultimately sells it later, she's paying taxes on the difference between what it was valued at on the date of her husband's passing versus the date that she sold it at, or the value that she sold it at when it was sold, minus, of course, any capital gains exclusions she would be eligible for. So there are nine community property states in the US. It's Arizona, california, idaho, louisiana, nevada, new Mexico, texas, washington and Wisconsin. If you live in one of those states and you jointly own a property with your spouse and they pass away, you get a step-up on the entirety of the basis of your property. Now, if you're not in one of those nine states, you're in what's called a common-law state, and in a common-law state you get a step-up in basis on half of the home that your spouse was deemed to have owned. So it works the same way in terms of a step-up in basis on the date of their passing, but it's a step-up in half the basis and your half is still subject to the same basis on the date in which you purchased the property. So be very mindful of that If you're looking to downsize and retire mentor, sell a property and potentially rent. Just understand the tax implications of what you'd be paying if you were to sell the property in. A step-up in basis is an important component to that. So that's one consideration. Hey everyone, it's me again for The Disclaimer. Please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. This is for informational purposes only. The second is just your budget. So how much can you afford to spend on rent each month? Now, this sounds pretty basic and it sounds like this should be a universal thing of. Hey, james, is it more expensive to rent or to own, or is it more beneficial to rent or to own, but it depends upon different parts of the country, and I say that because different parts of the country have different economics when it comes to what you might call a price-to-rent ratio. So if you look at properties all over the country and you want to say, on average, what's the median price of a home in any given city versus what's the median rent of a home in that same city, what you can do is you can divide that median price divided by the median rent and that gives you a sense of is it more affordable to rent or to buy in this area? So the higher the ratio, the cheaper it is to rent. Here are some numbers to show you what I mean by this. These are 2023 numbers for the 50 most populous metros in the United States. It's not every single city, every single county, but the 50 most populous metros in the US. The cheapest is Pittsburgh. So in Pittsburgh that price to rent ratio is 12 times. So here's where that number comes from. The median home price in Pittsburgh is $188,000. The median monthly rent is $1,333, or about $16,000 per year. So if you divide that median home price of $188,000 by the median annual rent of $16,000 per year, you get a price to rent ratio of 12 times. Now let's compare that to the most expensive metros in the US, and the most expensive is San Jose. In San Jose, there's a 38 times price to rent ratio. Here's how those numbers play out The median home price is $1,43 million and the median rent is $3,181. So there's certainly other factors to consider outside of just this, but if you're in Pittsburgh and you wanna stay in Pittsburgh, then that ratio says it probably makes a little bit more sense to buy. This does not factor in potential price appreciation or other financial factors. This is a fairly simple way of looking at it, but the lower that price to rent ratio, the more probable it is that it's gonna be cheaper for you over time, to buy a property, and the higher that price to rent ratio, what that means is it's probably gonna be a bit more affordable to rent in that same area. So if you're in Pittsburgh and wanna stay in Pittsburgh, then maybe it makes more sense to buy. If you're in San Jose, though, and you're Diane and you're looking at this, could I use this money to buy a home or to rent a home? Well, the cost of rent is relatively cheap, at least when compared to the cost of buying in that same exact area. So the goal of this analysis isn't to say what should you do if you specifically live in Pittsburgh or if you specifically live in San Jose. It's more designed to say understand the general economic landscape of what does that ratio look like For your given geography that you're looking to live in. Is it cheaper to rent, is it cheaper to buy, and understand how that would impact your retirement budget going forward. The next thing I'd look at really has nothing to do with money, but it has to do with your lifestyle. So, do you plan to stay in the same place for a long time or do you want the flexibility to move? If you want more flexibility, well, you probably lean more towards renting. Buying a home is a big decision and it's not just easy to get up and move anytime you want. It's costly, it's a lot of time, it's a lot of effort. There's a lot that goes into that. So if you want maximum flexibility, you're probably gonna be better off renting Versus if you want maximum stability, you're probably gonna be better off buying, if you can afford to do so. So this is another factor to keep in mind. Diane, based upon your question, i would assume you're leaning more towards stability. And so that stability aspect, yes, you could absolutely find that with renting in the right places. But, as I mentioned, it depends upon where you rent. If you're just renting a single family home from a family, well, their decision to continue renting that or not renting that is probably gonna be based upon their financial plan, not yours. Versus, if you rent in a community or a place where you have some certainty that you can be there for some time, well, you're still getting that stability. But make sure that you're keeping the lifestyle aspect in mind. And I say this because, again, it's so counterintuitive sometimes to think that why on earth would people rent at retirement if they have the option of buying? Well, i have clients that were retired and they sold their home And we ran an analysis to see, not just financially, what makes most sense, but what is your desired lifestyle look like? You'll hear us say often how do you get the most life out of your money? Well, for them, what that looked like was they wanted to be able to drop everything at any point and travel around the country or travel around the world. In fact, they went on a several month long road trip throughout the US And that was something they were planning to do. And we said does it really make sense to own a home if you're gonna be gone for a long period of time And you might do this type of thing regularly? So here's the amazing thing This seems like it might be a very expensive thing to do. Where they came to me and they said you know what? we wanna spend a year driving across the US, visiting different cities, seeing family, experiencing all that the US has to offer. That seems like it could be pretty expensive doing that for about a year straight. Well, here's the thing They spent about the same as they would have had they continued living in the same area Because they no longer had any rent or mortgage or property tax to cover. All that money went towards an Airbnb or a hotel or staying with friends and enjoying the lifestyle that they had with that Food same either way, whether you're eating in your hometown or whether you're eating across the country. It ended up being about the same cost. Now, if they owned a home, they still would have had to pay the mortgage or property taxes, even while they were gone, and this would have made that