Should I buy the house I am renting?

I am trying to get the "theoretical" issues raised in this post into a practical example.


Let’s take a particular individual facing a decision now

Age 30
Salary €80k
Savings €50k in cash
Saving around €10k per year

Renting a two bedroom apartment for around €900k per month.

His landlord offers to sell him the apartment for €220k.
For comparison purposes, assume he gets a 100% mortgage fixed at 4.4% for 10 years.

Rental cost: €11,000 per annum
Mortgage interest €10,000 per annum

So there is no significant difference between rental cost and mortgage interest.
Let’s also ignore the tax relief on rental payments and mortgage interest as they are not significant.
He can sub-let a room whether he owns it or is renting.

Let’s say he lives in it for 10 years and then sells it.

Transaction costs
No stamp duty
€1,000 legal fees to buy
€1,000 legal fees to sell
€3,000 auctioneers fees to sell

He will have decoration and furnishing costs but he gets a benefit from these costs. He can if he wishes not decorate it or he can furnish it cheaply which is presumably what comes with a rented apartment.


Risk in buying
The big risk is that house prices might fall over the ten years and he will have to fund the loss from his savings.
The additional risk is that his accommodation requirements may change and he may need to sell the apartment earlier than ten years. This spreads the €5,000 transaction costs over fewer years but they are not that significant.

Risk in continuing to rent
House prices and rents may rise over the ten years

That is a specific example at a specific time from a market point of view
If he believes that house prices will fall further, then of course, he should not buy.
If he thinks that rent will fall, then he should not buy.

If he thinks that house prices will rise, he should buy

So are his investments hopelessly focussed on just one asset class and one asset?
Sure they are focussed on one asset. But he can handle the risk of a long-term fall easily.

There is probably a greater risk of rising rents over ten years. Certainly a higher risk of rising rents over a longer term.

Alternative strategy
Continue to rent.
Borrow €220k and buy a portfolio of shares.
Over ten years, it should outperform the increase in property value.

What factors would shift the decision in favour of renting over buying
A fall in rental rates
A rise in interest rates
A rise in house prices over the current level before he decides.
Second time buyers will be paying stamp duty
A requirement for a much more expensive house which would increase the risk
Uncertainty over where he will be working or living over the next few years

I think that this guy should buy the house now. Depending on how safe his job is and how his earnings might rise, I think he could go for a more expensive house now to save him the expense trading up in a few years.

I don't know whether Irish house prices will fall further. I think that risk of a fall is probably well balanced by a potential rise over 10 years.

If he is convinced that they will fall, then he should wait and buy the house cheaper later.

But when house prices and the economy are at more normal and forecastable levels, it makes sense to buy.

Brendan

What sector does this person work? The salary and gender (80K 30 year old male) would indicate finance or something construction related.

Brendan said:

Alternative strategy
Borrow €220k and buy a portfolio of shares.
Over ten years, it should outperform the increase in property value.

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How likely is it that he could borrow €220K to spend on shares though? You can borrow 220K as a mortgage as the house will be used as security. What security can you offer the bank to cover 220K to buy shares??

I suppose one factor to look at is where he is buying. If its in an area that has good rental potential then the factor of his flexibility should not be a real issue.

If he needs to move (or wants to move) he can always rent out his main residence and rent elsewhere (I know several people that have done this). He can either continue to rent his house out or sell his house when he feels he will get a better value for it.

I think there are a couple of human factors which to my eyes skew the choice of our John Doe towards renting.

People in Ireland typically rent the cheapest place they can but buy the most expensive they can. That someone rents a 2 bed apt in Smithfield doesn't necessarilly mean the same person would be happy buying the same place for the same amount.

The financial comparison of someone who rents a 2 bed apt and sublets a room, versus someone who owns an apt and rents a room out under the rent a room scheme, isn't equal. When you're renting you'll make sure you have that other room sublet whist a lot of people who bought with the intention of renting a room never do. The desire to own often comes with a desire for your own space - a space you don't share with a tenant. People may have bought with the intention of renting out a room but never do, or do so only reluctantly, and ultimately never achieve the same level of occupancy that a rental property does.

This is just from my experience but an analysis of occupancy rates of rented versus owned properties should illustrate that.

Ronan Lyons of Daft does a similar number crunching exercise here

You do pay a premium for renting, but you should, shouldn't you? You pay for flexibility. If flexibiity is of no importance to you then, of course, buy.

Hi Howitzer

That is interesting research done by Daft

In my example, I assumed that the cost of renting is the same as the cost of buying. The Daft reseach shows that it is currently cheaper to buy and if house prices fall faster than rent falls, then it will become even cheaper.

Of course, if you believe that house prices will fall, then you should wait to buy.

If you do not know what will happen to house prices in the short term, then buying looks an even better idea.

I am not sure I understand why you should pay a premium for renting. If you assume that prices will remain level, then I suppose that the landlord must get a return for the risk he is taking. But most landlords invest in the expectation of a capital gain.

A friend of mine bought a house for €1.5m in 2006 which he had rented out for €24,000 a year. He was paying around €75,000 in interest. I told him that it made no sense to me but he told me I was too conservative.

Brendan

On balance, I would buy now but not be in any hurry.

Like the guy in today's [broken link removed], I would just make cheeky offers on houses and hope to get one at a dramatically reduced price.

