My local library has magazine back issues. I was reading a Money, August 2004 article by Paul Citheroe, entitled am I better off Renting or buying a home? on pg 22.
Virgin home loans are now available at 7.34%pa. That’s pretty darn cheap. But still not as cheap as my preferred lender, HomePath (a Commonwealth bank subsidiary). All this cheap money, someone should buy a house, right?
I advocate two positions. One I advance to those people I know that are good savers. That is, buying a home is for suckers. The other I push on those whose money management… leaves something to be desired. Perhaps they show the kind of financial restraint that the Enron accountants did. Anyways, to them, I say “buy a house. Now. Are you still here? Go on, get!”
Paul agrees with me, sort of. He thinks that we’re all spendthrifts, just because our country is going into the hole at $2b/month:
Given our poor track record as savers, I fear that you won’t “rent and buy shares.” You’ll rent and blow the money on lifestyle, leaving you in the situation at retirement with no house and no investments.
But, he says, that’s irrelevant, because of the figures in the article which show you’re better off buying real estate, regardless of the alternative of saving while renting. He give enough hints in the article that I might be able to reproduce his (well, the Macquarie Bank’s) workings and then refute his proposition.
|Buy and repay||Rent and invest|
|Income||–||4.12% dividend (what’s the franking level?)|
|Txn costs in||$8586||1 month’s bond ($14,300),
1% on shares
|Txn costs out||2%?||1%|
|Holding costs||$30,543pa interest +
~$3,700pa rates, insurance, etc
Shares at 8.1% capital gain, 4.12% dividend (what’s the franking level?). Actually, the long term average is about 10% gain; perhaps that’s with taxes paid and dividends re-invested. Don’t know about average dividends or franking levels. 8.1%pa growth for property matches my understanding, which is a long term average of 8%.
Shares with a 1% broker fee (you’d be hard pressed to pay that kind of fee, it ought to be more in the $50 range).
CGT at the marginal rate – I wonder if they 50% discounted it? CGT will only be payable on realization of the asset, which might not happen.
Strata levis (etc) increasing at 3%pa ($19,219 total by year 5), rental of $14300 (figure from NSW dept of housing for 2br flat) increasing at 5%pa ($78,890 total by year 5). I presume these figures are reasonable. Except, $337,500 property (average Sydney property) – is this the same property as the 2br flat used to calculate rent, or is it a better property?
Already I can see a problem – the yield on the property is incomparable to reality. I don’t think they’re comparing apples with oranges – $14,300 rental on a $337,500 flat is about a 4% yield, and you generally don’t see that high a gross yield. More like 2%, perhaps 3%.
30% marginal tax rate, $39086 in savings (questionable), $7K First Home Owner Grant (you might get more than that), acquisition/loan establishment costs of $8586, no stamp duty – (Flash stamp duty calculator, or non-flash) – but no stamp duty is unlikely.
1 month’s rent as bond. Agent fees on property realization 2% (this assumes no advertising etc costs, which is highly unlikely) – I don’t know why they’re indexed at 3%.
Initial mortgage of 337,500 at 7.6%pa fixed for 25yrs $30,543pa.
As he stated, he ignored reno costs of IBISWorld estimated $500pa – a lot on the low side by my figuring, and something your landlord picks up the tab on. You’re going to lose the hot water service every ten or twenty years, a new fence, new carpets, kitchen cabinets, curtains, a lick of paint every five years, new taps every twenty, light fittings, etc. Every 50-100 years you’re going to need to replace the whole house. It all adds up, even if all you’re paying for is materials.
Okay, what about HECS and Medicare? As your taxable income goes down, so do these components.
The analysis wasn’t controlled so that the take-home was the same for both parties. It would have allowed a tax-deductible margin loan to ramp up the share exposure. Apples with apples!
So, after all these random bullet points, I’ve decided that the analysis was flawed, and heavily biased towards home purchase. I did a similar analysis six years ago, and renting came out ahead of borrowing to buy. But the real money was in buying, and then mortgaging to purchase shares. But the spread between margin loans and home loans was a lot larger back then.
For a US-centric view on things, read Misconception: Renting is for Suckers. There, home loan interest is deductible from tax (you can get a similar arrangement here, if you are able to jump through the significantly large hoops).