Should military families buy or rent? There is obviously no answer that fits all situations to this often-asked question. With the recent "flattening of the market" and higher interest rates, more military families ask this question. Here are other factors that can impact the answer to the rent vs. buy question:
- Length of PCS orders and/or likelihood of re-tour or retirement in area of the base
- Strength of local economy
- Interest rate trends
- The prospective home buyer's cash position
- The prospective home buyer's total family income
- The prospective home buyer's tax bracket
- The prospective home buyer's tolerance for risk
It is no secret that national real estate prices have flattened considerably, and in some cases declined. An interesting phenomenon occurs in a declining market — whether it is the stock market or real estate market — the herd mentality sets in and everyone rushes to sell. Those not in the declining market are very reluctant to invest in that market, and begin to search for rentals.
Over the past four years everyone rushed to catch the huge appreciation as the market catapulted skyward. The pervasive thinking was, "Hurry and get into the market before rates and / or prices increase to the point where you can't get in!"
In just a moment we will construct a straw model of a buy vs. rent scenario, but first we should acknowledge a few facts:
- Generally speaking, when interest rates rise, so does the cost of a home mortgage. Thus renting appears to be more attractive than purchasing. Subsequently, the inventory of rentals decline, as the inventory of homes for sale increase. This increases the competition for rentals locally, driving up the cost to rent. Conversely, the home for sale inventory increases, forcing competition and downward pressure on home sale prices as they become more negotiable. ultimately, lower home sale prices equate to lower mortgages, which equate to lower monthly payments given a specific interest rate.
- No one, and I mean no one, can predict with certainty where any market will be two to three years in the future. However, a very safe assumption — based on the "laws of supply and demand"— is that despite periodic market fluctuations, real estate prices will continue to increase over time. The simple fact is that there is a finite amount of real estate and a growing population.
- No investment is without risk.
- Real estate investments have an inherent tax advantage in comparison to stock market investments. Military families may have an additional capital gains advantage (see Armed Forces Tax Guide Publication 3) due to the unpredictability of transfers.
- Hot Tip: Warren Buffet did not get rich by buying at the top of the stock market. He got rich by ignoring the "herd mentality" and buying undervalued stocks that were well positioned for growth.
Buy Verses Rent
Caveat: We are not tax advisers. Everyone's tax situation is different and if you have any questions, you most certainly should consult your tax adviser or accountant to determine how buying vs. renting would affect your taxes!
Scenario: 0-4, 10 years, with three dependents, PCS three-year orders
Base Pay: $5,482
Spouse Income: $2,500
Total Taxable Income: $7,982/mo., $95,784/year
Assume tax bracket of: 25 percent
BAH: $2,470
Total Income: $10,452 ; $125,424/year
Annual Tax liability Before Purchase (25 percent of $95,784) $23,946
Home Purchase Specifics / Interest Only Loan (for simplicity)
| Sales Price: | $420,000 | |
| Down Payment: | $20,000 | |
| Loan Balance: | $400,000 | |
| Interest Rate: | 6 percent | |
| Term: | 30 years | |
| Monthly Interest: | $2,000 | $24,000 / year |
| Taxes: | $300 | $3,600 / year |
Total Annual Tax Deductions from home ownership: $27,600 per year
Insurance: $50
HOA: $40
Total Payment: $2,390
Home Rent Specifics
Monthly Rent: $2,000; $24,000 annual
Cash flow before tax considerations: $390/mo.; $4,680 in favor of renting
After Tax Analysis
Annual Interest Paid = $27,600 in a 25 percent tax bracket yields an annual tax liability reduction of $6900 resulting in an annual net advantage of $2,220 ($6,900-$4,680) to purchasing. The three-year purchase advantage is $6,660.
Appreciation Factor
Assumption: $420,000 home, annual appreciation of a MODEST 3 percent (compounded annually)
Home value at the end of three years approximately $458,945, an increase of $38,945.
Assumption: realtor fees and closing costs at $29,500, net after fees from appreciation = $9,445.
Three year tax advantage: $6,660
Net appreciation: $9,445
Net three-year advantage to purchase compared to renting: $16,105
Of course it doesn't always turn out this way. The advantage can be significantly greater, or you can even lose a substantial amount of money! Been there, done that on both counts!
I will close this article with a true anecdote about a close personal friend who served 30 years in the military. Bet you know someone just like him. Over the years, he purchased four homes, rented three of them out (to other military members of course), and sold one near the end of his career. Two of the three are completely paid off, and one is half paid off. Combined, the three properties are worth well over $1,000,000 and generate approximately $36,000 in annual income. He did not get the huge 20 percent appreciation bumps of the recent "boom" market, but rather, plodded along at more modest appreciation rates.
Like any other investment, buying and holding real estate, if done in a thoughtful, disciplined manner can be an excellent investment and supplement to a military retirement.
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