rent vs. buy scenario(s)

Hi there,

I am trying to work out some math for renting vs. buying.
And, I (try to) take a likely conservative approach in any of the assumptions made, as far as can see.


My current situation:
currently I have some 125k cash, and renting at 380$ per week, in an apartment of 450k+ market value.
Working out the costs of buying an almost similar value house, I would need some 325k loan.


Costs of buying vs renting:
Say for a 15yr period at a fixed rate of 5%, the total loan interests may be around 138k, see Repayments Calculator

My total rent cost over that same period would be around 380*52*15=296k (rent fee may change over such a long period, but for now say it’s constant).

Considering some annual costs of owning the house (strata, council, maintenance, or else) say add up to 4k per year, that results in total “ownership” costs of 4*15=60k over the 15yr period.

On the other hand, if I rent instead of buying I would be able to “invest” the deposit (shares, bonds, cash, or else) obtaining, let's say, an average yearly return of 2.8% after tax (major assumption I know). The compound interest over 125k for the 15yr period may be 65k.


The ratio between renting over buying costs (in this scenario) become:
(296k - 65k) / (138k + 60k) = 1.17


Comments on the assumptions made:
-Interest rate at 5% appears somewhat conservative by 0.5% or more.
-Average annual repayments become some 50+% higher than my current annual rent, therefore highly increasing the risks against salary, accidental expenses, etc. Here, I could have increased the period to 25yr, but then all assumptions made would have been even less appropriate, isn’t it?
-Ownership costs are mostly based on the strata/council fees that I see on the ads. I did increased a bit for maintenance, though it does not include any likely renovation/improvement to the house that would be added to the costs.
-Investment#1: return is close or slightly higher to a savings account or bonds rate, say 4% gross on 30% tax bracket become 2.8% net, isn’t it?
-Investment#2: I could try to get some better return investments.
-Investment#3: I am not considering the fact that in the 15yr period, I would likely be able to save from my wages and put that savings into the investment, so again being conservative here.

In this scenario, I do not see any valid point for buying, also considering that I would just marginally be able to afford such a 450k house, heavily increasing my risks. Yes, paying about 17% more overall for lifestyle, positive cashflow and freedom to upgrade/downgrade or go living in another city.

Modified scenario, in a few years, I foster my money, perhaps requiring just a 150k loan, then yes buying vs renting become substantially better: rent costs/buy costs ~ 1.9


What do you think? Does this make any sense?
Am I missing anything?

Thanks,
surf

 

Not really, general consensus is that renting is financially better than buying, but obviously there are some lifestyle considerations that you give up.

There's some investors out there who buy IPs and rent where they live for this reason, myself included.

 

I may be reading it wrong, So your completely disregarding capital growth? How do the numbers fare if your $450k place is worth $900k in 15yrs. I think @thatbum is talking about renting being financially better if that extra $ is going into further IPs or accumulating stage to build a portfolio?

 

Yes that's right. I'm assuming that you invest the funds in a suitable IP.

 

Rents generally track inflation over the long term, with 3% inflation your rent would double in 24 years from 380 to 760 per week. Inflation could be higher or lower but it's definitely not s constant.

 

I don't see how this is correct or even possible. If avg growth is 7% and rents increase at 3% then yield would be decreasing indefinitely. ie in 20 years avg yield will go down from 4% to maybe 2%, and after another 20 years down to 1% and so on indefinitely, which would lead to nobody buying investment properties due to the poor return, which would in-turn lower supply of rentals which would then push prices back up to where investors would enter the market again. So it is not possible that rental growth would be lower than price growth over the long term once all the short term effects have been smoothed out. Please correct me if my logic is flawed.

It makes more sense that yields, and not rent, track interest rates (which I think is fairly close to inflation), but I could not find a source showing yield for specific house type and suburb over a long period such as 20+ years. I have heard PriceFinder may have this, but I don't have a subscription.

 

Good point. One could say also it is not possible for house prices to grow at ~8% as they have been doing in Sydney and Melbourne and wages only growing at ~3%. Compound this difference over any reasonable period of time and property becomes pretty unaffordable. Cannot go on forever.

 

The problem with doing figures for renting vs buying is the time frame used.

The shorter the time frame, the more attractive renting appears. But in the long term, buying is a clear winner. We bought our PPOR nearly 40 years ago, paid it off over 20 years ago. Living rent free ever since. Expenses and maintenance cost well under $8K-$10K per year.

Possibly renting and investing elsewhere makes sense, but only if extremely disciplined and investing the difference every week without fail. No exceptions, no excuses. Most start out well, then a minor hiccup sees them skip a week or two,,,.,

And if choosing renting, take into account cgt when you sell the assets you purchase instead of buying.

But if you want to live in the middle of Sydney, renting may be your only option.
Marg

 

PPORs are very tax effective v IP. No land tax, no capital gains tax. Holding cost also cheaper v IP as you live there and can do cheap repairs yourself v IP where it is a tradie call out. And the ‘accommodation benefit’ you get while living there is tax free (ie If your PPOR would ordinarily rent for $1k per week, you should think of this as $1k per week of income tax free). Looked at another way, you need to earn $2k per week pre tax (50% MTR) to rent equivalent house. At the end of day, I agree main benefit comes from the forced saving discipline and ‘buy rarely sell’ approach generally taken with PPOR.

