It is often quoted as the great Australian dream. The idea of buying your own home. Not only is it cited as a smart way to build wealth but just as importantly it represents security, a place to raise your family and build a community.
However, in recent times there has been a lot of discussion about the best way to build wealth. Should we buy our own home or should we rent and invest in other areas to build wealth.
Recently, two Melbourne based economists Dominic Crowley and Shuyun May Li looked at this very question in their research paper An NPV Analysis of Buying versus Renting for Prospective Australian First Home Buyers
Their paper looks at buying versus renting as an investment decision for first home buyers. The study focused on our 8 capital cities and the time frame was set from 1983 to 2015 with 23 periods analysed. The analysis examines whether buying a median price house and holding it for 10 years or renting a house of equivalent quality for 10 years and investing the avoided costs into other assets was a better ﬁnancial decision, given realised house price appreciation, mortgage rates, rental payments, returns on other assets, and other relevant factors in the subsequent 10 years.
How do Australians feel about home ownership?
It goes without saying that Australians love the idea of owning their own home, it’s part of our culture, ‘the great Australian dream’ and ‘a man’s home is his castle’. A home can also make us feel secure and safe, it’s a refuge from the outside world. And, for a lot of Australians, it feels like a great investment because we can see it, touch it and make improvements to it.
On the other hand, renting is often described as a negative choice to make. You will hear things like ‘renting is dead money’ and ‘why pay off someone else’s investment’.
What did Dominic Crowley and Shuyun May Li find as a result of their research?
They found that buying was a better option than renting for most of the periods they studied. There were some instances where renting was more favourable than buying. However, overall, buying your home was the winner.
So, what does this mean for those of us facing the same dilemma now?
As they say in the famous Taco add, ‘porque no los dos’ which means, you can have both, rent where you want to live and buy where you can afford. Which is standard finance theory 101. It actually does makes sense, rent where you want to live and then when you buy somewhere you can afford that also makes sense as an investment. That way you get to maintain the lifestyle (or at least the location of that lifestyle, you might have a little less cash to splash on the lifestyle) that you desire while getting into the property market and putting your money to work. Additionally, having two other parties contributing to the costs of holding a property, (a tenant and the ATO through potential tax refunds), may make more properties more affordable giving you more options.
Maybe we’re a bit old school, maybe we’re dreamers, we do still believe ‘he great Australian dream’ makes financial sense. It’s not for everyone, some people simply don’t have any desire to own a home, which is fine (we still recommend you consider property as a part of your wealth creation plan) but for those people that it is of interest to, make it happen, it’s worthwhile.
The reason it’s worthwhile is multifaceted;
- Having a home and the associated costs (including a mortgage) is a fantastic form of forced savings. One of the potential flaws in the research by Dominic Crowley and Shuyun May Li is that it assumes people will invest the ‘savings’ they have from renting instead of buying. In our experience and a plethora of behavioural economics research, this is easier said than done. Most people don’t save that money, instead, they spend it. Automating (forcing) as much of our money-related behaviour as possible is a key step in maximising the likelihood of a positive outcome. A home is one of the best forms of forced savings because defaulting on a mortgage or not paying the associated costs of maintaining a roof over your head is your last resort. Generally, people do whatever they need to meet those costs.
- Over the long term, a property is likely to increase in value. Don’t get us wrong, we’re not in the ‘property never goes down in value’ camp. It does, and probably will. If you hold it for a long time it hopefully won’t matter. If you’re paying it off and therefore saving some money along the way, the growth in value is cream on top. The real gold is that if it’s your own home when you sell it you won’t pay capital gains tax. Therefore you save 20.5% to 46.5% in tax when compared to other investments you own personally.
- You tend not to trade your home frequently, so in leaving it alone you allow the market to do its thing and you benefit from compound interest. Clients often say to us ‘The best investment I ever made is my home’. Often they’re right, but the main reason is not because it’s been a particularly good investment from a return viewpoint, it’s because they haven’t messed with it by trying to buy and sell at the right time. They simply bought a home and lived in it for ten years, and low and behold it’s gone up in value.
Not fiddling with your investments can be hard to do. Much of our value is added by helping clients manage this temptation.
So, if owning is your dream, good. It can be a sound financial decision, as Dominic Crowley and Shuyun May Li have shown us in their research. Maybe you don’t get the dream home straight away but that doesn’t mean it can’t be done. Make a plan, automate as much as you can and chase the dream!