Rent vs Buy: An Australian "Cost Comparison"

[Edmond Dantes]

To me it's clear that if you're starting from scratch, have a reasonable income and want to be aggressive you can achieve safer leverage into more growth assets if you rent somewhere cheap and buy up big with fully deductible debt into growth IPs with good cashflow. You simply cannot leverage into the same volume of assets with non-deductible debt hanging over you and it is the total overall exposure and cashflow that will drive your wealth in this game.

Quite close to what I'm doing. I bought a very small place as PPOR, even though I could've afforded something much bigger. But right now I'm living in my own place, and the mortgage is quite close to the rent I was paying before (beauty). Yes, it's far from the city, yes, it's small. But I'm having a good night sleep with the interest rates rises, and have plenty spare cash to buy more assets in the future. If I'd buy a bigger, more expensive PPOR, all my money would have gone paying the non-deductible debt.

time will tell...

 

[wylie]

In answer to the question about what the house I mentioned would rent for now.....

It rents for $440 per week. In the year until January 2010 it was renting for $460 per week but we dropped the rent to get someone quickly as the market was so slow then. Normally we would have increased the asking to $460 and, as a direct comparison, we own the house further up the street (exactly the same except with a deck on the back) and are getting $495 for it.

Again, we would normally have asked $520 for the one with the deck but we had three houses empty at the same time, my mother had passed away that week, we had lived the nightmare of her illness for three months, and we simply handed it all to an agent and said "find anyone suitable and show me where to sign". There were way more important things going on than holding out for a bit extra.

So, I would say we should be getting $460 per week without the deck (possibly a little more if the market was not so slow) and the one with the deck (cost, say $20K to add a deck to the other one) should be $520 per week. (That one cost us $156K in 1997 and is worth around $700K now.)

 

[Corey Batt]

Whoah! Did you say 8% CG? If I thought that was a realistic growth figure we would see every year over the next 7 then I would be loaded up with property! I think there is potential that in 7 years prices may still be lower than the peak nominal prices we've seen over the last 12 months.

Going by RPData's stats, over the last three decades property prices have increased on an average annual growth rate of 8.4%

http://www.vision6.com.au/em/message/email/view.php?a=9640&id=722416

Do you know where buying is always a better option than renting?

When you buy a house with repayments cheaper than renting. Extremely (nigh impossible) but definitely puts buying in your favour

 

[Indifference]

Recently re-entered the rent market...

I have recently re-entered the rent market and intend to stay there for at least another 5-6 yrs.

I sold my last PPOR and am re-investing the proceeds into better yielding & CG potential IPs 7 am currently saving the difference between mortgage/rent which is about to be split between share portfolio and IP acquisition.

My previous PPOR equated to about $600 /wk in outgoings. I can get a comparable rental with outgoings of $400 /wk and use the $200/wk difference to fund 2xIPs (using my current capital etc...) I can also get approx $15K per annum increase in my net pay due now having deductible debt, compared to having a non-deductible PPOR loan. Having 2 rental incomes also allows better loan serviceability and therefore I can comfortably afford a higher LVR.

There is only one flaw in this plan, BUT, it can be mitigated to an extent. Preserving your capital (avoid CGT liabilities).... A few things I am doing or putting into practice in the immediate future to ensure the renting strategy works for me:

1. Use IP offset accounts to store surplus cash.
2. Ensure one or more IPs are suitable for as a future PPOR if circumstances/desires change.
3. Don't tie up all existing capital in IPs, preserve a decent amount in other asset classes. (I.e. share portfolio)
4. Continue with my somewhat nomadic career choice. This ensures periodic movement which offsets renting instability, new opportunities, seeing the world etc.... Besides, I actually enjoy what I do. (most days)
5. Return to a PPOR only when doing so becomes economically viable... Ie. own outright and still have the required passive income stream.

I acknowledge that for a lot of people, they tend to live, work, play in the same area for large durations (or their entire life). But for the rest of us, who tend to enjoy traveling, moving to different parts of the country or world, enjoy the challenges of changing career directions every few years to keep things fresh and exciting etc.. etc... Renting can actually be not only cost comparable, but also more beneficial from an asset building perspective.

Besides that, the $1M house I currently call home, would otherwise be a pipe dream!

 

[Corey Batt]

You are renting a $1M house for $400/week?

