I am often surprised at how often people talk to me, even now, about the first Rent or Buy post that I wrote almost a year ago. And I’ve realised that it’s time for an update (or a clarification), because:
- People think that I’m not a fan of fun stuff like buying nice cars*; and
*what I actually hear is “Grinch“.
- My view has … evolved.
Oh – I haven’t changed my mind. I still think that home-owning is a (very) costly investment strategy. But not everything in life is an investment strategy, and not all the pay-offs result in higher net-worth.
To summarise the original position:
- Home-owning requires large upfront expenditure (the initial deposit, conveyancing fees, transfer duty, a bit of repainting, new furniture, etc).
- And the monthly cost of renting is almost always less than the monthly cost of home-owning (it’s not just mortgage repayments – there’s also maintenance, rates, etc).
- If you were disciplined enough to do it, it would be better to take that initial expenditure (and the money you’d save each month by renting) and invest it in something productive – like equities.
- And if you did that, you’d likely be able to buy your dream house in cash long before the mortgage repayment period on the original property expires*.
*Under the assumptions in my original scenario, you’d be able to buy the house outright for cash (at a real-adjusted cost) in year 10. I think this is the point that I should have emphasized – even if you do want to buy a house, I’m not convinced that going and buying a house today is the best way to get there.
And I want to reiterate here that I’m not talking about property investment in general – I’m talking specifically about how you pay for where you want to live. Property investment, I like. I wrote about it here: Rent or Buy: How To Be A Property Mogul.
But putting aside the investment strategy, I think that there are two particularly powerful (and economic) reasons for home-owning:
- Home-owning as an Insurance Policy.
- The Positive Externalities of Home-owning.
When A House Acts As Insurance
Home-owning is a little like health insurance: it becomes increasingly more important as you get older.
To illustrate: I’m unmarried and in my 20s (just). I don’t mind too much if my landlord wants to come round for an inspection, or if it takes a few months for him/her to fix the oven, or if I get evicted at two month’s notice. I can find a new place relatively easily. I don’t have too much in the way of prized furniture. My costs of inconvenience are low.
But as I get older, maybe there’ll be a family with small children, and a spouse that is prone to nagging. Small children necessitate cots and beds and admin. The home will gradually fill with dining room tables and sideboards of both the hire-purchased and inherited varieties. Suddenly, an inspection becomes a demeaning intrusion, and broken ovens make for a dissatisfying sex life. To say nothing of evictions, which may well break the marriage.
And then after that, it gets worse. Age brings loss of mobility and the setting of ways. There is emotional attachment and history invested in the walls. As sentiment starts to play a more important role than financial sense, eviction can become a death sentence.
I guess I’m saying that the original model from the first post does not take into account the hidden cost of renting. The inconvenience cost of eviction is one that increases with age, and is specific to the person in question. My inconvenience cost might be negligible – but for some of my peer group, that cost is intolerable. And they pay it by choosing to mortgage now and stay beholden to a bank for 20 years, rather than save now and own the house outright in half that time.
Home-owning is an insurance policy against an unwanted relocation. And the premium is your debt-burden.
The Home-owner’s Externalities
Externalities are the unintended benefits of a decision. And in this case, they’re psychological.
I think that most people would agree that they have a general desire to be “grounded”. Or, put differently, that they have a generalised aversion to change.
Given that, I suspect that there is a very clear psychological difference between home-owners and renters. When you rent, you are more aware of transience – almost as if you’re locked in a state of indecision, and continually aware of other options. And that awareness infuses your life with latent anxiety.
On the other hand, once you make the decision to buy a home, you’re committed. There is almost a calming matter-of-factness about it, as though you’ve made the leap. In the people around me that have recently bought a house, I have seen a perceptible relaxation in their characters (although that may just be relative to the amount of anxiety that preceded the bank’s approval of the mortgage!).
Speaking personally, my business just took the leap from being based out of coffee shops and client premises (the overhead-free approach) to having a three-year lease for offices in a well-manicured building with close proximity to a highway. On the face of it, there is just office space. But I seem to be working longer hours more productively, and I keep using phrases like “legitimacy” and “renewed sense of purpose”.
I can’t help but wonder whether the mental shift between renting and owning is just as dramatic as the one between squatting and renting. And also, if people that own homes don’t make more money: possibly because they have to (after all, they’ve got a mortgage to pay); but maybe also because the commitment makes them more fully invested in the life that they’re leading, alongside everything that accompanies it.
It’s just a thought.
