Wednesday, November 17, 2010

Rent vs Buy: An Australian "Cost Comparison"

In late August there was a segment on the 7pm Project about property, it posed the question whether it is better to rent or buy (landlord vs mortgage). The show concentrated on the cost aspect and I found this interesting as it was some of these very calculations that influenced my decision to rent rather than buy again after selling a house in Adelaide around 10 months ago.

They honed in on what families with a tight budget/low income could do with the extra dollars saved by renting (e.g. like going on holidays, paying for private education for the kids), when ultimately it's probably these groups of people that would benefit most from the forced savings of a mortgage (assuming they pay the loan principal and interest). This was an irresponsible angle in my opinion.

They gave the example of a $500k property (rent versus buy) where they attributed a 5% cost of purchase price to rent ($25,000pa) or alternatively paying a 7% rate on a mortgage ($35,000pa). No mention was made of other expenses that one would incur when buying such as:

- Council/Water rates
- Building insurance
- Maintenance costs
- Stamp duty
- Buying & selling fees (bank, agent, etc)

Briefly mentioned was that some money managers rented, invested their saved money elsewhere (e.g. in the stock market), but they did not make this option (rent while saving the difference) look attractive.

Overall it was lacking substance, but no doubt it was produced for the mass consumption of the general public and the reality is that more detailed analysis of the subject wouldn't interest many.

Following on from the example provided in the show, here is a more realistic breakdown of what it would cost to rent vs buy:


Rent vs Buy - The Figures

Property: $500k House


Rent:
$25k pa / 52 = $480pw


Buy:
$500k + $24,000 (stamp duty & transfer fee#) x 7.25%* = $37,990
1% of property value for maintenance & insurance = $5000
Council & water rates = $2000
Total = $44,990 / 52 = $865pw (interest only)


# Adelaide based figures, this would differ between states
* Cash rate has increased since 7pm Project aired with 7% example

While more detailed than the 7pm Project example I'm still making some assumptions:

Obviously a first home buyer would have the benefit of the FHOG and possibly other state incentives and stamp duty discount depending on location and type of property.

A 100% loan on the property is used in the example. A more realistic LVR would be 95% with the buyer funding the 5% and purchase costs with a saved deposit, however if we used that in the example then we would need to add the benefit that the funds would have otherwise provided in a term deposit for the renter (which just gets too finicky).

It also does not take into account buying and selling costs, such as:
- Mortgage application fee (not always applicable)
- Real Estate Sale Commission (usually around 2% of the sale price)
- Advertising costs during sale
- Conveyancer (for both purchase and sale)
- LMI (if buyer is using a high LVR to purchase)

Further to this in many metropolitan areas a 5% yield would probably be considered fairly generous (across most metropolitan/capital cities houses are at a gross yield of less than 5%)

So potentially we're looking at housing being 80% more expensive if you buy (with a mortgage) over renting the equivalent. Of course this is only a look at the average situation, each property will slightly differ for better or worse.

This example also doesn't take into account the potential for positive or negative price growth of the property if purchased. The reality is that only 4% capital growth would be required for the owner to break even with the renter in the example provided (that's not high growth if inflation is running at 3%). Suffice to say if you think property prices will continue to see moderate or even high growth then buying still may be the better option financially (from your point of view). 

The question remains though, will vendors always be able to find the greater fool to purchase the house for a higher price? It's a vicious circle and if those that seek housing start to look for refuge from overwhelming mortgages by renting then we could just as easily see price declines which puts the renter in an even better position.

The way I see it the landlord is not only providing me a place to live comfortably (for a great price, much less than it would cost to buy), but they are also absorbing the price risk. Win-win for the renter who believes that property prices will correct, of course not everything plays out as we expect.

This is only the financial aspect. There are other differences which separate renting from buying. Obviously the stability that owning provides might be invaluable to some, such as those with a family.

I would be interested in hearing how the rent vs buy situation stacks up in your neck of the woods...


BB.

6 comments:

  1. Rent is far far cheaper in my area. To buy is over 1 million for a house, 500k for a unit.

    You can rent a unit for about $400 a week, a house is about $700 a week.

    Mind you, most renters are usually forced renters anyway.

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  2. I'm one that rents and invests the difference.

    There is a lot of talk about the 'security' of owning your own home, yet for many they are only a weeks pay away from defaulting on the mortgage. You just need to lose your job, become ill and you could be in a bit of a bind.

    I rent on the otherhand, and have a little nestegg of savings built up over the years. If I loose my job tomorrow, and not find another for a while it wouldn't effect me. Money is not a day to day stress.

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  3. BB - the problem with the rent strategy is finding the right quality property with the tennure to ensure you and the family don't get moved every year or so. In europe properties are let for ten and twenty years at a time, but here landlords are often speculators and tennure periods cannot be guaranteed.
    JOC

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  4. Valid point JOC, but even if you did have to move once every year or two there still has to be a point where it's worth it... In my situation I am saving around $10k a year by renting, it would be worth having to move once per year for that sort of saving. That might not ring true for everyone though (for example someone with kids). Cheers, BB.

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  5. This is why I live with my parents, even though I'm in my late twenties. I pay "rent" of $75 per week and invest in banks, mining companies, real estate syndicate investments, and managed funds. Even if I do get kicked out by my parents, I would prefer to rent. You have more flexibility and you're not tied down to anything.

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  6. Interestingly you can buy a property internationally much cheaper than in oz. So you should rent and using the balance purchase a property in another country. Oz is overpriced because of the governments approach to home ownership.

    Once the bubble bursts, you liquidate your international property and buy.

    Win/Win

    ReplyDelete