rent v buy

Buying time better than buying a home
Nicole Pedersen-McKinnon | August 23 2004 | The Sun-Herald (subscribe)

When the property market is cool, renting rules, writes Nicole Pedersen-McKinnon.

If you are a first home buyer desperate to get a foot on the housing ladder, you may be better off staying planted on the ground. Exclusive research for AFR Investor, conducted by data provider InfoChoice, has found that buying today instead of continuing to rent would see you more than $70,000 out of pocket over five years if the property market simply moves sideways, or slumps and then recovers to where it is now.

To make buying worthwhile, house prices would need to increase by at least 3 per cent a year in each of the five years. And, if you had to pay stamp duty on your purchase, prices would need to go up that much more for you to come out ahead. “If property does appreciate and outperform 3 per cent, the flipside is that the person investing in property is going to be better off,” says Denis Orrock, general manager of InfoChoice. “At 5 per cent, your equity is going to increase enormously you’re probably going to be $50,000 better off.”

We’ve made a few assumptions to calculate these figures.

First, we’ve assumed you buy a house valued at $450,000 (with a 10 per cent deposit) or pay rent on that house of $400 a week. Over five years, that puts your house repayments, if standard variable rates remain at 7.07 per cent, at $172,834 or your rent, if it escalates by 2.5 per cent a year, at $109,437. (Interestingly, the rent does not even cover interest payments on the mortgage.) But, of course, there are extra costs associated with being a home owner. We’ve allowed for total rates and (possibly) body corporate payments of $7000 over five years and an annual maintenance bill of $2000, which takes the home owner’s bill to $189,834 overall.

Finally, we’ve assumed and this is the big assumption that you diligently save all of the extra money you would have paid on a mortgage and maintaining your house (and earned 5 per cent a year in interest). “For a lot of people that’s an incredibly difficult thing to do to have the discipline to save,” Orrock says.

But if you manage it, you would be looking at $150,943 additional cash in the bank (including the $45,000 deposit). This compares with equity in a house at that stage of $80,463 $35,463 that would have been paid off and the $45,000 deposit. You should note, though, that we haven’t taken tax into consideration, which could reduce your savings. Having said that, you would need to lose almost half of your accumulated funds in tax for this to swing the pendulum in favour of buying assuming there is zero growth in the market.

So the big wild cards are property prices and interest rates.

On the prices front, the latest figures show that the market has dipped. Meanwhile, the Reserve Bank of Australia this month gave a strong indication that interest rates will rise before the end of the year.

The worst possible combination for people who buy property today would be a slump in property prices that coincided with a significant increase in interest rates. Not only would they find themselves in negative equity but they may be forced to sell and realise the loss. This would skew our figures very much in favour of renting.

But even a modest interest rate increase more likely in a property market that is flat in real terms (in other words, grows only at inflation) would tilt the balance further in favour of renting.

The buyer’s utopia is interest rates maintained at their current levels (although a cut would be nicer still!) and property growth of 5 per cent a year or more. Under these circumstances, you would really miss out by renting.

But don’t forget that you would also really miss out by renting if you didn’t diligently put aside the money you saved on a mortgage. And, over the longer term, buying rather than renting always should pay off.

As Orrock says: “It’s bricks and mortar and there’s security, and it’s part of the great Aussie dream.”

Your situation after five years of no property growth

If you owned a $450,000 property Cost: $189,834. Equity in home: $80,463.
If you rented that property for $400 a week Cost: $109,437. Additional money in the bank: $150,943.
Outcome You are $70,480 better off renting in a flat market.
Buy or rent? Michael’s doing both
Michael Kelly, 33, made the leap from renter to home owner just over two years ago, buying a one-bedroom, inner-city apartment for $245,000 with a mortgage of 80 per cent.

Not only were mortgage payments new to him, so too were expenses such as rates and strata. “It was a bit of a shock. You know what costs are involved, but you don’t really realise until you have to pay them,” said Michael, who works in the mortgage industry. Then, 18 months ago, he had an epiphany. “If I shared [a rented place] with someone, my rent would be cheaper than my mortgage repayments.”

So he installed tenants in his own flat and became a renter again himself.

Michael is now in the ideal, but increasingly unusual situation of receiving enough rent for his unit to match his weekly mortgage repayments $310.

That means he only has to cover the cost of rates, strata and maintenance costs he would also have if he lived in his apartment, which come to $45 a week.

The only additional cost is $18 a week in real-estate management fees.

Meanwhile, Michael pays $205 a week in rent for the two-bedroom apartment he shares with a friend.

The upshot? He saves about $5000 a year.

If he put this much extra towards his loan each year, he would save more than $40,000 in interest and be clear of the loan 4 1/2 years early.