Rent vs. Buy - Is my math correct? Am I missing anything? (An Analytical Approach)

[turboizak]

Hey everyone,

I am a 30 yo male living with my partner in Auckland. Our combined household income is $150k p.a.

I am currently renting a 3 bed. house for ~$600 p.w. ($2400 per month) - I do not own a home in NZ. I have a deposit of approx. $350k saved up so far - enough to afford the median priced home in Auckland or the greater Waikato region. However, I've deployed all of that money into my personal portfolio of growth funds, ETFs, index funds, international equity and a small portion in bonds (90% Stocks, 10% Bond).

I am open-minded but I've always been 'pro' Stocks and belonged to the Stock Market Investment camp when it comes to the classic 'Real Estate vs Stock Market' Investment debates. Unlike the latter, I've had trouble viewing homes as productive assets unless the macro-economy and variables that are involved prove otherwise. Due to this personal bias, I've never really felt a strong desire to own a home here. Having said that, I realize the downfalls and dangers that come with this way of thinking i.e., 'not owning a home'.

Lately, I've been running the numbers to try and understand if it makes sense to buy a home. Below is my calculation.

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Investment Period - 10 Years

Rent per month = $2,400, Anticipated Annual Rent Increase = 6%

Property Price = $800,000. My Intended Staying period at the Property = 10 years.

Deposit = $350,000 (or) 43.75%

Mortgage rate = 7.25%, Mortgage Length = 10 Years

Principal - $450,000, Interest Paid over the 10Y period - $183,966

Total Cost of Loan (P + I) = ($5,283 x 12) x 10 = $633,966.

Buying and Selling cost at 1% ea. = ($8,000 + $8,000) = $16,000

Maintenance / Insurance and Service charges at 0.5% ea. over 10Y = ($4000 + $4000) * 10 = $80,000

Stamp Duty - NA (Not sure about this cost)

Total Cost of Owning Property at the end of 10Y = Deposit + Mortgage + Expenses = $350,000 + $633,966 + $80,000 + $16,000 = $1,079,966

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Property Growth Assumption = 6% p.a.

Stock Investment Growth Assumption = 8% p.a.

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Additional Monthly Investment (Leftover Cash) Towards High Growth Stock Portfolio over 10Y period.

Whilst Buying = $250 p.m. x 12 at 8% compounded annually = $45,737

Whilst Renting = $3,000 p.m. x 12 at 8% compounded annually = $548,838

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Buying Scenario:

Property Growth after 10Y compounded at 6% p.a. = ($800,000 x 6%) over 10Y = $1,432,678

Investment Portfolio Growth from Monthly Investments after 10Y whilst Buying = $45,737

Total Cost of Owning Property at the end of 10Y = $1,079,966

Net gain after 10Y = Capital from Sale + Monthly Investment Portfolio - Expenses = $1,432,678 + $45,737 - $1,079,966 = $398,449

Net Gains Realised after 10Y while Buying = $398,449

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Renting Scenario:

Investment Growth of Initial Capital $350k at 8% compounded annually at end of 10Y= $426,874

Investment Portfolio Growth from Monthly Investments after 10Y whilst Renting = $548,838

Renting Cost over 10Y period at 6% YoY increase = $379,607

Net gain after 10Y = Initial Investment Growth + Monthly Investment Portfolio - Expenses = $426,874 + $548,838 - $379,607 = $596,105

Net Gains Realised after 10Y while Renting = $596,105

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Conclusion: That's a net gain difference of $197,656 from renting compared to buying over the 10 year period.

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Further Analysis:

There are a number of reasons to assume the housing market has peaked.

In my opinion, the 6% growth assumption for housing in the above estimate is generously geared toward the buying scenario, yet renting came out to be the better option at the end of 10Y period. 30 Year loan period makes the buying scenario even worse. This is due to the opportunity cost of money (down payment) combined with the high interest rates on top of an already soaring inflationary environment working against buying a home. This makes cash and cost of capital important.

Many successful Real Estate investments are built on the principles financial leverage. OECD Countries have set interest rates far too low for far too long that many of us almost forgot what the normal healthy interest rates are. Since we are still facing the aftermath of GFC and Covid to this day, there is a high likelihood that the current interest rates may be the new normal.

The average house price in AKL region currently is $1.4 million, this would take a person earning $100k p.a. saving 100% of his income 14 years to buy it. If we only saved 50% of the income, then the time taken to own outright (without loan) is almost doubled. We've already shifted median multiple, i.e., affordability ratio of home ownership from 'house price to individual income' to 'house price to household income' ratio. This is unsustainable on many levels.

I believe we are entering a new era in the economic cycle where the sensible way forward and priority for the economy should be the focus in 'increase in wage growth' rather than 'growth in house prices'. The wage growth will bring the median multiples back in balance. This is more challenging to achieve in a low interest rate than a high interest rate environment, which is another reason why I believe the interest rates are here to stay.

Finally, my assumptions for the future could be completely wrong. The future could surprise us and totally go in the opposite direction i.e., house prices could keep climbing without real wage growth to back it up, especially when the majority of us are obsessed with only affording the down payment instead of affording a home. This scenario is frightening due to many possibilities.

I understand that no amount of substantiation or numbers can justify when the emotional factors of buying a home are put into the equation. This is purely intended as an analytical approach.

Keen to get others' thoughts and perspective on this.

