A Real Life Look at the Rent or Buy Question

Howie writes in:

My wife and I have been running our own home-based business for three years now. We rent and work out of a smallish 2-bedroom apartment in the very expensive SF Bay Area. One of those bedrooms is an office that we both share as an office. We spend day in/day out working together in this small space.

About a year ago we realized we could afford to buy a house in an outer suburb of the Bay Area now that the prices have come down. After a year of looking, we’ve now found ourselves in contract on a wonderful 4-bedroom house that we love. However, it’s at the top of our price range–about 30% of our income would go to the mortgage.

I realize that typically this would not be a good idea, as at least at the beginning, we would be stretched. However, the biggest reason we are looking to move right now is to gain more space so that we can grow our business. Currently, we feel like we’ve reach critical mass with what we can do in our small office. With this house, we feel it could be an income-generating asset for us in that it will afford us more space for us to grow our business and make more money. I very much feel like if we had more room to operate and a more official dedicated workspace, we could increase our income significantly.

Most financial advisers I’ve been reading say to buy a small, inexpensive home. This would be fine for us if we didn’t both work from home, but we simply need more space to operate our business.

Of course we could buy a small house and rent an office somewhere, but I’ve done the math on that too, and when you combine smaller house mortgage with separate office rent, the cost is essentially a wash.

The other option would be to rent a bigger house. Rents in the Bay Area are still high, and we would spend about $200/mo less doing this. I know every bit counts, but I don’t know if this savings outweighs the emotional benefits that go with working and living in a home that we own. We also want to start a family and are ready to put down roots.

Finally, we could ditch the Bay Area entirely and move somewhere much cheaper, such as Oregon. While there is some risk in leaving a few of our local clients behind, we could do this with not much risk, as most of clients are all over the country. This option would put us where we want to be financially, but as I mentioned, we want to start having kids soon, and most of my family is here in the Bay Area. Moving away seems daunting.

First of all, your emotional argument is clearly in favor of buying the home. Most of the argument you lay out here is one that makes the case for buying above all else.

Most of the time, regardless of the dollars and cents, people operate with their emotions. They’ll find ways to make the dollars and cents work. In fact, that’s when personal finance really cooks – people spend time soul searching, discover the key things they really want, and then stop wasting money on the things that don’t really matter to them.

In this case, it’s clear that the home matters to you. What things are less important in your life that you’re willing to trade for it?

The True Cost of Home Ownership

The maintenance costs of home ownership are far higher than renting

When you buy a home, you no longer have a landlord to call when a toilet breaks or a hot water heater goes out. Instead, you’re calling a repairman – or doing it yourself – and all expenses come out of your pocket. You also have lawn maintenance costs. You also have homeowners’ insurance. You also have property taxes. You also may have association fees. Those can be enormous – they can be enough to break the back of someone who thinks they can afford home ownership.

Beyond the financial cost is the time cost

Suddenly, you’re spending time mowing the yard. You’re spending time changing filters and doing maintenance work on your equipment. You’ve also got more space than you had before, so you’re spending more time cleaning.

Paying these costs – in addition to merely writing the check for your monthly mortgage payments – will exact a toll on your life as you currently live it.

In exchange for that toll, you will gain other things – the room to grow your business and the room to house your family.

It’s an emotional decision that you have likely already made. There are just two things I would suggest seriously evaluating before you actually make the leap to buy.

Questions to Consider Before Buying a Home

1. Do you have an adequate down payment?

This is important for two reasons. First, if you don’t have the financial fortitude to save up that payment while living in a rental unit, where the costs are much lower, you may not have the fortitude to handle the costs of home ownership. Second, without a 20% down payment, you’ll be paying a higher interest rate and/or mortgage insurance costs.

2. Do you have a written, clear plan for how you will make ends meet

What about how you will utilize that space to grow your business? These both may be nebulous concepts for you right now, but if you buy, they will become your reality. Spend some time actually planning for both of these events. Make a home budget. Make a business plan. Make sure you can actually do this with some breathing room (and an emergency fund) intact.

