As a twenty-something year old living in Sydney in 2010, it would be nice to know whether I should buy or rent the apartment (or house) I live in.
Many people from my parents’ generation would say buy a house now and watch it grow in value. And perhaps it really is this simple; it was for them.
That said, not many of my friends can afford to buy property in Sydney, and for the ones that can, many still choose not to. Is it overpriced? Is it a change in attitudes? do we get more value out of flexibility? Is renting good value?
I’ve told myself that one day I would sit down and do some calculations and figure out which is better for me. After just completing this process, at least to some extent, I still have no idea which is better. But I do understand more of the factors that influence it and to what extent.
The first thing I learnt is that some calculations turned out to be many calculations. The second is that there are so many variables in my solution that I can only know for sure which is the better option for me if I am able to predict the future. And after reading The Black Swan recently, I’m not very comfortable with my ability to predict the future.
A useful tool to help you choose between renting and buying
After spending hours trying to create a spreadsheet myself, I’ve found a very useful tool made by the NY Times to help with this analysis (a screenshot is here). In the example screenshot, I compared buying a $450,000 apartment versus paying $1,200 a month in rent and investing the leftover cash at 7% over a 30 year period. I also assumed that both house prices and rental prices will increase by 5% each year on average. As you can see under this scenario, renting remains financially better than buying for the full 30 years (a full list of assumptions are here).
Now, if only it were that simple. Unfortunately, the assumed variables in the above example are not so simple at all.
What if house prices don’t keep rising?
We don’t know that house prices will increase at 5% per annum for the next thirty years (many would argue Australian house prices are due for a correction). Regardless of the answer to this and despite plenty of research, I personally have no idea. But I still need to make the best decision I can with the information that I have.
Suppose that house prices stay at the same level they are now for the next 30 years, based on these assumptions, the tool tells us that If you stay in your home for 30 years, renting is better. It will cost you $887,567 less than buying, an average saving of $29,586 each year.
What if I can’t produce 7% on my investments?
The nice thing about simple graphs like the one above is that they are often not so simple. If you can’t manage to invest the money that you save by choosing to rent at 7% per annum (though some stock market experts might call this a conservative expectation) , things can start to look less peachy for renters. Keeping house prices increasing at our initial assumption of 5%, but changing your investment returns per annum by just 2% to 5%, buying takes the lead after 30 years for the first time in this analysis.
If you stay in your home for 30 years, buying is better. It will cost you $494,992 less than renting, an average saving of $16,500 each year.
The flipside of this point is that if you can produce returns in excess of 7%, things starts to swing very quickly in favour of renting. At 10% per annum on your investment returns, If you stay in your home for 30 years, renting is better. It will cost you $1,446,552 less than buying, an average saving of $48,218 each year.
Without taking a view on this myself, for those of you thinking that achieving 10% returns on the stock market year on year is easy, consider that half of the return of the US stock market over the past 50 years was associated with just 10 days with the greatest daily change (The Black Swan, Ch 17).
What Other factors affect the decision to buy or rent a house or apartment?
As you can probably tell by now, deciding whether to rent or buy is going to depend on your opinion on a number of factors, most of which you probably have little idea about. And that’s from a financial perspective only.
During my analysis, other factors (this is not an exhaustive list) that can have a big impact included:
- Rental Prices (if rental prices rise by less than 5% a year, renting becomes even more appealing)
- Interest rates (6% interest on $450,000 is $27,000 that you’re giving to a bank in the first year)
- Strata fees (just watch $1,000-3,000 a quarter decimate your choice to buy that sleek apartment in Elizabeth Bay)
- Down Payment Value (the amount your ready to part with now will make a difference to where you are 30 years later)
- House or Apartment Improvements and Maintenance (whilst maintenance and improvements can have different effects, the more you spend when buying the worse off you are unless it adds value to your house or apartment)
- Selling and Buying costs (both negatively impact buying versus renting)
- Your Marginal Tax rate (this is again situation dependant but the more tax your paying the better off you are where you can claim that tax, as such buying can work out better)
So should you rent or should you buy?
What all this analysis has led to for me is knowing that I’m going to have make some educated bets and be ready to change them if necessary. Some of these bets include what I think about the future of house prices, rental prices, and how I think I’ll go investing my own money.
At least for the moment, i’m not going to buy property in Sydney. This by no means implies it won’t work out for those that do choose to buy. I can see a scarcity of houses in Sydney continue to push prices up for decades to come.
Sydney property prices near the city (or preferably in it) for a 1 bedroom place seem nothing short of crazy (unless i want to own 38 square metres in an apartment complex on Oxford St). That’s not saying they might not get more crazy and make many people profit in the process.
The place where I live is a much nicer place than I would get if I bought a $300,000 – $450,000 place in a similar suburb (my share of the 2 bedroom place close to the city is $350 pw) . Buying a place in Sydney seems only to be an option to me if I am ready to live in it since rental yields of 2-5% really don’t excite me (I feel my money is safer in my Virgin Saver account). If I want to travel for an extended period of time, buying doesn’t give me that flexibility either.
One other factor I think about is the end game. At the end of 30 years, I either have a house that I own or (hopefully) a pile of cash and some investing skills. From a financial perspective only, I’d take the cash and investing skills over the 2-5% yields per annum that are common at the moment in the property market. That said, maybe in 30 years or before then, I’ll want a house for me or me and my family to grow old in. The trick for me here is to realise that if I do want a house at some point, I might have said pile of cash to buy it with if I can manage to invest well until then.
As for investing my own money, if anything, this analysis has shown me that if I am going to follow the renting path, I do have to focus on investing my money as wisely as I can. To do so, I’ll be focusing on investing in things I can understand and that appeal to me (I outlined an approach this in my article Successful Investing, Worldly Wisdom and Your Circle of Competence). This will hopefully be in my own business.
Whether you should rent or buy will come down to analysis of all these factors. The main points I want to get across in this article is that it is not as simple as some think (though that doesn’t mean that what you would have chosen won’t end up working anyway) and that you need to spend some time thinking about these factors before and after making your choice.
For those that want to go even further that the NY Times tool, check out this one. In terms of disclosure, my friend Max has informed me that I should let people know that I work for a company that recommends stocks on the ASX.