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Current Article - March 2007Renting versus Renting (PDF file)
Renting versus Renting
It has long intrigued me that the banks and media have a fixation about long term loans especially loans over fifty years and “shock horror” interest only. Yet renting a property for a life time is accepted as reasonable behavior!
What I would like to suggest and explain is that in the long term it would be better, more economical even to rent money than rent a property.
Just how do you make such a comparison? If you rent a property then all you have as an out going is rent.
Let’s look at this over a 10 year time period.
At present rents provide a yield of approx 6% pa so for arguments sake lets say the 3 bedroom home is worth $300,000. So a yield of 6% on this amount would be $18,000 or $346 pw.
Mr & Mrs Renter
Mr and Mrs Renter looked at their options and decided that renting was the way to go as it was the cheapest option, after all they argued, who wants to pay rates, insurance, interest and maintenance. This would just cost us too much. So they decided to rent.
In this table I have worked on inflation of three percent per annum and we can calculate that over the 10 years our renters have paid out $206,350 in the 10 years they have rented. Mr & Mrs Owner
Mr & Mrs Owner how ever had a different mind set and believed that in the long run owning their own property was a better way to go.
Year | Debt | Property Value | Operating Expenses | Interest | Cumulative Costs | One | $300,000 | $315,000 | $3,600 | $24,000 | $27,600 | Two | $300,000 | $330,750 | $3,708 | $24,000 | $55,308 | Three | $300,000 | $347,288 | $3,819 | $24,000 | $83,127 | Four | $300,000 | $364,652 | $3,934 | $24,000 | $111,061 | Five | $300,000 | $382,884 | $4,052 | $24,000 | $139,113 | Six | $300,000 | $402,029 | $4,173 | $24,000 | $167,286 | Seven | $300,000 | $422,130 | $4,299 | $24,000 | $195,585 | Eight | $300,000 | $443,237 | $4,428 | $24,000 | $224,012 | Nine | $300,000 | $465,398 | $4,560 | $24,000 | $252,573 | Ten | $300,000 | $488,668 | $4,697 | $24,000 | $281,270 |
Using an interest rate of 8 % pa fixed for 5 years and rolled over at this rate for another 5 years. I have also factored in rates, maintenance and insurance as operating expenses at approx 15% of interest income (which I have used as the defacto rental income) and increasing by 3% p.a inflation.
This is based on the following comment “I’ve always found that 15% of the Gross income is a reasonable amount to take off for operating expenses. (Or 23-25% if managed as well.) This has always stood me in good stead over a great variety of residential property types as a rule of thumb."
Tony Brazier, Brazier Property Investments Ltd. MREINZ
So on the face of this it is costing Mr & Mrs Owner approx $531 per week from the outset and $185 pw in extra payments over what Mr & Mrs Renter are paying. This amounts to approximately $74,920 in additional outgoings.
A no brainer you would think!
But is it a fair comparison if we ignore the fact that properties increase in value and double every seven to 10 years. If you look at the table above, I have shown the property value increasing at only 5 % per annum, which is well below historical capital appreciation in NZ which has averaged over 10 % pa over the last 35 years.
So Mr & Mrs Owner have spent $75,000 more than Mr & Mrs Renter but now have capital in their property of approx $190,000. Over the 10 years their wealth has gone up by $365 pw.
What about the opportunity cost of Mr and Mrs Renter, what if they invested their savings each year and compounded the interest, say at 5 % pa.
| | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | Total | Rent | $18,000 | $18,540 | $19,096 | $19,669 | $20,259 | $20,867 | $21,493 | $22,138 | $22,802 | $23,486 | $206,350 | Own | $27,600 | $27,708 | $27,819 | $27,934 | $28,052 | $28,173 | $28,299 | $28,428 | $28,560 | $28,697 | $281,270 | Dif | $9,600 | $9,168 | $8,723 | $8,265 | $7,793 | $7,306 | $6,806 | $6,290 | $5,758 | $5,211 | $74,920 | Plus 5% | 0 | $480 | $962 | $1447 | $1932 | $2419 | $2905 | $3390 | $3874 | $4356 | $21765 | Total | $9,600 | $19,248 | $28,934 | $38,645 | $48,370 | $58,095 | $67,805 | $77,485 | $87,118 | $96,685 | | So Mr and Mrs Renter could turn their savings into $96,685 (ignoring the tax, if only!) but they would have to save this and my experience tells me, very few are likely to do this. How does this compare to the capital growth of approx $190,000? I know a lot of commentators are now saying that the property boom is over, and it may be for a short time, who knows? But I think I will continue to back historical trends both in NZ and internationally. Renting the House or Renting the Money, you do what works for you. Just make sure you make an informed decision. David Weusten is a finance Broker who brings with him over 29 years experience in the finance industry, both in NZ and overseas. He has personally been involved in arranging for his clients finance in excess of $150 million. He has been published in the Sunday Star Times, the New Zealand Franchise Magazine, and regularly on various websites. He has also published a business guide “What do banks want? So you can get what you want”, “Owning your own business, an overview of what to consider” and recently released “Money, Your Master? Your Slave? Your Choice!”. He would be happy to answer any questions you may have related to Business, Finance, Franchising and Banking. Email him at dweusten@fspnz.com . If you would like to know more about his company, Financial Service Providers NZ Ltd visit their website www.fspnz.com . |
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