Recently there have been a handful of articles circulating regarding the few major metro markets in the USA where buying is actually more economical than renting. Philadelphia has been named as one of the cities where this is the case, and these articles have been proudly circulated within real estate networks to promote buying a home in the city.
If you're a buyer currently in the market for a home in Philadelphia, these articles may have you scratching your head. Why is everyone promoting the fact that buying is cheaper than renting, when it doesn't feel that way if you're actually in the market to purchase a home right now?
Looking at the city of Philadelphia as a whole, and taking into account a number of factors & benefits of owning real estate, these articles aren't entirely wrong. There are number of factors that can make owning real estate a huge benefit including capital appreciation over time, along with potential tax advantages, the ability to rent a property for consistent income through rental yields, etc. Additionally, it offers a tangible asset that can provide a hedge against inflation, and diversifying an investment portfolio.
With that being said, if we are simply comparing the monthly payment to rent vs. the monthly payment to own a home, or money out of pocket, and get hyper-focused on certain zip codes in Center City and closeby, the plot starts to thicken a bit.
Below, I'll dive deeper into the numbers to give you a true sense of the cost of renting a home vs the cost of purchasing one, in some of Philadelphia's highest activity zip codes in theCenter City and surrounding area:
Out of Pocket Cost - Buying vs Renting:
The first thing to take a look at here is the out of pocket cost to purchase a home vs the out of pocket cost to rent a home.
When renting, typically the landlord will require a total of 3 months rent upfront. Essentially, you pay first months rent, last months rent, and typically a refundable security deposit in the amount of one additional month's rent.
When purchasing, the lowest amount that you can typically put down for your down payment is 3% of the purchase price. Your down payment isn't technically an "expense" because it goes directly into the equity of the home, however, it is still money that is needed upfront in order to purchase the home with a mortgage.
Additionally, in Philadelphia, you will pay 2.14% in transfer tax, and additional roughly 2-3% in closing costs for title & lender fees. Typically we estimate about 5% in closing costs. So in total, you're likely looking at roughly a minimum of 8%.
With this being said, you can sometimes negotiate a "seller assist", in which the seller will help you to cover the closing costs associated with the purchase.
Below, I'll compare the out of pocket to rent a home vs. the out of pocket to purchase a home, assuming that someone puts 3% down, and also receives a 3% seller assist towards their purchase (Bringing closing costs down from 5% to 2%), and the total out of pocket to roughly 5% of the purchase price.
While you'll see that across the board, on average, the up front cost to purchase costs more than the up front cost to rent.
However, if you take into account the fact that your down payment is going towards the equity that you have in the home, the cost to rent and the closing costs that you are paying in this scenario are very similar in most zip codes, assuming you're able to negotiate a 3% assist from the seller towards the purchase of the home.
Of the zip codes that we are analyzing, here are actually 3 zip codes (highlighted green) where you could potentially spend less on your closing costs, that you would on the out of pocket up front expense of renting.
There were also a few other zip codes where the closing costs for a purchase only slightly exceed the money out of pocket for a rental.
Philadelphia as a whole shows that generally the cost to rent is higher than cost to purchase, but when looking strictly at the majority of the zip codes in the Center City and surrounding area, purchasing would still be more expensive than renting in most cases.
Monthly Payment - Buying vs Renting:
When comparing monthly costs, there are a handful of factors to take a look at.
On the rental side it's easy. We will take the median monthly rental payment in each of the neighborhoods being analyzed.
For purchases, we will break down the monthly payment of a potential mortgage based on how much the buyer is putting is down, estimate interest rates, estimated taxes, home owners insurance, as well as how much of your payment is going towards your principle vs interest.
In a monthly mortgage payment, a percentage of the payment goes towards your principle, which build your equity in the home, and the other percentage goes towards your interest payment. As you continue to pay, each month the amount towards your principle increases and amount towards interest decreases. For the sake of this scenario, we are breaking it down by the payment you would have on Month #1 of owning a home.
The following assumptions were made for the chart below:
Down Payment: 3%
Interest Rate: 6.5%
Taxes: Estimated based on Purchase Price x Philadelphia Milage Rate (1.3998%)
Home Owners Insurance: Estimated $1000 per year
Again, across the board aside from 3 zip codes (highlighted green) , the monthly rental payments are about 15%+ less than your monthly costs for a mortgage in most of Center City or nearby surrounding zip codes, even when taking out the amount going towards your principle.
So with this being said, when does it become more economical to purchase than to rent in these areas?
Well, if you're putting up a higher down payment, you can bring down your monthly payment and pay less interest, which can potentially make a home purchase more advantageous. For example, putting 20% shift the balance and brings a handful of zip codes into contention.
The following assumptions were made for the chart below:
Down Payment: 20%
Interest Rate: 6.5%
Taxes: Estimated based on Purchase Price x Philadelphia Milage Rate (1.3998%)
Home Owners Insurance: Estimated $1000 per year
Does this mean it is better to rent than to buy?
The short answer is, it depends.
Right now can be a great time to buy depending on your financial situation, and your long term goals. Generally, over time, purchasing a home can be a great investment, and as formerly mentioned, has a wide range of benefits.
The Philadelphia market when looked at in it's entirety, with every zip code lumped together, gives the illusions that overall, buying a home is more affordable than renting one, however, when you dive into the zip codes in the immediate area surrounding Center City, this isn't necessarily the case.
All in all, the national news headlines are a bit misleading, as purchasing in the majority of zip codes in the Center City and surrounding area still seems to be a bit more expensive than renting.
With this being said, if you have enough saved to put down a higher down payment on a home, while also getting creating to negotiate a lower price, a rate buy-down, or a seller assist, buying can absolutely make sense. Also, if you plan on being in a home long term, buying now and refinancing if/when rates come down can help you lock in a monthly payment that you feel comfortable with, without having the worry of potential rental rate increases down the line.
Right now is a great time to negotiate extremely advantageous terms as buyer in the Philadelphia market, given that as inventory has ticked up a bit (making the market more buyer friendly) and interest rates at a recent high (which has decreased the amount of demand.)
If rates come down a bit, this could also help affordability for prospective buyers looking to purchase a home, and level the playing field even more for renting vs purchasing, however, if rates do come down, you can expect an uptick in demand which could counterbalance the rate decreases with rising prices.
Regardless, there are absolutely great opportunities out there right now for opportunistic buyers who have the means to purchase, and the fortitude to stick it out through some of the turbulence in the market as as it rebalances and reaches a new equilibrium.
Working with a great real estate agent who knows the ins and outs of these zip codes, as well as how to structure an advantageous deal to create the best financial situation is extremely important.
As always, feel free to reach out if you need help navigating the current market in Philadelphia.
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