To buy or to rent? To help find a more definitive answer to this much-debated question, the Reserve Bank of Australia (RBA) published a research paper to assess the costs of each option. By assigning values to key property costs, the report provided consumers with a measure of the cost of home ownership compared to rental yields to determine which option represents better value.
Unlike previous research, the study went a step further to compare owning and renting costs for the same properties. However, the report is not without its limitations as it is based on a series of assumptions including:
- a lack of consideration of factors such as the costs of construction and future prices, and
- capital appreciation in the future will be the same as the past.
And the answer is..?
The report determined that 2.4%pa is the long-term rate at which house prices are considered fairly valued. If the real house price increases continued at this rate, consumers would be better off buying a home. However, the average rate over the past ten years has been just 1.7%pa. At this rate, house prices would be 19% overvalued, making renting a more attractive option.
Whilst studies such as these provide a useful comparative tool, in reality, the decision to purchase a home is based on both tangible and intangible costs plus benefits such as:
Security – purchasing a property ensures the owner is not subject to regular inspections, nor a landlord’s decisions to sell, renovate, or make other lease changes without concern for the tenant.
Ability to make capital improvements – an owner is able to personalise a property to his or her taste, or make alterations/additions to improve the value.
Flexibility – renting a property provides flexibility not offered by home ownership, eg. tenants are not tied to a particular location by a mortgage.
No maintenance costs – when renting, the only outlay on the property is rent, with all rates, repairs and maintenance costs borne by the landlord.
The RBA study also doesn’t consider a third option which is renting and investing. This alternative sees owners buy an investment property which they rent out to others while renting a separate property in which to live. Unlike purchasing a home to reside in, purchasing an investment property provides an opportunity to have someone else pay off the mortgage, and allows many of the associated costs to be claimed as tax deductions. However, these benefits are offset by the potential for capital gains tax liabilities when the property sells, as well as no guaranteed tenancy, and liquidity issues.
Property forms part of any diversified portfolio. Exposure to property can be gained directly through the purchase of “bricks and mortar” or indirectly through property trust investments. Investors should be aware that a portfolio heavily dominated by property will be highly subject to this sector’s movements, with any appreciation or depreciation in property values having a significant impact on a portfolio as a whole.
Research Discussion Paper – Is Housing Overvalued? By Ryan Fox and Peter Tulip, July 2014
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