Sometimes, a post needs a shout-out. And this one goes out to my friend Kate – who tells me that we are America and Afghanistan on this subject.
You see, Kate wants to buy a house instead of “paying someone else’s mortgage”. I, on the other hand, am quite happy to make that contribution. And seeing as this debate happened in a public setting with gin and a drinking game, it inevitably led to a challenge and an acceptance. Hence this post and a spreadsheet with numbers.
Firstly, some facts (from the SA Commercial Property News website):
- Last year, the South African property market offered a total return of 15.2% – comprising of an income return (rental) of 8.9%, along with a capital appreciation (increase in the value of the house) of 5.8%.
- At the same time, equities returned 20.6% (based on the MSCI South African equity index).
Now I realise that equities are generally riskier than property. However, in general, those two asset classes will move in the same way. When the economy is doing well, property prices do well and equities boom. When the economy is doing less well, property prices get muted and equities crash*. Nevertheless – historically speaking, over long time periods (say, the 20 year period that it takes to repay a mortgage), equities consistently outperform property.
And as for the riskier part – Kate and I are young adults. Ergo: we should be doing more risky stuff like buying equity and playing drinking games with gin.
But those risk/return principles aside, there is another, more pragmatic point to be made about buying property: the presence of hidden costs. Some examples:
- Transfer duty on purchase (about 4%);
- Rates (they add up);
- Repairs and Maintenance (a plumber, an electrician, a new oven top, repainting, replacing wiring, cracked cisterns, leaking tiles, broken tiles, broken windows);
- Levies (everybody wants a well-manicured public area in their complex);
- Water (always part of the rent…);
- An agent taking commission off the rent;
- An agent taking commission off the selling price at the end;
- And so on.
That’s before we even get to the topic of your mortgage repayment. Because you’re probably, as a young adult, going to get an interest rate of, say, 10.5% (the Prime Rate of Interest + 2). I mean – that’s a great rate. But what’s your average rental yield? 8.9%? That doesn’t sound like it’s covering interest, let alone capital…
Which leads me to an example (how I love the numbers):
- You have the option of buying a house for R2 million.
- You’re lucky enough to get a 20 year 10.5% mortgage with a 5% downpayment.
- That works out to about R230,000 per year in mortgage repayments.
- In addition, you work out some other monthly costs: rates, maintenance, repairs, water and levies. Those amount to about R60,000 per year (or R5,000 per month).
- So every year, you pay about R290,000 for your house.
- If you were to rent the property, you’re looking at monthly rentals of about R15,000.
- That works out to an extra R112,000 in cash every year**.
You have two options here:
- You can buy the house, put down the deposit of R100,000, pay SARS transfer duty of R80,000, and then pay annual mortgage repayments and expenses of R290,000 for the next 20 years; or
- You can rent the house for R15,000 per month, take the R180,000 initial costs you’re saving and put it into a passive equity fund, and then take the R112,000 that you would “save” every year and put that amount into the same fund.
Those “savings” if you rent would change every year though. Because if you bought the house, your mortgage remains fixed while your rentals (and other costs) would go up every year with inflation. So let’s assume that the renter (me) would only invest what he saved by not-buying. Also, to illustrate the point, I’ll assume that I would earn exactly the same return on my equity-invested savings as if I bought the house (ie. 8.9% rental return + 5.8% capital appreciation = 15.2% return).
Here’s a graph showing relative worth over time:
What you should notice is, at the end of the 20 year period, assuming equal returns, your net worth as a renter-saver is two-thirds larger than your net worth as a home-owner.
This difference grows magnificently if you assume that the equity return-property return differential remains the same as it did in 2012:
Still sitting at the R6 million mark as a home-owner; but when you rent and invest the difference in equity, we’re looking at the R24 million mark at the end of 20 years.
THEN WHY WOULD YOU BUY A HOUSE?
Well – there are good reasons for owning a home. And I can think of two main ones:
- Because it is sometimes a really good deal
Let me deal with the “qualitative” side first. I’m not talking here about the joy of owning your own home, where you get to bring up your children with the picket fences and the apple tree out back (although – that is a really good reason***). No – I’m talking here about discipline.
The renter-saver scenario requires you to maintain the habit of placing a significant part of your savings into an equity fund every month. If you have a mortgage – you damn well make that payment. You go without food before you default. But if you don’t have any specific obligation as such, you are much more likely to go on holiday with the money. Not so?
Homes work for most of us because they enforce a saving discipline that we would otherwise avoid. And that is the best reason for buying a home. Because then my alternative is irrelevant: you are choosing between owning an asset, and blowing it on fun stuff****.
Which brings me back to the good deal.
When is Buying a House a Good Deal?
Home-buying is generally-speaking a good deal when your rental yields are high. That’s almost stating-the-obvious. But I went to this data set, and discovered that rental yields on two-bedroom apartments in Johannesburg (for 2012) were 13.31%. Which is amazing. So I plugged that into my spreadsheet (with my R2 million example), and even assuming that equity returns are higher, you get a picture that looks like this:
Of course – that’s because your rental returns are more than covering your mortgage repayments. I mean – it’s like buying a house for free. Plus, with those kind of yields, you’re likely to see an upswing in the value of two-bedroom apartments (wouldn’t you start buying those apartments? Driving the price up?).
Let’s compare this to Cape Town, where a similar apartment has a 4.65% rental return. You get this:
Moral of the Story
Don’t buy houses in Cape Town. But if you, like Kate, are looking to buy a two bedroom apartment in Johannesburg – you’re in the money.
Kitty, I apologise.
I blame the gin.
*Which makes sense. If you’re doing not-so-well financially – the first place you go to is your investment portfolio. Selling your house is a dramatic, last resort-y kind of action.
**Lots of people give me the “I’d rather spend an extra R4,000 on a mortgage repayment and own the house at the end than pay rent” story. But you often forget the extra R5,000 odd that you pay every month for levies, rates and maintenance.
***Just one that costs you in terms of where you could have been had you not lived that dream. There are no free lunches!
****And best you be extremely self-honest when making the self-assessment. Because almost all of us impulse-buy at the till*****.
*****One realistic alternative is to force a debit order on your account into a passive equity fund. That way, the money is not there for you to spend from the start.