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Wednesday, 27 July 2016 15:06

Renting vs Buying

Renting vs Buying Renting vs Buying

Renting vs Buying – The Math

The vast majority of the time, Australians purchase their own house simply because it makes sense for them and their family; but, if you’re anything like me, you may be curious as to the long-term financial effects of renting vs. buying.  When I purchased my own apartment, it was all very exciting, but I did go to various lengths to figure out what it might mean for my financial position in the long term.  I have decided to write this article to help others that are trying to decide whether to continue renting, or purchase a home of their own. 

The Math

I will give a forewarning to those that don’t like math: this part is fairly technical and boring, so feel free to skip to the graphs and findings in the next section.

It came to my attention that the biggest variable in these calculations is the rise and fall of the property/rental market.  Everyone knows about the high volatility of property prices in Gladstone, so without speculating too much, my best attempt at giving accurate information will come from Gladstone’s past performance.  As found on CoreLogic’s RP Data, the following graph summarises the last 10 years of house’s capital growth in Gladstone, in all its up-and-down glory:

RP Data Gladstone Growth

In working out the financial differences between renting and buying, I needed a case study – I used the following figures for all calculations.

  • Loan interest rate: 6.00% - Where the current home loan rate is below 4% in many cases, with expected cuts to come, I have put 6.00% to account for any rate increases over the next 30 years.  This should be treated as the average interest rate over the 30 years.
  • Growth in rent/prices: 5.23% - Gladstone’s performance over the past 10 years, including the latest “bust”.
  • House value: $320,000.
  • Deposit: 5% i.e. $16,000 - The majority of purchases I see recently use only a 5% deposit.  I have also added the mortgage insurance premium into the loan, as would be the case on a 5% loan. 
  • Rent Value: $220 p.w – A reasonable rental price for a property valued at $320,000.
  • Rates: $2,500 p.a – Estimate only.
  • Maintenance costs: $3,200 p.a - Estimate Only.

The following assumptions were made:

  • Rent and property values both increase/decrease relative to each other i.e. if property values increase by 5.23%p.a, rent also increases by 5.23% p.a. 
  • Rent and property values are compounded monthly. 

Please note: I have also tried compounding rent and property values annually, as this makes more mathematical sense; however, the change in results is negligible, and the graphs come out very jagged and ugly.

  • Any savings i.e. the difference between the cost of renting and owning a home, are invested for the remaining term at 7% p.a.
  • The interest rate on the loan is constant throughout the 30 year period.  The rate used is above the current rate to account for fluctuations.

The calculations at a glance

Rent

This was the easy part - the “Net Wealth Position” for renting was calculated using the cumulative rent payments.  When the cost of owning a home is higher than renting, the difference is set aside and invested at a rate of 7% p.a: the value of this "investment fund" is added to to "Net Wealth Position".

Buying

I won’t go into all the calculations in detail, as they can be seen in the excel spreadsheet, found at the bottom of the page.  The simplified version of how I reached the results is:

-          “PropertyValue” is compounded and calculated monthly based on the growth factor.

-          “LoanBalance” is based off a standard, 30 year amortisation of a bank loan – it only represents the principal owing on the loan.

-          “TotalExpensesToDate” is the sum of: the deposit; cumulative loan payments; maintenance costs and council rates.

 Purchasing Net Wealth Formula

When the cost of renting a home is higher than owning, the difference is set aside and invested at a rate of 7% p.a: the value of this "investment fund" is added to to "Net Wealth Position.

Results

The above values and calculations result in the below graph.

 Results V3

This predicts a wealth difference, after 30 years, of $775,389.07 in favour of purchasing a house.

It is well known that rent is "dead money"; but, less commonly known, is that purchasing your own home will usually result in a such a large profit over the long term.  

What about the rest of Australia?

These calculations and conclusions are valid anywhere in Australia, the only thing changing being the rate of growth - but what is the average rate of growth throughout Australia?

This is a hard question to answer.  I have looked at various sources and seen figures around 8.4% averaged over the last 30 years; unfortunately, I have struggled to find anything with much credibility.  I did manage to find a very interesting graph in RP Data’s 2015 Capital Markets Report (Australia), as seen below.  They did not release the data points, or the mean growth over the period, but based off the figure, I don’t see 8.4% p.a being too far from the truth.

RP Data Australia Growth

Conclusion

While the fact of home ownership is generally more important than the economics; hopefully, this article gives a little insight into the long-term, financial consequences when choosing whether to rent or buy.  Let me know what you think.

The original excel sheet used, which has been edited to be user friendly, can be found as an attachment below.

N.B.  I have tried to write this article as accurately and unbiased as possible.  If anyone has any suggestions/corrections, I’d love to hear it, and I’m more than happy to make edits where necessary.  

Edited on 29/07/2016.

Zak Avery

0466 392 717

This email address is being protected from spambots. You need JavaScript enabled to view it.

26/07/2016

 

DISCLAIMER: You must not rely on the information in the report as an alternative to financial advice from an appropriately qualified professional.  If you have any specific questions about any financial  matter you should consult an appropriately qualified professional.  We do not represent, warrant, undertake or guarantee that the use of guidance in the report will lead to any particular outcome or result.  The content, calculations and opinions contained in this article are of the writer only, and are not necessarily those of Gladstone Home Loans.

Last modified on Friday, 29 July 2016 02:07

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