Yes, this seems like a lot of planning that takes away the “fun” of buying a home. Without that planning, though, you’re quite likely to find yourself losing that very house in a few years. A little planning now makes your dreams come true.

If you enjoyed reading this, sign up for free updates!

Loading Disqus Comments ...
Loading Facebook Comments ...
  1. Anna is now Raven says:

    For some unknown reason, this post leaves out one essential aspect of a home-based business. As long as office space is dedicated to the business, a percentage of mortgage or rent payments, utilities, and maintenance can be deducted from federal taxes as a business expense, usually on the basis of square footage of office relative to square footage of the entire house. The IRS (www.irs.gov) has clear guidelines on how this is done, and forms for detailing these expenses and deducting them.

    Howie and Mrs. Howie should also investigate the local laws and ordinances regarding home business. For example, some municipalities forbid home businesses that generate extra traffic.

  2. Johanna says:

    Here’s what sticks out at me from Howie’s letter: In paragraph 3, where he lays out his idea that having a bigger house will allow him to grow his business, there are three sentences in a row of the form “we feel” or “I feel.” Is the idea that you’ll make more money if you work in a bigger house just a gut feeling? Or do you actually have anything to back it up?

    Also: You say renting would be $200/month less than owning. How are you calculating that? Is it just rent versus mortgage? Rent versus mortgage plus taxes plus insurance? Rent versus mortgage plus taxes, insurance, routine maintenance, and extra saving for irregular large repairs, like replacing the roof? Have you considered how your transportation expenses will be affected by moving to an “outer suburb”?

    It was just last week that Trent wrote a post patting himself on the back for walking away from a house that he “fell in love with” but couldn’t afford (by which he meant that he could have afforded if he’d worked extra hours at the office and had fewer kids). That post concluded with, “Houses and cars and televisions and boats are just stuff. Don’t sacrifice your life for them because you want them in this moment.” Why didn’t he give Howie this advice as well?

  3. KC says:

    The article doesn’t mention the tax savings of a home business. There are quite a few deductions you can take for operating a business out of your home and they add up. My father is a part-time independent interpreter (for the deaf) – it’s amazing the number of deductions he’s allowed to take on the home office. Ditto for my sister and her part-time horse business.

    Anyway, Trent gives you some really good things to think about. Emotions play a big part in home ownership. Now I’m not that familiar with the real estate market in your area, but during recessions you have unique opportunities. My husband and I moved from Memphis to central NC in Dec 08. It was a fantastic time to move – housing was at a bottom in this area. We got a great deal on a nice, large home. It easily fit our budget constraints and he is incredibly close to his office (one of our more important requirements). A few years ago we couldn’t have afforded this location – but the recession created some sellers. So we are in unique times – you might just find a great opportunity to buy – but don’t push it and make it happen – just let it happen if the right opportunity is there.

  4. lurker carl says:

    What exactly is Howie hoping for by relaying this story? He didn’t ask any questions.

    No one “finds themselves” in a contract to buy real estate. My experience has been that a lot of personal effort and time goes into the process before contracts are brought out. Second guessing this decision should have occurred before signing on the dotted line.

  5. thisisbeth says:

    He mentions that moving out of the area would be cheaper, but not practical. I don’t know real estate, but is moving just outside of the Bay Area an option (i.e., cheaper)? You could still be rasonably close to the family to attend holidays, Christmas, random Saturdays, etc., with them, but it wouldn’t be a production that moving further away would be.

    I live in a suburb just outside of Minneapolis, MN. I know it would be chaper to live 50 miles out of town (where my siblings and parents do), but for me the location was more important. I’ll live in a smaller house, etc., in order to be in a better location for my life (friends, job, etc.). The rest of my family has long commutes; I take the bus (which gives me extra time for reading, napping, or socializing).

  6. sjw says:

    I’d also note that since both earners are at the same job, this is a risky situation. It is critical that this couple have a large emergency fund, and adequate insurance (both business and personal).

