Rent or Own

Homeownership is an investment decision but it is also a lifestyle choice. There is no right answer but set out below are the circumstances for you to take into consideration in making a decision as to which is best for you.

Making an investment

About 94% of working Australians will have the opportunity during their working life to make investments. For them they will, in most cases, have a right to choose which form of investments they make. The most popular investments for individuals are property, shares, precious metals or works of art.

You need to understand right at the beginning, that in purchasing your own house you will be forgoing the opportunity of making this investments in an alternatives. You could look back over history of housing in Australia and do the calculation for any person who has brought their own house and compared it with investment alternatives and you will find a wide margin of outcomes.

The house that you live in will have a capital value. Your options are whether that is your capital or someone else. Let's look at the former first.    

Owning your house

One of the most common sayings I encounter from a lot of people including those who should know better is that paying rent is dead money.  I find this statement interesting especially when it comes from people that have mortgages and don't consider paying interest is dead money.

Whether you have all the money, some of the money or hardly any of the money to buy your house, is not relevant. The reasons are obvious, the more of your capital you have invested in your house the less you must have available for other investment purposes.

Borrowing money to buy your house

Historically home ownership in Australia has been a popular policy of the community, I would imagine since the First Fleet arrived. This is reflected in the generous way that home ownership is treated by the government and corporate Australia.

It is important at this point however to be very careful not to confuse consideration of homeownership with any relationship to the housing industry.

The housing industry is a national 'cave making' industry. Whether you own or rent the cave is of no consequence, this industry is driven entirely by the demand for caves, not the demand for homeownership, which is another matter all together.

Shop around online for less than 10 minutes and you will find that the costs for borrowing to invest in your own house are the second most favourable for any investment. (Governments bonds get the best deals).

Borrowing to invest in alternate investments is considerably more expensive. This is the first point in favour of buying your own house.

Capital Investment

A lot of people over the age of 12 know that when considering a Capital investment there is two characteristics to consider:

• income; and
• growth on capital invested.

Let's take income first.

Income.

The money you save by not having to pay rent can be considered to be the income generated by owning your house. However you will need to test this income against the expenses involved in generating the income.

These expenses will comprise a consideration of three aspects. They are:

• forgone income from alternative sources; and
• loan servicing cost paid in acquiring the facility; and
• cost of owning the income producing asset.

The amount of your money you will have invested in your home will range anywhere from your initial deposit to  100% of the cost of purchase

Let’s look at an example.

You purchase a house for the selling price of $400,000. You use $40,000 of your money. The rest you borrow from a lender. By the time you take possession of the house will cost you say $440,000.

The purchase of this house now provide you with rent-free accommodation thus generating for you an income of say $20,000 year (The cost to rent the premises)

Your expenses in owning the house will be

the funding cost of servicing your loan, which will comprise

• the additional funds you investment (loan repayment); and
• the interest on the loan.

the costs of supporting the asset. They are:

• insurance
• local government charges
• building repairs and maintenance

The precise accounting is quite complex because some costs are common to the options of both owning and renting -i.e. insurance of contents and some costs are exclusive to owning the building -i.e. building insurance and essential services charges.

The costs in maintaining the property are likewise intertwined.

For example, the cost of maintaining the landscaping is common to both options where as the cost of structural repairs is solely the responsibility of the building owner. Just for the purposes of the simplified example I have not drill down to this level of complexity. Table 1 set out a simple but indicative sample of a Financial Statement for a purchased house.

TABLE 1

Sale Price	$400,000
Taxes ect	$40,000
Purchase price	$440,000
Balance Sheet			Profit and Loss
Year 1
			Income
			Rent Savings	$20,000
			Expenses
Your Investment	$40,000		Forgone Income @3.8%	$1,520
Loan @ 5%	$400,000		Insurance	$1,200
Annual Repayment	$5,764		Local Council	$2,500
Interest Payment	$20,000		Interest	$20,000
Service Charges	$25,764		Repairs & B Maintenance	$1,000
Capital Growth @1%	$4,000		TOTAL	$26,220
			Net	-$6,220
Year 2
			Income
			Rent Savings (Up 3.8%)	$20,780
			Expenses
Your Investment	$45,764		Forgone Income @3.9%	$1,785
Loan @ 5.1%	$394,236		Insurance	$1,250
Annual Repayment	$5,658		Local Council	$2,700
Interest Payment	$20,106		Interest	$20,106
Service Charges	$25,764		Repairs & B Maintenance	$1,050
Capital Growth @3%	$12,120		TOTAL	$26,891
			Net	-$6,111
Year 3
			Income
			Rent Savings (Up 3.8%)	$21,403
			Expenses
Your Investment	$51,422		Forgone Income @ 4.0%	$2,057
Loan @ 5.2%	$388,578		Insurance	$1,300
Annual Repayment	$5,558		Local Council	$2,900
Interest Payment	$20,206		Interest	$20,206
Service Charges	$25,764		Repairs & B Maintenance	$1,100
Capital Growth @-3%	-$12,484		TOTAL	$27,563
			Net	-$6,160

 

and now to Capital

Capital

I know that it is stating the bleeding obvious but there are two spheres of capital growth in owning your own house

• one is the land that it sits upon; and
• the other the materials it is constructed from.