 

[snlmommy]

@turboizak TLDR; Buying does not make sense at current prices (if we are just looking at the mathematics)

You are not wrong.

 

[alicehaynes]

@snlmommy *Purely from an investment perspective. There are several other benefits to home ownership not included in the math.

 

[ironh1de]

@alicehaynes Yeah, you may have to move multiple times in a 10 year period to preserve only a 6% increase rent increase would come with a decent amount of stress, plus moving costs.

Still, you can't project everything with great confidence, so good on OP for at least crunching the numbers in one scenario.

 

[blessedisshe]

@alicehaynes This is a financial sub... Not a homesteading sub. The pure financials are exactly what a savvy person should be focusing on.

OP is correct with his figures. He forgot to factor in rates which is $4k per year and increasing by 6% annually.

Home prices will not double over the next ten years. They will eventually increase, but this crash still has 12 to 24 months to play out - at a guess.

 

[turboizak]

@blessedisshe You are right, the council rates needs be a separate item.

Strongly agree! home prices will rise inevitably but it will not double over the next ten years.

 

[ditto333]

@turboizak Not all homes will double in the next 10 years. But undervalued homes (ie in poor state, large land plots) will catch up to 2x if not 3x within the 10 yr timeframe.

 

[hankventure]

@turboizak You shouldn't be factoring in expenses in the housing scenario that you are not considering in the rent scenario.

Yes, you may have to spend 4k on maintenance once you own a house but the fact that you didn't count that 4k towards investments in your rental scenario means you spent that money somewhere else.

Which means it has a net zero impact.

 

[resjudicata]

@blessedisshe Op isn’t correct with his figures. He’s included his monthly investment as part of the net gain. Renting should be $360k lower

 

[blessedisshe]

@resjudicata No. You are wrong.

His monthly investment is the difference between renting cost and ownership cost.

 

[resjudicata]

@blessedisshe Yes I understand that but he’s saying he’s going to make $548k from monthly investments of $3,000. The only way that works is if the $360k invested is included in the number. That’s not a net gain.

It’s fine to do it that way if you want but you need to consistent. In which case remove the principal from the expenses in the buying option. Increasing that by $450k.

Or you can (and should) do it in the most basic way. Using the numbers he’s provided at the end of 10 years his net asset position is $1,478k if he buys and $1,325k if he rents.

 

[hankventure]

@resjudicata Correct. For his investment gain he's trying to calculate net position but he forgot to subtract his monthly 3k payments from the value.

 

[gamebai886]

@snlmommy While mostly right, there was too much math this late at night. To make the math err more right.... you can buy the house on the lower end price, rent out the rooms and pay extra so less interest overall. Effectively what this does, is increase your income to pay more principal leveraging others income. Generate less interest as you increase amount paid and lower your household bills with flatmates. Personal finance 101 is lower your expenses and add that to the payments. By owning, you also catch any upside in equity along with having inflation eat away at your debt since yearly your income will increase. This is what I did and knocked off 12 yrs on my 25 year mortgage. 7.5 of those years my income was less than 50k till I got a 2nd job

 

[sherylb]

@gamebai886 Nothing stops you doing that renting though. You can have flatmates in the rooms just like you can with owning. So I dont think that makes any difference.

 

[gamebai886]

@sherylb The rent will likely increase along with inflation. A mortgage will go down as it's eaten up by inflation

 

[sherylb]

@gamebai886 The principal will go down with inflation. But the interest rates will rise with inflation. As will insurance, rates, BC fees (if any) and all the repairs and maintenance. Meanwhile, while renting, due to significantly lower expenses you can grow a substantial asset portfolio which will also inflate with inflation as well as the earnings it delivers you.

 

[turboizak]

@sherylb

The principal will go down with inflation. But the interest rates will rise with inflation. As will insurance, rates, BC fees (if any) and all the repairs and maintenance. Meanwhile, while renting, due to significantly lower expenses you can grow a substantial asset portfolio which will also inflate with inflation as well as the earnings it delivers you.

Agree with that!

 

[cfitz]

@sherylb You’re a bit off here…

Yes, the principal will ‘go down’ with inflation relatively. But probably better to consider that you’re locking in principal amount against inflation. So other costs will increase but the principle will never increase.

Interest rates don’t have anything to do with inflation and are related to the market/economic conditions.

As you pay down the principal you become more and more immune to interest rate volatility as the interest you’re paying decreases.

Think in a twenty year timeframe - if renting, you’re still paying market rate and exposed to inflationary rent increases, but if you had a mortgage you would be paying interest on say 1/4 of a purchase price from 20 years ago.

 

[sherylb]

@cfitz I dont know how you can say interest rates have nothing to do with inflation when it is unfolding right before our eyes.

While the debt decreases in real terms, the interest rates increase and its cost increase. Property buyers in NZ like to gamble on property as much as possible and go for the shortest terms and get burnt with inflation increased interest rates.

Also, your 20 year time horizon does not stack up against reality. Average home ownership in NZ is 6 point something years. So. before any debt is paid off, people incur a whole bunch of transaction costs and then incur even more debt to buy a more expensive home, also incurring inflated housing costs in doing so and bigger debt.

 

[cfitz]

@sherylb "the interest rates increase"... what do you think this means? I'm not trolling... unless you are, you're misunderstanding something here.

In a couple of years, the rates could be up, down, the same. This isn't related to inflation.