PCS Time: Rent or Buy?

Warning Order

As the summer months rapidly approach, so does the primary moving season for members of our military.  With any move comes the inevitable debate over renting or buying a home.  While this debate involves both emotional and financial dynamics, I’ll discuss the financial aspects.  Ultimately, the desire to own your home can be powerful and might sway the final decision, but the financial aspects of the decision aren’t so clear.  In fact, due to military moves that happen every three years on average, it usually makes financial sense to rent.  Analysis indicates that the transaction costs associated with buying and selling a property eat away at most potential equity gains in the short timespan absent significant increases in home value.  As a result, owners take on significantly more financial risk in return for paltry expected returns.

Situation

PCS season is nearly upon us.  Even though the military moves service members throughout the year, many of the moves come in the summer months when the weather makes packing, traveling, and unpacking a bit more bearable.  Service members face this reality every three years or so depending on their situation.  I moved six times in my eight years in the Army.  Not all were associated with a PCS, but my household goods were packed up and moved to a new location.

With every PCS comes the inevitable debate over renting a home or buying one.  Often, decisions are made using generalizations, such as “it’s an investment,” “renting is throwing money away,” or “I need the flexibility of a rental.”  To inform this debate, I’ll compare renting versus buying from a financial perspective and highlight some of the variables that might sway a decision one way or another.  Covering three periods in a home, “moving in,” “living in,” and “moving out,” I’ll explain the major tradeoffs of each choice.  One thing to remember, not all rental or purchase options are the same.  Furthermore, limiting options to a home removes possible lower cost alternatives like apartments.

Moving In

When a service member arrives at a new base, they are often on a well-defined timeline to in-process and report to their new unit.  They can take up to ten days of permissive TDY to search for a home, too.  During this time, prospective home buyers will need to find their new home, negotiate for the one they pick, go through the inspection, mortgage approval, closing, and move-in.  It’s unlikely that this process will be complete before finishing in-processing, likely causing the home purchase to interfere with the first few weeks at the new unit.

The process to rent a home is more truncated.  It will still take time to find the right home, but outside of negotiating rent, which may not be necessary, it only takes a few days to complete an application, sign a lease agreement, and take possession on the home.

My comments above certainly aren’t related to the financial decision to buy or rent, but I did want to highlight the difference in the process and timeline.  So what costs go into buying a home?  Because I’m breaking this article down by phase, I’ll highlight the cash costs of the purchase process.  A standard mortgage on a home would include a 20% down payment, closing costs, and the cost of a home inspection.  Additionally, the real estate agent earns a commission, although that is usually paid by the seller (everything is negotiable to a point, though).

On a $200,000 home, 20% is $40,000.  Add in the $2,000 national average for closing costs plus $500 for the property inspection and we are at a cash outlay of $42,500 to buy the home.  The scenario is overly simple, but there are too many variables to capture all possibilities.  Service members also have access to the VA loan, which allows active-duty and veteran home-buyers to purchase homes without a down payment up to a price of $453,100.  Plenty of room to buy most homes surrounding military bases.

So, the VA loan helps reduce or eliminate the down payment but also has some additional costs.  The primary added cost is the VA Funding Fee, which is an upfront version of mortgage insurance.  It costs 2.15% for active-duty service members for their first use of the VA loan. On the $200,000 house, that cost is $4,300.  With the VA loan, the cash outlay to purchase the home is reduced to about $6,800, not bad.

A rental, on the other hand, is simpler.  In a standard case, moving into a rental property requires payment for the application, which could range from about $50-100, plus the deposit and first month’s rent.  The standard deposit seems to be equal to first month’s rent, but that can vary, especially with pets.  If rent is $1,400 per month for a home worth about $200,000, the cost to move in will total around $2,900.  That amounts to less than half the cost to purchase a home with no down payment.

In short, the cash required to buy a $200,000 home using a VA loan is $6,800 while renting a similar home would require $2,900 to start.

Living In

Now that the hypothetical service member has moved into a home at the new duty station, I’ll delve into costs on a month to month basis.  For the homeowner, costs will consist of the mortgage payment and maintenance costs.  Keep in mind; the mortgage payment includes payments toward principle, interest, property taxes, and homeowner’s insurance.

I calculated a 30-year mortgage payment for a $200,000 loan (0% down payment, VA loan) at 4.5% interest with $1,000 for property taxes and $1,500 for homeowner’s insurance each year.  The payment comes to $1,221.70 per month.  The rule of thumb for home maintenance costs is 1% of the property value per year or $2,000 in this case.  Monthly, the total comes to $1,388.36, very similar to the rental cost, assuming no abnormal maintenance or repairs.

One of the generalizations that people like to use when buying a home is that they are at least gaining equity in the home through principle payments.  One thing to consider is that the first few years of ownership, especially without a down payment, result in most of the monthly payments going toward interest.  On the first month, only $263 of $1,388 would go toward the $200,000 of principle.  In fact, over the three-year average length of ownership, home buyers would pay $10,129 toward principle, about 5% of the total loan.

At this point in the scenario, home buyers are doing slightly better.  Monthly costs are slightly lower than rent plus a small monthly renter’s insurance premium while also building equity ownership in the home.  In the final phase, though, transaction costs to leave the home may tip the balance.  Note: the analysis assumes other costs, like utilities, are equal in both situations and are therefore excluded here.