    And if you are at the top end of your money if you buy the house you want, how will you cope when one of you is taking care of a newborn and so you need to pay someone else to help with the home business?

  7. Sara A. says:

    I don’t think it makes sense to own in SF. Or LA. Or NYC. I would say, either rent a bigger place and stay in SF, or move someplace that fits both your lifestyle and your budget if you are going to buy. I would consider property ownership in SF to be a major liability unless you have a lot of cash reserves.

  8. Becky says:

    Moving is a pain, true, but I think this couple would be much better served renting a larger place for a while, starting their family, *then* buying the big house in an outer suburb.

    While renting, note down the extra time and costs involved in living in a house vs. an apartment – maintenance, cleaning. Even though the landlord is paying to fix things, take note of what needs fixing.

    We don’t have enough information – maybe yes, Howie’s $200/less per month rental figure includes big maintenance, taxes, insurance, HOA fees, etc. Or maybe it doesn’t. If it doesn’t, then double or maybe triple that amount for a more realistic picture of what that big house is going to cost you.

    Another good option is to buy, but buy a smaller home in the same area you want a bigger home in. Find out whether you like living in this outer suburb. Don’t stretch up to 30% of your income right away. Go with 3 bedrooms and see how *that* much extra space impacts your business. Learn the ropes of homeownership.

    A few years after I bought my first home, my priorities about what I wanted in a home had changed somewhat based on my experiences. I still loved that first house, but owning it was a lot more work and a lot less soul-satisfying than I expected it to be. Because I had a mortgage, I did not actually feel a powerful sense of ownership, and dedicating such a large portion of my income to housing supplanted all my other goals. I had dreams of fixing up the house and putting in wonderful landscaping, but just making the payments and fixing the stuff that broke meant I had nothing left over to realize my dreams for the place. I would have been better off in a smaller, less wondeful house that I could afford to improve to my own taste & satisfaction. In fact, I am still more in love with what I *imagine* that house could have become than what it actually looked like when I moved out.

    Starting a family is expensive, too. How will that big mortgage feel when you’re paying for childcare, or one of you is dedicating less time to your business to focus on children?

    I say, if you’re starting to have doubts and ask questions, *back off* and listen to your reservations. The big lovely house is so tempting, I know, and you imagine filling it with children and a booming business and all kinds of joy. The reality is, though, that the business and the children are probably what is so tempting. The house is just a stage setting for your imaginings. Let that go and focus on the numbers.

    If you find things taking off the way you expect in your smaller house, then move up to the big one in a few years, confident that it’s a smart move that you can afford. The risk you’re taking in jumping into the big one requires everything to work out perfectly in order not to make you regret your decision. As a business owner, you know that business plans should not assume that everything is going to work perfectly.

  9. CB says:

    When I rented, I did take my office deduction (a room was dedicated to just that). When I bought a home, I was warned NOT to take any home office deduction because I would have to pay back part of my appreciation when I sold it. Many people warned me that the home-owned office deduction just wasn’t worth it.

  10. Bethany says:

    The only caveat I have is that we are not certain that the housing prices in the Bay Area have reached bottom. I would bet that they haven’t. In that case, it would be better to wait another year or two for prices to fall further.

    I first saw a house we could “almost” afford in the spring of 2008. It was an old farmhouse, cute as could be, that would need a little work. I was estatic to find a house we could actually purchase in our area (Chicago suburbs). But I waited, and the price of that same home fell another 35 percent!

    We are still waiting. I keep running the numbers, and once I account for taxes, insurance & repairs, we’re still better off renting, even with the lower home prices. I am glad we didn’t buy that wonderful red farmhouse fixer-upper I first saw in 2008. We would be upside down by now, and stuck.

    If you don’t plan on moving, you can ride out some flucuation in price, but still.

  11. Craig says:

    I stick with renting, unless I plan on staying put, I have no intention of buying…it’s too expensive and the upkeep is expensive.

