At Life Sherpa, the question people most often ask is whether they should rent or buy their home. And it’s one of the most difficult to answer definitively. It’s the ultimate ‘it depends’ question! When people ask this question they are usually thinking of this as an investment decision. And when it comes to our own home this is usually the wrong way of looking at it. It is better looked at as a risk management decision.
Let me explain.
The golden rule is to buy property, not too much, only when the time is right for you.
We all need somewhere to live. By this I mean a safe, secure roof over our heads that meets our needs and those of our families. This is a lifelong commitment that never goes away.
We can choose to buy this on the short-term market by renting. This way we pay the market rate from time to time. I call this the variable option. Or we can choose to fix the price we pay by buying a property.
The Cash Cost of renting is usually lower
In Australia, the cash cost of renting, at least in the short term, has almost always been lower than the ongoing cost of buying.
There are three main drivers of this:
- There are significant transaction costs in buying and selling real estate. The main cost is stamp duty, which for example, would be $18,000 for a $500,000 property in NSW. This is the equivalent of nine months’ rent.
- The rental cost is usually less than the cost of borrowing the money required to buy the property, or the income that is forgone because this money could not be invested elsewhere. The rental yield (annual rent divided by the market value of the property) in Australian capital cities has historically been around 5%, (or roughly $1 per week for each $1,000 the property is worth). Right now this can be as low as 3% in parts of Sydney. This means that a $500,000 property will usually rent for $300/week or less. The standard variable home loan interest rate by way of comparison is around 5% right now – lower than it has been at any other time in the past 50 years.
- Home owners incur a number of expenses that renters don’t. These include rates, maintenance, strata levies, building insurance and the fixed proportion of water charges.
Over time, however, inflation helps push up all of the costs other than the amount the owner has spent to purchase the property, so that at some point the renter’s cash cost starts to exceed the owner’s cash cost.
Over long enough a time period, buying will work out cheaper.
This phenomenon, whereby an initially higher cost to buy is slowly whittled away by inflation, means that given a long enough time period, buying will work out cheaper. How long that period will be is the great unknown. As the famous economist John Maynard Keynes said, ‘In the long run we are all dead.’
In practice, buying delivers certainty and a bunch of intangible benefits. The question for you then should be, ‘is now the right time for me to buy certainty at the expense of flexibility, knowing it will cost me a little more right now?’
There are some circumstances where the fixed option will almost always be more expensive. For example, if you need to move homes in a short period (usually any period less than five years). Here the transaction costs and the increased expenses almost always outweigh the benefits of fixing the costs of housing.
On the other hand, over any long period (usually 10 years or more) over the past 50 years, the fixed option worked out cheaper.
But what about the gain (or loss) in the value of the property?
In some ways this is somewhat academic, because the value of any alternative property is likely to have risen (or fallen) by the same amount, so the increase in wealth can never be realised for so long as you need somewhere to live.
Similarly, any loss can be deferred, so long as you can keep up your mortgage payments and don’t need to move.
The wealth effect, whereby we feel richer because the value of our homes has gone up, can also encourage us to spend more of our incomes. This can secretly whittle away much of the advantage.
Its not a one way bet
RPdata, a property researcher, tracks these things its ‘Pain and Gain Report’ series. The latest report shows that one in five resales are at a loss or a gain of less than 10%. These owners would have been financially better off renting. On the other hand four out of every five resales yielded a gain of 10% or more. The average hold period for those selling for a gain was eight to 13 years.
Oh, and don’t forget we could have invested the difference in cash cost between renting and buying, which could be worth more or less than the increase in the value of the property.
There are other benefits
Nevertheless, home ownership creates discipline around saving, it provides a store of wealth that can be accessed, is favourably treated by our tax and welfare systems, and improves your credit rating, which can lead to lower borrowing costs in future.
Either way, the homeowner gets the benefit of fixed housing costs and all of the psychological benefits of home ownership. These should not be underestimated. Ultimately this is a very personal decision. In my view, the key is buying the right amount of house with a cost that allows you to sit tight through thick and thin (see the 50/30/20 rule for budgeting). Oh and don’t move for a long time!
Don't forget the third way
There is a third way that shouldn’t be forgotten; an option that is becoming popular among young Australians. That is to rent where you live and buy an investment property elsewhere. This gives you the best of both worlds—you can afford to live where you want and you get to hedge your future housing costs. Not only that, but the Australian tax system provides a significant boost to your finances.
Founder and Chief Sherpa
With over 25 years in Financial Services from consulting to management, Vince Scully is the go-to guy for wealth management and financial advice. Vince founded the Calliva Group; a fund manager, product issuer, advisor and lender to Government and private clients. Vince is an advisor to the Wealth Management Industry, and prior to his role as CEO at Calliva, a senior member of Macquarie bank’s infrastructure team.