Let’s look at whether to rent or buy your home and which one has really worked out better over the long term in Australia and maybe demystify the adage “Rent money is Dead money”.
According to The Reserve Bank of Australia (RBA) their findings since 1955 are that there hasn’t been much difference whether to rent or buy your home.
Despite the constant news of property booms and million dollar sales in suburbs not known for being expensive, owners and renters over the last 60 years ended up in roughly the same place.
That of course relied on renters being equally disciplined about saving, and investing those savings outside of cash deposits.
There are costs and benefits associated with both buying and renting with pros and cons to consider when deciding whether to rent or buy your home, and work out which is likely to give the best results based on your long term objectives, both financially and personally.
- The appreciation in property prices over time.
- Leverage, i.e. when you borrow money to buy a property, the bank lends a reasonable percentage of the purchase price. For example, say you buy a property for $800,000 with a deposit of 20% or $160,000 and borrow the remaining $640,000. If you sell the property 2 years later for $900,000, the property’s value would have risen by 12.5% at the time of sale but your return on investment is 62.5% since you have made $100,000 gain on a $160,000 investment being your original deposit (before allowing for other acquisition costs e.g. stamp duty, legal fees, due diligence expenses).
- Security of not being displaced when the landlord terminates your lease.
- It is your property and you can do what you want e.g. renovate.
- Interest repayments. If rent money is dead money then interest repayments are dead money too. On an average Principal & Interest variable rate of 4.00%, your annual repayment is approximately $37,000 on a loan of $640,000 to buy a $800,000 property.
That’s about $6,000 more than the annual rental cost of the property. With interest rates at all time lows, there’s a good chance that future rates will be much higher than now, increasing the mortgage repayments. The RBA estimates that long term variable mortgage rates have been about 6.20% over the long term.
- Opportunity cost. This is a cost that is often ignored during the assessment. It refers to the cost of having your money tied up in a property versus having it available to use elsewhere.
- Ownership costs. The transaction costs of buying a property. In this example, stamp duty, due diligence and legal fees are estimated to be $35,0000. The RBA estimates that the costs of buying a house including stamp duty and other buying costs including conveyancing can be 4.3% on average.
- Ongoing running costs, including council rates, repairs, depreciation, body corporate fees, water and insurance costs estimated per this example to be around $10,000 per annum.
- Return on your savings. Renting frees up your savings to earn a return elsewhere and depending on where those savings are invested, they may be able to earn a higher return than would be possible in property. This is the flip side of the opportunity cost of buying.
- Flexibility. While owning a property provides more stability, renting gives more flexibility. This may be attractive especially for young singles and families who may need to move from place to place for different reasons i.e. works.
- Diversification. When you buy your own home, most (if not all) of your eggs are in one basket. One property in one suburb in one city in one country. That’s a lot of your total wealth riding on a single investment that can be impacted by a whole list of factors outside your control. Renting allows you to spread that risk across a much broader range of investments.
- Rental costs. Renting costs have been steadily increasing in Australia. A typical rental yield (annual rent costs / house value) in Australia is now 3.9%, depending on factors such as location, property value and whether it’s an apartment or house. Rent is the equivalent to interest you pay on a mortgage. It’s the cost of borrowing an asset – in the case of renting, the asset is a property whereas for a mortgage you’re borrowing money.
- No forced savings. Unlike buying where you are forced to contribute to a mortgage each month (which includes interest and principal repayments), renting doesn’t encourage forced savings. This can make it tempting for renters to spend spare cash rather than setting it aside.
We have looked at whether to rent or buy your home from a cash flow point of view and guess what, neither one is better or worse than the other.
It is all about one’s objectives (medium to long term), financial position and life style.