Buy or Rent?

People are so obsessed with ‘owning their own home’ in Australia and America, that over the last 4 years, they forgot to consider the impact of higher interest rates at the time of purchase.  Notwithstanding the tragedies which followed financially across the globe, last year, the property devaluation in the US in particular is a timely reminder that the very biggest investment of everyone’s lives can be the most risky of all.

For so long, property has been treated like a safehaven, superannuation type product for people of all ages.  Yet, financial planning theory recognises  property as the second most risky asset class next to international shares.  Although it is regarded as a long term investment vehicle it can produce high volatility capital value and income returns over the course of the life of the investment.

Why then, do Australians and Americans see property ownership as the ‘great dream’?  The benefits of owning your own home are attractive, but there are other, far more liquid investment prospects out there.  In addition, if by running a business from home and renting the property to live in the business would pay up to a half of the rent.  From a personal tax perspective, the cost of living is then greatly reduced and the business owner/tenant saves on paying significant amounts in interest over the life of what would be a loan.

Renal rates in Australia have been producing on average about 3% return in some capital cities before other maintenance and real estate expenses have been taken out.  For tenants, this is a fantastic price to pay considering, if they had bought, they would be paying the bank an effective rate of between 5% and 9% over the last 4 years.  Capital values have appreciated, but it is questionable how many people have actually cashed in on the appreciated values and now hold property close to or below the value of where they purchase it.

For the number crunchers, if $300,000 was borrowed from a bank to purchase a property, at an average interest rate of 6%, over the course of 25 years, the borrower would pay back almost $280,000 in interest.  Is it guaranteed that the property value will double in 25 years?  Who knows? 

Alternatively, if the equivalent monthly payment required to pay back the $300,000 to the bank was invested at an average rate of 3% over 25 years, the investor would accumulate almost $861,000!  Of course, to equate the figures, the cost of renting should be taken out of the $861,000, however, it remains to be an attractive option.

Potential borrowers should carefully check their calculations and take note of the consequences of the last 12-18 months events in the global economy.  Property is not the only method of wealth creation and in decades to come is one of the least convenient.