  12. chacha1 says:

    It does seem this question may have come too late. If Howie is already under contract on the house, it’s probably gonna cost him some money to walk away from it. And yet, as noted, he’s clearly got some reservations fighting with his emotional pull toward going through with the purchase. At some level, he knows he’s over-committed.

    I would think the potential risk – banking on the home business to take off in a way that justifies the home purchase – far outweighs the potential benefits of more space, etc.

    California home prices have not yet bottomed. If staying near family is really important, Howie could back out of this contract, wait another year or two to further improve the financial picture, and then buy in a low-cost (now) area like Sacramento. It’s only an hour from SF, plenty close enough for family to visit.

    I would advise Howie to get out of the contract and find a more capacious rental, preferably in the area where they’re considering buying so they can really get to know it. Maybe even out of state (he mentions Oregon) to really test the business and to test the relationship away from the family.

  13. Most people, it seems, buy a house for a sense of permanence, a tax write-off and to raise a family. Howie & his wife are doing it for those reasons, but also for a home business; there’s an income benefit to owning the house. That’s all pretty compelling, so I think they’re heading in the right direction.

    We have to add that buying now should be less risky than it would have been 2-3 years ago at the peak of the price boom.

    Two caveats I’d raise though…

    1) Trent discusses the amount of time involved in owning compared to renting–will that detract from business activity???

    2) Howie doesn’t tell us what kind of business it is, but we can guess that it’s some sort of product based business since they need more space. They REALLY need to check to be sure that their business won’t run afoul of any ordinances. Certain businesses can’t be run in some locations. Hope he does this before he closes!

  14. sarah says:

    Just out of curiosity, why has no one mentioned the first time home buyer tax credit? I know that in the long run 8k is not a huge amount of money over the life of the loan. However, since he and his wife are living in an apartment now it’s quite possible they qualify for this. It may be what motivated them to get into this contract. While it shouldn’t be a deciding factor, some people do see that as a nice boost towards their down payment.

  15. Bill says:

    Is the 30% of your income figure pre-tax or post tax?

    If I make $100,000, I probably wind up in the 25% federal tax bracket and in MA the 5%. So 30% of my pretax is income is $30,000. 30% of my post-tax income of $70,000 is $21,000. However $30,000 is 42% of $70,000.

  16. Michele says:

    My husband and I moved to Oregon to maximize our retirement dollars. We were able to buy a beautiful brand new home (one story-after 20 years in a two story) in a wonderful resort type area with lower taxes and less than half the cost of the same home in a similar area of CA. We don’t pay any sales tax, either. I’d move to Oregon if you can operate your business there. Business taxes are also low- not withstanding the soon to be dismantled increase on corporations and ‘the rich’ who make over $125,000 a year :) The election is Tuesday, and it looks like it’s going down in defeat to encourage more businesses to come to Oregon and flee CA.

  17. Des says:

    I would ask 30% of what? 30% of $40,000 is a tight budget. 30% of $200,000 isn’t nearly as bad. Same percentage, but its a lot easier to work with the latter budget and not starve.

  18. spaces says:

    I’m having trouble imaging what kind of business needs additional living space to grow, that could not be grown out of a garage, storage space or well-built shed. I suggest Howie & fam consider buying a smaller house and building a nice, wired two-story shed in the yard to use as a workspace. It wouldn’t even need to be plumbed (and that could always be done later), and it would be a heck of a lot less expensive than buying extra bedrooms.

  19. Bill says:

    I moved from San Fransisco to Portland Or, 20 years ago. I loved living in the city. The weather is pretty close, on the average I prefer San Fransisco’s which I rate near perfect if only they could throw in a good blizzard every year or two. Portland is a great city and is cheaper, not as cheaper as it use to be, but cheaper that San Fran and Seattle and with less traffic.

  20. Treva says:

    My parents have run a business from their home for 23 years now. We lived in a cape-cod type of house where the square footage is typically 800-1000 sq ft. The business took them years to grow; it was mostly something they did on the weekends or in the evenings while working full time jobs elsewhere. When I was 12 they had the house renovated, adding 14 feet across the back of it. This gave them some much needed space for the growing business, which now is one of the largest where they live. They had the machine for their business in a corner of the master bedroom and a 3rd bedroom became a workroom for materials. We had a den to use as a family and they used the living room to put in a nice armoire desk and see customers when they needed to come over. When I moved out, they turned my bedroom into the room for the machines (there are 2 now) and got their master bedroom to be completely theirs.

