Rent Versus Own Term Paper

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Rent vs. Own

Housing serves as a shelter for all the people and their family, satisfying their main physical need and holding the equipment people need for their daily routines. Although the necessity of having a housing unit is clear, owning a house has become fashionable and is looked upon nowadays as a long-run investment decision which provides stable and rather good return. In this scope, the tenure choice, or the decision whether to own a house or to rent, is a personal choice, which depends on personal financial situation as well as socio-cultural factors as the desire for independence and security connected with owning a house rather than renting.

This issue has raised many discussions among scholars on the factors that influence the tenure decision and whether the decision is rational. Especially such works have become important after several amazing rises in the house prices, which were then followed, but not less amazing falls. In this research I shall try to concentrate on the purchasing a house as an investment decision and try to recapitulate the underlying fundamentals affecting tenure choice in preference for renting or owning.

If to consider housing as an investment, it is necessary to single out the qualities of the investment asset, which any investor will evaluate when making the investment decision. These qualities are the 'divisibility of holdings, security of real capital value and income, volatility of returns, liquidity of capital, the cost of purchase and sale and capital appreciation prospects'

. Thus, the main financial characteristics of an investment are whether the income and capital values are fixed or whether they are variable, and if they are variable, to what is the variation linked.

Applying these investment characteristics to property, the real estate investment will have the following features. First, heterogeneity implies that in contrast with other financial assets, such as stocks and bonds, which are the same for particular company and particular issue, all the housing units are unique and differ in size, location, age, construction, maintenance, tenant, surroundings and other features. The fixed location of the property adds another important factor for consideration, as sometimes it will be the determining underlying feature for the value of the property as an investment. The location of the property together with the surroundings is the central players in appraising the property value as they can change it dramatically. As the property is immobile, the change for demand in one location due to varying urban region development trends may lead to the fall or a big rise in the price (value) of the specific residential, commercial, retail of warehouse property.

The size of the property will imply a specific use for it which can be the highest and best use and the demand for this particular use in a certain point of time will also lead to add or decrease the value of this piece of property. For some real estate market segments, age would be a big plus, but for office space, for example, taking into consideration the ever changing technological conditions and preferences for commercial space interior, the age of the building would decrease its' value if the building is old. As Wheaton argues in his famous article

"The Persistence of Real Estate Cycles', it is exactly the fact of the big readjusting costs of the commercial space for new tenants or due to changing demand, that leads to the vacancy rates and then to the cycles within property markets. As the fashion is a very capricious, and the technology boom leads to completely new requirements and fashion standards, the construction is vitally important as the demand for this very building may depend exactly on it.

Sometimes development companies create specific development projects for target groups because some households 'are willing to pay more than is justified by a rational analysis of the future income stream' for a unit which a better location or a very favorable design

. As these psychological features are very important for buyers, the tenants would be also willing to pay higher rents for such a unit which gives companies incentives to create such 'niched projects' for target groups of households (firms) with specific preferences. Several cases have been present in the history when the development companies suffered enormous losses, as their development projects were a complete failure due to badly predicted for the specific target group construction preferences.

Ownership of a bond or a stock are rather passive investments and require little management, while property needs to be managed and maintained very well to generate profits for the holder. Especially for commercial, retail and warehouse space, maintenance costs, rent collections, rent reviews and lease negotiations are very important as rents serve as the source of profits and must be set carefully.

Another very important fundamental is the housing unit value, which implies that very big cash outlays together with borrowing are connected to investing in real estate. One can buy a set of shares or bonds for $100, but from 300 and even more times finances are required to become the holder of a real estate asset. This increases the significance of thorough evaluation of the gains and benefits from purchasing this asset. This is also the explanation why only big investment funds hold properties in their portfolios and why the transaction times on the property markets are much longer than on any other asset markets. The seller of the property, if not a broker, is involved in marketing and then selling his property only several times in life which brings difficulties for him when trying to sell the property. The same can be said about the purchaser, for whom the buying decision also needs much time for careful investigation and consideration. Furthermore, for stocks and bonds a regularly functioning market exists and all the transaction prices and trends are easy to follow and trace, while for the property there is no such a market. The information on the transactions in the markets is rather limited and also cannot serve as the benchmark for setting a price for another property due to its' heterogeneity. All these factors make it rather difficult for ordinary households to trace the property market movements and realize what their residential property is actually worth. Property valuations and forecasts are usually done by the realtors or consultancy firms, but they are likely to be biased by their wish to increase their profits and each valuation technique has its' pitfalls. This also arises from the fact that property is an illiquid asset and trading and capital gain tax limit liquidity even more.

An important consequence of high value is that borrowing becomes the only possible way to purchase housing for households and the credit constraints can limit the desirable property size or can postpone the purchase decision at all. Family must carefully estimate the future income in order to take a loan to purchase a property, but with very volatile economic situation in the U.S.A. this decision may be very hard to give careful estimation correctly.

The financial return from housing, just like from the majority of other financial assets, takes the form of income or the capital gains or losses. The income for a landlord will be the rents received from tenants, and the income from property for home-owners are the cash outlays that the owner would have paid in renting if not having owned this unit. The capital growth is the change of the housing value due to the inflationary gains or losses or due to the increased/decreased demand for this very property, which will lead to the increase/decrease in the transaction price, which could have been received for it in the market. But, real estate is a long-term holding asset and the 'value gains' are rather 'virtual' due to the fact that the family will not be likely to sell the property as soon as the price goes up just because the price for an alternative substitute property where family will live after the deal will be likely also to go up, releasing the assumption that the property that the family owns is unique.

On the negative side of owning a property is the depreciation 'as a result of wear and tear and the effects of elements' which results in the 'decline of the income earning capacity of an investment over time when compared to an identical new investment'.

Due to the importance of home ownership to the households, property is one segment where government interventions such as planning and environmental control, building regulations, rent controls on housing, subsidized industrial and housing rents, development incentives and restrictions on ownership are very frequent.

Even though so many pitfalls when investing in real estate exist, still, according to MARS study in 2003, nearly 71% of American adults own their homes as opposed to renting or other arrangements

. Among married couples, 85% own a home and for households with as low income as below $20,000 still 50% own a house, while for households…[continue]

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