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Monday 17 October 2016

Is It Better To Buy Or Rent? (And Why We Bought)


Round 1....Fight! 
The Buy or Rent debate is always a controversial one, and I think the reason it's so controversial is that there is so much money at stake. Those that have bought property want to believe that they have made a good decision because they have put a shit load of money down. (Don't worry buyers property generally does appreciate). Those that are renting fork out a lot of cash each month and are then are made to feel guilty because they are told that they are paying their landlord's bond (don't worry renters the buyers are paying their Bank Manager's bond!).

Although the Buy versus Rent question has been doing the rounds on the internet for a number of years already, it was recently brought back to life with some vigour by those F-bomb dropping people over at Just One Lap. The Just One Lap team boldly stirred the pot by declaring that it is better to rent than to buy. This caused a mini panic attack and subsequent backlash from all the people who bought property during the boom years. However after the Just One Lap example scenario and follow up podcast, they were not comprehensively proved wrong, and it did seem that by renting you would come out on top.

The Stealthy family recently faced a Buy versus Rent decision, for which I had run some calculations. So this post is sort of my take on the decision together with the numbers and other factors that lead us to end up buying. Now it is dangerous to use examples as statistics, so keep in mind that this blog post is in relation to our very particular and unique situation. Having said that however, our situation is kind of the perfect scenario to use for an investigation into the Buy versus Rent debate, because we were renting our place, and then the owners sold to us. So it is an exact apples and apples1 comparison.

Right let me go open Excel and allow it to do some of the heavy lifting, as I show you the numbers...

The Finances Behind Buying and Renting

As per usual let me dump my assumptions before we begin.
  • Inflation is 6.28%. I am going to assume that equities will return 15.28%. You can read more about how I got to these numbers in this post
  • House price growth is 0.6% above inflation - you can read how I got to this value in this post
  • This is for a townhouse, which means there are levies. The advantage of levies is that it covers the structural insurance, and some of the maintenance costs. So I assume that the insurance cost is 0, and I assume that maintenance is 0.5% of the property value per year (you can see how I got this number by checking out the Expenses section of my post on Investing In Residential Property). 
  • Rental Escalation is usually pegged at 10% in most rental contracts. However if you accept this then you are screwing yourself (especially with inflation around 6% and house price growth around 6.8%.) So before signing any rental contract you should definitely check what your escalation clause is and if possible try to negotiate it lower. I do not think a landlord can continually jack up rental by 10% each and every year - the tenant will soon get pissed off and move to a cheaper place. So for this reason I put rental escalation at the same rate as house price growth - 6.88%. I think this is more realistic.
  • I am going to assume a normal 20 year bond - no additional payments or anything like that.

Okay, and now for the numbers relating to my particular case:
  • Rental was R8800 per month
  • The sale price was R1.15 million
  • I was able to get a bond at a little under prime - 10.45%
  • We put down a R130k deposit
  • Bond has a monthly account fee of R57 a month....coz they can....
  • Our bond repayments are therefore R10206 (including the bank fee)
  • The transfer costs were in the region of R40k (this includes transfer duty, sharks lawyers fees, etc).
  • The bond initiation fee was R5700
  • Levies and Rates and Taxes is R2108

Right, we got all the parameters set, and we are ready to unleash the power of Excel. I ran this scenario on a month by month basis with the Buy and the Rent scenario side side by. 

If we continued renting our place, we would have a long list of monthly costs consisting of:
  • Rent

However, if we bought the place, then each month we would incur the following costs:
  • Bond repayment (including bank charges)
  • Maintenance
  • Levies
  • Rates and Taxes
I ignore the costs which are common to both (e.g. household contents insurance). These just cancel out, so no point in including them.

At the end of each month I looked at the difference between the monthly rental total and the monthly purchase total. If the Rental scenario total came out less than the Buy scenario total for the month, then I added this saving to an "Investment Account" in favour of the rental scenario. This of course assumes that you are disciplined and in a position to invest the savings instead of blowing it on other stuff.

Rental contracts have a clause which allows for annual rental increases (if your rental contract has no increase clause, then you need to immediately call the psychiatric ward and book your landlord in....no wait actually don't, just keep renting there instead!) So each year the rental gets bumped up and up, usually faster than inflation. Eventually it reaches a point where the rental expense is more than the Bond Payment + Levies + Maintenance + Rates and Taxes (using my assumptions this happens around the 8 year mark).

Annual rental escalation means at some point the rental will exceed the monthly costs of buying.
(**Quick aside - you may have noticed I have added these tweet this/key point/quote box type thingies into this post (as well as some others). If you think something is share-worthy then you can click the "Tweet This" link and the dark magic of Twitter will compose it into a tweet for you, ready to be sent out. What a time to be alive!)

Once the buy scenario becomes cheaper, the saving is subtracted from the rental "Investment Account" (this is the same as if I were to set up an Investment Account in favour of the Buy scenario. I hope this making sense - adding to the Buy scenario investment account is the same as subtracting from the Rent scenario's investment account).

I also kept track of what the value of the house would be based on my assumptions about house price growth. Each year I adjusted the house value accordingly.

Lastly I had to take the initial costs into account (Deposit, transfer costs, bond initiation fee). The upfront costs totalled R175 700. So at month 0, I put this into the Rental scenario's "Investment Account"

I have sent the complete spreadsheet to those of you on the mailing list, so you can check it out if you are interested in the numbers, and adapt it for any scenarios you may want to run. If you would like the spreadsheet but I do not have your email address then why the hell aren't you on the mailing list!? get in touch and I will swing it your way.