    What I’m saying is to buy a smaller house with an attached garage and improve on it (the house, the garage, the FROG, wherever you can find space) when the money becomes available. Just because you have a big house does not guarantee sales adequate to pay for the house. Start small and grow big.

  21. Rob says:

    When I started my small business we sold our home. This enabled us to put some of the money into it of course, but we new rent and use a portion of the rental as a company expense / deduction. If we were to try and deduct a part of the mortgage/interest as an expense on our old home we would be forced to pay a percentage of the profit as capital gains tax. (FYI – Im in Australia, Capital Gains Tax (CGT) is a Federal Government Tax & is payable on any capital gain except on the family home/principal place of residence)

  22. Lou says:

    Did you actually quote this guy: “we FOUND ourselves IN CONTRACT for a house…”

    So he’s writing to you after he’s already committed (it happendd while he was sleeping of what?) and you write an analysis that makes him feel not too bad about it? What about asking how much of a deposit he’d be leaving on the table now that he has started to have second thoughts? A house is like a marriage – easier to leave before you’ve said “I do.”

  23. matt says:

    @#8 becky, ditto on all of this, I find myself in a similar situation after just buying my first home, Additionally the time for up-keep (i cant justify paying a repair man for things i can do myself) has started to severely detract from hobby time, which is the reason I decided to buy a house instead of to keep renting (i wanted space to build a workshop and have large stationary tools). So now I have my dream workshop, and space, but have no time to play, as all my time is split between work and keeping the house from falling apart. The experience has taught me a lot about my needs and wants, and what things I didnt even know where needs, and which wants were impractical and ridiculous. The plan now is to build my next house, so I can get exactly what I need, and the wants that are the most important without having to compromise.

  24. AnnJo says:

    If you’ve never owned a home, it is easy to underestimate what it costs to maintain one. I’ve heard it said that a good estimate for maintenance and repair costs might be 1% of the home’s value, per year – so a home worth $400,000 might need $4,000 a year in repairs. Personally, I think that’s low.

    Here are a few (by no means all) of the expenses I’ve had in maintaining my home in a suburb of Seattle, which was effectively new (totally rehabilitated) when purchased 25 years ago. These are all heavily researched and vigorously negotiated prices, by the way. I would guess prices will be higher in the Bay Area, and some of these prices will have been inflated since I paid them:

    New composition roof (has to be done every 15-30 years depending on quality of materials used and environmental challenges): $10,000 (top grade materials – should last 30 yrs).

    Interior painting (did some myself, but had to hire quite a bit done): $3,400;

    Tree-trimming (every 4-5 yrs): $400;

    Pressure-spray deck, driveway (every 3-4 yrs) $400;

    Patch damaged drywall in ceiling (from roof leak), replace dryrotted window sill and siding, install additional downspout and clean gutters: $1,400;

    Clean out sewer pipe for root-growth (will probably have to be done every two years until the sewer pipe is replaced at a cost of $3,000 or so): $300;

    Exterior paint job (once every 12 years if done REALLY well, every 7 years more likely): $3,500;

    Replace deck (every 20 years if well maintained): Depends on size, materials, but in the $5-20,000 range);

    Replace every appliance and fixture every 10-25 years depending on their initial quality, your usage and your maintenance habits.

    Handle flooding from clogged storm gutter or burst washer hose or whatever: $500 on up;

    Clean woodstove or fireplace chimney (every 1-3 years, depending on usage, type of wood burned): $200, and re-tuck chimney every 10-12 years: $500+;

    Re-carpet every 5-12 years depending on maintenance habits, quality of materials: $3,000 or more;

    Replace and upgrade electrical breaker box: $1,100;

    After 15-20 years, the seals in your double-pane windows degrade and the window panes must be replaced and the windows reglazed – $100-$300 each depending on size, location). Window treatments must be purchased, cleaned and eventually replaced.