Brendan

Brendan said:

I am not sure I understand why you should pay a premium for renting. If you assume that prices will remain level, then I suppose that the landlord must get a return for the risk he is taking. But most landlords invest in the expectation of a capital gain.

A friend of mine bought a house for €1.5m in 2006 which he had rented out for €24,000 a year. He was paying around €75,000 in interest. I told him that it made no sense to me but he told me I was too conservative.

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I think we move in different social circles. I don't think your firends situation is the typical rental verus buy scenario.

In general you pay a premium for renting versus buying, for flexibility versus fixed circumstances. Is there another commodity where you might expect to pay less for the priviledge of renting?

Brendan said:

A friend of mine bought a house for €1.5m in 2006 which he had rented out for €24,000 a year. He was paying around €75,000 in interest. I told him that it made no sense to me but he told me I was too conservative.

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That does not make sense on any normal level, in fact is is sheer madness. The only way I would say it wasn't is if no matter what could afford the 50K interest. As in had other assets or a really permanent job. 2K a month rent is also top of the market. Not many of those exist.

How on earth did he get a mortgage?

'If you do not know what will happen to house prices in the short term, then buying looks an even better idea'

Hi Brendan,
Could you explain this one to me ? Surely if you have no idea whats going to happen it makes more sense to hold onto your deposit ?

Brendan said:

I think that this guy should buy the house now.


But when house prices and the economy are at more normal and forecastable levels, it makes sense to buy.

Brendan

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These sentences seem contradictory or have I misunderstood?

IMO the reason buying seems cheaper than renting is because of historically low interest rates and not clear to me that this daft comparison includes management/maintenance cost of ownership of apartment/new estate dwelling.

The example seems atypical in terms of salary for age - many professionals who remain employed (with say 2-4 years pqe) are not achieving this salary in current climate.

As you quite rightly stated the decision to buy can only be made based on view of market. Considering the economic factors both for residential market, banking and economy in general not clear to me that real increase in value could be expected over 10 year period.

Furthermore, individual likely to be of an age where (s)/he would consider moving jobs within 5 years and, as rental market also oversupplied, rental void periods have been getting longer and rents dropping; therefore not clear that it would be easy to let and move (assuming that sale of property not possible due to negative equity).

Sangster said:

'If you do not know what will happen to house prices in the short term, then buying looks an even better idea'

Hi Brendan,
Could you explain this one to me ? Surely if you have no idea whats going to happen it makes more sense to hold onto your deposit ?

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Hi Sangster and others.

This was badly phrased by me.

It is a point which I have made frequently. I do not know what will happen to house prices. I also know that no one else knows. But lots of people think that they know that prices will fall. Lots of others think that they know that they have hit the bottom and will recover.

In general, if the house suits you, and you are not overborrowing, it is a good idea to buy a house.

If you think that house prices will fall 10%, then you should not buy a house. you should wait until it hits the bottom before buying.

But if you realise that you don't really know what will happen to house prices, you should buy a house. Using the expression "even better" was not appropriate.

Brendan said:

If you think that house prices will fall 10%, then you should not buy a house. you should wait until it hits the bottom before buying.

.

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No one can really call the bottom, some will be lucky and manage it, if you buy close to the bottom and prices subsequently rise it will knock out the say 10% decrease in your example.

If deciding to purchase your home the important thing is location, affordability, job security, ability to withstand job voids, and try to get a house that's value will hold and not have too many highs and lows, if the rent is at or close to the mortgage repayments it's also better to buy.

What we've had during the boom is people overborrowing, paying inflated prices in bad locations for in many cases small apartments not suited to growing families using many multiples of income to get 100% mortgages which didn't take into account other debt that people had. We need to get back to responsible lending and teaching people to save before they buy a house/car/holiday.

The amount of people on AAM who have high mortgages, other debt and don't understand their mortgages, how they work, what fixed rate penalties are, what they signed for is shocking. It's like a collective madness of I want a house it's my entitlement and I'm buying it and I'll worry about it's location and how to pay for it after I have it and in any case I'll consolidate if things go wrong.

Bronte, I have to agree on your comments above. A lot of the problems with the housing market was down to bad decisions by the banks, but also bad decisions by many buyers. Nobody forced these people into taking mortgages.

Brendan said:

Hi Sangster and others.


If you think that house prices will fall 10%, then you should not buy a house. you should wait until it hits the bottom before buying.

But if you realise that you don't really know what will happen to house prices, you should buy a house.

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I am baffled by these statements. Are they not contradictory?

What if you 'realise' that prices are going to fall in the near term? What is the difference between 'thinking' and 'realising'? Are you trying to say that someone should not think about the direction of the market and should realise that they simply don't know?

Speaking of contradictions.

From Ronan Lyons of Daft.ie:

[broken link removed]

Rents may continue to fall but they are not expected to fall by as much as house prices so in the near term the buying option will continue to prove more attractive.

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Does my brain not work like everyone elses or what? If the premise of the article is that you know house prices are going to fall how can that be taken as a justification for saying buying is better than renting? Better on a month to month basis hardly equates to being better off after 1 year or so when you see your deposit wiped out and negative equity rearing it's head.

Hi Howitzer

I was puzzled by that in the original article and I think this is what he means:

It is now cheaper to buy than to rent.

House prices are expected to fall more than rent will fall.

Therefore it will be even better value in a few months to buy rather than rent.

But of course, if you know that house prices will fall, then you should wait.

Brendan