Should You Buy or Rent a Home for Retirement?

Should you buy or rent a home? That is a question that a lot of baby boomers will be asking themselves when they are planning to retire. Even if you are in the home in which you plan to retire, in some cases it can make more financial sense to sell it and rent something else.

The Problems with Owning Your Home When Retired

Financially, owning a home when you retire can be good or bad, depending on other circumstances. First, let’s look at the problems.

If you have a mortgage, paying the mortgage requires regular income – you have no choice. This reduces your flexibility in tax planning, i.e., deciding how much income you will withdraw from retirement accounts and when you will withdraw it. Taxable withdrawals can trigger increases in taxation of Social Security income, for example.

Also, in some cases the annual mortgage, insurance premiums, property tax payments, and home maintenance costs can total substantially more than it would cost to rent a suitable home. Here are some comments from one homeowner who learned this lesson hard way:

Even more sobering, Seaman did some math showing that the $60,000 in yearly mortgage payments, insurance and property taxes she’s been shelling out exceeded what she would have spent renting a similar home at $36,000 annually. The tax deductions she got for mortgage interest and property taxes don’t come close to making up the $96,000 difference in cost over the four years, she says. “I feel like the whole housing dream is kind of a joke,” Seaman says. “I paid in for four years and got nothing. I wish I’d never bought.”

(Source:  Forbes.com)

If you own a home that is mortgage-free, you can still come out worse financially if a lot of your net worth is tied up in home equity. Residential real estate value have fallen dramatically in the past few years. Some of the worst hit areas are traditional retirement destinations such as Florida and Arizona.

There is no reason to be confident that real estate values will return in our lifetimes to the days of rapid appreciation that produced the housing bubble. Thus, your equity could be sitting there not earning you anything. If that is the case, you would be better off selling and either downsizing or renting while investing the cash that you freed up. This is part of the “house rich but nest egg poor” home equity strategy.

How to Analyze the Rent vs. Buy Issue

Financial experts will tell you that one analytical approach to the rent or buy in retirement question is to study the net rental yield of homes you are considering for retirement living. The “net rental yield” is also called the capitalization rate or “cap rate” for short.

Essentially, the cap rate is the annual net rent as a percentage of the resale value of the home. The annual net rent is what an all-cash buyer of the property would clear in rental income by owning it and renting it out to someone else. (The cap rate is comparable to a bond yield.)

Let’s assume that the cap rate on a house you are living in is lower than the yield on an alternative investment that is less risky and more liquid (such as a high-grade municipal bond fund). This is an indication that you would do better financially by selling the home if you’re the owner or that you should keep renting if you’ve been considering buying.

Forbes has actually determined typical cap rates in different cities.

Final Thoughts on Renting or Buying When Retired

There is no question that the rent or buy issue is an emotional one for a lot of us. When we look at where we are living, it is hard to ignore long-standing attachments. On the other hand, lots of folks assume that owning a home always makes more financial sense than renting. Clearly that is not the case now.

Image credit: Extremeezine

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