## Introduction

Is it better to buy or rent your house?

The buy versus rent house decision is made more difficult because most of us think that renting is throwing money away. But if you buy a house you're throwing away interest payments on the mortgage interest and maintenance costs for the house plus the huge costs of purchasing and selling.

In this blog we look at different ways of comparing the option to buy or rent. We also provide access to a spreadsheet at the end so you can play with the assumptions for yourself.

## Buy vs Rent

In this example I've assumed £35,000 in savings. You can either invest it in the stock market then rent a house or alternatively you could use it as a deposit to purchase a house.

### House Price Growth

In order to make that comparison we need to estimate how much house prices will grow in the future and we can calibrate our expectations by looking at house price growth in the past.

The general pattern, that you can see below, is that the further back we look in time, the slower the house price growth.

Our first source of information is from the Land Registry and it goes back to 1968 and although there are huge fluctuations in house price growth over time the average annual price growth is 8.5%.

The Nationwide House Price Index goes back further to 1952. Notice that the period before 1970 falls below the average, so it's not surprising that the average over that period of time is 7.4%, which is lower than it is over the period since 1968.

If we use the very long time series from Dimson, Marsh & Staunton which covers the period from 1900 to 2017 we see that in the UK the real house price growth has been 1.8%.

Unlike the previous numbers, this has not had inflation subtracted from it. If we add inflation back in we would be looking at something more like 4% annual growth, but that is still far lower than we've seen since the 1970s.

### Share Price Growth

If we're going to compare house price growth with share price growth we also need an estimate for that.

Using Robert Shiller's data set we can push the S&P 500 back to 1871. Over that period the growth has been 6.8% per year but this is just for the US stock market. The figure is inflation adjusted so we will have to add back the 2%, it assumes that dividends are reinvested which increases the return significantly and the time period is a huge 148 years.

We can also use Dimson, Marsh & Staunton’s work which shows that the global rate of equity growth is about 5.2%. Again this is the real rate of return so we have to add inflation back to get to about 7% and the UK is pretty similar to that global growth rate.

Vanguard’s 10 year outlook suggests that we may not see the very high returns that we saw in the past.

The 1970’s were just a period of much greater growth and just like house prices, if we look at a more recent period, the rate of growth comes down. In the coming decade they expect returns to be around 4% per year. They think that the 11% returns since 1970 and 8% returns since 1990 are very unlikely to be repeated. That is because of a combination of high valuations, in other words things are just expensive, but also low interest rates. According to their forecasts there's almost nowhere to hide, we get these lower rates of return in almost any asset class whether it's bonds or equity.

## Cash vs House Comparisons

The first two comparisons which I'll show you compared buying a house with investing your money in cash and as you might expect the economic gain from buying a house is much better than that of investing your money in cash.

### Example One

The first piece of research below is by Mostafa & Jones in which they compare the financial returns from buying versus renting and focus on first-time buyers

Source: *“The financial returns from buying versus renting: The experience of first-time buyers in different regions of Britain”*

*Mostafa & Jones, Journal of European Real Estate Research, 2019*

*The average First Time Buyer (FTB) cases created on average***£12.40**of wealth for every £1 of the Initial Outlay (IO) in present value terms over the 37-year study period (1975-2012)*Seen in terms of gross return for every holding year per £1 IO:**Generate £0.61 per every holding year on average**90% of all cases create £0.30 per year*

*Ignoring capital gain for every £1 of the IO:**Average FTB cases create***£5.60**of wealth*£0.30 on average per holding year*

*Capital gains contribute to just***56%**of the overall return*Varies amongst regions with some regions’ return relying more on the growth in house prices (London) than others*

*Despite the huge range in the level of average house prices between regions broadly from north to south, the financial benefits hold***for all localities.**

### Example Two

Again in this comparison by Rob Thomas the cash was simply put into a savings account compared to being invested in a house.

Source: “The intergenerational divide in the housing and mortgage markets”

Rob Thomas, Intermediary Mortgage Lenders Association, October 2019.

*“Even assuming no house price growth for the next 30 years, someone buying an average home, initially with a 25 year 95% LTV repayment mortgage, could be £352,000 better off than someone who continues to rent privately. Mortgage rates would have to exceed 11.5% over the life of the loan before renting was as financially advantageous as buying”*

Below is one of the tables from his paper comparing the cost of renting and buying from 1996 to 2018.

