Owning a Home versus Renting

Part 3 of Inflation for Real Estate Investors

This series is an EXPANDED VERSION of the new book I just published called Inflation for Real Estate Investors.

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Owning a Home versus Renting

Prior to this point, the individuals in our example were renting a home to live in. Deciding to purchase a property has a substantial impact on their financial journey.

To fully appreciate the effect of homeownership on their financial independence, it's important to first understand how inflation impacts the different aspects of owning a home versus renting.

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How Inflation Impacts Homeownership Expenses

When you own a home, various expenses are affected by inflation in different ways. Here’s a breakdown of key expenses:

• Principal and Interest on the Mortgage - If you have a fixed-rate mortgage, the principal and interest portion of your monthly payment does not change with inflation. This stability is one of the key advantages of homeownership during inflationary periods. This will also apply to any investment properties we buy with financing as well, but we’ll get to that when we talk about investment properties shortly.

• Private Mortgage Insurance (PMI) - PMI is required by lenders when you put down less than 20% of the purchase price on a property. This insurance protects the lender in case you default on the loan, as a smaller down payment represents a higher risk. PMI payments are usually set by the lender and may not be directly affected by inflation. However, once you build up enough equity—typically reaching at least 20% of the home's value—you can usually eliminate this expense on most loans. A notable exception is with FHA (Federal Housing Administration) loans, where PMI (known as a mortgage insurance premium, or MIP) can only be removed through refinancing or paying off the loan entirely.

• Property Taxes - Property taxes tend to increase over time as local governments reassess property values or raise tax rates. Rising home values, often driven by inflation, lead to higher assessed values, which in turn increase property taxes. In our models, we assume that property tax changes are directly tied to how property values change. So, if property values rise quickly due to inflation, property taxes increase at the same inflation rate, creating a direct link between rising market values and higher tax burdens.

• Homeowner’s Insurance - Insurance premiums tend to increase at inflation rates because they are based on the cost of rebuilding and replacing insured assets, which rise as property values and construction costs go up. Since insurance coverage reflects the value of the property and the cost to repair or rebuild it, we model this in line with property value changes. As property values rise due to inflation, insurance premiums typically increase at the same rate, maintaining consistent coverage relative to the value of the property. On an unrelated note, if insurance companies experience an increase in claims on properties—such as from a rise in the frequency and severity of hurricanes—they may raise insurance premiums faster than inflation. Some markets are currently seeing this trend.

• Maintenance Costs - Maintenance and repairs are subject to inflation, as labor and material costs generally rise over time. For example, replacing a roof or repairing plumbing may become more expensive as prices for materials and services increase. In fact, we model maintenance costs as a percentage of rent. Since rent, which is a major component in measuring inflation, typically increases at the inflation rate, maintenance costs also rise accordingly. This ensures that maintenance expenses remain aligned with broader inflation trends in the market.

• Homeowners Association (HOA) Fees - HOA fees typically cover insurance, maintenance of common areas, and administrative costs to run the HOA, all of which are impacted by inflation. As the costs for maintaining and insuring common areas and managing the HOA rise due to inflation, HOA fees tend to increase accordingly. We model this by assuming that HOA fees rise at the same inflation rate to reflect these increasing costs.

Here’s a quick summary of which homeownership expenses are impacted by inflation and which are not:

Impacted by Inflation:

• Property Taxes - Increase as property values rise with inflation.

• Homeowner’s Insurance - Tied to the value of the property and cost to rebuild, typically increasing with inflation.

• Maintenance Costs - Rise due to increasing labor and material costs, often modeled as a percentage of rent.

• Homeowners Association (HOA) Fees - Increase as the costs of maintaining and insuring common areas rise with inflation.

Not Impacted by Inflation:

• Principal and Interest on Fixed-Rate Mortgages - Remains stable throughout the term of the loan.

• Private Mortgage Insurance (PMI) - Generally not tied directly to inflation; set by lenders and can be eliminated once enough equity is built (with some exceptions for FHA loans).

5% Inflation for Homeowner vs Renter

To illustrate how inflation affects homeowners compared to renters, let's break down the expenses over the course of a year and compare a scenario with 5% inflation.

We'll use $10,000 as the total annual cost for homeownership expenses (PITI - Principal, Interest, Taxes, Insurance, HOA fees, PMI, and Maintenance) and $10,000 for annual rent. This will make it easier to see the impact of inflation.

Example for Homeownership

Assume a total annual expense breakdown for a homeowner as follows:

• Principal and Interest - $6,000 (fixed, not impacted by inflation)

• Private Mortgage Insurance (PMI) - $500 (fixed, not impacted by inflation)

• Property Taxes - $1,000 (subject to inflation)

• Homeowner's Insurance - $1,000 (subject to inflation)

• HOA Fees - $500 (subject to inflation)

• Maintenance - $1,000 (subject to inflation)

For a total of $10,000 for the year before a year of 5% inflation.

