Buying a home is an admonishment that is drummed into the heads of most people. Buy don’t rent. Renting is throwing money away. At least if you lose everything, you’ll have some place to sleep. At least that’s what people say. But is it rational? Before you decide to invest such a large amount of money, don’t you want to analyse it a bit? You know, the same way you analyse a share purchase that costs a fraction of the cost of a home? Or analyse the merits of a Samsung versus an iPhone?

I think that the main confusion is due to the fact that there are several issues interwoven into this decision. In particular, two cash flows are being net off, thus hiding a valuable insight. To understand this, consider somebody who is renting a house. He pays rent to the owner of the house which results in a cash outflow to the renter and a cash inflow to the owner. When the renter is the owner these two cash flows do not go away, they just cancel each other out. Absurd as this may initially seem, getting to grips with this unintuitive insight is key to making intelligent investment decisions.

Let’s simplify things a little. Assume that you have the ability to tell how much a house will be to rent for the rest of your life and how much an investment equal to the price of the house will pay for the rest of your life. If the former is $200,000 per annum and the latter is $300,000 per annum, wouldn’t it make sense to make the investment and use the proceeds to rent rather than to buy?

This simplifying example is not realistic but introduces the idea of asset — liability matching, in this case to make your income equal (or be greater to) your expenses.

In reality it would usually not be possible to know exactly the income and rent so far into the future. It might be a good idea, therefore, to simply buy and not risk your asset paying less than your rent. This argument might work (it doesn’t) if you were paying all cash for the house. But you are not. You will invariably get a mortgage. And with a mortgage invariably comes mortgage payments, an expense.

The conventional wisdom at this point usually replies, quite smugly, that mortgage payments build equity whilst rent is just money flushed down the toilet. Again, there are various implicit assumptions that confuse the matter. Just check the cash flows.

The home buyer is borrowing cash from a bank to buy an asset (house). The renter isn’t. If the renter also borrowed money to by a risk equivalent asset then all other things being equal, he would receive income from the asset that would be equal to rent. More directly, the renter could simply buy a house and rent it out, whilst he lived in a different that he rented.

The other hidden issue in the above scenario is that a mortgaged house has far more risk than a house you are renting. The risk inverts as the debt is paid off, and you own the home, reducing for the owner and increasing for the renter.

Owning your home has a strong intuitive appeal but you are doing yourself a disservice in assuming that it is in all cases a better decision than lending. Besides, nobody said you have to live in the house you own.