    Kitchen counters need replacing every 10-25 years depending on quality of materials;

    Cabinets need to be replaced or refinished. Laminate floors need to be replaced or wood ones refinished. Wiring has to be upgraded.

    Termites, carpenter ants, rats, mice, and other pests must be dealt with. An annual pest control contract can run $300-600. If the rats get into your insulation, it will probably need to be replaced sooner than otherwise.

    Landscaping must be installed, kept under control, pruned, fed, watered, weeded, mowed, thatched, aerated, mulched, and the tools and systems (sprinklers, etc.) to do this must be purchased, installed, maintained and replaced.

    Foundation cracks must be repaired, and foundations sometimes even need to be rebuilt, usually as a result of poor drainage, which must also be corrected.

    Buckling driveways, sidewalks, walkways and steps must be repaired or replaced.

    Furnaces and water heaters must be maintained and replaced. Filters must be purchased for furnaces. Water pipes must be kept from freezing, or repaired if they do.

    Hinges get bent, knobs fall off and are lost or broken, refrigerator shelf brackets break, firescreens crack, locks jam, siding weathers, cracks or rots, trees fall and take out the side of the garage, rails for sliding doors get warped, and always, always, small problems left untended get bigger.

    I’m not sorry I bought my home, but I had been in charge of managing an apartment building first, so I knew at least a little of what to expect. I wouldn’t want to discourage anyone from buying, but do it with your eyes open to the real costs.

  25. Amy says:

    Ditto with what Kevin said! Have they looked into any possible zoning problems with running a business out of the new residence? The fact that they feel they need a bigger space for the business made me also think that this was not just a home-office situation. They must be storing & shipping things. They just need to be careful & check local zoning to be sure they can run whatever sort of business they have out of the house they intend to buy.

    And I personally wouldn’t buy anything, at any time, that would make me feel “stretched.”

  26. matt says:

    @#25 Amy: I could justify buying a house that makes me feel stretched if in like my case, the mortgage payment is only $100 more than my rental cost. Granted there are extra expenses with the house, but that extra $100 that I would have to find in my budget means than instead of throwing $1k away a month in rent, a portion of that is going to build equity (savings vehicle). While I dont view a home as an investment per say. Its a heck of a lot better than throwing money into a black hole that is rent, Therefor I could justify reducing my emergency fund transfer by $100 a month to make the mortgage payment.

  27. Howie says:

    Thanks Trent, and everyone else for all these enlightening comments. A few things to clarify:

    Saying we “found” ourselves in contract was a poor choice of words. We’ve been house shopping for 4 months. This house is a short sale, and our offer was accepted. Now we wait a period of months for the bank to approve the offer. We can back out any time during this period without losing anything.

    The 8K tax credit, along with low interest rates and a 50% drop in Bay Area home prices are certainly strong reasons for our heightened sense of urgency to buy now.

    We are FHA and have 3.5% down, which adds $100/mo in mortgage insurance. (I’ve already calculated this into our monthly expense.) We have good credit, have been approved for a fixed rate loan of 5%, and we’ve built up an emergency fund and operate according to a strict budget.

    Certainly it’s an emotional decision. It’s also a professional decision. Hence the conundrum. We don’t have much equipment for our office (I’m a graphic designer, she’s an editor), but imagine sharing a 9′ x 9′ office in a 2-bedroom apt with your significant other every day, all day, for 3 years, and you might understand our need for more space.

    That being said, you can’t predict the future about our family needs, and we’ve really taken to heart the comments about the high cost of home maintenance. This is something lots of people have told us, but I must admit we’ve probably been in a state of denial about.

    The prolonged short sale process has been a blessing, and though we’re still undecided, we very well might decide to move and rent for a couple more years, build up our business some more to the point where this decision feels more secure, start a family, then buy.

    Thanks again for all of your feedback.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>