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Understanding the hidden cost of rent

Understanding the hidden cost of renting

There is a deeply hidden cost in renting. This cost will affect you for years to come and understanding this misunderstood concept can tremendously help your life’s financial story.

Whether you are a millennial and renting, or whoever and renting, you could save hundreds of thousands unknowingly by understanding your view of rent vs. what it really is and what renting now is doing to your future.

Up until this day a period of your time after school spent renting has almost always been an expectation in our society but a prolonged period such as those experienced when living in or near big cities, comes with it an unexpected setback.

Some who are living in areas that have more affordable homes in the form of cheaper property costs are able to move to ownership sooner than others, thus can get away with only renting for a short period of their lives.

Whereas others, who live in more urban areas around bigger cities put up with higher property costs, thus far longer rent periods.    

Albeit both have their advantages and disadvantages, many living in the city enjoy higher wages, better job opportunities, city culture and being close to the action. Whereas rural suburban areas do have more affordable housing, but job opportunities and job availability are nowhere near comparable and long commutes into the city are clear disadvantages.

For the rest of us this expectation of rent takes a giant toll on our finances and could very much offset the increased salary rates found in major cities.    

More importantly however the act of renting in or near the city could leave a financial impact on us that could easily last for 10+ years.  

Calculating the cost of renting

Take for instance:

Rural Setting

You rent for 4 years, before being able to afford your own home and at that point on enter a period of investing. In those 4 years, you spend a total of $72,000  ($1500/monthly x 12 months x 4 years)

City Setting

You rent for 10 years, before being able to afford your own home and at that point on enter a period of investing. In those 4 years, you spend a total of $216,000  ($1800/monthly x 12 months x 10 years)

A difference of $144,000 (216,000 – 72,000). These numbers can be arbitrary but you will end up with a large difference in the end regardless.

That $144,000 is indeed life changing money, it may not seem like it but with $144,000 you can invest that, make a savvy career move, buy a second property and let it appreciate over the years to yield a 6 figure profit, plus get your $144,000 back. It’s not uncommon to obtain a $150,000-$200,000 return on a secondary income property holding long. Follow? If you don’t go back a sec–you’re here after all!

The cost of lost investments

Whatever amount it is, it could get you ahead or really, hold you behind. Think of the cost of rent and where you are financially now, what you may not understand is investments are actually a multiplier of your financial wealth. A multiplier of the cash you have throughout your life really. Investing that $144,000 say in a second home or an investment is really money that is working for you on the side.

These are life impacting things to consider, opportunity costs really, renting now will directly or indirectly affect you negatively later. We all get that renting is bad but the impact isn’t realized until you logically look at the greater longer term picture of your life.

In other words the immediate perspective is obvious but the long term is a bit of surprise to many when they begin to see the financial choices that are in your control today, really do heavily influence your quality of life and lifestyle later.

To help you understand the hidden costs of renting now, let’s take you through a quick and simple exercise:

Understand your likely future

To get the full benefit of this exercise let’s look at what you have spent on rent in the past. Note down exactly how many years (and months) you’ve been renting (and if you haven’t been renting for a while this is still relevant).

Working along using a real friend Matt’s numbers, Take the number of years you have been renting and multiply it by the average rent you have been paying, so in his case that’s 5.2 years at $1600  = $99,840 (5 Years * $1650/mo * 12) You follow?

So, so far living near San Francisco but not in the city, Matt has already spent about $100,000 in rent, money that he will never see again.

Now look at your average price per home in your city,

New York (Manhattan) $1.34m

San Francisco $1.2m

San Jose $881,000

Los Angeles (General) $631,000

Vancovuer $1.17m

Conventional mortgages require 20% down as a down payment when purchasing a home, which is the norm. In Matt’s case living near San Francisco a home’s down payment is $240,000.

Now, looking at your savings over the recent past how much have you actually saved in the last 3 years per year? Looking at the most recent years gives us a strong reality check as to how much you actually save per year.

Surprised it’s nowhere near what you make? That’s reality! But don’t fret it’s normal, the average American in 2016 only saved 5.2% of their earnings according to the Bureau of Economic Analysis.

Let’s arbitrarily say (because we can’t account for every type of earner or saving type) that you’re able to save $1500 a month (yes we’re mighty savers and somehow are able to pull that off) that equates to saving $18,000 clean per year, that’s well above average by the way.

Time. Time. Time!

Next, you have to ask yourself how much time will it take to earn your down payment? Calculate it. Go on, do it. Seriously. In our case $240,000 / $18,000 is roughly 13.3 years. The important thing here is note how many years it takes to earn that down payment in other words own your first home.

Why is the number of years important? Because the period in which you are trying to save up for that home, you are also simultaneously spending on rent, every month.

During that time you might want to factor in rent increase, upgrading to a better apartment or choosing to live alone instead of having multiple roommates.

In our case spending 13.3 years just to come up with our $240,000 down payment–we actually spend $263,000 on rent!  ($1650 our rent * 12 months * 13.3 years)

Does that make sense? While trying to save up you spend a ridiculous amount of money on rent, simply because of the number of years it takes to own. Welcome to a giant hidden expense in your life and unlike owning you never see that money again.

The surprise here is realizing the time it takes to own. The second important consideration or surprise is the amount you will spend in your coming future years on rent! This might surprise you and it may be a good question to ask your coworkers and friends. Are they aware?

To consider: Because we don’t necessarily save up to buy a home the very first year we make a salary, we in reality on average only begin saving seriously for a home when we start to think of buying a home in the future.  

Question or two for ya

1) Can you afford this?

2) Would you spend $___,___ (whatever number you calculated) in our San Francisco case
     $263,000 if you knew ahead of time?

So why do it?

How to work around this!

Obviously you can reduce your monthly rent cost, but that’s not the significant element. The significant element is the number of years you are renting for. Rent is money thrown out with the garbage as long as there is an opportunity cost to put it somewhere else i.e owning.

One way to drastically reduce the number of years spent renting, thus the amount of money you will eventually commit to spending on rent, is to maybe follow the advice of property mogul Tim Gurner (famously known for the widely covered advice for millennials to stop spending so much on Avocado Toast) in his 60 minutes interview–purchase a home with a friend.

Tackle the problem head on: What does co-buying a home do?

It obviously beats spending $200,000+ in rent over 10+ years in your future to eventually own a home.

But think for a second, if you co-buy a house your down payment requirement is split in half by at least 50%.      

So now you can half the dollar number required to own i.e half the down payment and immediately halve the rent cycle.  

If you use Home Savvy, Home Savvy has multiple down payment options i.e a 5% down payment option, in our case instead of needing $240,000 you’ll need just $60,000, which many can afford now or soon or with the help of mom and dad/family.

This immediately enables you to save $___,___ (whatever number you are expecting to pay in rent and __ years in renting, in Matt’s real life case that’s 13.3 years and $236,000 in thrown away rent. He could easily save $236,000 a quarter of a million dollars in his lifetime, by co-buying with a friend riding the property appreciation curve, and earning a profit when he goes to sell and buy his next home.

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