With interest rates at all-time lows, in some situations, it is now a lot cheaper to be an owner-occupier than a renter. And with the prospect of interest rates not rising anytime soon, it could stay that way for a few years, unless the market changes.
I thought it would be interesting to analyse the potential impact of this phenomenon. Obviously, there are some practical implications for people contemplating renting versus buying. But also, there will no doubt be broader consequences for the property market as a whole.
How much cheaper and for who?
Our analysis is summarised in the table below. Essentially, we compared the current value and rental cost of five property types and locations. The five scenarios were as follows:
- Luxury, high-end, boutique apartment for $2.2 million;
- Entry level 2-bedroom apartment that is considered investment-grade for $580,000;
- Investment-grade, 2-bedroom house in a blue-chip suburb for $1.2 million;
- A 3-bedroom family home in a desirable suburb for $2.5 million; and
- A 3-bedroom home in an outer suburb for $660,000.
|Property type||Interest costs||– Rental cost||= Saving/(cost)|
|Entry-level, investment-grade apartment||$13,500||$28,600||$15,100|
|Family home (blue-chip suburb)||$58,200||$52,000||($6,200)|
|Family home (outer suburb)||$15,400||$24,440||$9,040|
The interest cost was based on an interest rate of 2.2% p.a., which is the current 3 -year fixed rate for owner-occupier mortgages. It assumes that the owner has borrowed 100% of the purchase price plus stamp duty, which isn’t practical unless they have additional security to offer the bank. But we had to make this assumption to ensure it was a fair comparison, even though consequently it becomes more of an academic comparison than a practical one.
I’m sure you agree that it defies logic that it is less expensive to own your home than rent it. If this continued to be true, renting becomes far less attractive. As such, it is reasonable to assume that market forces will eventually conspire to reverse this i.e. make it more expensive to own. More on this later.
Comparing interest and rental is not the full picture
The above table compared the mortgage interest cost with the rental cost. However, as a homeowner, there might be additional cash flow implications associated with owning your home.
Firstly, there’s the cost of maintenance to consider. This will depend on the type and age of the of property. It’s important to distinguish between maintenance and improvements. It is often very tempting to make improvements to your home, but these tend to be discretionary in nature, and probably should be excluded from this analysis.
Secondly, there are also running costs that are exclusive to owners including owners’ corporation fees if you live in an apartment, council rates, water rates, insurance and so on.
Finally, if your loan repayments are structured as ‘principal and interest’, the dollar value of your monthly loan repayments will be higher than that interest costs included in the table above. This is not a sunk cost however, as it reduces your liability and helps you accumulate equity in your home. So, it should be excluded from a financial comparison, but taken into account from a cash flow affordability perspective.
Including owners’ costs
The table below includes an estimate of the above owning costs including maintenance, owners’ corporation fees, council rates, water rates, insurance and so on.
|Property type||Interest costs||+ Owners’ costs||– Rental cost|| = Saving/|
|Luxury apartment||$51,200||$10,000 – $20,000||$57,200||($4,000 – $14,000)||Rent|
|Entry-level, investment-grade apartment||$13,500||$4,000 – $8,000||$28,600||$7,100 – $11,100||Own|
|Family home (blue-chip suburb)||$58,200||$12,000||$52,000||($18,200)||Rent|
|Family home (outer suburb)||$15,400||$7,000||$24,440||$2,040||Lineball|
Tax free capital growth
Of course, one of the benefits of being a homeowner is that you are able to benefit from the capital appreciation of your home and that gain is tax free (due to the main residence capital gains tax exemption). I discussed this a few weeks ago and concluded that “investing in your home” can be a very rewarding strategy.
Owning provides certainty
One of the problems with renting is that tenancy agreements are typically only 12 months long. This doesn’t provide renters with any long-term certainty. This is particularly an issue for family’s with school-aged children. As such, particularly in this circumstance, owning your home does provide more certainty.
A higher demand from owner-occupiers could put downward pressure on rents
If demand for rental properties falls because demand from owner-occupiers increases, then that is likely to have a negative impact on rent incomes. That is, existing investors may find it harder to rent their properties for the same amount. If this is the case investors will have to consider dropping their rent or making improvements to the property to improve its appeal. And, of course, if rents fall, it might once again, be cheaper to rent than own.
It will likely provide a temporary stimulus
Clearly, due to a fall in interest rates, housing is more affordable than it used to be. That fact has to eventually result in an increase in property demand which will ultimately push property prices higher.
However, interest rates will only have a temporary impact on demand as they won’t stay low forever. As I wrote in this blog last year, there are typically only four macro factors that persistently influence the level of demand for property on a long term basis. These include population growth, money supply, employment diversification and infrastructure.
The Morrison government has already affirmed its commitment to return to previous levels of overseas migration once the Coronavirus passes. Given all monetary policy initiatives have already been employed (i.e. rates can’t fall any further), the government will have to turn to fiscal policy, which inevitably will include increased infrastructure expenditure, to stimulate the economy. And finally, the RBA expects the unemployment rate to recover to 7.5% by the end of 2021.
Most of these factors, in the long run, are likely to stimulate property price growth.
Need a deposit to buy a home
Of course, to be able to purchase a home, you need to qualify for a loan. This means you need to have enough income and low financial commitments to demonstrate you have surplus financial capacity to make loan repayments. Also, you need to have either a cash deposit or equity in another property. If you are weak on the deposit front, then a family guarantee can be a good solution.
Owning eats into your borrowing capacity
If you have plans to borrow to invest in assets other than your home, you must consider how owning your home will impact this. Renting is better for your borrowing capacity i.e. generally you can borrow more for investment than if you own your home with a large mortgage.
Renting allows you to ‘try before you buy’
One of the advantages of renting is that allows you to experience living in a location without needing to make a large financial commitment. You may be better off renting in various locations in order to identify the one that suits you best.
Also, if you are unsure which school you would like your children to attend, renting may (initially) provides you with more flexibility.
What should you do?
Of course, everyone’s situation and goals are different so it’s impossible to provide blanket advice. However, it would seem to me that if you want to live in a location that is regarded as investment-grade, then buying in that location might not only be more cost effective in the short run, but financial better in the long run.