Objectively calculating the difference between buying and renting

[nest egg]

Came across this interesting video on trying to objectively calculate the difference buying and renting, thought I'd try and work out my own figure. Spot any errors?

A rated / new build	Amount / %	Comment
Overall Value	€ 875,000.00
Equity	€ 465,000.00
Debt	€ 410,000.00
Scenario 1: Using a tax free (eg Pension) return on Equities
Property Tax	0.11%​
Maintenance & home improvements	0.33%​	new build thus low figure, will increase the older the house gets
Cost of debt	1.22%​	2.6% rate, applied to the Debt, then expressed as a % of the overall value
Cost of equity (no tax applied)	1.59%​	3% rate, applied to the Equity, expressed as a % of the overall value
TOTAL	3.25%​
Scenario 2: Using a taxable (top rate 52%) return on Equities
Property Tax (from 2022)	0.11%​
Maintenance & home improvements	0.33%​	new build, this figure will increase the older the house gets
Cost of debt	1.22%​	2.6% rate, applied to the Debt, then expressed as a % of the overall value
Cost of equity (after tax)	0.77%​	1.44% (3%*48%) rate, applied to the Equity, expressed as a % of the overall value
TOTAL	2.42%​
Market Rent	€ 4,000	Monthly mortgage payment is ~€1,800
Scenario 1
Calculated rental maximum	€ 2,368	per month
Calculated property price based on market rent	€ 1,478,028
Scenario 2
Calculated rental maximum	€ 1,764	per month
Calculated property price based on market rent	€ 1,984,666

 

[nest egg]

Seems I'm on my own with this, perhaps you're all faster than me! Certainly it's the clearest explanation I have come across as to how to compare buying & renting, and by implication, how to calculate the real cost of home ownership, it also answered another question I constantly ask myself...

His 5% rule is as follows:

1. Maintenance - buildings depreciate approx 1.5% per annum (excluding land), he factors 1% of the total value.
2. Property taxes - 1%
3. Cost of capital - 3% (both figures below come out the same in his example)
   1. Cost of debt - interest on debt
   2. Cost of equity - the % difference between historical return from stocks vs property (not allowing for differences in taxation)

What this copper-fastens in my mind is that while property, generally speaking, isn't a bad investment, it isn't as good historically as the stock market, and there are hidden costs to home ownership which I had failed to recongise.

Secondly, by owning a home, I am not investing the the property market, I am making a very individual "bet", by selecting a particular property, in a particular county/region, in a particular country. Just because the market overall does well, it doesn't mean that my particular choice of property will (the reverse may also be true of course).

Therefore it's also answered one of my on-going questions, is it better to overpay my mortgage or make pension AVCs? I know there all sorts of caveats here but the facts would suggest that the stock market is more likely to generate a better return in the long run.

 

[SPC100]

I didn't follow how you calculated 'Calculated rental maximum'. I suspect if you summarize what you are trying to calculate rather than expecting folks to watch the video you might get some more input.

 

[TheBig40]

I saw this a few years ago or something similar and found if nothing else the 1% or 1.5% of property value as a guide of home Maintanance was a rule of thumb as any.

I think the hardest thing here is to see this in an Irish context. The Canadians and Americans have a means of investing in equity outside of a pension and still benefit from zero or low taxes.

We have a CGT of 33% on the investment, not sure why you’ve used 48% unless you’re assuming you’ll just live off the dividends in retirement?

I’ve tried renting and owning at this stage and I know that I don’t tend to look at my home as an investment because short of selling it (no idea where I’d go from here) I can’t realise the gains but I know that something very drastic would have to happen to suddenly find myself without somewhere to live and there is a value to be found in the psychological aspect of home ownership. I don’t mean buying a house to “get on the ladder” more finding what seems like your forever home and making it what you want.

You laid it out pretty clearly and it helps widen the things to consider for sure.

 

[nest egg]

I didn't follow how you calculated 'Calculated rental maximum'. I suspect if you summarize what you are trying to calculate rather than expecting folks to watch the video you might get some more input.

It's what the rent would have to be (or lower) for it to be as attractive (or more attractive) to rent than buy. This is my attempt at an apples to apples comparison between renting and buying, based on the methodology in his video. It's not very important tbh as I've already made that decision. What was more interesting was what I learnt from the exercise in my follow up post.

 

[nest egg]

I saw this a few years ago or something similar and found if nothing else the 1% or 1.5% of property value as a guide of home Maintanance was a rule of thumb as any.

