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21st April 2007

Rent versus Buy Decision

All through my adult life I have heard variations of the arguments to rent or to buy. It often seemed to be biased towards one or the other by those who had a particular point of view or even lifestyle to defend. For those already renting, they supported the view to rent as a better decision, conversely those who had purchased seemed to need to defend their own decision.

The points put across ranged from financial (without factual support) to those based on lifestyle/freedom choice. There are arguments to support both positions, which is the stronger argument depends largely on the importance you place on your current lifestyle or your future lifestyle and what you want to achieve. Perhaps by listing some of these, you can get a feel of what makes sense to you.

Advantages of Renting

  • It is generally cheaper to rent than having to make a mortgage payment. This is particularly true in the earlier years of a loan repayment cycle
  • You have less financial costs, not having to pay for maintenance or rates or major repairs and have more certainty what the costs will be
  • The benefit of lower costs is lifestyle choice, you have a greater disposable income to either spend on lifestyle or save in alternative investments.
  • Rental agreements are short term, only committing you for 6 months usually, perhaps 12 months, so you have more choice to move if it is unsuitable or that your career or lifestyle requires move or you like change
  • You are not locked into a 30 year mortgage repayment term
  • Renting now does not preclude from buying if you do want to enter the property market at a later point, especially if you think the property market is heading for a downturn
  • Alternative investments reaping a better reward than the property market. The share market is considered to outperform the property market on a long term basis. It also is a far more liquid market, you are able to buy and sell to take advantages of changing market conditions, where the property market, due to high costs of buying and selling, limit much trading.
  • There may be better investment vehicles, such as superannuation, than owning property
  • You may be able to afford to rent in an area that you could not afford to buy in or rent a better quality residence than you could buy

Advantages of Buying

  • It is your house and you can decorate and fix it to how you want it to be.
  • It helps give a sense of community by being established in an area, but conversely long term renting can as well
  • It is a forced saving, where you are putting money ultimately into your property. This presumes that the value of your property actually increases over time.
  • You don't face the prospect of the landlord selling the property or dramatically increasing rents forcing you to move involuntarily
  • By paying off a mortgage and with increasing house prices, you build equity in an asset which you can later use to borrow against if needed.
  • You can choose to renovate or develop a property and done well, will add further value
  • If you eventually sell, under current income tax laws, any capital gain is tax free on owner occupied residential houses
  • The long term price growth of residential property in Australia averages around a 7% growth per year over the last 30 years or more. That means the price doubles about every 10 years. It is considered a relatively low risk investment that generates reasonable returns.
  • It is easy to obtain finance to purchase, especially in metro areas. Some lenders will lend up to 100% of the purchase price, with the major Banks lending up to 95% in most cases.
  • Home residence are exempt from aged pension tests where alternative investments are included

The two financial arguments that are perhaps the most critical are:

  1. Will the renters save and invest the cash difference between the rent paid and the mortgage, rates and maintenance costs?
  2. Will the alternative investments generate a greater return after tax than the increase in the property itself?

If you don't save and invest the difference, then after 1 year, 10 years or even 30 years, you may have great memories of lifestyle choice, perhaps many holidays taken, but you will not have a financial return or assets from the forced savings.

From a pure financial view comparing the effects of Buy versus Rent, there are a number of calculators readily available that you can input your own information and assumptions to see what the financial effects are. Do a web search, type in 'rent versus buy calculator' and you will get a variety to choose from, one of the easiest to use (and free) is from yourmortgage.com.au. I decided to develop my own, a summary is shown below. This is based on a local suburb and using a real example.

By changing some of the assumptions, we get a sense of where the financial benefits are in either renting or buying. In nearly every case I have run, over a 30 year period, benefit is obtained with ownership. However over a shorter period, unless there is strong property growth, the rent option produces a better result.

Obvious extreme assumptions will show that renting is a better outcome over 30 years than buying, but then it needs to assume property growth is equal or lower than inflation (or CPI), return on other investments is high and marginal tax rates are low. The graph below shows the Moderate scenario over 20 years. In this case the break-even point is just under 10 years.

The decision to purchase an investment property and continue renting is a different decision and a topic for another day. There are some tax implications to consider as well as the effect of qualifying for the First Home Owners Grant, if applicable.

Give me a call to find out what you could borrow based on your present circumstances, your income, your savings, your available cash flow and what support you may be able to obtain through family guarantees or pledges if appropriate. We will work with you to structure a solution that suits your needs and circumstances. We take the approach of looking at your long term goals and working to find a solution through finance for you. This appointment is no-cost and is obligation free, call – 9397 7275

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