The unrecoverable costs of buying a million dollar house now equate to around $1730 in rent a week

[thestarside]

A few years ago there was a Canadian portfolio manager who put out a video discussing the actual unrecoverable costs of buying, accounting for generally ignored costs such as opportunity cost, maintenance costs and cost of capital. This was entitled "The 5% rule", and assumed that the mortgage interest rates would be around 3%. Basically, the rule of thumb guide meant that if your yearly cost of renting an equivalent property were less than 5% of the value of the home, you would expect to be financially better off renting than buying. If the cost of renting an equivalent home were more than that number, than it is financially better to buy the house if you were living there long term. You can see the video here The 5% rule

Today, interest rates are around 7%. So if we take the same rule, it becomes the 9% rule. If we take the median house price in Auckland, it is around a million dollars. 9% of 1 million dollars/52 weeks in a year = $1730 a week. A $1700 rental in Auckland is typically far, far nicer than an average million dollar house.

Of course there are a few things that could happen. Mortgage rates could drop again. Rental yields could also go up more than inflation. Council rates could drop (unlikely). The rule cannot predict the future. There are also plenty of non-financial reasons to buy a house, which I'm not going to discuss as this is a personal finance subreddit.

Is buying an average Auckland property at current prices a bad financial decision, even as a long term investment?

 

[jamesbates]

@thestarside Surely it depends on future prices more than anything. If house prices and rents double in the next 5 years it will of course have been better to own than rent. If house prices fall 20% and rent stays the same it would have been better to rent.

These formulas that people present are not much better than guesses, if any better at all. And they seem to miss out some key variables in this case.

 

[cdg41592]

@jamesbates He explains at 3:30 the math behind why it’s not about guessing and it’s weighted in risk modeling even going on to use Ontario as an example. In this example they’ve also had higher than average returns and then explains why isn’t an accurate way to cost model the opportunity cost of equity when properly assessing the mathematical risk.

What you’re saying isn’t entirely incorrect, it’s just not factoring in the risk that comes with watching house prices continue to outpace income for long periods of time. Take the growth rate in recent history of Auckland and eventually the risk is no one will be able to afford the house because the cost of debt is too high. This reduces the demand for the house buying and sets a ceiling on prices because fewer and fewer people are able to buy as house prices exceed income growth unless the gap is covered through generational wealth transfers (e.g. bank of mom and dad). It’s not only interest rates that can cause this. Over inflated house prices can as well.

That’s why it’s important to look at the bigger picture like past 100 years as well. Then the way you’re modeling on higher house prices becomes more speculative than a risk adjusted returns model. That’s not to say it’s bad to buy, but rather you’re specifically assessing and accepting the risk because you believe it will pay off. The question is for how long?

 

[sorrowedhart]

@jamesbates And NZ has just elected a guy who has a $20 million plus portfolio value to protect and enhance, and is behaving like that. Every chance he'll come up with more ways to support and inflate property too.

 

[renwei]

@sorrowedhart How does a PM single handedly inflate property ? Its supply and demand. Nothing else. I know its tough but playing victim and blame games will not help you.

Take 2020-21 for example. Covid era, house prices shot up by ~ 37%

was he to blame ? Ya m

 

[marseph98]

@renwei It’s a little daft to ignore all the pro landlord legislation that this govt has rolled out.

 

[renwei]

@marseph98 "this govt" has only been in power for a week. The other govt was in power for 6 years and the property prices shot up 37% in 2 years. and doubled or in some cases tripled. That is houses too not just rental properties.

 

[marseph98]

@renwei Yeah obviously in large part to the RBNZ dropping the OCR to record lows and leaving it there.

When it became clear that the low interest rates was leading to insane asset price inflation, the RBNZ should have started raising rates.

It doesn’t matter that the govt has been in for a week, their policy agenda sets the tone for the housing market and what they want. For what it’s worth, the now repealed MDRS would have had significant long term implications for supply. Now gone.

Not to say that the last govt was competent overall, just that it’s clear to everyone that this is a pro property, pro landlord govt and we’re absolutely fucked.

 

[sorrowedhart]

@renwei Don't ignore their favourable changes to policy for speculators, that'd be absurd. And just because successive previous governments have also done things to support property doesn't make it right for him with his conflict of interest to do so.

I encourage you to learn about the effects of policy on both supply and demand. It's educational. I know it's tough but ignoring reality will not help you.

I also own property.

 

[renwei]

@sorrowedhart Supply and demand are economics. Policies are short-term plays that influence the market but it does take away the fundamentals

Read up - it's happening all over the world.