Agreed, I've put 0.33% in my example as it's a new build, although that figure will increase the older the property gets. I'm tracking expenses so I'll get to know it's true cost over time. What I wasn't doing before now though was thinking about the physical property as a depreciating asset. Whether this is a cost I bear during my ownership, or if I skimp on maintenance over the years, is a cost I bear when I sell it, either way I'll have to pay it.

 

[nest egg]

I think the hardest thing here is to see this in an Irish context. The Canadians and Americans have a means of investing in equity outside of a pension and still benefit from zero or low taxes.

We have a CGT of 33% on the investment, not sure why you’ve used 48% unless you’re assuming you’ll just live off the dividends in retirement?

Exactly, putting it in an Irish context is what I'm attempting to do, which basically means within a pension, or outside it. You're right, the tax rate should reflect a combination of CGT and dividend income.

 

[nest egg]

I’ve tried renting and owning at this stage and I know that I don’t tend to look at my home as an investment because short of selling it (no idea where I’d go from here) I can’t realise the gains but I know that something very drastic would have to happen to suddenly find myself without somewhere to live and there is a value to be found in the psychological aspect of home ownership. I don’t mean buying a house to “get on the ladder” more finding what seems like your forever home and making it what you want.

You laid it out pretty clearly and it helps widen the things to consider for sure.

There are two sides to viewing your home as investment in my mind anyway. The first is purely in terms of maximising return for any spare cash, with minimum effort. Given the lack of investment opportunities in Ireland, after pension limits are maxed out, where can you turn? Mortgage overpayments are an easy option as you get a guaranteed "return" equal to the rate, with no risk, and no tax implications.

In terms of viewing the it as a true investment, who knows what the future will hold, but in our case at least, the intention is to downsize when the kids have flown the nest (there's a great thread on AAM about life after retirement). We consider the house as a home first of all, but we already know it will be too big for just the two of us in the future, and we won't want the hassle of the maintenance, or cleaning, or even the stairs at some point in time

This exercise has even done more to further that view, as I am now more aware of the additional opportunity cost which comes with greater home equity. Realise this is a personal choice, but I see real benefits in viewing the house as an investment, albeit it's a riskier one than previously thought! At least I'll know what return it really gave us in the end...

 

[Brendan Burgess]

I have read this twice now and I am not sure what question you are trying to answer?

It might be one or all three of the following:

1) Should I own my own home or rent one and invest in equities instead?
2) Should I overpay my mortgage or contribute to a pension fund?
3) Are equities a better investment than residential(?) property?

You need to look at all three separately. And then you can see later how they interact.

As the question in the title is : "should I own my own home or rent one?" and as it's the one with the clearest answer, I will answer this.

In Ireland at least, it is very clear for the majority of people most of the time: you should own your own home.


1) You are reducing risk by owning your own home

Imagine you have returned to Ireland with €300k cash - enough to buy a house without a mortgage. Would you rent or buy? It's clear to me that you should eliminate all risk by buying.

Sure, house prices may fall, but that wouldn't really affect you.

If you buy shares, share prices may fall and house prices and rents may rise. That would not be a good position to be in.

Even if you are very confident that share prices are likely to outperform property and rents in the long-term, you should not be taking on that risk.

Taking out a mortgage to buy a house makes this a bit more complicated as it exposes you to interest rate rises. But as you pay down the mortgage the impact of that risk reduces.

While I started this section with the scenario of someone returning to Ireland with €300k cash, that is the situation most people who buy houses will be in after 20 years of a mortgage.

2) In Ireland at least, most of the time, and at most levels, it is much cheaper to rent money than to rent property.

1. If you were to rent €300k to buy a house for €300k, it would cost you about 3% or €9,000 a year in interest
2. I am guessing that renting a €300k house would cost you about €15,000 a year.

So it's much cheaper to rent money than to rent property.
This is not always the case, but if you are making a long-term plan, then it is likely that will apply most of the time.

Interest rates may rise and rents may fall. But most of the time, renting property will be more expensive than renting money.

There may be parts of Ireland where rents are very low. But if that is the case, I would imagine that property prices would be very low as well.

3) The tax advantages of home ownership are huge:

1. There is no Capital Gains Tax on any increase in value
2. There is no tax on the "return" on your investment in your home.
3. If you ever require a means-tested benefit, the family home is ignored even if it's worth €2m.

If you rent and buy shares instead
You will pay Capital Gains Tax on any gains.
You will pay Income Tax on your dividend income
And if you ever need means-tested social welfare payments, your wealth be a significant factor.

