Once upon a time, only the less affluent rented houses. They rented because they could not afford the deposits to buy, or they couldn’t get a loan, or they were simply priced out of the market.
Then homeownership became easier. Buyers could buy with “no money-down.” Banks’ lending policies became lax. Now everyone could buy a house.
Then came 2008.
Globally, people are looking at homeownership differently since the great housing recession in the U.S.
One segment that has been rethinking homeownership is the rich.
On the outset, it doesn’t make sense. Why rent when you can clearly afford to buy?
If you’re Malaysian, you probably find this to be an act most foul. How can you not aspire to own a home? What evil is this?
Whatever your thoughts on this, a wind of change is blowing - and with more force in developed countries.
Let’s take a deeper look.
Why Do People Rent Today? (Hint: It’s More Than Just Affordability)
The answer would seem obvious. People rent because they cannot afford to buy.
House prices in most major cities are just too high. Even for those that can get financing, the deposits and closing costs are quite restrictive.
If you want to buy a RM450,000 house, you’ll need to fork out RM45,000 for the deposit and about RMRM22,000 in closing costs. You’ll also have to cough up at least RM30,000 for renovations.
In total, this is RM97,000 or 21% of the house cost.
Few people have 21% of the house cost saved up in cash. So, yes, the primary reason most people rent is because they lack the financial resources to buy.
But then, why is the fastest growing segment of renters the affluent?
This segment (earning RM645,000 annually) of renters grew by 175% between 2007 to 2017 according to a survey by Rent Cafe.
It gets more interesting.
In the same period, the increase in homeowners for this segment was only 67%. The verdict is clear: rich households are overwhelmingly choosing to rent.
This begs a more specific question…
Why Do Rich People Rent Instead of Buy?
One explanation for this is that even the rich are finding it increasingly unaffordable to buy.
In the Rent Cafe survey, cities like New York, San Francisco, and LA had the highest number of rich renters. House prices in these cities are among the highest in all of the U.S.
But, in terms of growth, cities like Seattle, Charlotte, Baltimore, Fort Worth and San Jose came out on top.
These cities are not the least affordable housing markets.
So there must be other reasons the rich rent.
A likely reason for this reason is the 2008 housing market crash or the great recession. This event wiped out the property values of many homeowners. Defaults rose and large financial institutions like Bear Stearns and Lehman Brothers collapsed.
Everyone in the economy learned a bitter lesson and homeowners realised that real estate was not necessarily the safest asset class.
Homeownership is no longer the bedrock of financial security post-2008.
A second reason is that the rich are more sophisticated investors. They have access to a variety of investment options that they can understand and leverage.
For the general masses, homeownership is easy to understand - buy a house, the price appreciates over time and equity is gained. It’s not difficult to understand relative to the stock market, bond market, and ETFs for example.
A 2019 survey by UBS reported that the asset allocation of the super rich was unlike the average household. 32.4% of the super rich’s asset allocation was in the equities markets.
Direct investments in real estate comprised only 17% of their asset allocation.
Other surveys consistently support this finding; the rich favor a diversified portfolio and real estate is not their top investment instrument.
Rich households today also comprise millennials who have a different perspective on life. The old “get a good job, get married, have children and buy a house” formula does not stick with millennials.
And they’re a big group. Roughly 22% of the U.S population are millennials, making them the 2nd largest group after Generation Z.
Globally, millennials will soon make up 75% of the workforce.
Previous generations may have favored the security of homeownership but a house anchors you to a single place in an era where mobility has never been easier.
People like FIREcracker and the Wanderer, founders of the Millennial Revolution are leading this generation's revolt against the traditional idea of security. They’re gaining traction.
In fact, studies show that the rate of homeownership among millennials is lower than previous generations.
Another reason I believe the rich are the fastest growing segment of renters has to do with financial mathematics.