If you start with £2600 which you had saved at the start of 1996 and used it as a 5% deposit with a 95% mortgage then that would buy an average priced property at the time.

The rent over the period would be £212,000 using average rental rates.

The comparison is with cash deposit rates which over that period averaged about 3.2%.

Now that 3.2% is a very low bar to beat if we compare it to the total return on the FTSE 100 over that same period, it was a much higher at 6.3% and the S&P 500 was higher still at 8.3%.

So part of the reason why the mortgage rate would have to be so high to make renting worthwhile is because the investments were put into cash which has a very low rate of return.

## Stocks vs House Comparisons

In this section we will look at the comparisons between buying a house versus renting a house and investing in the stock market.

### 5% Rule Example

The first example is from based on numbers from an excellent video from Benjamin Felix called "Renting vs Buying a Home: The 5% Rule".

Ben Felix also uses the Dimson, Marsh & Staunton’s estimate which gives you a 3% growth rate for real estate and he uses a 6.57% for stocks. This gives you a 3.57% difference in expected return between real estate vs. stocks. To keep things simple and conservative he rounds that down to 3%.

That 3% opportunity cost, which is the difference between the rate on real estate and the stock market is very similar to the interest rates on mortgages in Canada at the moment, which is where Benjamin Felix is based. Therefore he says that the cost of capital is 3% whether it's through a mortgage where rates are 3% or a down payment where the opportunity cost is 3%.

In Canada, property taxes are about 1% per year and he estimates that maintenance will also be 1% per year, therefore 3% + 2% gives you the 5% rule! Homeowners can expect to pay about 5% of the value of their home in unrecoverable costs.

Now the accepted wisdom is that it's always better to buy because if you rent you're just throwing that money away but what's great about Benjamin Felix's video is that he also shows that you have unrecoverable costs when buying a house. For example the maintenance that you pay when the boiler breaks down or when the roof leaks and you have to mend it.

Below is an example of how the 5% rule works to have comparable unrecoverable costs between buying and renting.

For buying in Canada you will pay 3% to the bank in interest payments. You will pay 1% maintenance costs per year for the property and you'll pay that 1% Canadian property tax so you will get a 5% unrecoverable cost.

To get an equivalent unrecoverable cost for rent you would have to pay rent which is 5% of the house price. For example, if you want to buy a house for $430,000, 5% of that would be $21,500. Therefore if you pay a rental of less than $1,792 per month then your unrecoverable cost for rent will be lower than if you had purchased a house.

- Here's Ben Felix's article in full: https://www.pwlcapital.com/rent-or-own-your-home-5-rule/

### UK Example

Next I will look at an example from the UK and there is a spreadsheet at the end of this blog which will allow you to experiment with the numbers for yourself.

For my example I have just chosen the following amounts and based the calculations on those long term returns which I explained at the beginning of the blog.

I've assumed you have £35,000 to invest and you can either use that to buy a house by putting a deposit down and also paying those initial costs or you can invest that money in the stock market and to rent.

You have £5,000 worth of costs (outlined below) leaving you with £30,000, which is a 10% deposit on a £300,000 house.

You can see from the slide below, if you break that down to a monthly repayment mortgage, it will be £605 principle in the first month plus £675 unrecoverable interest, which gives you a total of £1,280 per month. In the first year the total you pay will be £15,364 of which about £8000 in unrecoverable interest payments.

I have assumed the maintenance cost is going to be 1% and that's going to be £3,000 per year/ £250 per month. That figure needs to go up in line with the rate of inflation as there's no way that a plumber will charge you as much today as they'll charge you in 25 years time. That is why you can see those monthly maintenance costs creeping upwards at 2% per year, so after one year it's not £3,000 but £3032.

At the end of the first year, if the property is increasing at 3% pa then the value of the property is going to be £309,000. Because the house price is roughly the national average, I have also assumed a national average for the rent which is £926 per month or £11,000 pa (based on figures from the BBC __https://www.bbc.co.uk/news/business-50056177__)

You will see that in the first month you're going to invest £603, which is the difference between the mortgage and the maintenance you would have paid on a house and the rent.

