There exists an old adage that “renting is throwing money away”. For many people, buying a home is by definition a great investment. This belief is particularly strong in some countries such as China, India, the United Kingdom, France or Italy but weaker in countries such as the United States of America, Germany or Japan.
Before going further, we should begin by recalling a few facts.
1. For any comparison to be worthwhile, we need to compare buying to renting for perfectly comparable properties.
2. We also need to make sure to take account of all the costs associated with buying a property. These costs are not limited to mortgage repayments, but also include maintenance, opportunity costs of your deposit (it could have been invested into other asset classes) and transaction costs.
3. If your calculations are correct, you are likely to find that, at least for the first few years, renting would bring you extra cash each month.
4. Even though it’s true that buying your home is a good way to build capital, this capital must be compared to the one you could have built by investing the deposit and the monthly extra cash in other financial vehicles.
5. Even though house prices tend to increase on the long term, they can also dramatically fall. Everyone should know that Tokyo’s property prices collapsed by 80% during the nineties or that Paris market suffered a 40% fall in nominal value between 1991 and 1996.
Using a calculator to assess your own situation
Many calculators have been built and are freely available online. However, many of them are incorrect or biased towards homeownership since real estate professionals built them. The New York Times has developed one of the best calculators you can find online. Here is the link (please note that you need internet explorer to use it):
The calculator has twenty-three variables but not all of them are equally important and you should focus your attention on the following ones:
1. The property’s monthly rent
2. The same property’s selling price
3. Down payment in %
4. Mortgage rate in %
5. The expected annual rent price increase or decrease
6. The expected annual home price increase or decrease
7. The expected rate of return on investments (in Advanced settings/ Others)
It should not be too difficult for anyone to come up with realistic values for the four first variables. The three last variables, however, will require some assumptions.
• The expected annual rent price increase or decrease
Rent price changes tend to be correlated with household incomes. Since they also tend to rise a bit faster, adding 1% to the expected household incomes changes in your area is a reasonable way to obtain a good indicator.
• The expected annual home price increase or decrease
As said earlier, property prices usually go up. Unfortunately, this is not always true and they can also fall dramatically. There are many ways to spot, or at least suspect, a property bubble, but it is close to impossible to know when it will burst.
Therefore, even though it is still a good idea to simulate how your numbers would be impacted by a crash, it makes perfect sense to assume that property prices will increase in line with rent prices.
• The expected rate of return on investments (in Advanced settings/ Others)
If you are risk-averse, you should opt for the average annual return on your bank savings account. On the other hand, if you are willing to take more risks, you could achieve much higher returns and obtain something like 3% or 4% above inflation.
We will discuss this further later on. Now that you have all the required assumptions, you can start playing with the model. There are many different scenarios possible, but most people will end up with a chart that looks like the below.
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| Buying versus Renting |
Let’s try to briefly explain the shape of the graph. In year 0, you buy your property and immediately lose money because of the transaction costs. After the purchase, as the months go by, you own more and more of your house and you are building capital faster than if you were renting.
After a period generally comprised between five and seven years, you reach break-even! At this stage, having bought or rented your property over the last few years would have made no difference to your finances. If you do not sell the property, you will now be better off as homeowner. But wait.. what would happen if when you reach break-even point (or even worst earlier) you sell your property to buy another one? You can see how the shape of the graph would change below:
On year 7 your finances take a hit because of transaction costs (you sell your current property and buy a new one). This brings you back to square one and you now have to wait for an additional five to seven years to break even again. Following the same logic, it can be argued that if you were to sell your property and buy a new one every five to seven years for the rest of your life renting or buying would make no difference on your finances.
The importance of the rate of returns on investments
As we have seen earlier, one of the most important variables, in order to determine if renting, would be better than buying is the return you would be able to make on your savings (remember that by renting, instead of buying, you are extremely likely to end up with excess cash flows). If you are looking for above average returns and have the risk appetite, you have plenty of options to consider.
In most countries of the World, it is not difficult to open a broker account and start buying stocks. As long as you diversify (that is investing in different stocks across different industries) and keep your investments over a long period of time you should manage to do well. If you do not want or do not know what to buy, it is also easy to find professional advisers that can help you. If you are even more adventurous, you have the possibility to invest in emerging countries where the biggest potential lies.
It is nowadays possible to find advisors such as Anh Thomas Investment and Management Consulting (www.anhthomas.com) that help their clients finding the most lucrative investments worldwide. Interestingly enough, if you manage to obtain a high rate of returns on investments, it is possible that your graph will remain in favour of renting all the way, even if you never move out! This would be the case, for instance, with the below assumptions.
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| Buying is never better than Renting after 30 years |
The model has many variables that lead to many different possible scenarios and the below table was only conceived as a ‘rule of thumb’.
Bottom line:
The aim of this article was simply to demonstrate that the choice between buying and renting his property is not as straightforward as many people think and that depending on your personal circumstances and risk tolerance, renting might be a better option for you after all. Since buying a house is a huge commitment, it is worth spending some time to make sure that you are taking the right decision.
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