 

[Indifference]

You are renting a $1M house for $400/week?

Actually less.... I have chosen to maximise my employer benefits by NOT owning my own home

We all have different circumstances, but for me, renting is a cash cow.... shocking but true...

 

[hobo-jo]

i'm not saying it can't be done, because JIT has done it ... but i am with the majority of people here who would say that the "average" australian wouldn't invest.

Sure, but the average Australian isn’t a successful real estate investor either. The fact the average Australian isn’t doing “X” is a good enough reason TO discuss it in my opinion

So, I would say we should be getting $460 per week without the deck (possibly a little more if the market was not so slow)

So based on the figures provided (190pw/170k to 460pw/600k) the property has gone from a gross yield of 5.8% to 4%. So while the property has worked for you over the last decade (decent capital growth has overshadowed any negative cash flow to begin with), does that mean it will work for someone else that bought it off you to manage for the next 10 years? Will the gross yield drop to 2.75%?

I think property has been a great investment over the last decade or 3, but that’s no guarantee it will continue at the rate it has. We’ve been pushed to a point where a large percentage of funding to drive growth is now being sourced overseas; an unravelling of this funding source could mean a collapse in prices. We’ve been pushed to a point where a 2% increase in interest rates could be enough to push a large number of mortgage holders to the wall when in the past we’ve seen interest rates up to 10% higher than they are currently. We’ve been pushed to the point where house prices relative to incomes (single or household) are 60%+ higher in REAL terms than they were 20-30 years ago, is such growth sustainable over the next 20-30 years? We need to be looking at what is possible going forward, not what we’ve seen in the past. Past performance is no guarantee of future results.

 

[Ausprop]

You are renting a $1M house for $400/week?

sounds fairly typical. The owner would have their eyes on the bigger picture.... banking on that cap gain as demonstrated 2000-2007

 

[MellyBelly]

so - from you figures - they've made a profit of around $67,000/yr average by paying not much more than they would have paid in rent. a total of $800,000 that they now have complete control over.

that's an entire other income. even with saving the small difference if they rented and investing would they have been able to achieve the same results?

using the example given of the pros of renting at $500/wk, owner paying out $800/wk ... that is a difference of $15,600/yr, say invested at 10% compounding would - in the first year bring in an extra $1,560 ... by year 10, if saving 15,600/yr the amount of savings/equity would rise to $197,300 (approx) and an income of $19,730.

now, my maths is very poor so please correct me if the figures are wrong.

for ease i have assumed rents haven't risen and the landlords costs have remained the same. however, one could guarantee that the rents would rise over a 10 year period and that the landlords costs would remain relatively stable as the major expense would be their mortgage that, even on interest only, would remain the around the same (yes, council/water rates etc do go up but are not a significant part of costs compared to mortgage repayments).

i'm not saying it can't be done, because JIT has done it ... but i am with the majority of people here who would say that the "average" australian wouldn't invest.

Whose renting at 500 p/w and owner paying out $ 800 p/w? In our case, on interest alone I am better off renting by 86,639 p.a., not to mention numerous other costs for the owner. But the most important factor is being able to live in my desired suburb. What's the point of using my "rent money" in buying a PPOR if it doesn't meet my most important criteria for choosing this particular suburb?

By the way, when they bought the property in 1998, my bil's income was $ 60k p.a. and the cost of their house was $ 180,000 - just 3x his income. His salary today is around $100k a year.

 

[Ausprop]

it's quite easy really... instead of blowing $1m on PPOR, spend it on a comm property and use the positive income to pay your rent.

 

[MellyBelly]

sounds fairly typical. The owner would have their eyes on the bigger picture.... banking on that cap gain as demonstrated 2000-2007

Very typical in my suburb! Some of the properties recently sold for between $1.1 -1.2 M are being let out for $400 p/w.

 

[Jonril]

You are renting a $1M house for $400/week?

Not as uncommon as it sounds. Some landlords are happy land banking.

Someone I know was renting out a ~$800k+ Patterson Lakes property (had a private boat mooring) for ~$250pw.

Someone else I know is renting out a ~$550K Parkdale/Moridalloc property for ~$100pw.