Let's take housing materials first.

Housing Material

All most all housing materials depreciate. Depreciation rate for every house is special to that structure. The rate of depreciation is dependent upon a huge number of factors and they include:

• the quality of materials used in construction;
• the popularity of the construction material;
• the quality of workmanship which assembled the materials;
• the climatic exposure location of the house;
• the amount of maintenance applied to the house,

but to name a few

Another statement I often hear that also stuns me is something like "...and it only cost me 1200 quid (£) to build (their house)".

The comparison between the cost to purchase materials when a house was originally constructed and the cost to purchase those materials today is useless, unless you know it's converted cost to today's equivalent. [£1200 in 1930 when annual average income was £300 is $200,000 in 2014]

It is this aspect which gives the illusion that in fact all building materials are appreciating. They well be appreciating in monitory value but may not be appreciating in relative value. Technology has made construction of some material relatively cheaper. i.e. concrete blocks and bricks.

There are a few materials that actually have appreciated in real value. The most significant of those is Australian hardwood timber, for the very same reason that antiques and works of art appreciate. In 2014 Australian hardwood timber is a scarce resource compared to 1914  and the quality of the material is unsurpassed by any other, for house building. A fact adopted by a large part of the planet which are now planning large forests of Australian hardwood. However any house you build today will have precious little if any of this particular material. We shall revisit this aspect again in the section where we consider existing verses new housing.

The remainder of housing materials take the same path as humans, downhill from the day they were first installed. Maintenance is crucial and just like attention to good health will delay the ageing process so to with house material but the process itself, in the end, wins every time.

You only need visit a cemetery, find yourself a marble headstone that was erected in the 19th century and read the inscription, if you can. All the while remembering that this is built of granite one of the more hardy rocks on this planet. Any headstone over 200 years of age without maintenance is indecipherable.

Now let's look at land.

Land

We know the story of capital growth within the capital cities and we have heard of the astronomical growth in some regional centres involved in the mining boom. We are aware of the capital depreciation  that exists within townships  supported by robust farming industries and we should be aware of the mediocre performance of a whole range of localities that sits somewhere outside this mix.

I'm a baby boomer so I'll look at my generation. We started purchasing houses generally in the late 1960' early 70s and most baby boomers have now reached the stage where for those that purchased their property on the mortgage system now own then outright. The capital appreciation story for our generation is likewise remarkably different. Some have appreciated as much as 20 times the rate of inflation and some less than the rate of inflation rate, with everything in between.

Two forces drive the price of land:

• the first one is growing population; and
• the second is affluence -

Australia has both.

Population

Although Australians of childbearing age who were born in Australia are unlikely to reproduce above their replacement level, Australia still is a significant migration destination and migration will continue to influence land prices (in capital cities) until well into the middle of the 21st century.

In balance to this, Australia is one of the lowest population to area density countries in the world so Australia has no real shortage of available land for housing. This situation should see land competitively priced for house buyers. Unfortunately though because we have high migration and newcomers to a country tend to cluster in areas where there is a level of familiarity as well as access to lots of low skilled jobs, our capital cities acts like independent states drawing and holding the majority of population growth and while the regions possess an abundance of housing stock land, the demand is primarily in the major capital cities.

Further the rise of an emphasis on sustainable living by regulatory controls over land use, has seen the general availability of land for housing use become restricted, particularly with the exclusion for example of good quality agricultural land, ecco system protection and with climate change, foreshore land, but to name a few, from use for housing.

Another very important practice has evolved in the last 20 years is that of requiring the purchases of housing land to pay at the point of purchase, all the costs of delivering all infrastructure such as sewerage, water, electricity, telecommunications, waste services, parks, recreation land, sports fields, transport systems, transport corridors, street lighting, bikeways, pedestrian access - addend infinitum, to their property. Add to this the existing trend of all State governments to raise a fair proportion of their revenue by taxing people, at very heavy marginal rates of tax, for dealing with property. and the 10% slug to land prices caused by GST and you have a recipe for high prices for housing land.

All these factors are responsible for the huge windfall delivered to the baby boomers who were never required to pay any where near these cost when they purchased land in the 1960s and 70s but now can trade their purchases in a market where housing real estate reflects this huge cost burden.

When I purchased my first house in 1968 I paid 1.5 times the Australian average annual income for my land, Today homeowners are paying in excess of 4.5 times that benchmark for the same lot. All of these factors have put upward pressure on land for housing and are responsible for the capital growth that has occurred in areas affected by these factors.

A word of caution

I am not a believer in a linear approach to predicting the future. Huge forces are currently in play within the world we live in. Technology: Climate Change: Natural Resource Exhaustion: Planetary Pollution: Species Population Change: but to mention a smattering of players.