4) The psychological benefits of owning your home are immense.

1. You have security of tenure as long as you pay something towards your mortgage. If you are renting and your landlord decides to sell, you have to move out.
2. You have more control. If something needs to be fixed, you call in the guy to fix it. You don't have to chase a landlord who might not get around to it.
3. You can extend it and decorate it or neglect it as you wish.
4. You feel more part of the community

If we can establish and agree with the point that it is better to buy than rent, then we can move onto the downstream questions:

1) Should I pay down my mortgage or invest directly in equities or contribute to a pension?
2) Should my pension fund be invested in equities or property?

 

[nest egg]

I have read this twice now and I am not sure what question you are trying to answer?

It might be one or all three of the following:

1) Should I own my own home or rent one and invest in equities instead?
2) Should I overpay my mortgage or contribute to a pension fund?
3) Are equities a better investment than residential(?) property?

You need to look at all three separately. And then you can see later how they interact.

As the question in the title is : "should I own my own home or rent one?" and as it's the one with the clearest answer, I will answer this.

In Ireland at least, it is very clear for the majority of people most of the time: you should own your own home.


1) You are reducing risk by owning your own home

Imagine you have returned to Ireland with €300k cash - enough to buy a house without a mortgage. Would you rent or buy? It's clear to me that you should eliminate all risk by buying.

Sure, house prices may fall, but that wouldn't really affect you.

If you buy shares, share prices may fall and house prices and rents may rise. That would not be a good position to be in.

Even if you are very confident that share prices are likely to outperform property and rents in the long-term, you should not be taking on that risk.

Taking out a mortgage to buy a house makes this a bit more complicated as it exposes you to interest rate rises. But as you pay down the mortgage the impact of that risk reduces.

While I started this section with the scenario of someone returning to Ireland with €300k cash, that is the situation most people who buy houses will be in after 20 years of a mortgage.

2) In Ireland at least, most of the time, and at most levels, it is much cheaper to rent money than to rent property.

1. If you were to rent €300k to buy a house for €300k, it would cost you about 3% or €9,000 a year in interest
2. I am guessing that renting a €300k house would cost you about €15,000 a year.

So it's much cheaper to rent money than to rent property.
This is not always the case, but if you are making a long-term plan, then it is likely that will apply most of the time.

Interest rates may rise and rents may fall. But most of the time, renting property will be more expensive than renting money.

There may be parts of Ireland where rents are very low. But if that is the case, I would imagine that property prices would be very low as well.

3) The tax advantages of home ownership are huge:

1. There is no Capital Gains Tax on any increase in value
2. There is no tax on the "return" on your investment in your home.
3. If you ever require a means-tested benefit, the family home is ignored even if it's worth €2m.

If you rent and buy shares instead
You will pay Capital Gains Tax on any gains.
You will pay Income Tax on your dividend income
And if you ever need means-tested social welfare payments, your wealth be a significant factor.

4) The psychological benefits of owning your home are immense.

1. You have security of tenure as long as you pay something towards your mortgage. If you are renting and your landlord decides to sell, you have to move out.
2. You have more control. If something needs to be fixed, you call in the guy to fix it. You don't have to chase a landlord who might not get around to it.
3. You can extend it and decorate it or neglect it as you wish.
4. You feel more part of the community

If we can establish and agree with the point that it is better to buy than rent, then we can move onto the downstream questions:

1) Should I pay down my mortgage or invest directly in equities or contribute to a pension?
2) Should my pension fund be invested in equities or property?

Thanks for taking the time Brendan to look at my posts. The answer is that it started as an exercise to calculate the difference between renting and buying, as I had never really seen an holistic way of doing that, which expands on the cost of capital, and I wanted to see if others could spot any issues with how I had interpreted what the video author was saying.

However in the process, I started to fully understand previously hidden-to-me costs of home ownership, and I was curious as to whether others on this forum had ever considered these?

The two main costs I hadn't fully considered were
1) Physical property depreciation, this is a cost you cannot avoid
2) Opportunity cost, which increases the greater the equity you hold in your home

This may all have been self-evident to those on this forum, but it wasn't to me, and I'll now factor in those costs when making future decisions, such as whether to overpay the mortgage or pension contributions or whatever else comes along.

