Key insights

• ⚖️ Comparing mortgage payment to rent is flawed
• 💰 Total unrecoverable costs of renting vs. owning need to be compared
• 📊 The 5% rule provides a simple way to assess the decision
• 🏠 Unrecoverable costs for homeowners include property taxes, maintenance costs, and cost of capital
• 📉 The cost of equity capital applies to the down payment and requires digging into some data
• 📈 Estimating expected returns using historical data is essential to understand the economic cost
• 📉 Historical stock returns may not be accurate for estimating future returns due to factors like market crashes and world wars
• 🔍 Use 5% rule to compare rent and buy decision, Adjustments needed for tax rates and portfolio mix

Q&A

• What is the opportunity cost of paying cash for a home?

  Paying cash for a home has an opportunity cost compared to investing in stocks. This cost should be factored in when using the 5% rule for homeownership costs to evaluate the rent versus buy decision.

• How can the 5% rule help with rent versus buy decisions?

  The 5% rule can be used to compare the total unrecoverable costs of renting to owning, providing a simple way to assess the decision. However, adjustments for tax rates and portfolio asset mix may be needed for a more accurate analysis.

• Why is using historical stock returns to estimate future returns considered inaccurate?

  Using historical stock returns may not accurately estimate future returns due to factors like market crashes and world wars. To address this, PWL Capital uses a combination of historical returns and current expected returns to estimate future equity returns.

• How is the cost of equity capital calculated?

  The cost of equity capital is calculated by considering the opportunity cost of investing in stocks instead of making a down payment on real estate. It is an essential component of the 5% rule for homeownership expenses.

• What are the unrecoverable costs for homeowners?

  Unrecoverable costs for homeowners include property taxes (1% of home's value), maintenance costs (1% of property value per year), and the cost of equity capital, which applies to the down payment and requires an analysis of historical returns to understand the economic cost.

• What is the 5% rule for homeowners?

  The 5% rule for homeownership expenses includes property taxes, maintenance costs, mortgage interest, and cost of equity capital. Property taxes are generally 1% of the value of the home. Maintenance costs cover a wide range of expenses and are estimated at 1% of the property value per year on average. The cost of capital includes the cost of debt and the cost of equity, with mortgage interest being around 3%.

• 00:00 The common perception of comparing mortgage payment to rent is flawed. To assess rent versus buy decision, it's important to compare total unrecoverable costs of renting to owning. The 5% rule provides a simple way to think about the decision.
• 01:39 The 5% rule for homeownership expenses includes property taxes, maintenance costs, mortgage interest, and cost of equity capital. Property taxes are usually 1% of the home's value, maintenance costs are estimated at 1% of the property value per year, and mortgage interest is around 3%. Cost of equity capital applies to the down payment.
• 03:20 When making a 20% down payment on real estate, there's an opportunity cost compared to investing in stocks due to the difference in historical returns. Estimating expected returns using historical data is essential to understand the economic cost. Market prices of assets are based on available information, and assuming high recent historical returns will persist is not sensible.
• 05:04 Using historical stock returns as an estimate for future returns may not be accurate. PWL Capital uses a combination of historical returns and current expected returns to estimate future equity returns. The current expected return for a 100% equity portfolio is 6.57%, lower than the historical average. Comparing real estate and stock expected returns yields a 3% difference. The cost of equity capital is 3%, which equals the cost of debt capital, leading to a total of 5% unrecoverable costs for homeowners.
• 06:44 The 5% rule can help with rent versus buy decisions, but it's oversimplified and needs adjustments for tax rates and portfolio asset mix.
• 08:31 Paying cash for a home involves an opportunity cost compared to investing in stocks. The 5% rule for home ownership costs may need adjustments based on investment variables. Considering the estimated unrecoverable costs makes it easier to evaluate the rent versus buy decision.