Rental applications. Urgh! I think they were designed to make you feel like a second-rate citizen. Certainly you get the feeling that property managers think you to be very stupid indeed.
But there are perfectly good reasons for renting that have nothing to do with being unintelligent so don’t let any house spruiking hype make you feel insecure. Very rarely do you see these reasons discussed, and most personal finance spokespeople when discussing the rent vs buy decision target their ramblings at people they consider to be gullible. So often you see the typical argument of “If real estate continues to increase at X% (highest amount) and interest rates stay at Y% (lowest amount) then your house will be worth Z in 5 years time and you’ll be rich. If you rent then you’ll have nothing in 5 years time.” Well this argument is only partially true and there are so many holes in it that its not funny.
Here is just one reason why renting can be better than buying. There are more, but I will run out of space!
Even if it is true that property values “always go up” (which they don’t by the way) you can still lose money buying real estate if you are not prepared to settle down in the one house for the long-term. If you are making many career moves or you are a contractor and working at many different locations, you may not want to commit to living in just one house for the next five to ten years. If you bought a house to live in and then wanted to move you would have to sell the house or rent it out. But this has some very significant tax implications which could potentially see you lose money.
Irrespective of what the tax experts say, owning your own home is not a tax-free investment. In fact it is taxed very highly if you are not wanting to live in the one house long term, because you are taxed upfront. The tax that is paid upfront is based on the price of the house, and therefore in a property boom the tax on buying a house increases as a percentage of our annual income. So if you want to move house as frequently as you can when renting then watch out!
Here is an example of the kind of expenses we could be talking about:
Tim and Sarah are a young professional couple who are trying to build their career.
Tim Jones earns $75,000 plus super
Sarah Jones earns $75,000 plus super
Combined their income after tax is $106,000 because they also had some HECS debt to pay.
Tim and Sarah buy a house for $600,000 in Victoria
The 20% deposit is $120,000 (if they only paid 10% they would have to pay a lot of money in compulsory mortgage insurance)
The stamp duty (tax) is $33000
The cost of conveyancing and bank fees and post inspections and building inspections and what not come to another $2000 (this is cheap – I’m just rounding the numbers)
So all up they have paid 155,000 to secure their house.
Now lets say they get a loan at 8% over 25 years. The repayment is $3,704.72 per month.
What happens if they live in the house for 12 months and then Tim wants to take a new job in Sydney in order to improve his career progression?
The mortgage balance after 12 months will still be approximately $473,700. So they will have gained only $6300 in equity without considering the house value, but over one year Tim and Sarah have made $44,500 in repayments.
The cost of selling would be around $10,000 in real estate agent fees and plus Tim and Sarah need to pay council rates and water rates and sewerage (more tax), and the cost of having the yard tidied up and the house cleaned and anything that they accidentally damaged needs to be fixed. Realistically they can expect to pay $15,000 to sell.
So, if the house price stayed exactly the same after 12 months, what would be their return on investment?
- investment = $155,000 (house purchase) + $44,500 (repayments) + $15,000 (selling cost)
- total money invested = $214,500
- capital returned after house sale = $120,000 (initial deposit) + $6,300 (capital repayment)
- total capital returned = $126,300
- housing cost deficit = $88,200 – this is 83% of the couple’s net income for the year spent on housing
Yikes!
But what if the house price increased by the supposed average value of 7% per annum? Wouldn’t Tim and Sarah be fine then?
- investment = $155,000 (house purchase) + $44,500 (repayments) + $15,000 (selling cost)
- total money invested = $214,500
- capital returned after house sale = $120,000 (initial deposit) + $6,300 (capital repayment) + $42,000 (capital increase)
- total capital returned = $168,300
- housing cost deficit = $46,200 – this is 44% of the couple’s net income spent on housing
So as you can see, if you are not in a stable situation where you can live in the same house for a number of years you can lose a lot of money buying a house. This is not even considering the terrible situation that could happen if the house actually went backwards in value in the year that the house is owned.
If Tim and Sarah had actually rented the same house at 4% yield, and put the rest of their money into different investments this is how it would have turned out.
If they put their money in a zero interest bank account:
- total money invested = $155,000 (house deposit sitting in the bank) + $24,000 (rent) == 179,000
- capital returned = $155,000
- housing cost deficit = $24,000 – this is 23% of the couple’s net income spent on housing
If they put their money in a managed fund or shares that earned 7% after tax and fees (10-11% before tax and fees):
- total money invested = $155,000 (house deposit sitting in the managed fund) + $24,000 (rent) == 179,000
- capital returned = $155,000 + $11,000 (profit)
- housing cost deficit = $13,000 – this is 12% of the couple’s net income spent on housing
In order to get the same result in one year from buying their home, Tim and Sarah would have had to get a 12.5% increase in their house value in the 12 months they owned it. Yes, it happens sometimes but don’t expect that kind of increase in real estate every year. Then again, don’t just expect good returns in managed funds and other investments in just one year either, but look at your own situation and what looks safest.
So as you can see, if your circumstances change (which they tend to when you are young) you can make a huge mistake by buying a house and then selling it again instead of renting! You could make the financial situation better by renting out the house while you rent another house closer to your work, but keep in mind that that could be very stressful because you would be paying rent and paying off mortgage debt in excess of the rent you charge at the same time, you will now have to pay capital gains tax when you sell, and in the meantime you will have to be a landlord or pay a management company to look after your real estate investment. The benefit however would be that your upfront tax would be divided over more years.
Unless you’re buying a house for the long-term (and lets face it, some of us don’t know what we’re doing next week, let alone in five years time) buying a house is very risky indeed. The only reason I have consistently made money in real estate given I have moved house six times in six years to move closer to higher paying work is because I have always bought a cheaper house (less stamp duty tax – my first house was only $7,000 in tax) at the beginning of a property price increase, did it up cheaply and then sold it 1.5 years later for 25-55% increase. I always picked the market and rented during the times when I didn’t expect house prices to do much. But if I had saved all the money I have spent on deposits and paying off mortgages and correctly picked the sharemarket instead, I might have done much better (but then again I could have lost the lot – you can never tell). At the end of the day, the expense of renting a house is the only consumable part of a house purchase – everything else is an investment and needs to be treated accordingly and compared with other investment returns.
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