How Renting Can Build Long-Term Wealth

Home might be where your heart is, but it isn’t necessarily where your money grows. With interest rates set to increase and salaries in many households stagnant, renting is still the better financial option for many Americans. With American home ownership in a steady decline, according to the U.S. Census Bureau, many households are in the market for the passive asset that is home ownership.

[Related: To Buy or To Rent? That is the Question]

In fact, homeownership is a long-term play and, for most families, true wealth only materializes when they’ve accumulated sufficient equity or when the mortgage is nearly paid off. Renters have an array of alternative strategies for building wealth, but doing so requires an extra dose of self-discipline to save money in the absence of a mortgage that converts an essential cost of living to an asset.

Even so, many Americans view a mortgage as a forced savings plan that converts a basic cost of living into property ownership. If that’s not part of your plan, you’ll want to think about how to integrate similar long-term asset growth into your strategy.

Diversify Your Assets
The more diversified your assets, the more choices you have in the future. Real estate is a traditional mainstay among asset choices. Renters have to know how to get diversification with the same characteristics of real estate. The costs of ownership are so high in so many areas that it does make sense to rent – if you can invest the difference. Yuval D. Bar-Or, assistant professor at the Johns Hopkins Carey Business School, recommends, “Start by validating your decision to rent. Map out both the renting and owning scenarios in order to make a detailed comparison.”

Weigh Property Appreciation
Weigh property appreciation against the costs of property ownership. This includes property taxes, utilities, maintenance, improvements, homeowners insurance, and the reality that you’ll lose approximately 6% of the property’s value when you sell, owing in large part to realty commissions.

Consider Long-Term Gains
There are two ways to capture long-term gains: equities and real estate. Bar-Or recommends two categories of equities that are likely to diversify the typical retirement portfolio and serve as a stand-in for home equity: foreign stocks and domestic small-cap stocks.

Another strategy is to approach real estate ownership purely from an investment standpoint. The two ways to accomplish this are through investment vehicles or direct ownership. Real estate investment trusts (REITs) and real estate-based funds invest in real estate, as opposed to stocks. Typically, REITs hold commercial and large-scale rental properties, although some specialize in portfolios of single-family homes, while others focus on the stocks of publicly traded home builders.

Owning Rental Properties
For some, directly owning rental properties may be a more feasible option. If you can identify a potentially sound business investment – that is, a fair, affordable price; good location; and the ability to build equity with profitable cash flow – then it’s a smart business decision. But beware of the down side. Being a landlord can in itself be costly, time consuming, and stressful. You are at the mercy of your own landlord’s decisions about the rent you pay, while you are, in turn, a landlord at the mercy of your tenants. Consider if it is worth the cost to hire a property management firm to buffer you from the daily headaches.

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