trip a lot more expensive. Yes, they could have rented the home out. They could have used that income to cover the mortgage, cover, the property taxes, but based upon what they wanted to do, that just wasn't a hassle they wanted to have to put up with. They wanted total flexibility, to be where they wanted to be and not have to think about how things were back home. Now they plan to do the same thing in the next year or couple of years And they don't know where they're ultimately going to settle down, because they don't know exactly where their daughter's going to end up. So for them specifically, renting was best, not just financially due to where they live now and where they might live in the future, but it fit their lifestyle better. So look at your desired lifestyle, look at what you want retirement to represent for you and then start to understand as renting or buying better for you in that type of lifestyle. Another consideration is your health. So if you have health problems or complications or anticipate health problems in the future, you may need a more accessible home. You may need to make some improvements or additions or renovations to the home that support your mobility and your accessibility in that property. Now, if you own something, you have free reign to do what you want with a property, versus, if you rent something, you might have that, depending upon where you rent, but you might not if it's not a home that supports that type of add on or renovation. So that's an important consideration. Don't just imagine yourself today where you want to be, but if this is somewhere you want to age in place, what would this look like in five years or ten years or 15 years, and could you still be there, based on any potential health complications? And then the final consideration is your investment goals. So I referenced this earlier where I said look, one of the downsides to renting is you're not building equity in a home. However, when you just look at it that way, it seems like a bad thing. Gosh, i'm losing out on a lot of equity that I could be building. But what that doesn't consider is what the equity you put into your home could be doing for you had it been invested elsewhere. Let's look at an example of what I mean by this, and I'm going to use Diane as an example here. So, diane, let's assume that you lived in San Jose, so one of the cities we just mentioned here. And let's assume and again I have no idea what you'd actually be able to sell your home for. But let's assume you lived in San Jose and you sold your home for the median home value. Call it $1.5 million. You're looking at that and, by the way, don't let the actual number get you hung up that's the most expensive median area in the United States, so chances are that's not the median area of where you live. So don't focus on the numbers as much as the ratio and the proportion here. But let's assume you have $1.5 million and you could either go buy another home in San Jose or you could rent in San Jose. But if you needed to rent, you would need to pull money from that $1.5 million to pay the cost of rent each year, so that equity is no longer in a home that is mortgage free, it's invested, but you need to use that to pay for your cost of living. So if the average rent is $3,181 per month, what that means is, on an annual basis, you would need to pull out about 2.5% of your $1.5 million that you invested from the sale of your home to fund the cost of renting for the year. So here's what that means If you could grow that investment account by call it 6% over the next 20 years and you were to take out 2.5% per year for rent. Effectively, what that means is your investment accounts continuing to compound at 3.5% per year. If that's the case, you would then have about $3 million in your investment account Diane by the age of 90. So 70 today. 20 years later, age 90. Again, i'm using a very simple example here. Here's why this matters. When people talk about building equity in their home and their investment goals, some people they want to use their home and pass that to their children. Some people say I want to use my home as a long-term care policy. If I need the equity, then I'll sell it and fund long-term care. Or some will say if you don't buy a home, then how could you possibly build equity? Well, look at this example. You're still building equity. That 1.5 million grew to 3 million in this example, all while funding the monthly cost of rent. So you still have equity. It's just being built in a different way. Now, those numbers worked out that way because I cherry picked the most expensive price rent area in the country. If I had used Pittsburgh instead, for example, it probably wouldn't have worked out that way. It probably would have made a lot more sense to go buy a home, at least in that basic financial analysis. So all that I'm trying to say here is make sure you're considering your comprehensive financial goals. Some people get so laser focused on building equity in a home, but the reality is that home doesn't do anything for you. The equity doesn't do anything for you, unless you sell it, rent it or pass it to family who later sells it. You can't live on it by itself. So, yes, it's a great thing, yes, you can build equity, yes, it's an automatic way to build equity, but there's other ways to do it. There's other alternatives, but you need to base it upon your specific numbers of what would it cost to buy versus what would it cost to rent And, at the end of the day, weigh all of these factors, whether it's your investment goals, your health, your lifestyle, your budget. All of these different things should be considered, because there are instances where it does make sense to rent and there's many other instances where it absolutely makes sense to buy, or at least not to sell, a home. Diane, in your specific situation, the one factor that we haven't covered quite yet is that emotional factor. So you bring up a very valid point of, hey, this home, there's just too many memories of myself and my husband and after he passed it's just difficult to be here. I hear that a lot and that's an extremely valid point. So, on top of the financial considerations, on top of the taxes or investment goals or lifestyle goals, keep in mind the emotional component of it. A home is more than just a house with four walls. There's a lot of memories there and sometimes that can be difficult. So make sure that you're considering all these different factors so that you can make the right decision for you. But don't get pulled into doing what you think you should be doing because all of culture or all of finance says you need to own your home or you need to do this, or this is the absolute best way to do things. Make the decisions right for you and make sure you're checking off all these boxes to consider as you go through that. So that's it for today's episode. Thank you again for tuning in and joining me on your drive, your commute, your walk, wherever you may be listening. As a reminder, if you are enjoying this podcast, please let me know by leaving a review. It helps me, it helps more people find the show and ultimately, it helps people to create a better, more secure retirement. So thank you again for listening and I'll see you all next time. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how Root Financial can help you implement the techniques I discussed with this podcast, then go to rootfinancialpartnerscom. Click Start Here, where you can schedule a call to one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember, nothing we discuss on this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.