For most Australians, there isn’t even a question in this statement. Retate the question as “when to buy a home”, and you’re probably closer to the mark. Maybe even “how to buy a home”. It is borderline heresay to phrase it as “don’t buy a home if…”.
If you don’t want to read my background to this note then skip to the bottom, which shows a link to a website where you can put in variables to work out for yourself whether you think buying is better than renting…
Should you buy or rent?
Let’s start with a statement of the blindingly obvious. There are few investments that you could have made in the past 6 or so years that would have outperformed a simple purchase of an investment property in Perth. The broad market peaked somewhere around 2006/07, depending on which suburbs you were in but anything much before that and you would be sitting on a profitable purchase about now.
A quick look at REIWA figures shows that many suburbs have shown capital growth rates of return around the 10%pa level. That is a seriously high rate of return, given that rental income comes on top of that.
So let’s just accept all of that for the moment and then put it aside and have a look at the purchase of a home today.
Why even do the maths? Isn’t it obvious?
It is extremely easy to see a new purchase as being likely to follow the paths of the past, and in many cases this would probably be a reasonable assessment. However, most of us do not really have a robust understanding of the past – our memories are like those of racetrack gamblers talking about their big winnings and glossing over the not-so-good days. An academically strong look at returns for areas such as property and shares would show that the returns of both are broadly in line with each other, the actual results differing according to the periods that you choose to look at, compounded by respective cycles for interest rates, availability of credit, economic conditions such as employment and national growth.
What’s my point? It is that the purchase of a home is likely to involve the largest chunk of capital and income that you are going to make in your lifetime. Get it right, and the world is bliss. Get it wrong, and not so blissful. This seems a ridiculous statement to make in Perth, as the vast bulk of home purchases in this lovely city have turned out to be fine decisions. However, the world of money is a fickle place, and after more than just a few years of trying to learn more and more about how money works or doesn’t, i cannot really say with any sense of conviction that the future is any more obvious to me than it was when i left high school. And yet our technologically driven world is throwing data and statistics and news at us in volumes and at a rate unprecedented in history. Many commentators and analysts and individuals talk as if there were no mysteries in the world, and everything is coherent and logical and understandable – so long as you buy a yearly subscription or a book or subscribe to a website or read the 27 secrets to picking the right investments at the right time. Frankly, i do not believe that our minds have yet developed to the point where we can efficiently see through the clutter to establish what are useful facts and what are simply opinions or useless changes in data values. And this is my point – the purchase of a home should NOT be a foregone conclusion. It should be a considered decision, and it is my belief that this is even more important in todays world.
A quick restatement of the Great Disclaimer
Remember the Great Disclaimer for this site (http://www.michaelsmusings.com.au/warnings-and-disclaimers/) – nothing here is to be considered personal advice. You have to read the Great Disclaimer and understand that personal advice cannot be delivered across a blog or any such scatter-gun forum. So, please read this and any other notes as simply the opinion of a person with an opinion and as a broad statement of that opinion and not as a statement that says you should buy, sell, hold or paint a particular asset/share/property/deposit that you may or may not own.
Gotta love disclaimers. Actually, i don’t have to and i don’t. However, this disclaimer is important – even if only because Australians take their properties seriously (think of the barbeque discussions of renovation horror-stories told with such relish that it actually sounds like these people enjoyed being deprived of a life for those 9 months).
How to compare buying and renting
How do you start to do a comparison of whether it is better to buy or to sell? There are so many variables that the task can seem daunting, if not impossible. The best way to start is to look at a specific property that you would like to buy. An alternative is to look at the average house price. In Perth that could be any one of a number of possibilities, as “average” means different things to different people. However, let’s go on the assumption that it is something like $500,000 so we at least have a starting point.
Now you need to save up a deposit, ’cause you ain’t gonna get 100% without putting up other security – and for the moment, we are not looking at that as a scenario. So, any money you put into the home is money that you could have invested if you were renting. So that is one thing to account for.
If you rent then you don’t usually have to pay water or council rates, house insurance (although having contents insurance would be prudent), maintenance, repairs or renovations. These are all costs that the landlord wears. So, any look at the prospective value of a house purchase should take this into account. You should also take account of the rental bond or other costs associated with renting.
If you are buying then there is most likely going to be a mortgage. Most folk don’t save up $500,000 – and those who do aren’t usually in the market for a $500,000 property…. So you are going to have to account for mortgage interest and loan costs.
There will definitely be purchase and sale costs. The primary purchase cost is stamp-duty and various government charges. These are going to add up, and there are a plethora of websites that will give you an idea of what these costs are likely to be.
For the moment, let’s ignore vanity and artistic flair – how much you devote to buying the latest and greatest to make your house a home is a very personal choice – but don’t completely ignore the fact that you will tend to buy a good deal of housewares when you own a property as opposed to when you rent. It’s not something you can really measure and maybe you shouldn’t anyway – after all, that is the bit that makes it all worthwhile, fun and fulfilling, isn’t it?
The difficulty is in the future
So far we are measuring fairly distinct figures that can be identified relatively easily. The big issue is trying to work out what is going to happen in the future, and the truth is that you simply cannot know. You cannot ask someone because they aren’t going to know either. If they can convince you that they do then call into the office next week, ’cause i have a bridge that you might want to buy.
From here we need to start with some kind of projection into the future. What increases are likely to happen to the rent that you would be paying? What rate of interest are you likely to pay on a mortgage? How much are house prices likely to shift, and in what direction? What are the likely taxation imposts in the future? How will purchase and sale costs alter?
As mentioned at the start of this note, many people have an expectation that Perth property will run at 10% pa growth in prices. Maybe it will and maybe it won’t. Just keep in mind that Australia is almost alone in the developed world in having an average house price that isn’t too far away from its peak a few years ago – and in some places it is back at that level. There have been severe price drops in the USA, UK, Ireland, Spain, Italy, and the list goes on. Japan house prices are still where they were back in the early 1990’s or even lower. So when looking at the future, it is a good idea to temper any visions of splendour you may have as to capital returns from our current level.
In broad terms, the price of a home is the replacement cost of the buildings/improvements and the value of the land as determined by supply/demand. The buildings costs will normally move with inflation, while the land costs will be more a factor of how many people want to live in that area. Residential property is therefore considered a very good hedge against inflation, and so long as demographics continue to point to a growing population then it is logical to assume increased demand for well located property and therefore capital growth.
There are so many aspects to cover on this that we aren’t really going to try here. Let’s just agree that the above is a starting point for considering how you work out a future growth rate for property prices (remember, growth rates can be negative..!).
Now do your calculations
If you’ve worked through to this point, you are probably a bit tired and deserve a break. So go and grab a coffee/ tea / water/ wine and come back refreshed to tackle this lovely calculator sitting on the New York Times website. It is aimed at US markets, and therfore shows default house prices that are a bit of a joke for Perth buyers – but the point is that you can change all of the variables and do your own mathematics using this calculator.
New York Times buy vs rent calculator – http://www.nytimes.com/interactive/business/buy-rent-calculator.html?nl=todaysheadlines&emc=thab1
Remember a few key points. You’ll need to alter the buying and selling costs to Australian conditions, and you will need to make the deductibility of interest costs zero (it seems interest on a home mortgage can be deductible in the USofA). You will need to put in an inflation rate closer to Australia’s – maybe 3%?, and you will need to decide on likely rental costs and a rate of increase for rents.
That’s it. Have fun, and feel free to send in any feedback on the outcomes you come up with.