*2018/01 Update - I have made the spreadsheet available for download on the Spreadsheets page.

So What Was The Outcome?

If we bought, then, after 240 months we would end up with a paid off house worth around R4.071 million. If we decided to continue renting instead, we would end up with an Investment Account worth around R4.172 million. Wow, after all that, almost identical! (Of course it must be said that one massive advantage of the renting is that you have an investment account of what will probably be diversified holdings, whereas if you bought you get one house in one location, which carries a lot more risk!)

Note that these values assume we will not move. Selling and re-buying costs money (quite a lot of it!) and will swing the calculations back to the rental scenario. However, our plan is to stay put for the foreseeable future (but of course we cannot be 100% sure...)

I also just want to just say a something about these values - they are extremely sensitive to the inputs. If for example I change house price growth to 8%, the Buy scenario looks way more impressive. But if, for example, I up the interest rate from 10.45% to 11.45% then the rental case looks pretty good.

It was also interesting to note that if I increased the maintenance expense from 0.5% to 1% of the property value per year (most people say a good rule of thumb for house maintenance is 1% per year) then the Rental scenario came out quite far ahead. This leads me to believe that if you are going to buy, then buy a sectional title instead of a house.
The financial case for buying a house over a sectional title looks dead in the water.
For my situation I am comfortable with the values I used, and so from a financial value point of view, there was pretty much nothing in it!

Also note that I have ignored the Tax implications of both selling the house and selling the investment account.

The Finances Are The Same. So Why Did We Buy?

Well, the numbers are only one part of a decision like this (although quite an important part). There are of course a lot of other pros and cons to consider. Allow me to sound smug and educated and call them the "qualitative factors" (for added effect say it like a stuck up Englishman)

Why movers shouldn't do pot
On the renting side, you get the advantage that you have a lot of flexibility and you can up and leave pretty easily and cheaply. However on the other side of this coin, your landlord has just as much flexibility and can boot you out pretty easily and even more cheaply! Also, moving costs money and is about as fun as renewing your drivers license. In short, moving is a real pain in the ass! (Believe me we know - and you get the added benefit that the movers will more than likely break something of yours, as Potty Mc Potplant in the pic on the left will testify!)

Another plus for the renting is you never have to worry about repairs to the place - I confess I had a little smile when our landlord was moaning about the fact that he was going to have to replace our broken garage door...

On the buy side you have the disadvantage that you are pretty much stuck in your location, and it will take some time and considerable cost to sell and leave. However, this also means no one can force you to leave either, and if you are happy, you get to stay in your place for as long as you want.

Also, if you own your place, there is the added bonus that you can be very manly and hit nails into the wall....and stuff... Ah yes, that warm fuzzy feeling as I expertly measured, marked, drilled and mounted a shelf in our baby room (the position was checked and confirmed no less than 3 times by my wife. When I was done, the wife then declared that the shelf is too high! I subsequently had to polyfilla, paint, re-measure, redrill and remount....no comment...)

So with the finances pretty much the same in my view, the factor that swung it for us was one of these qualitative factors - while my wife was pregnant, our landlord informed us that we would not be able to renew our lease as he was going to be selling the place. Now I will give you one guess as to the date we would have to move out... Yup, exactly around the time that my wife would be giving birth! So even though moving house with a one week old baby sounded like a delightful activity filled with unicorns and rainbows, we decided we would rather make the owners an offer to buy the place instead.

The Cherry On The Top

After estimating my cost of living in retirement, I realised that there is one other big benefit to buying and owning your house in retirement.
Believe it or not there is a retirement tax benefit to owning the house you live in.
A tax cherry on a retirement sundae

You see once the house is paid off, your cost of living is significantly reduced compared to if you would still need to pay rent.

A lower cost of living, means you can draw less money each year to cover your expenses. And the less you draw down, the less tax you pay. So by owning the house, our annual drawdown would be quite a bit less, as would our Tax bill.

One Last Calculation

If your brains aren't too fried, there is one more calculation I want to look at.

Ok, so if we bought our house, then after 20 years we would no longer have a bond payment (only levies, maintenance and rates). If we rented, then after 20 years we would continue to pay rent indefinitely - however we would have a nice investment on the side as well.

So I thought it would be interesting to see if the investment amount which had built up from all the years of renting would be enough to cover the rental cost going forward. How do I calculate this? Well once again I come back to the 4% rule (I know, I know - you sick of hearing about it).

I expanded the Buy versus Rent spreadsheet by one more row, to get the monthly rental amount of the 21st year. It came to R33 297. The maintenance and levies at this point in time would be R1 813 and R7 977 respectively - so that gives a total of around R9 790 per month.

So renting is R33 297 - R9 790 = R23 507 per month more expensive than living in the paid off house. So would the investment account which had built up over the 20 years be enough to cover this shortfall?

To get the lumpsum amount to cover the monthly shortfall, the 4% Rule says we need to multiply the monthly amount by 300. So this means we would need R23 507 x 300 = R7 052 100. This is quite a bit higher than the R4.172 million available. In other words, the savings generated by renting over buying would not be enough to cover the rental in retirement.
Renting & saving the difference will leave you with insufficient funds for rental in retirement.
So this again swings our case to the Buy scenario and I am comfortable with our decision.

Till next time, Stay Stealthy!
 - ~ - ~

1 With all those apples, we should make some cider! Seriously though if anyone has a good recipe, swing it my way, I have been attempting a little home brewing lately and would appreciate a good recipe from anyone whose been down the apple cider avenue. I would prefer the version of the recipe that will be safe for drinking and will not put me into Ward 2C :)