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Renting versus Buying

  • 03-12-10

With growing concern over housing affordability plaguing would be first home buyers, the issue of whether to rent or buy is more hotly debated now than it has ever been.

As property prices continue to rise, along with interest rates and therefore mortgage repayments, many young Gen Y’s are concerned that they may have missed their opportunity to get onto the property ladder altogether. And some commentators insist that Australian housing markets are just too expensive so it makes more financial sense to rent.

So what is the best way to go? Do you rent or buy? 

The truth is there are pros and cons for both options and ultimately, it’s up to you to work out whether renting or buying a home suits your personal and financial situation best.

The most obvious advantage to renting is flexibility; as a tenant you can freely relocate from home to home and area to area once your lease expires. But because of the costs associated with buying and selling property, as a home owner you have less flexibility when it comes to moving house. It costs about 4% of the sale price of your home to sell (agents fees, advertising, etc) and about 6% of the purchase cost to buy (stamp duty, government fees, loan establishment fees, etc).

Secondly, renting can often be a cheaper alternative to buying, particularly if like many young professionals you prefer the lifestyle and career opportunities that inner city locations provide.

Even though rents are undoubtedly rising significantly as vacancy rates in our major capital cities continue to remain low, more often than not your monthly rental payments will be less than what your mortgage repayments would be if you were to buy a comparable property. This is why a lot of Gen Y’s decide to rent, as it can be difficult to break into the more expensive inner city markets they find desirable as a first home buyer.

Finally, one of the big bonuses to renting is that you avoid costly maintenance, repair, rates and insurance bills that go hand in hand with home ownership. As a tenant, it’s your landlord who is responsible for taking care of such ongoing expenses.

On the other hand, renting has many disadvantages; the most obvious being uncertainty as to whether you will be able to remain in a home you have grown fond of. Tenants have very little say in how long they occupy a rental property. Ultimately this is up to the landlord, who can ask you to move once your lease expires and can also terminate your lease early for a number of reasons.

Essentially the home is never really yours. For instance when you rent, your property manager and landlord can come into your property at any time, as long as they provide sufficient notice and have good reason, such as regular inspections which can happen as frequently as every two or three months. You also cannot make any changes to the property to improve your living space or even put pictures up on the wall without the landlord’s permission. 

The other consideration as a tenant is the rising cost of renting. Even though renting may currently be the cheaper option, rents will always continue to rise in line with the cost of living. Currently rents are increasing at an average rate of about 7% every year. Further, you never stop paying rent, whereas most people will pay off their mortgage within 25 to 30 years. 

When you buy a home however, you have a certain sense of stability. You choose how long you wish to live there (as long as you make your repayments!) and can make improvements to your living space and potentially add value while doing so; creating a wonderful thing called equity (the value of your home minus the amount you owe the banks = your equity).

Basically, renting costs you money while home ownership makes you money. This is because as you pay off your home loan and the value of your property increases, you own more equity. In fact on average, well located properties in Australia double in value every 7 to 10 years, providing a very good return on your initial investment (your deposit) and increasing your net wealth.

Not only that, while your mortgage repayments will generally average out to be around the same for the life of your loan as a home owner, rental payments continue to rise. And even though interest rates can move up and down throughout the time you pay off your home, these fluctuations can generally be planned for, as long as you don’t over extend yourself when buying. 

Lastly, while most people take out a home loan for a term of 25 to 30 years, many home owners will actually pay their mortgage off much quicker as wages increase and their repayments remain relatively consistent. Whereas tenants may never know the feeling of being able to say – this home is mine, I own it.

Of course some would argue that buying property comes with additional costs that many young people simply cannot afford, such as the responsibility of paying for your home’s upkeep in the form of general repairs and maintenance, as well as rates, building insurance, etc. On top of that, more often that not mortgage repayments are higher than rents, particularly in prime inner city locations where housing is less affordable. 

The bottom line for me though, is the difference that buying a home versus renting will make to someone’s personal net wealth and cashflow over their lifetime.  

Let’s say you are a 25 year old first home buyer with about 50 more years of living to do and you have the option to either buy or rent an inner city apartment worth $350,000.

If you were to rent this property, you would be paying your landlord around 5% of the apartment’s value (this is the expected annual return for most investments), which would equal $17,500 per annum or $335 every week ($1458 per calendar month). On top of this, rents double around every ten years, so for the same apartment you will end up paying approximately $35,000 in rent per annum after a decade.

On the other hand, if you were to buy this apartment for $350,000 as a first home buyer, you would have to come up with at least a 5% deposit of $17,500 and borrow the balance of $332,500 (assuming you have the FHOG to pay your buying costs). The interest payable on your 30 year loan (if we assume interest rates average around 6.5% per annum over that time) will be $21,612 per annum or $415 per week.

In addition, you will pay expenses associated with home ownership such as rates, maintenance, insurance, etc which average around 20% of the potential rental income, so in our example this would be $67 per week.

This example shows that it would cost an extra $4112 in the first year ($80 per week) to buy the $350,000 apartment rather than rent.

But what might it cost you over the long term in net wealth if you were to rent rather than buy this apartment? 

If we assume that rents will double in value every ten years, by the time you have rented your apartment for 50 years, you will have paid a total of $11,025,000 and have a net worth of $0 (if you had not purchased any other investments). 

However, if you had bought the apartment for $350,000 and it had doubled in value every ten years (assuming average growth of 7% per annum), the story would be a lot different. While it would have cost you a total of $3,201,600 to own your home over the fifty years, your property has also doubled in value every decade and would be worth $11.2 million.

Therefore, if you purchased the apartment, after fifty years of ownership you would end up with a net worth of almost $8 million.

While there are many arguments for and against renting and buying, the above example clearly illustrates that buying a home has the potential to make you wealthy, even tough it might cost you a little more in the short term. On the other hand, renting will make your landlord rich and put a smile on their face! 

Just remember, it’s all about buying well and buying right.

George Raptis is a director of Metropole Property Investment Strategists in Sydney. He shares his 22 years of experience in the property industry as a licensed estate agent and active property investor. Go to www.metropole.com.au


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