Key Post Is now a good time to buy a home?

D

DerKaiser

Registered User
Messages
1,443
I've split out a case study I developed on another thread.

In this specific thread I want to set out a framework for evaluating the financial decision of whether to purchase a home.

In this analysis the key factor, in terms of personal situation, is whether you need to borrow to purchase or if you have sufficient savings.

Let's assume the following (currently) realistic scenario:

A house costs €250k
Rent is €12k p.a.
Deposit Savings rate net of dirt is 2%
Mortgage interest on residential is 4.5%

For simplicity I'll initially ignore a couple of factors which probably should be taken into account in more detailed decision making e.g. costs of owning (repairs, etc), rent inflation, etc.

We'll also assume that this is a buy to hold decision rather than a short term speculative play.

1. Buy vs rent for someone with savings
If it's a straight choice between (a) using savings to buy or (b) holding onto the savings and paying rent, the key factor is how rents compare to net of tax interest on savings.

In this case buying property is the clear winner as €12k saved in rent trumps €5k interest.

2. Buy vs rent for someone needing to borrow
If it's a straight choice between (a) using borrowings to buy or (b) paying rent, the key factor is how rents compare to cost of borrowing

In this case buying property is marginal winner as €12k saved in rent trumps €11.25k in interest repayments.

Developing the scenarios
If we build in a couple of more realistic assumptions e.g. rents increase @1.5% p.a. and owner has €2500 p.a. in costs, we get the following:

Scenario 1: Buying is still the clear winner
Scenario 2: Buying is costlier initially but more cost effective in the long run (9 years+, still a marginal decision to buy overall)

Obviously there are many other factors / risks to consider, but this method provides an initial framework to make a decision.

As can be seen, it is very dependent on whether you are a borrower or saver. It is also hugely sensitive to deposit savings rates, mortgage interest rates, taxes on savings and long term expected growth in rents.

All this before even getting into the emotional value / drag of owning a home!


Simple Mathematical rule of thumb
In each circumstance above we are effectively targetting a ratio of rent to market value that is the tipping point for the decision to buy.


In the scenario I have chosen, the ratio of rent to market value is 4.8% (€12k/€250k). Allowing for the fact that renting saves on ownership expenses, the effective rate is 3.8% (€9.5k/€250k).


A return of 2% is available on savings, whilst a mortgage costs 4.5%. If there is expected rent inflation, you can simply deduct the level of inflation from the interest rates to arrive at an effective "real" interest rate. In this case 0.5% on savings and 3% on the mortgage.


The simple rule of thumb then becomes 'purchase only if the effective rental yield exceeds the real interest rate'
 
Hi Der Kaiser

Thanks for that.

We know that the current SVR on mortages is 4.5%.

Do we know what the current rental yield on property is? Looking at the Allsops auctions, it seems to be around 10%.

I think that a €250k property would command a rent far more than €1k a month.

Or maybe market yields are not especially relevant. One has to look at the house one wants to buy.

|current |what might happen
Cost to buy | €250,000. |€250,000
Deposit|€ 50,000|€50,000
Mortgage rate| 4.5%|6.5%
Mortgage cost|€9,000 |€13,000
to rent an equivalent house| €15,000|€12,000
Less deposit interest|€1,000|€1,000
Net cost of renting| €14,000|€11,000
Saving through buying|€5,000|(€2,000)

So if interest rates rise by 2% and rent falls by €3,000, one would be better off renting than buying.
 
Other factors in favour of buying
Security of tenure - if you rent you can be kicked out
You can put your own stamp on the house - decorate it and change it as you like - not wasting money doing up someone else's investment
Owners tend to put down roots and feel part of the community
Capital gains are tax-free
Avoids the hassles of renting and the risk of a useless landlord

Other factors in favour of renting
Flexibility - you can move much more easily
Much easier to split up - huge problems splitting up when a house is jointly owned
On balance, less risky - not affected by house price falls or interest rate increases , but vulnerable to rent increases
 
Yes this analysis deals very well with the tangible aspects on whether to buy or not to buy under the various scenarios. Great credit to Der Kaiser for the way he has laid this out.

On the downside, I think it could be greatly misleading to the novice home purchaser or investor to make a decision based on the analysis.
Analysing if net rents are greater than net interest might be more relevant in more stable times, as a basis for making this type of decision but its just not relevant today. In Der Kaisers Scenario 1, the punter is in line to save 7K by purchasing his own home (with savings) but thats not going to be much of a saving if house prices fall 10% or 25K next year.