Over the first year that would add up to over £7,000 which you would invest in the stock market

Therefore if you take your initial money put towards buying a house which was £35,000 and add the extra money which you saved by not owning a house and you also consider the return on investing it, (which i’ve estimated at 6%), you would end up with about £44,500.

This £44,500 is the investment value if you had rented and not bought.

#### Sale Profits

When you come to sell we can compare the overall economic advantage of renting versus buying by examining the sale profits.

Below is an example after 25 years and the assumptions in the calculation are in the top right hand corner of the slide.

The mortgage rate of interest might seem fairly high at 4.5%, but I will explain later why I have chosen that figure in the Mortgage Rate Sensitivity section.

The rate of house price appreciation is 3% and that is the global long-term average.

I've assumed the investment return is a fairly low 6% and that is for a 100% equity investment which is somehow tax sheltered for example in a ISA or SIPP.

After 25 years the house price has more than doubled but unfortunately the estate agent fee, the conveyancing fee and the maintenance have all risen in line with inflation.

The interest is money we will never get back which has been paid on the mortgage. The principal and the deposit was simply repaying the purchase cost of the house. Once we subtract all those costs we get a net gain of about £43,000.

If instead we had rented over the same 25 year period, the total rent would have been about £360,000 but our investment value would be £625,000.

If we look at the net gain, which is the difference between the investment value and the total rent we paid, it is about £43,000, which is the same as we would have if we had bought the house and sold after 25 years.

If you are interested to learn more about what drives house prices the I go into this in detail in my House Prices After Brexit blog and video.

#### Mortgage Rate Sensitivity

One of the key things in the calculation above is the sensitivity to the mortgage rate of interest.

In the graph below, the block in yellow is the monthly mortgage payments on a house which stays fixed over a 25 year period.

In this scenario, I've assumed a much lower mortgage rate than the previous example at 1%.

I have added the other big unrecoverable cost which is the maintenance cost of running a house. This gradually creeps up at 2% per year due to inflation.

I have also assumed that rent goes up in line with inflation. Any difference between the total cost of owning the house and the rent is invested into the stock market so initially that's just under £300 a month.

You will see the rent creeps upwards until it finally surpasses the mortgage payments. After this point there will be no additional investments into the stock market because the rent is more than the monthly cost of owning the house.

In the example below where the mortgage rate increases to 2% the house purchase has a double disadvantage.

I have assumed the rent is unaffected by the higher mortgage rate but that now means that the mortgage is always higher than the rent, so you're continually investing in the stock market right until the end of the 25 year period as you're paying more interest.

Below is a graph with the mortgage interest rate plotted on the x-axis ranging from 1.5% up to 4.9%.

What you can see is that when the mortgage rate is 3.8% the money you throw away and rent will be matched by the profit you make with your stock market investment.

Above the 3.8% breakeven you will start to make a profit, where your investment is more than the amount you pay in rent.

In the graph below, If we compare the profit you make in renting versus buying the break-even is much higher, it is now at 4.5%.

So if the mortgage rate is above 4.5% on average over the 30-year life span of the mortgage, then according to these assumptions you would be better off renting.

If you think a 4.5% rate seems very high, it is worth looking at the graph below which shows the Bank of England interest rates since 1694.

The current rates, which are very low close to 0%, are extremely unusual. We've never seen anything like this in the last three centuries. Therefore, it may be more realistic to think in terms of rates of around 4% or more.

I hope I have illustrated that it is not as clear-cut as you might think.

Renting isn't just throwing money away because any money that you keep and which you don't spend on a deposit, maintenance or interest payments can actually be ploughed into the equity markets or to other investments.

Of course it does depend critically on those numbers that I've assumed for the mortgage interest rate, for the rate of return on the investments and also on the rate of inflation. All of these numbers affect the outcome and that's why I hope you'll find the spreadsheet useful, so you can play around with those numbers for yourself and make up your own mind.

## Buy vs Rent Calculator

This spreadsheet will allow you to get an idea of the costs and benefits of buying versus renting. It isn't a recommendation about either course of action. The decision is going to involve many factors many of which aren't financial.

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