Many young people fear they may never get a foot on the property ladder. We’ve all heard the phrase, ‘rent money is dead money’ – after all, why pay off someone else’s mortgage? But in the current market, does it make more financial sense to buy or rent?
Recent research suggests it’s still better to buy
Two economists at Melbourne University, Dominic Crowley and Shuyun May Li, frustrated at being outbid at auction, decided to crunch the numbers. Their research paper asked if it was better to buy real estate or rent a similar property and invest the principal home loan payments into shares and term deposits instead.
The researchers constructed two scenarios:
Scenario 1: A home buyer puts a 20% deposit on a medium-priced free-standing established home, on which they then make interest-only payments, making no additional repayments. After ten years they sell and realise a capital gain, minus both the initial and ongoing costs of home ownership to reach a net gain.
Scenario 2: Another person rents a similar property but has to move three times during the ten-year period (as is common for renters). They invest the equivalent of the home owner’s deposit into a mix of shares and term deposits, making no extra investments but reinvesting the dividends. At the end of the ten years, they sell their investments and realise a capital gain, minus capital gains taxes.
They then tracked each year from 1983 until 2005 for a ten-year period to determine which strategy would have come out ahead during that time. Overall, buying was the winner. Over the last three decades, Australian property owners were found to have gained greater returns than renters who invested elsewhere.
In Sydney, buying was the better financial strategy in all but four years, during which house prices had peaked, but interest rates were high. Likewise, in Melbourne buying was better in all but six years and the same was true for the other capital cities the pair looked at.
Timing was important, as there were periods when prices would fall and stagnate, and therefore renting came out ahead, but overall — providing you don’t move too often — the returns on home ownership were higher. However, their research also found that returns on share investing were better than other forms of saving.
However, it’s important to note that while past performance is a good indicator, it isn’t a perfect predictor when it comes to investing, and some years renting came out the winner.
Weighing up your options
The question of renting or buying is not just a financial decision but also a lifestyle one. Much also depends on your circumstances and personality.
Renting pros and cons
- Flexibility to move whenever you want and live in areas you may not be able to afford to buy in.
- Less stability as you can be forced to move when you don’t want to.
- Less expenses without all the associated costs of home ownership, although rent costs are rising in many cities.
- Less freedom to make changes, improvements or upgrades to your home.
- Retirement security – If you choose to rent you will need to make sure you have enough money to continue to rent throughout your retirement as a pension income is unlikely to cover the cost.
Buying pros and cons
- Less flexibility as moving as a homeowner can be prohibitively expensive.
- Security because you never have to move if you don’t want to.
- Being house proud – When you own, you can renovate and make changes to your home as you please.
- Equity and capital gains are a major benefit for home ownership.
Retirement security – Ideally, by retirement age or earlier you will have paid off your home and can save that extra money into your superannuation.
The best of both worlds: rentvesting?
As it gets harder to enter the market, a final option more young people are choosing these days is renting where they want to live and buying an investment property elsewhere. As with any major financial decision, it’s all about getting the right advice and figuring out what’s right for you.
Any advice given is of a general nature only and does not take into consideration your personal circumstances. Please consider the appropriateness of the advice before acting.