With a 5% inflation rate:

• Principal and Interest - $6,000 (does not change with inflation)

• PMI - $500 (does not change with inflation)

• Property Taxes - Increase by 5%: +$50 (totaling $1,050)

• Homeowner's Insurance - Increase by 5%: +$50 (totaling $1,050)

• HOA Fees - Increase by 5%: +$25 (totaling $525)

• Maintenance - Increase by 5%: +$50 (totaling $1,050)

For a total new cost of $6,000 (principal and interest) + $500 (PMI) + $1,050 (property taxes) + $1,050 (homeowner's insurance) + $525 (HOA fees) + $1,050 (maintenance) = $10,175 per year

The overall increase in total housing cost is $175 due to inflation-affected components, representing a 1.75% increase for the year. This example shows how fixed costs such as principal, interest, and PMI create stability, while inflation-driven increases affect other expenses, leading to a slower rise in total costs compared to renting.

Example for Renting

Assume a total annual rent of $10,000 before a year of 5% inflation.

With a 5% inflation rate:

• Total Rent - $10,000 (original cost)

• Rent Increase - 5% of $10,000 is +$500 (totaling $10,500)

For a total new cost of $10,500 per year.

The overall increase in total housing cost is $500, representing a 5% increase for the year.

Unlike homeownership, where some costs remain stable (principal, interest and PMI), renting is fully subject to inflation-driven increases.

This results in a larger proportional rise in total housing costs compared to homeowners.

This represents just a single year's impact. Now, imagine the compounding effect over 30 years.

Mortgage Payments and Inflation

In summary, inflation offers a unique benefit for homeowners with fixed-rate mortgages. As inflation increases the cost of goods, services, and wages, your mortgage payment remains unchanged. When adjusted for inflation, this means that in "real" terms, your mortgage payment becomes more affordable over time. High inflation further amplifies this effect, making your mortgage payments feel smaller relative to your growing income and the rising costs around you.

I’ll illustrate this concept with charts in our modeling, but you heard it here first.

Paying Off Debt with Inflated Dollars

Inflation gradually erodes the value of money, which can work in favor of homeowners with debt. With fixed mortgage payments remaining constant while wages and prices rise, you are effectively paying down your debt with "cheaper" dollars.

I’ll provide charts of this effect when we dive into the models.

Financial Independence and Homeownership

Once your mortgage is fully paid off, the amount of income you need to achieve financial independence decreases significantly. This is because your largest housing expense—the mortgage payment—is eliminated.

For example, imagine you need $9,000 per month to cover all your expenses, with $2,000 of that amount going toward principal and interest on your mortgage. While you will still have to cover taxes, insurance, maintenance, and HOA fees, you no longer need the $2,000 you previously allocated to your mortgage payment. This means your monthly financial independence target drops to $7,000.

In contrast, renters face rising housing costs indefinitely as rent prices increase with inflation. This makes achieving financial security more challenging for renters and highlights the unique long-term stability that homeownership can provide in building financial resilience against inflation.

Modeling Owner-Occupant versus Renter

I think it’s time I shared with you the model of them buying an owner-occupant property instead of renting.

Here are my assumptions for the property they’re buying as an owner-occupant.

• Using Stock Savings for Purchase - They’re using the money they have saved up in stocks to buy a property to live in. This shifts their assets from stocks to real estate.

• Property Value and Appreciation - The property has an initial value and purchase price of $300,000 and appreciates at a rate of 3% per year, which aligns with the assumed inflation rate.

• Down Payment - They are making a down payment of 5% of the purchase price, totaling $15,000.

• Closing Costs - 1% of the purchase price is allocated for closing costs at the time of purchase, amounting to $3,000.

• No Seller Concessions - There are no concessions from the seller to reduce closing costs or other expenses.

• Mortgage Interest Rate and Term - The mortgage interest rate is 7.25% with a 360-month (30-year) term, which is standard for residential mortgages.

• Private Mortgage Insurance (PMI) - PMI is set at a rate of 0.85% of the initial loan balance. It remains until the loan-to-value ratio drops below 80%, at which point PMI goes away.

• Vacancy Rate - A 3% vacancy rate is assumed for rental income scenarios. Since this is a percentage of rent, and rent increases with inflation, the dollar value of the vacancy also rises with inflation.

• Maintenance Costs - Maintenance costs are assumed to be 10% of monthly income. As a percentage of rent, this cost increases with inflation, leading to a rising dollar amount over time.

• HOA Fees - The property has HOA fees of $500 per year, which increase at a rate of 3% annually, matching inflation. This ensures HOA fees rise in line with broader cost increases.

• Property Taxes - Property taxes are assumed to be 0.65% of the property's value per year. For an initial value of $300,000, this amounts to $1,950 per year. Property taxes change as the property value changes with inflation, leading to annual increases.

• Property Insurance - Property insurance costs are set at 0.4% of the property’s value per year. For a $300,000 property, this equals $1,200 per year initially. As property values rise with inflation, insurance costs increase accordingly.

And even though they are going to be living in this property, these are the assumptions for when we use the same property as a rental in future modeling:

• Potential Rent - If they were to rent out this property, it would generate $2,177.43 per month in rent, with rental income increasing at a rate of 3% per year (matching the assumed inflation rate). While they’re living in the property as owner-occupants, this rental rate provides a benchmark for future scenarios.

• Land Value for Depreciation - For depreciation calculations (if they rent out the property later), 15% of the purchase price is considered the land value. This affects the depreciation calculation used for tax purposes.

I won’t keep you waiting any longer, in a normal 3% inflation environment they achieve financial independence faster by buying an owner-occupant property versus renting. See Figure 11 below.