Australia birth rate is now below replacement levels. Global population growth peaked in 2004 at about adding 97 Million extra inhabitants per year and will be in the vicinity of about 88 Million this year (2014) and if the decline in growth is a linear projection humans will reach ZPG [Zero Population Growth] in 2060 at about 8.8 billion humans: All of these will effect the price of land - catastrophically for some: advantageous for others.

Affluence

If you think there are a large number of variables in population driving a consideration of the prospects related to the capital of your investment, they pale into insignificance when compared to the variables that make up the economy and therefore the prosperity or affluence of the Australian community.

A country has only two options in generating wealth. Either it can be created by the use of its natural resources (such as Australia and Saudi Arabia currently does) or it import the wealth of other countries into your economy such as the Germany, Japanese and to a lesser extent the Chinese, currently do.

Once an economy generates wealth, it then distributes that wealth albeit unevenly throughout the community either through the mechanism of the private sector, in the service industries or through the government by support to a range of recipients. In any event the affluence of the community at any point in time depends on the good fortune of the nations economy and this is a big drivers in housing prices.

The other big affluence factor in housing prices is interest rate, because 96% of house purchases will be to buyers that will need to borrow a portion of the sum of money they wished to invest. Further, the younger the borrower the less likely they will be in a position make an accurate assessment of the likely future movement of interest rates over the term of the loan.

Thus when interest rates are low, more purchases of houses are made thus driving up demand, thus driving up the price. When interest rates are high purchases of houses are deferred and current ownership abandonment by default circumstances, thus lessening demand, thus lowering house price. Rarely does a house purchaser access the likely risk of spread of the mortgage rate possibly encountered over the term of the loan and and factor this risk into the decision making process.

I have yet to discover a mortgage rate calculator that allows you to plug in 10 likely interest rates changes that could occur over the term of your loan and the sequence in which this will happen and then provide you with this feed back. Perhaps it is too cynical of me to say that most of the mortgage rate loan repayment calculators available are on websites, belong to lending authorities whose life blood is to lend money.

Global affluence is on the increase and Australia has a high desirability as a destination for investment. This will also fuel demand driven by the inflow of capital, a portion of which will be directed towards the housing market in capital cities.

I am sure that you can see by now the plethora of complex factors that need to be plugged in to the equation in determine or estimating whether and by what amount and in which direction capital appreciation on the purchase of a particular house will involve.

Life Style

Every day we spend some of our resources on lifestyle choices, be they, to take a holiday, buy additional clothes, watch a movie or someone playing sport, abandon a perfectly good motor vehicle to acquire a new or so on and so on.

Owning your own house is a lifestyle choice. Irrespective of whether it is a good investment or not.

For most of my life I made the lifestyle choice to own my own house, except for a five-year period when I rented someone else’s. These five years were the most unpleasant living experience in my 45 years of home occupation.

Being told where I can store items and how my kitchen sink plugs hole is not to the required standard of cleanliness. Having to note every scratch and dent on taking up occupation so as to not have to fund repairs when the occupancy is over. Living my life in 12 month cycles not knowing if I’d still be at that address after the current contract expired. At the mercy of the owner in relation to rent increases because the onerous task and cost of shifting places, puts the tenant at a distinct bargaining disadvantage and so on.

You can buy yourself out of these particular circumstances, if like me, you found them obnoxious but they can come at a cost and you have to calculate the monetary value of what it is worth to you to be free of these regular and externally imposed hassles as a tenant in favour of a much more independent living experience .

Maintenance

Maintenance of a house you own will make many more demands upon you than the house you rent. These demands require both your time and your financial resources.

Renting
The maintenance of a rented house will broadly be set out in a written agreement, which you will enter into and will defined what your obligations will be and may allow you to determine how this is delivered for all or maybe most these service obligations. You may for example be obliged by the contract to have the services of maintenance of swimming pools, air-conditioned filters and landscape management undertaken by commercial contractors.

There is less maintenance required of you, as a tenant, than there is as a homeowner and so you will have more time available with which you may invest in other lifestyle activities. The quality of your maintenance though will be under constant external supervision and over which you will have little practical bargaining power as to satisfaction of the quality of the service provided. There are statutory authorities who will arbitrate grievances but they are not a practical facility. They are cumbersome and time hungry procedures.

Ownership

The amount of maintenance required for your house will depend significantly on the house you acquire taking into consideration my comments above under Housing Material.

The amount of maintenance you actually do on your house will be entirely at your discretion, as to will be the quality.

While not actually maintenance, another function that is available to you as the homeowner is to actually undertake improvements to both the quality and livability of your house. The amount of this activity you undertake is likewise entirely at your discretion but normally the pride of ownership is a driving motivational force to encourage a reasonable number of homeowners to invest significantly in this activity.

It is worthwhile to make the comment here that these improvements may or may not add capital value on to your house. It will very much depend what you do and how you do it.

 

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