 

[thestarside]

@jamesbates I still go to the supermarket with a budget every week even if I don't know what the price of eggplants will be in 1 year.

All of this is unknowable, but people still need to have some way of running the numbers when they're making the biggest financial decision of their lives. This tool uses somewhat predictable and historic data which i find to be a best guess method.

 

[jeff2112]

@thestarside It depends what you do with the money you save by renting, because a mortgage is a form of forced saving. Say you could afford the $1700 a week but choose to rent the same house for $900 a week instead. If you spend the $800 a week you’ll end up worse off. If you saved it in an investment fund you’d probably end up better off.

 

[jamesbates]

@thestarside If you were to have used this method a decade ago you would have decided in 2013 it was better to rent in Auckland than to buy and at no time until now would that data have flipped to push you into buying one. But I'm pretty sure that the people who bought in 2013, 2014, 2015, 2016, 2017, 2018 or 2019 don't regret their purchase. Will be a little more common in 2020 and then more in 21 and 22.

I would say if you are looking at the historical data to make a best guess, it is almost always better to buy a house in NZ provided you have some breathing room for increased rates.

 

[jason123]

@jamesbates This holds true for the last 30 years, basically since our pivot to neoliberalism and the application of QE ensuring ever decreasing interest rates. If you look back further, the historic trend has interest rates at around 5-6% on average, with far more cyclic swings, not the steady 2-3% that is targeted. The question currently is whether we'll see a return to the norms of the last 30 years (which was historically abonormal) or not... an interesting risk, particulary when shelter is an essential need.

 

[fola]

@jason123

If you look back further, the historic trend has interest rates at around 5-6% on average, with far more cyclic swings, not the steady 2-3% that is targeted.

Why would you look back beyond the last thirty years though? The RBNZ Act was established in the 1980s to implement the mandate of price stability - and we aren’t ever going back to the preceding age of finance ministers instructing the Reserve Bank to set interest rates and foreign exchange rates. We have firmly closed that chapter of our economic history.

But with that being said, you might be interested to know that the Government used the State Advances Corporation to offer 3% loans on homes and farms during the decades following WWII. Low interest rates aren’t a modern innovation.

 

[jason123]

@fola Why would I look back at historic patterns? A few years ago, I was looking to understand the context that our modern convention of having central banks and the very mandate for price stability.

I looked both locally and more globally as far back as I could get decent data for, in some cases there was reasonably useful longer interval data available back to the 1700s (computers have sure made that a lot more accesssible, but a lot of data was either non-existent or simply not digitised so useful data prior to the 1850s was hard to come by). Add to that a host of reading to understand the context of different periods, including pre and post-Great Depression era accounts of that particular period (perhaps the most well documented).

I'm sure central banks around the world have no intention of giving up their mandates. That said, I do not have the absolute confidence some seem to that their ability to successfully maintain price stability is a given. The aim of holding a steady 2-3% inflation, essentially holding inflation below what would appear to be the natural midpoint of economic systems, doesn't appear to be a sustainable goal from where I'm standing. I don't say this as in any doom and gloom sense, I actually think there's still a bit more gas in the tank as it were. I simply don't take the status quo for granted, particularly when considering a 30-year horizon.

And yes, I'm quite aware of the post-war govt backed loans. I spoke to averages, not the peaks and troughs.

 

[fola]

@jason123

Why would I look back at historic patterns?

I was replying to your question about whether we will maintain the norms of the last thirty years - which you described as “historically abnormal”.

The economic norms of the last thirty years will eventually make the previous norms appear “historically abnormal” because we will never return to those old ways of managing our economy. We have firmly and resolutely closed the door on that chapter of our economic history.

 

[jason123]

@fola I understand that you're saying we've closed the door on them, but as a never-say-never type of guy, I have to ask: on what basis?

 

[fola]

@jason123 Our Government’s ability to sell its sovereign debt at affordable rates is dependent upon maintaining our current economic and monetary settings in perpetuity.

We can’t afford to pay the risk premium that would result from the credit downgrade that would inevitably occur if major changes were made to our current central banking arrangements.

Every dollar that the Government raises from selling debt has the effect of further cementing our monetary policy.

 

[jason123]

@fola Ok, I am largely in agreement there.

I don't think it logically follows that we need to maintain the current 2-3% target in perpetuity to preserve the value of our sovereign debt, though. We do, however, need to maintain more or less the same relative position to other countries to do so, which is why the OCR gets adjusted periodically. Imagine if we kept the 2017 settings through to today...