 

[wylie]

So based on the figures provided (190pw/170k to 460pw/600k) the property has gone from a gross yield of 5.8% to 4%. So while the property has worked for you over the last decade (decent capital growth has overshadowed any negative cash flow to begin with), does that mean it will work for someone else that bought it off you to manage for the next 10 years? Will the gross yield drop to 2.75%?

I guess that is up to the buyer, whether they wish to subdivide it (we chose not to) and make money by creating a second block, put two townhouses or one house in the back. It could still have profit in it. But to just buy it and rent it out.... I couldn't afford to buy it now for the rent it is bringing in . It is on the market and I believe the buyer will be a developer or someone looking for a block big enough for a big reno and a pool or tennis court.

Whose renting at 500 p/w and owner paying out $ 800 p/w?

House near us, value about $800K is rented at $650 per week. House we control value $1.2M should rent for $800 per week (currently between tenants).

House quoted earlier that knocked back $2.8M and couldn't get $1.6M recently was on rental market for $1400 per week, now down to $1200 per week (still empty).

There would be no houses value $1M around my area that would rent for as little as $400 per week, but if you can find one, then it would be a good cheap rental.

By the way, when they bought the property in 1998, my bil's income was $ 60k p.a. and the cost of their house was $ 180,000 - just 3x his income. His salary today is around $100k a year.

My son, on a salary of $38K is looking to buy for around $320K interest only. He can get a loan that size only because he will rent one room out.

In 1960 my parents did the same thing, three children under three years old, plus a grown man as a boarder to enable them to move from a besser block garage into a grotty first house. If you want it badly enough, you find a way.

 

[Corey Batt]

How interesting. Houses I am used to hearing being rent for circa $400/week valued at 500k.

At $1M, madness!

 

[tom32]

I hate moving as well, but in my opinion adding moving costs is a bit of a cop out for something you could do yourself. A majority of moving is simply a time expense and there are far more time expenses to do with buying a property than renting one, for example add up the hours you might spend in negotiation with an agent to work out a price, then contract signing, mortgage application process, etc. Buying would be much more a time hog than being forced to move if renting. I think forced moving every 12 months is probably too regular to be realistic.

Time / Opportunity cost:

Agree it is probably too often to say every 12months, on average I move about every 18 months but probably about every second one of these moves is initiated by myself or my family.

I would not have said signing contracts etc is the time expense in buying property but certainly maintenance is. One good thing about renting is no matter how garish the paint job is when the missus says she doesn't like it you can just say too bad we only rent the joint...

My last move had the following costs: $850.00 3 fellas and truck for 6 hours to first pack and then unpack the boxes we had packed.

$280.00 for exit clean + steam clean of carpets.

On top of this we had to pack all the boxes which had to take at least 10hours x 2 people x 2 days one to pack one to unpack. 40 hours even if I calculate our time at $25.00 an hour is still $1000.00. My wife could instead take on a shift a work and for myself on salary as I said I just don't like packing / moving. If someone offered me $60.00 per hour to do it I would still baulk at it. It is fiddly and frustrating all at the same time!

So I suppose upon reflection a better analysis might be $2000.00 per move and ever 2years (being conservative) so call it $1000.00 per year for the average punter who doesn't mind moving as much as I do.

On buying the regularity of moving is about 8 years. I think their is even data suggesting this so it is many times less of an expense.


Outcome for me:

Don't get me wrong after saying all this I still rent my own home so I agree the overall picture for someone taking out a 90% even in my case an approx 75% LVR mortgage renting stacks up big time short of assuming above inflation moves in house prices going forward forever. I take the 3 decades of evidence and add that the first of these decades was mostly only at inflation and it was really when the inflation stopped house prices kept going. I cannot see this being sustainable forever.

All that aside when you put it up against a term deposit for the full purchase price even assuming 0 capital growth i.e. in real terms falls each year to the extent of inflation, which is IMO a pretty bearish view over say 10 years, a 30% odd fall in real terms assuming 3% inflation rate. Buying your PPOR still stacks with the gigantic assumption that you have 100% of the capital to buy it when you compare it to say a 6.5% term deposit taxed at 40% a >> 3.9% NETT yield. Funnily enough about the same as yields in our capital cities. It is for this reason I do not see panic among PPOR owners if property values started to fall.

Imagine selling your PPOR putting it in U bank and first going wow look at all this interest, covers the rent easily! but the very next tax time being slugged with a $13,000.00 tax bill on interest earned assuming a 500k PPOR and a 40% marginal tax rate.

