The Hidden Cost of Renting

I often hear people (especially real estate agents) say, "As a homeowner, you get the benefit of price appreciation." Technically, that statement is true but it needs some interpretation. For starters, how do you benefit from price appreciation if you never sell your house? If you live to 100 and die in the house that you bought 50 years ago, does that mean that you lost the homeownership gamble?

Not by a longshot. As a homeowner, the bulk of your housing cost (namely, interest on your loan) is fixed for life. As a renter, on the other hand, you can expect steady rent increases for the rest of your days. (Yes, I know San Francisco has rent control, but what if you decide to move?)

The chart below compares median rent to median household income for the Bay Area. There is obviously a strong correlation between the two data series. That's to be expected in a densely populated region like the Bay Area. As incomes rise, people naturally demand more housing. Zoning restrictions limit the supply of new construction, however, so higher demand leads directly to higher rents.

Over the 38-year period represented in the chart, rents and incomes both increased by more than 600%. In contrast, if you had been a homeowner for that same 38-year period, your only cost increases would have been associated with marginal items such as insurance and property tax. Those are not insignificant items, but they'll start to look that way after 20 or 30 years of 5% rent increases.

Now to be honest, rents probably won't increase at a 5% annual rate in the future. The Federal Reserve is unlikely to repeat the mistakes of the 1970's, so inflation is likely to be lower than it was in the past. Let's assume it will be 2.5%. If that were the end of the story, we would conclude that rents are likely to increase by 2.5% per year. However, median incomes in the Bay Area have generally grown faster than inflation, by about 1% per year. (That makes sense. Improvements in technology lead to higher productivity, which leads to higher income even after accounting for price inflation.) All told then, rents are likely to increase by 3%-4% per year. Over a 20-year period, that translates to a cumulative increase of somewhere between 80% and 120%. Over 30 years, the cumulative increase will be between 140% and 320%.

That's the hidden cost of renting. It's also the true benefit of owning, at least in a financial sense. While owners get to lock in the bulk of their housing costs when they close escrow, renters can look forward to a lifetime of rent increases. When projected out over 20 or 30 years, the impact of those rent increases will be measured in multiples, not percentages.