Like it or not, there is only one main issue to consider in deciding whether this is a good time to buy or not and that is the likely direction of houseprices over the next 10 years. Of course we have no way of measuring this or knowing it in advance but it is the only thing that matters. Ignoring this and making precise calculations between interest foregone and rent received etc etc is futile.
 
Thanks importer some very good points.

I'm afraid my analysis completely ignores whether it's better to buy now or, say, in 5 years time.

I think I can credibly point to some indicators of long term inflation and interest rates, but I would not (and could not) attempt to predict how long term fundamentals will shift in the shorter term.

An example of a shift would be that the world may move to a high interest and low inflation environment, but the markets aren't forseeing that, and I'm just trying to use long term market fundamentals rather trying to second guess the market.
 
Brendan Burgess said:
So if interest rates rise by 2% and rent falls by €3,000, one would be better off renting than buying.
Click to expand...

Another thing is to consider your own profile and circumstances, and the time lag which may occur between the above comment on interest rate rise (or fixing) and rent falling.

If you buy at SVR/fix at 4.5-5% now for a few years and have very low risk chance of losing income and reasonable expectation of steady or increased income, then combined with tax incentives it may be a good way to spend over a specific timeframe of up to maybe the next 3-5 years.

In relation to house price insulation- perhaps buying a 'do-er upper' and making use of the tax incentives available may help here.
 
I am very much of the opinion that mortgage interest in this country will be in the region of 7% into the future as competition diminishes and banks want to become more profitable so purchasers will need to take this on board. On the other hand there are very few areas where a developer could make a sustainable profit on a green field site given the price of houses at the moment. There is a lot of surplus capacity out there and until this is sold prices will not recover where they are. As regards the rental market I would suspect that an awful lot of landlords will get out of the business when prices improve a little or when they can negotiate a deal with the banks. The landlord business is getting too complicated and not being treated as a business by by Government. I know that there will be posters having another view but if you are in the business you cannot but be of the view that it is over regulated.
 
@Dermot, I think the main problem in Ireland (unlike our EU neighbours) is that our rental market is blighted by a huge amount of amateur landlords
 
Dr.Debt said:
@Dermot, I think the main problem in Ireland (unlike our EU neighbours) is that our rental market is blighted by a huge amount of amateur landlords
Click to expand...

I have added the following to the list of advantages of buying

Avoids the hassles of renting and the risk of a useless landlord
Click to expand...

There is no need to take the thread off topic to argue the woes of landlords and the woes of tenants. There are many other threads which do that very well e.g. Who wants to be a landlord?
 
Whether you live in a house or not, you need to decide first if it is good value before you buy it.


daft.ie estimates that rental yields in South Dublin are 6.20%. A rental yield of 6.20% is the same as the house having a price/earnings ratio of 16. According to the Nasdaq, for example, Apple today has a PE ratio of 11.92. So at a rental yield of 6.20% it would take 16 years for your house to generate enough earnings before taxes to break even; whereas an investment in Apple or an equivalent top rate international company would payback before taxes in about 12 years. (Apple used as an example, not a recommendation to buy). At these rental yields a 250k house is overvalued and the price needs to fall to about 190k – 200k for it to have the equivalent value as a top rate international company (i.e. if you assume value is based on ability to generating earnings). And this applies whether you live in the house or rent it out.

The simple rule of thumb then becomes 'purchase only where the inverse of the rental yield indicates good value relative to equivalent investments’.
 
Hi pmu

I will move that post to the "What is the future direction of house prices" thread when someone writes it.

I think that the pricing of houses is far more complex than that simple rule of thumb.

Brendan
 
I think there are too many factors to consider to make a blanket statement. Rental prices are completely random depending on when you began renting, etc. For example, my sister is renting a house for 1100 a month and those sold recently in the area were selling for approx 290,000.
 
First regarding, "Security of tenure - if you rent you can be kicked out" Part 4 tenancies offer quite a bit of protection once you avail of it. Yes you can still be asked to leave, but the notice periods do grow out quite a bit.

Regarding prices, at a minimum the effects of inflation need to be mentioned. No one can really predict where house prices are going, and any country-wide statement will be wrong, but how inflation changes things does make a large difference, even in the inflation capped EU world. It can swing a buy or not buy decision quite a bit.
 
You must log in or register to reply here.
Back
Top