Moving Out

At some point, it’s time to move out.  While the average time at one duty station is about three years, actual time can vary wildly for individual service members.  When I deployed to Afghanistan in 2013, I moved out of my house after two years of living there. In total, I was at Fort Riley for a little over three years.  And my time at Fort Hood was just over two years.

Moving out of a rental is relatively straightforward, especially for military service members.  PCS or deployment orders are sufficient enough to break a lease agreement with 30 day notice.  If the renters don’t damage the property, they receive their deposit upon vacating the property.  Rental managers often require home and carpet cleaning prior to allowing renters to turn over the keys.  The cleaning might cost $500 in total depending on size.  Subtract $500 from the deposit refund and the renter is plus $900 when moving out.

Selling a home is more difficult and entails some risk.  Perhaps home prices are depressed when it goes on the market, forcing owners to sell below the purchase price.  Or perhaps the opposite is true!  Other factors around a military post directly affect home prices.  Factors include an expanding or contracting military strength, new home building around the base, BAH policy changes, etc.  Nationally, home prices tend to increase at the rate of inflation absent location-specific factors.

For this case, we will assume that the value of the home increased at recent inflation rates of 2% per year.  Its value after three years would be $212,241.  Selling a home doesn’t include the costs associated with applying for a mortgage, but it does entail paying the real estate agent commission that owners avoid at purchase.  Also, they have to prep the home for sale.  For the sake of equality, I’ll assume that it costs $500 to clean the home and no repairs are needed nor is the home staged for sale.

Adding the 6% real estate agent commission to $500 in cleaning costs comes out to $13,234.  Subtracted from the sale price, the homeowner receives $198,971 and then pays the lender the remaining balance of $189,869.  After all is said and done, the homeowner walks away with just over $9,000 from three years of ownership.  Pretty good, compared to $900, right?

Tallying It All Up

After comparing the three phases of home ownership and renting, it’s clear that it’s less expensive and simpler to move into a rental, it’s a wash between the options during the period of living in the home, and home ownership comes out as the clear winner when moving out.  Over the full life-cycle, owning a home results in a cash outlay of $6,800 to purchase and $9,000 income upon sale for a net profit of $2,200.  Renting, on the other hand, requires $2,900 to move in and receives $900 on the move out for a net loss of $2,000.  Note: these profit and loss statements view monthly costs as irrelevant to profit/loss due to their similarity and the assumptions for the scenario.

Risk

This highly standardized scenario indicates that it would be beneficial over a three-year period to buy a home instead of rent one.  However, it’s difficult to compare the options without looking at the relative risks involved.  In renting, the service member bears little risk.   Maybe rent increases slightly each year or the landlord keeps part of the deposit due to damage beyond normal wear and tear.

Those risks pale in comparison to the risks of homeownership.  In this scenario, what if the home sold for the original purchase price?  Or less?  All of a sudden, the transaction costs eat up the equity and make ownership worse than renting!  Imagine, instead of having cash left over after the sale, having to pay out cash to the lender.  Another scenario is making several unexpected minor or major repairs to the property during ownership.  Perhaps the fence needs replacement.  Or the roof develops a leak.  Or a storm damages the home, necessitating payment of the insurance deductible.  Any one of these factors results in poor financial prospects for short-term home ownership.  Sure, price increases can make ownership profitable, but it’s unlikely that someone could repeat that success every three years, especially around many military bases.

Another major risk to military home ownership is the time it takes to sell a home.  In the previous scenario, the home sold immediately.  It’s more likely, however, that the time between moving to the next duty station and closing the sale on the home could take in excess of 30 days.  Maybe 60 or more!  During that period, the service member has payments toward two homes.  Even worse, he or she couldn’t use equity from the old home to quickly purchase a home at the new station.

Rent, Don’t Buy

Short-term home ownership is like short-term stock ownership.  Returns can be highly volatile and transaction costs are always a drain.  The key to building wealth through home ownership and stock ownership holding for the long-term.  Owners are rewarded for the extra risk over time and through minimizing transaction costs.  The reality is that financially justifying a home purchase requires the intent to live in that home for at least five years, perhaps longer.

As I mentioned in the beginning, I’m ignoring the emotional factor in my analysis.  Some satisfaction comes from owning a home, I can’t deny that, and if the personal or emotional need dictates buying a home, go ahead.  But it’s vital to avoid reinforcing emotion-based decisions with incorrect financial generalizations associated with home ownership.

Assumptions

Critics of my analysis could point to many assumptions that I made to suggest that the review is poor.  Many, many variables exist in this discussion and I would start going in circles trying to account the hundreds or thousands of slight changes to assumptions.  For example, home maintenance expenses might be less in a newer home, making monthly costs much cheaper for an owner.  However, that fact might also increase the purchase price.  Another example is that real estate commissions might be lower.  Sure!  But they still eat away at the benefits of short-term ownership.  Home prices could be increasing in the area under consideration.  But will they be higher three years from purchase?  That’s a guess at best.  In the end, no matter how we massage variables, the potential positive financial outcomes of short-term home ownership are far outweighed by the risks involved.

 

 

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