I need to stress I am not in this position nor anywhere near it and have a spouse on a lower tax rate than myself who I thought by piling the money in would help only to find out we now miss all FTB's, I don't even know what the real marginal rate is for her but am starting to suspect in effect it is higher than my own!!! Anyway as time wears on I will likely bite the bullet and buy as I can already see it is not as simple as comparing rent to yield in a bank. Anyway the upshot is at this stage running the numbers is not stacking up for me but with other considerations the time is getting closer by the month with the only caveat being that the higher interest rates go the more renting is appealing...

 

[tom32]

How interesting. Houses I am used to hearing being rent for circa $400/week valued at 500k.

At $1M, madness!

People do not pay the same premium for views etc when renting as they will when buying. I am not sure why this is, but I have seen it time and time again?

The best "value" when renting as far as I can tell is if you want to rent on the beach or on the harbour etc. It seems the high end over $1200.00 per week is lucky to yield more than 3% if we are talking houses and not talking Karratha!

 

[Brett IP]

There seem to be a lot of comparisons based on previous years. We all know that the last 10 years has seen fantastic growth in many properties. For example, my PPOR was bought for $160k in 2003, I bought it in 2006 and its now worth $460k. That kind of growth is not sustainable or continuous. Im certain that in just another 7 years it will not be worth $1.3m. Can hope though

I wish I started investing in the 90's, having 2 or more properties between then and now would make anyone well off. Bit hard to invest when I would have been 7 in 1990 though. I just dont feel it will be like that over the next 5years.

So if you were talking renting 'vs' buying in the current climate, renting would most likely be cheaper if there is no or very little capital growth. The lifestyle choice makes me an owner too though.

 

[MellyBelly]

How interesting. Houses I am used to hearing being rent for circa $400/week valued at 500k.

At $1M, madness!

Over 1M, and if they want a higher rent then the only option is to demolish and spend another 300k+ to rebuild. Even then, places with rents above $850 aren't getting leased quickly and it gets worse for places with rents above $1000 p/w. Most are currently languishing for 8+ weeks in the market. I've got nothing better to do at the moment so am keeping a close watch on the rental market here

 

[Brett IP]

Oh Yeah, and If I could rent a $1m house around my area for $400 - $500 a week id be in there tomorrow. Definitely no point buying in that circumstance.

that is relying on a lot of capital growth

 

[MichaelW]

Ok, lets assume the buyer doesn't make pincipal repayments.. lets calculate the term for the rent to catch up with the buyers repayments

n = {\log(FV) - \log(PV)} / {\log(1 + i)}

assuming rent goes up with inflation i = 3%
FV = 865
PV = 480

n = 20years

naturally there are a lot of other variables in there.. e.g an offset account would cut down the period.

And how many years until the cash flow is on par for renting versus buying if we assume rent rises at 7% pa (i = 7%)...

Rents to rise

Yields are too low at present but are set to take off with income increases and high inflation on the back of the mining boom phase II. Prices might take a breather for a year or two before that rental yield hits the tipping point. I've posted my tipping point hypothesis before. I reckon a two percent differential between prevailing interest rates and rental yields sees tennants become buyers. Today yields are 4.5% and interest rates 7.5% so the gap is too large for now but will close in time.

My $950K property in Sydney is rented at $800pw. Sure, that's a yield of 4.4% and pretty standard, but its actually a yield of 6.4% on my $650K purchase cost in 2002 so I'm sitting pretty. I've locked all my rates at 6.99% for three years so am virtually neutral on a 100% lend on that one but of course I've only got a 20% lend left I think and I've used the equity on my IP development.

IMHO its stupid to assume a zero% down purchase. That sort of argument panders to the bottom socio-economic demographic only. For them it will pretty much always make sense to rent versus buy as they live hand to mouth and can live in a nicer house by renting than buying. For the vast majority of us with the means to service more than the entry level rent then it becomes a choice of buying versus renting. By buying a cheaper house you can pay the same amount in outgoings as you would by renting a more expensive one, but at the end of the day you have an asset to show for it. Inflation reduces your mortgage in real terms over time and you win.

Its not mensa, if there was no inflation then you wouldn't buy. So long as inflation exists, then buying will always beat renting in the long term.

Cheers,
Michael