So what should the title be? "Calculating the true cost of home ownership" is probably the most accurate, although a catchier one I would suggest is "Home truths"

 

[Brendan Burgess]

The two main costs I hadn't fully considered were
1) Physical property depreciation, this is a cost you cannot avoid
2) Opportunity cost, which increases the greater the equity you hold in your home

Don't get carried away by stuff written for a different environment.
Don't get carried away by some supposed arithmetical accuracy.

Make sure you know what question you are asking.

Sometimes people don't know what they are thinking until they start writing. That clarifies the thinking.

You have a really simple question - should you buy or rent?

Sure property depreciates physically, but over time, the value of the property has risen well in excess of any depreciation.

The concept of Opportunity Cost can really distract you from the key question. You start looking for a very complex analysis, when a simple analysis will do.

If you have €300k cash today, would you buy or rent?

The answer is crystal clear.

You can lose sight of the answer by trying to be too clever.

Brendan

 

[nest egg]

I could counter that by saying don't get carried away thinking stuff written for a different environment isn't applicable here, or don't get carried away thinking arithmetical accuracy doesn't provide value. Perhaps better to call it a day though!

 

[lff12]

I have read this twice now and I am not sure what question you are trying to answer?

It might be one or all three of the following:

1) Should I own my own home or rent one and invest in equities instead?
2) Should I overpay my mortgage or contribute to a pension fund?
3) Are equities a better investment than residential(?) property?

You need to look at all three separately. And then you can see later how they interact.

As the question in the title is : "should I own my own home or rent one?" and as it's the one with the clearest answer, I will answer this.

In Ireland at least, it is very clear for the majority of people most of the time: you should own your own home.


1) You are reducing risk by owning your own home

Imagine you have returned to Ireland with €300k cash - enough to buy a house without a mortgage. Would you rent or buy? It's clear to me that you should eliminate all risk by buying.

Sure, house prices may fall, but that wouldn't really affect you.

If you buy shares, share prices may fall and house prices and rents may rise. That would not be a good position to be in.

Even if you are very confident that share prices are likely to outperform property and rents in the long-term, you should not be taking on that risk.

Taking out a mortgage to buy a house makes this a bit more complicated as it exposes you to interest rate rises. But as you pay down the mortgage the impact of that risk reduces.

While I started this section with the scenario of someone returning to Ireland with €300k cash, that is the situation most people who buy houses will be in after 20 years of a mortgage.

2) In Ireland at least, most of the time, and at most levels, it is much cheaper to rent money than to rent property.

1. If you were to rent €300k to buy a house for €300k, it would cost you about 3% or €9,000 a year in interest
2. I am guessing that renting a €300k house would cost you about €15,000 a year.

So it's much cheaper to rent money than to rent property.
This is not always the case, but if you are making a long-term plan, then it is likely that will apply most of the time.

Interest rates may rise and rents may fall. But most of the time, renting property will be more expensive than renting money.

There may be parts of Ireland where rents are very low. But if that is the case, I would imagine that property prices would be very low as well.

3) The tax advantages of home ownership are huge:

1. There is no Capital Gains Tax on any increase in value
2. There is no tax on the "return" on your investment in your home.
3. If you ever require a means-tested benefit, the family home is ignored even if it's worth €2m.

If you rent and buy shares instead
You will pay Capital Gains Tax on any gains.
You will pay Income Tax on your dividend income
And if you ever need means-tested social welfare payments, your wealth be a significant factor.

4) The psychological benefits of owning your home are immense.

1. You have security of tenure as long as you pay something towards your mortgage. If you are renting and your landlord decides to sell, you have to move out.
2. You have more control. If something needs to be fixed, you call in the guy to fix it. You don't have to chase a landlord who might not get around to it.
3. You can extend it and decorate it or neglect it as you wish.
4. You feel more part of the community

If we can establish and agree with the point that it is better to buy than rent, then we can move onto the downstream questions:

1) Should I pay down my mortgage or invest directly in equities or contribute to a pension?
2) Should my pension fund be invested in equities or property?

Was going to reply with references to recent research published by PRTB but you've answered nearly everything, just to add that most buyers purchase properties that are slightly larger than they may currently be renting. Its fairly unusual for someone to buy an identical property to the one they are renting because the imputed mortgage will pay for a larger property in 80% of cases (the exceptions being a lucky and rapidly diminishing minority of tenants who were "locked in" at lower rents circa 2014 when the govt started using rent capping, and haven't already been evicted as it seems most of these rentals are high risk of landlord sale).
Would be interesting to do a study of FTBs moving from renting to owning to see differences in what they paid in rent and mortgage and the sizes of properties they moved from and to.