Real Estate: Rent or Buy your primary residence real estate?

An investor’s viewpoint on whether to buy or rent a property by Stuart Wemyss of API Magazine (Feb 2007). Which is better, renting your home or buying? It’s a topic that’s been discussed ad nauseam, but there are important considerations specific to real estate property investors which need to be considered.

I was recently asked for my views on the ‘rent versus buy’ question. I sat down and prepared a spreadsheet which compared the two options, like a typical accountant! There are some important assumptions used in this calculation including:

- I prepared the comparison over a five-year period. Holding a real estate property for less than five years isn’t generally viable, because of the large transactional costs such as stamp duty and selling costs.

- I assumed the real estate property mortgage interest rate was 7 per cent. According to the Reserve Bank of Australia, the standard variable rate over the past 10 years has fluctuated between 6 per cent and 8 per cent. Therefore, 7 per cent is the midpoint.

- The real estate buyer borrowed 80 per cent of the property’s purchase price to avoid the cost of mortgage insurance (therefore, they had a deposit of 20 per cent plus costs).

- The renter had to pay a rental yield of 3.6 per cent (therefore, the rent payable on the real estate home worth $400,000 is $14,400 per year, or $277 per week).

- The renter is able to earn an interest rate of 6 per cent on any savings deposited in a bank (i.e. the money they would have used as a deposit).

- The real estate renter saves the difference between the potential mortgage repayments (principal and interest) and the lower rental costs. For example, if the renter bought a $400,000 property, the monthly momrtgage repayments would be $2130. However, renting a $400,000 property real estate would cost $1215 a month. Therefore, I assumed that the renter saved $915 per month ($2130 less $1215). This is a really important assumption. More about this later.

The results

What my calculation revealed was that the key variable was capital growth, which is the amount of rate at which the real estate property’s value would increase. I worked out that if you’re buying a home and you expect the capital growth to exceed 6.4 per cent per annum (on average over a five year period), then you’ll be better off buying that home rather than renting it. Therefore, in my opinion, the key question to ask yourself if you’re thinking of buying real estate a home is what capital growth can I expect if I buy the type of property I want (i.e. house, apartment etc.) in the area I want to live in? If you think the average capital growth over the next five years will be less than 6.4 per cent per annum, then you’re better off renting in the same area and not buying real estate property.

I based my calculations on the assumption that the real estate buyer would borrow 80 per cent of the property’s value. However, if you need to borrow a higher percentage of the property’s value, say 95 per cent, then the capital growth rate needs to exceed 7.6 per cent for you to be better off buying real estate rather than renting a home.

The higher the purchase price, the higher the capital growth rate needs to be. I based my numbers on a purchase for $400,000. Howver, if you’re spending $800,000 on a property purchase, the capital growth rate needs to exceed 7.9 per cent for you to be better off buying. If you’re spending $1.2 million, the capital growth rate of the real estate property needs ot exceen 8.4 per cent and at $1.5 million, the rate needs to exceed 8.6 per cent.

Achieving capital graoth of real estate above 6.4 per cent to 8 per cent

Many people reading this article may think property prices will be pretty stable over the next few years. From that, they may deduce that they should rent and not buy. However, their opinions may have been incorrectly influenced by “average” property real estate price data and media hype. It’s important to understand that the property market is very fragmented.

While real estate property values overall remain steady, values in some suburbs will increase and values in other suburbs will decrease. In fact, certain streets within a suburb may outperform the suburb as a whole, and other streets will underperform the suburb. Therefore, condluing that “because property values are expected to be flat across the board it’s not a good time to buy property” is ill informed. You need to research the particular area where you’d like to live.

Monique Walkin, director of Wakelin Property Advisory, suggest real estate investors should aim to achieve long term average capital growth rate of 5 per cent to 8 per cent in excess of inflation. The inflation rate is currently around the 3 per cent mark. Therefore, Wakelin believes real estate purchasers should be able to achieve a nominal (long term) capital growth rate of 8 per cent to 11 per cent.

“Astute real estate purchasers should be able to generate strong capital growth by selecting a quality asset that exhibits scarcity value,” says Wakelin.

For more information, please visit apimagazine.com.au or read on to the next blog string for the second part of Rent or Buy Real Estate.