 

My point was that the op used a constant rent which would be incorrect. Its likely to increase significantly tipping the balance in favour of buying over the long term (20+years).

I was careful to say generally tracks inflation.

What you are suggesting regarding yields has happened, they have gone from 7-7.5% to 3-3.5% over 20-25 years.
Just because prices increase doesn't mean tenants can afford to spend more on rent. They can to a point but then look for other options like sharing, living with relatives or an apartment inside of a house etc.

Prices have overshot due to low rates and easy credit. That has passed in most markets, now yields will increase over time.

Price growth will not be 7% going forward without higher inflation and therefore wage growth. Interest rates can't go much lower either.

I also never said inflation would be 3%, I used it to give an example. Using the rule of 72 means the rent would take 24 years to double.

Of course there are plenty of other factors at play especially supply and demand. There is also a relationship between inflation, wages and interest rates .

Historically high inflation has meant higher wage growth and higher interest rates.

 

Thanks for the comment! At the moment, I see a wide range of growth rates here in Perth (be aware I am a newbie about property), but let's say the average growth is 2% (instead of a more pleasing 5%), then I would have some 156k total capital gain to be discounted from my "buy" costs.

Again thanks! Considering 3% inflation, my total rent cost become 321k (if I made it correctly...).


Scenario updates:
considering both growth and inflation I may potentially end up with rent/buy costs of (-321k+64k) / (-137k-60k+156k) = 6.1

To be fair though, I would need to add any extra savings that I would be able to put aside. So, let's say I manage to save 200$ p.w., and invest them somehow obtaining the same return as my other investments 2.8% after tax. This would add up to 236k in 15yr time. In this scenario the rent costs would be (-321k+64k+236k)= -21k, and the rent/buy costs ratio become 0.5.

Optimistic scenario #1:
the growth is indeed 5%, my buy costs would actually become earnings, (-137k-60k+486k) = +289k

Optimistic scenario #2:
both growth and after tax interests on savings are 5%, the latter delivering some (-321k+135k+324k)=+138k earnings from the rent option. The rent/buy ratio would be ~2 (earnings from house value growth are double the savings/investments obtained in the rent option, returning a "cost" rent/buy of 2).


So from what I can see, the house value growth really plays a major role, isn't it? Same does the mortgage.
Saving money and reducing the required loan ends up being the feasible scenario, in case I am not able to find such a growth gem

Cheers,
surf

 

Okay, but REALLY one should never constrain him/herself into a loan commitment because he/she is not able to save money.
What if one week he/she spends the money assigned to the repayment? Risk the whole equity for a hiccup?
Renting another story, you don't pay you get kicked out, no equity/savings at risk, isn't it?

 

same as above, unfortunately I do not see such a commitment as a benefit, it's a risk in my newbie opinion. Or am I missing anything?

 

This is because once you have a mortgage, you will probably do everything in your power to make the repayments and not lose the house. If you ever are in difficulty, you can find a way to get that money. Necessity is the mother of invention. Rent out rooms, get a housemate, find additional income...

Whereas if it's a case of rent and put the extra money difference into an outside investment, most people will not make it their main priority if something else more interesting comes up or tough times comes and they lose a portion of income. Without thinking and without too much regret they'll drop the amount allocated from the investment pie.

Eg. Lets say your friends decide to go to Hawaii (or Asia) for a surfing holiday. If you have the spare money sitting around someplace easily accessible, you'll join them and do it. No guilt. Say sayonara to your outside investment money. But if the funds are already tied up as a mortgage repayment, you won't be dipping into that money.

My additional two cents... re: Buying. I think it makes sense if you are looking to buy in Perth now. I think the prices are possibly as low as they'll ever be.

 

There is no right and wrong answer. All depends on whether you have discipline to save. I found for myself that the forced savings was good, but others may be different.

 

properties are growing asset ( in general term), their values grow over time. @surfando, I understand your concept of renting vs buying, you are more focusing on the costs side of these 2, rather the growth side of buying. the Capital growth is what most ppl looking for, which actually increase ppl's overall financial position.

the other thing is the leveraging power of buying properties, 10-20% of cash spending while receiving 100% of the growth.

and there is an emotional side of things as well, many or majority of ppl would like to "own" their home at some stage, especially after they have kids.

 

I haven't read any of the replies but

Don’t forget to factor in

- Debt recycling

- Investing at owner occupied rates

- Effect on borrowing capacity

- Tax free capital growth asset

- Land tax exempt asset too

- Etc

 

Over 60pc of Sydney buyers better off renting

 

Older Australians who own their home more than 20 times better off than those who rent, data shows - ABC News

 

Yeah but it doesn't control for cause and effect, so the article might as well read "People who have lots of money are better off than those who have less money, data shows".

Although I probably do agree some of it probably has to do with the whole forced saving thing of having a mortgage.