Anonymous March 25, 2014 at 12:06
“Suddenly, an inspection becomes a demeaning intrusion, and broken ovens make for a dissatisfying sex life” – lol
Nice post and yes you are getting soft in your old age:)Reply
Jayson March 25, 2014 at 18:21
Anonymous March 25, 2014 at 16:45
Hi Jayson, I live in the UK where things may be a little different (ratios of rent to mortgage payments; mortgage to income ratios etc) but I think the biggest element in the buy versus renting economic reasoning is leverage. Logically, neither may be better, but in a scenario where house prices increase – which they have historically in the UK – the increase is made on the house value (equity + debt) where as returns on a share portfolio for a retail investor are made on the equity only. If house prices decreased for 10 years the standard view in the UK that home ownership is better would quickly erode. But, in the UK supply of housing is limited whereas in SA it is far more market driven…Reply
Jayson March 25, 2014 at 18:21
Thanks for your comment! I always appreciate the leveraging argument, the idea being that you enter a swap arrangement in which you receive the return offered on the full value of the house in exchange for paying the interest rate on the bond. So sure, an equity investor might get higher returns – but they’re getting higher returns off a smaller capital base.
But the thing is, when you do the math, the equity investor usually gets a head-start. I’m not familiar with the UK house-buying process – but in South Africa, there are high initial costs associated with your home purchase. You pay transfer duties and conveyancing fees. The SA Homeloans Association talks about the 108% mortgage for mortgage bonds that also cover your initial costs. In other words, off the bat, the homeowner’s investment begins down by 8%.
Then, when you look at it on a monthly basis, the actual return of the home-owner isn’t quite “Increase in Housing Value – Interest on Principle”, because there are other costs associated with the investment. The return is more “Increase in Housing Value – Interest on Principle – Repairs and Maintenance Costs – Rates – Levies – etc”. If anything, you just hope that your leverage return covers the other costs of home-ownership.
Meanwhile, the equity investor (the renter) can continually add both the rent saving and the saved costs (of maintenance, etc) as capital to his/her portfolio.
I just think that we underestimate how much the head-start and the capital growth can matter over the duration of a mortgage (we’re programmed to think arithmetically – but the growth pattern here is exponential). Maybe have a look at some of the numbers in my first post on this? I definitely modelled the leverage impact into the return of my hypthotical home-owner – and even taking that into account, the renter-saver tends to win where initial mortgage costs are high and rental yields are low.
I’d be interested to hear what you think of those numbers.
Thanks again for the comment!
Zaheer Hoosain March 28, 2014 at 18:22
I don’t really agree, hey. There are definitely more risks associated with owning, but there are with every investment. I have an investment property in SA and I’ve only had it for 21 months now. I put down a 12% deposit.
After 15 months I changed tenants and had the opportunity to ask for a more market related rental. Now my rent received is higher than my bond repayments plus rates and insurance. Water, refuse and electricity is covered by the tenant.
In the past 21 months I have needed to fork out about R15k worth of maintenance (including a stove and plumbing).
Each year, rental goes up but my bond repayments stay static. In year 12 my rental income could easily double my bond repayments. Put that down as early repayments on your bond and you might not need to commit for 20 years. As an analyst I have crunched the numbers assuming conservative growths. You start off in the red because of your capital investment but the rewards far outweigh any safe comparable investment.Reply
Jayson March 28, 2014 at 20:55
Hi Zaheer. I totally agree with you – for an investment property, because you’re earning rental income. As I said in my post, I’m talking specifically about choosing where you want to live, and how you choose to pay for it. In that scenario, you don’t have a tenant paying for your rates, insurance, water, refuse, electricity and maintenance – you have to cover it yourself.
If you’d like to have a look at my own number-crunching, you’ll find them in the original post. Hope that helps!Reply
imoddigital March 29, 2014 at 15:56
Cool article, I love the discussion of buy or rent, just like VW or Opel or EFTs or Unit Trusts .. for each article for it there’s one against it, so a difficult space to justify but a well written article.
What I do find in most articles along these lines is that there is never any math involved, things are almost assumed. I’d love to see the article backed up by some tables or charts showing the growth of a property vs an equity fund. I’d love to know exactly which equity fund would have the growth the trump the growth on a property and I’d love to know what type of area and/or cost said property would be. All these factors are crucial to the justification of whether it’s better to buy or rent. I also believe that it’s hugely important to know what a person’s end goal is.
I do agree that buy to rent as an investment vehicle is a stellar investment and that in most cases would trump the buy-to-live-in vs equities situation.
But I’d love to see some real math behind all these statements and if you’d care to share that it would be an incredible addition to your article.Reply
Jayson March 29, 2014 at 17:00
Thanks for this – I do appreciate appreciation. If you go back to the original post that I discuss above (Rent or Buy: The Problem with Home-owning), I did the math. There are graphs and assumptions – I hope that’s what you’re looking for!Reply