The Big Question: Renting Versus Buying A Home
Over the two decades to December 2012 Australian residential property earned an average of 9.5% per annum. Most clients who owned properties did well, and those who own properties in the next two decades will probably do well too.
But not everyone agrees.
Phil Ruthven is a well-known economics and social commentator. He argues owning a home as an investment is irrational (His article on Domain.com.au 'Rent your way to real wealth') and unlikely to produce optimum investment results.
He says home ownership is nice emotionally but most will be better off renting a home that suits us now, and implementing a disciplined investment strategy based purely on rational grounds.
Mr Ruthven says this is particularly the case once the hidden costs of home ownership are considered, such as hours and dollars spent improving the home, rates and repairs, and stamp duty, legal fees and other transaction costs when we move every seven years.
There is something in what Mr Ruthven says. This is particularly the case if you move more than once every seven years or if your home is not in a well-performing suburb.
Is Housing Overvalued?
In July 2014 the Reserve Bank released a report ('Is Housing Overvalued?') saying that house prices need to go up by more than 2.9% a year for buying to beat renting.
On balance many would not agree with Mr Ruthven. Fundamentally, the great advantage of home ownership is forced savings, and apart from super most people would not save a cent without regular home loan repayments. (Interesting isn’t it?...The forced saving of a home loan and the legislated saving in Super tend to be the only ways most people save).
Yes, there may be other ways of doing things that are more ‘efficient’ in the pure sense of the word...but few people actually do things these other ways.
Over the two decades to December 2012 residential property earned 9.5% per annum. Most clients who owned properties did well, and those who own properties in the next two decades will probably do well too.
And on balance we expect the Reserve Bank’s 2.9% price increase to be easily beaten by the better suburbs in most capital cities: 2.9% is essentially the inflation rate, and well below the historical rates of return actually generated in these markets. If prices simply keep track with inflation, then buying will make more sense than renting over the long-term.
Case Study: Renting and Investing Instead.
There is a theory that renting any given house or unit rather than buying the property costs less than the mortgage payments required to own it.
For example, a typical property 5km from the city centre may:
- Cost $650 pw in rent ($33,800 per annum), or;
- Costs $990 per week in mortgage repayments (or $51,480 per annum an $800,000 mortgage @ 5% on a $1,000,000 property)
- The difference per week is $340 or $17,680 per annum
If you invested the difference, each year, in long term growth investments at a return of 9%, over a 20-30 year period, your investment fund would be worth:
Investment Fund End Value:
- Assumed starting value: $200,000 (which otherwise would have been the house deposit)
- $2,255,613.61 after 20 years (growing at 9%)
- $5,676,836.90 after 30 years (growing at 9%)
- Total spent on rent over 30 years: $1,014,000 (not adjusted upwards for inflation)
- Net after 30 years: $4,280,919
- Tax payable when selling, assuming 25% of gains: $1,070,229
- Net after tax: $3,210,690
- Dividends assumed to have been reinvested.
Buying versus Renting
What about the house?
- Starting value: $1,000,000
- $3,207,135.47 after 20 years (growing at 6%)
- $5,743,491.17 after 30 years (growing at 6%)
- Total spent on home loan repayments: $1,544,980.22 ($800k, with interest at 5%)
- Total paid for asset: $1,170,000 (inc. stamp duty, repairs, and rates).
- Net after 30 years: $3,028,510
- Tax payable on selling: $0.00
What conclusions can I draw from this?
Renting and investing the difference is a very valid option that could produce comparable, or better results to buying a home.
However, for the vast majority of people, home ownership is the fail safe option for long term wealth building. It takes extreme patience and discipline to stick to investing each week for 30 years, and for many people they will not stick to that.
There are just too many temptations of things to spend money on!
But, paying debt back - they will stick to that 'forced savings plan' like glue and make sure they do not miss a beat, each month for 30 years. No wonder many of our relatives that have paid off a home loan feel amazing about that!
Also, rents rise, but mortgage repayments remain relatively constant due to the 30 year pay-off curve.
Another advantage of home ownership is that it is the last great tax shelter for Australians. The principal place of residence is excluded from the CGT (Capital Gains Tax) net by dint of social policy and political survival.
You can buy a home, sell it, then buy another one, and keep doing this as many times as you like - all while never paying capital gains tax (GCT) as long as you have lived in the home as your principal place of residence and that you owned it for at least 365 days.
This is not possible with any other type of asset.
...Want to put a pool in?
Any improvements to the family home are is usually free of capital gains tax. Improvements to the home are also CGT-free, so if a $100,000 improvement creates $150,000 of value, that extra $50,000 is tax-free.
The Australian Master Financial Planning Guide 2015-16 (Walters Kluwers) recognises other advantages of housing. These include:
- Providing security and stability. The alternative to home ownership, renting, may involve the owner selling the property (and the renting family having to move...)
- Avoiding the stigma that some feel if they do not own a home (this is partly why the housing affordability debate is so fiery at times, I'd imagine);
- Providing lifestyle choice even where wealth creation is not the primary objective;
- Paying off the home loan is a form of personal saving; and
- Freedom to make personal changes to the property.
What are some of the disadvantages of home ownership?
Critics say residential property is not a liquid asset. This has become less of a problem in the past 10 years because equity access loans (debt facilities linked to the value of the home) allow clients to ‘cash out’ some of the value of their home, whether for consumption, investment or business purposes.
The Australian Master Financial Planning Guide 2015-16 (Walters Kluwers) recognises other potential disadvantages as including:
Property prices can fall, as well as rise:
Demand for property may be lower in the future due to:
- Low inflation, which reduces the potential for high capital gains;
- Increasing unemployment rates;
- More people deferring the purchase of the first home;
- The high costs of buying and selling property, including legal fees and stamp duty;
- The opportunity cost on missing out on other better performing investments;
- Lack of diversification;
- Property not being suited to investment;
- Miss out on other tax concessions, even though homes are CGT free; and
- Homes are illiquid, i.e. hard to convert to cash.