For the past few years, I’ve been terrified of the property market. Looking at what has happened in various places around the world, it is clear that property has not been a good investment for a lot of people.
Rent or Buy?
Living in Sydney, Australia, I get to see and hear reports about how the houses here are among the most unaffordable in the world, and there is a huge bubble ready to explode in Australian property.
This may or may not be true. Who knows? The fact remains that people need somewhere to live regardless of what is happening in the economy. The only real ways to meet this basic need are to rent a home or buy a home.
When I speak to people about this, they’re always in the pro-buy camp and spout off the same old lines:
- Property always goes up!
- Property prices double every 7 years!
- Property is a surefire way to becoming mega-wealthy!
And various other ill-researched cult-like statements, to which I rebut:
- No it doesn’t!
- Here’s a graph to show that isn’t true!
- Almost none of the world’s wealthiest people became wealthy via property!
So if buying a house is such a bad investment, renting should be the better option, right?
Well, not so fast!
Kris Sayce at Money Morning (a free newsletter I subscribe to) said the following which really made me think:
“In short, housing is still a bad investment. If you want to buy a house to live in, or a holiday home, go for it. But in both cases don’t assume you’ll make a profit. Housing is going back to what it has been for most of history, and that is an expensive consumption item.“
- Money Morning: Kris Sayce Uncensored
Kris is arguably the biggest property bear in Australia. He regularly writes about how poor property is as an investment. But here, even he is advocating buying a property.
Then the penny dropped.
If you look at what he’s saying, he isn’t saying “Don’t buy property”, he’s saying “Don’t buy property as an investment.” He’s saying buy it purely as a consumption item. A place to live, not a way to make money.
“Don’t assume you’ll make a profit.” Why would you? I don’t assume I’ll make a profit on my power or grocery bills, so why would I assume I’d make a profit on my housing bill?
See, that’s the way to think about it. Separate the home from the house. Think about buying a property as a place to live as purely the cost of paying for your accomodation. A living expense.
Culturally we have been trained to think that your home is an investment.
The fact you might be able to get an increase in property price over time should be a nice side benefit rather than the primary goal.
A good way to increase your wealth is to reduce your living expenses. If you can do this with housing, so much the better. I decided to prove to myself once and for all, which was the better (or cheaper) path to tread.
What’s So Hard, Isn’t It Obvious?
Before you start calling me an idiot, the situation in Australia makes this a little cloudy. You see, over 75% of Australian rental properties are what’s called negatively geared.
Let me explain.
This means that the owners of these properties are making a regular loss on their investments, which they can offset against their tax. It’s all very convoluted and I personally think its a terrible investment strategy. I’ll talk about why in another post.
The basic idea is, let’s say my rent is $600 per week. You would normally assume that the landlord gets most of that which covers his loan payment and leaves him a little profit. But with negative gearing, his loan payment might be $800 per week - he makes a $200 per week loss!
Another way to look at it is: if you rent, you can live in a $800 per week house for only $600. The landlord is subsidising your rent. Smart people can save this difference and invest it.
So its possible that you’re better off renting since its a lower outgoing per week, right?
I love to geek out in Excel on things like this. I designed a spreadsheet that assesses the different scenarios:
- Buying and living in the house you own
Scenario 1: Renting
This is simple to work out. You pay rent and that’s all you pay for your housing. Easy. Figure out what a reasonable increase is per year and you can use that as the yearly increases. My last rental increase was 3.7%, so I’ve assumed that to project forward for 30 more years so it can be compared to Scenario 2.
If there’s a difference in what your mortgage payment might be and the rent you pay (like it would be in Australia), you can pocket that difference.
In the spreadsheet, I pretend like that’s the equity in your home you’re building up. But since you don’t own a house in this scenario, I’m calling it Pseudo-Equity.
Here’s an example with the following details:
- a Rent of $600 per week, with a yearly increase of 3.7% per year;
- a Bond deposited of $2,400.00 that is returned without any earnings on it;
- a 9% return on your pseudo-equity (which starts with the same amount of deposit from Scenario 2) that you’ve been saving and investing on the side (the difference between the rent and what the loan payment is in the next section); and
- a 30% tax deduction on any earnings you make on the pseudo-equity
After 30 years you’ll end up with a net position of -1,992,457.41
That’s made up from:
- -1,664,687.63 of lost money spent on pure rent.
- -330,169.78 loss of pseudo-equity.
- Return of your 2,400.00 bond.
That’s right, you’ll be down over $1.9 million dollars by just renting! The loss in pseudo-equity is because the rent increases every year, where your mortgage payment would stay relatively the same amount. So in only a few years, the difference you save is gone and you’re actually topping it up!
Spread across 30 years, that an average cost per week of 1,277.22. So much for $600 and that’s all you pay!
How does that compare to buying a house to live in?
Scenario 2: Buying
Using a similar property to Scenario 1, let’s say you decide to buy the place which might be around $570,000 with a 5% deposit.
Let’s factor in the following:
- an interest rate of 5.79% (just checked and that’s the rate from ANZ Bank);
- all the buying costs like stamp duty and legal fees which are added to the loan;
- the holding costs like paying the council and strata fees, and water;
You’re looking to amortise a loan of $567,640 over 30 years.
Now, to be ultra-conservative, I’m going to assume that the house price does not go up at all over those 30 years!
Even so, at the end of it, you’ll end up with a net position of -1,011,360.44.
That’s right, by buying the place, you’ll end up over $800,000 better off!
The reasons for this are:
- The mortgage payment stays pretty much the same throughout the 30 years – it won’t rise with inflation.
- The amount of interest goes down over those 30 years as you repay the principal amount.
Now, remember that we’re not thinking about this as an investment. Losing a million dollars is a terrible investment.
The way to look at it is, you have reduced your costs of living substantially. Over the 30 years, you’ve gone from an average weekly cost of accomodation of $1,277.22 while renting, to $648.30 by buying. That’s a great saving!
Here’s a visual representation of the yearly rental increases vs the mortgage payment which stays pretty much the same year upon year:
Renting vs Buying
So Should You Rent or Buy?
If you do the numbers and make sure you’re keeping the properties the same, then I can’t see why buying isn’t the way to go. And in saying that, do your own research and no you can’t blame me for anything that goes wrong.
Renting has come out as the worst way to provide yourself with a home. The scenario doesn’t even cover the fact that once the mortgage has been paid off, you get to live in the house for (almost) free!
This has clearly shown that if you can get a house to live in and keep enough income to pay for it so it won’t be repossessed, you can drastically reduce your living expenses over the long term.
The best part of this is that even if you gave the house away at the end or if it was worth zero (I tested the spreadsheet with a 20% house price drop every year for 30 years!) you are still better off buying than renting.
This really makes a lot of sense to me. Leave a comment if you’d like more information or a follow up post!
Go on then, get saving for that deposit!