2023 SF rent vs buy

August 17th, 2023

In your 30s, you hit this moment where you have some income/wealth but have yet to have children. In those brief years, your only meaningful cost is shelter. The choice becomes rent vs buy.

Some caveats. First, this analysis breaks down if you’re buying single family homes or extremely luxurious condos. There just isn’t much of a market for renting. Markets create prices. Second, I have no idea how housing works outside of America. I recognize there’s some emotional value in ownership. But there’s also an emotional value in being able to walk away anytime, fee-free. Third, I’m assuming SF/NYC-style rent control, but without rent control, the stability of buying becomes much more appealing.

Refinancing is only worth it if you’re planning on staying in the home for years. The cost of refinancing is 2-6% of the loan value. Let’s assume 4%. If you’re planning on staying in a home for 10+ years, buying is 100% the right option. If you’re only planning on staying for 5 years (the recommended minimum), betting on refinancing means you’re basically assuming the federal reserve starts rapidly cutting interest rates this year.

Let’s assume an average return of 9% on capital, the S&P 500 average. However, if you have a Bay Area tech income, your marginal tax rate is probably ~45%, so your return on capital is actually ~5%. This is critical, because the mortgage interest on 750k is tax deductible but rent is not tax.

Let’s assume a $4,300/month rent for a “luxury” 1 bedroom 1 bath with parking. An equivalent condo recently sold for 1m. Assuming 750k mortgage at today’s 7% interest (but assuming that deductible chops you out of the 45% bracket), plus 1.18% property tax (~1k/month).

Everything comes down to appreciation. Let’s assume you plan on selling the condo after 7 years, so we spread out the gains and the transaction costs (6%) over that time. Also, you assume that your real estate gains never exceed 500k (if you live there two years), so you don’t pay taxes on those gains.

You roughly breakeven if condos start appreciating at the rate of inflation. For the last 7 years, condos are largely stagnant. Prices in 2016 were probably ahead of their skis and owners have suffered since then. If you average them out since 2005, it comes out to about 3% a year. Still, that 3% growth includes SF’s greatest decade as the tech capital of the world. Doom loop or not, it’s very uncertain that the next 5-7 years will see greater than 2% appreciation.

Addendum: I would very much love to see a net appreciation analysis for real estate, in particular accounting for the cost of renovations and new construction.

Renovation costs can be estimated by building permits and tax assessments, slightly discounted. If a renovation improves the value of a house by 500k, you can estimate it costs at least 250k (though I would not be surprised if the true number is 500k for non-builder renovations), or else the demand for renovations would increase until the price went up to absorb the excess.

Permits to tear down and rebuild should be obvious and new construction can be ignored entirely because most homeowners will never build their own homes, nor is it generally advisable to do so. It’s a bit like ignoring venture capital when it comes to investment gains: you’re not going.

Discounting all these costs (including taxes, HOA fees, insurance, routine maintenance), I’m curious what the actual appreciation of real estate as a publicly available asset is.