A buy-to-stay house is more a liability than an asset. When you add the mortgage interest rate, inflation rate, and running costs of maintaining a house, the capital appreciation doesn’t necessarily give you a substantial increase in wealth.
In addition, mortgage repayments are often higher than rental income in affluent areas.
This creates an opportunity cost for buyers.
Combine all these factors above and you can understand why the rich are the fastest growing segment of renters in the U.S and why this trend will probably spread to other countries.
Why Do Celebrities Rent Houses?
Would you be surprised if I told you that some of the richest celebrities rent their mansions? These are individuals with net worths that exceed RM200 million.
How about I give you some names?
According to The Richest, these are some celebrities who rent their mansions:
Most of them pay exorbitant amounts in rent. So why wouldn’t they buy?
Mobility comes to mind almost immediately. Celebrities are jet setters and love being in vogue. Renting gives them the freedom to move to the latest, newest, or whatever fancies them at the time.
Another reason proffered by The Richest, is that many of them would not want to drop RM80 million in liquid assets in one go.
Do Rich People Buy Homes? (Of Course They Do! But…)
Despite all the reasons for the rich to rent, many do buy their own homes.
In fact, many celebrities own houses but also rent. Ewan McGregor for example owns a house in Ireland but rents his “Mac Mansion” in Las Vegas.
I’ve pointed out here and in another post that buying-to-rent is a great investment option. The returns are better than buying-to-stay and it’s an attractive option for the rich.
But, the rich don’t necessarily view the purchase of their house as an investment.
In my experience, rich people aren’t thinking primarily about resale value and appreciation when they buy a house to stay in.
They buy because they love the house, or the neighborhood. Perhaps for convenience. Perhaps to elevate their social status. Perhaps for a combination of all these reasons.
These are appropriate reasons. A house doesn’t have to be an investment everytime. Sometimes (if you can afford it), there’s nothing wrong with doing things that make you happy. If owning your dream house gives you such happiness and fulfilment, then why not?
The rich often spend extensively on renovations and furnishing even though the value of a house does not commensurate with how much the owner has spent on propping it up.
The satisfaction of living in the dream house is more important.
So, yes, the rich do buy homes to live in but many do so with little consideration to investment return.
Why Rent When You Can Own? (Beware, Marketers Love This Phrase)
People in the business of selling homes will give you plenty of reasons to buy a house. Often, you’ll hear this phrase, “why rent when you can own?”
Then, you’ll be provided with information like potential appreciation, and rental returns.
If you’re buying-to-stay, the rent that the property can fetch has no effect on your investment. At least not while you live in it.
In fact, when you buy-to-stay, your house is everything but an attractive investment deal. Marketing speak will try to convince you otherwise but don’t be fooled.
Even marketers sometimes understand the futility of speaking about financial returns with buy-to-stay properties.
Have you noticed how marketers for ultra luxurious projects rarely talk about investment return? Experience is emphasised - usually a combination of a pampered lifestyle, social elevation, beauty, and scarcity.
The joy that comes from owning the house you live in and being able to customise every inch of it to your liking is the true reason to buy a house.
The financial arguments for owning-to-stay are weak, except when the monthly mortgage payment is significantly lower than the potential rent.
For example, if the rent you can fetch from owning a house is RM20,000 whereas the monthly payments to your bank is only RM12,000, the financial case for owning is good.
With high-end properties, this isn’t usually the case. Let’s take a closer look.
Why Should You Rent Instead of Buy?
The argument in favor of renting can be demonstrated by an actual example. Let’s assume you work in KL Sentral.
You’re rich. Your job pays you RM40,000 per month.
Your partner rakes in another RM40,000 from her job. She works in KL city.
You have 3 children who go to school about 5 KM away from KL Sentral.
The ideal place for you to stay would be KL Sentral but because of the children, you prefer the nearby suburbs of Bangsar, Damansara Heights or Taman Seputeh.
The 4-bedroom houses you like in these neighborhoods cost RM5 million. Your monthly mortgage payments would be RM21,000 at least.
Renting a similar type of house instead would cost you RM15,000 per month. You save RM6,100 if you rent.
Let’s say you buy the house and spend RM300,000 on renovations and furnishing. After 15-years, with a 4% average yearly appreciation on the property, your total equity built would be in the region of RM500,000. This is your gross profit if you sold.
After deducting RPGT and agent fees, you may net RM310,000. Your annualised rate of return in this case is 1.69%. You’d have fared better keeping your money in a bank which pays you 3% p.a in interest.
Now, let’s assume you rent instead. You’re saving RM6,100 every month as a result. You also save about RM1,000,000 in deposit, renovations and closing costs.
You then open an account in StashAway (an ETF platform) with the RM1,000,000 and deposit the savings of RM6,100 every month into this account. You choose an average annual interest of 7% net.
At the end of year 15, your account would have RM4.8 million. Your net profit (after deducting the initial capital and monthly deposits) would be RM2.7 million..
Relative to owning, that’s a difference of nearly RM2.4 million in equity!
As you can see, the financial argument for renting the house you stay in is rock-solid. And then you have the other reason that is attractive for many millennials - mobility.
Want to upgrade to a larger home? Easy. Want to downsize? No problem. Want to move to a different country? Anytime.
This freedom is absolute gold for the rich and for many millennials.
Should You Sell and Rent Instead? (Hold On to Your Horses, Pal.)
We looked at the math for buying-to-stay.
What about buying-to-rent. Let’s go back to the example we just used.
If you buy the 4-bedroom house to rent, you would be collecting RM15,000 in rent. On the outset it looks like a loss making proposition. Your monthly payments to the bank is RM21,000, so you’re short by RM6,100 every month on that count alone.
You also have other costs like vacancy, insurance, taxes, annual repairs, maintenance, and agent fees. Your total outgoings will be about RM12,000.
But, if the house appreciated by 4% every year and the rent increased by 10% every 5 years, at the end of 15 years, you’d net nearly RM2.5 million. The gain is 800% more than if you buy-to-stay!
So don’t sell your house as yet. You can rent it out.
If you’re wondering why the huge difference between buy-to-own and buy-to-rent despite low rental yields, let me explain.
Even though the rental income does not cover your full monthly payments to the bank, it covers the interest. That means, your mortgage is actually interest-free.
And the interest cost is significant. Over 15 years, it amounts to RM2,271,490.
Therefore, buying-to-rent can be profitable. Do the math. If you’re not sure, hold on. Make thorough inquiry into the financials.
Watch your cash flow.
Remember, in the example above, you have to fork out about RM12,000 every year. In addition to that, you also have the cost of the house you live in.
Note that the gains I have demonstrated with renting the house you live in only works if you have strong financial discipline. If you’re not in the habit of saving diligently, you will not gain from the savings in opportunity cost.
In this case, you will be better off buying a house to live in.
Remember the non-financial considerations too. Do you want the freedom of mobility? You can’t easily up and leave if you own the house you stay in. Whereas if you rent, you have more freedom to move locations or upgrade.
If this freedom doesn’t excite you, renting the house you live in may not give much satisfaction.
Forget the Rich and Famous. What Do You Want?
Forget the fact that the fastest growing segment of renters in the U.S are the rich. Forget that many celebrities rent. Forget the investment calculations.
What is it you want?
Do you want the joy, satisfaction, and pride of owning the house you live in? Do you imagine yourself raising children and growing old with your partner in a house of your own? A house that you’ll renovate, and beautify over time in the way that you want?
Do you hate being tethered to any single place? Do you love keeping up with the trendiest neighborhoods? Are you a digital nomad? Are you driven by the highest investment returns?
Knowing your aspirations and what resonates with you is important. Whether you’re affluent or not, you don’t have to parrot the rich. Instead, remain true to yourself.
Need more information? Check out my previous post, To Buy or Rent.