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A year on, do the sums still add up?

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  • A year on, do the sums still add up?

    A year on, do the sums still add up?

    By GREG NINNESS - Sunday Star Times Last updated 05:00 28/06/2009

    Is there still an advantage to be gained from selling your home and renting instead?
    It is usually about rent versus mortgage repayments, and which option would leave you better off in the longer term. But that ignores the hundreds of thousands of people who own their own homes and are mortgage free.
    For them, the debate about renting or owning can be just as important.
    According to the 2006 census, 27.1% of all households throughout the country were owner-occupied without a mortgage. That was nearly 394,000 of the country's 1,454,175 households.
    Only slightly more, 32.9%, had a mortgage. Then there were the 26.7% of households that paid rent, and the remainder who either had more complicated living arrangements not easily classified or had not filled in their census forms correctly.
    Many of those in the fortunate position of being mortgage-free in their own homes will be retired and their home is likely to be their biggest asset.
    A large number of those will have limited incomes which means their weekly budgets are likely to be tight. These are the people often referred to as being asset rich but cash poor.
    Would these people be financially better off if they sold their homes and invested the proceeds, using the income from this to pay rent and any surplus to go towards other things they would not otherwise be able to afford?
    When you are on a modest fixed income, anything which improves your access to cash is worth looking at.
    A year ago, when the property market was already in decline, the Sunday Star-Times looked at this question.
    We took median property prices in three parts of the country the high-priced suburb of Devonport on Auckland's North Shore where the median price in May 2008 was $820,000), the average-priced locality of Mt Maunganui/Papamoa (May 2008 median $395,000) and relatively low-priced Timaru where the May 2008 median was $240,000.
    At the time, that money could have earned interest of 8.5% if it had been invested in a bank term deposit for around 18 months. We have ignored the higher returns available from riskier investments such as Hanover Finance, which at this time last year was still touting for business, offering 10.25% on its debentures.
    From the investment income we deducted what it would cost to rent a home in the same location. We based this on the upper quartile (top 25%) of rents for a three-bedroom house in each area (as compiled by the Department of Building and Housing) to ensure this represented a good quality rental property.
    We also made a modest allowance for home ownership expenses such as maintenance, insurance and rates, which people would probably not have to pay if they were renting.

    The results are set out in the accompanying table.
    In upmarket Devonport, $820,000 invested at 8.5% a year ago would have provided interest income of $69,700.
    If this was taxed at 33c, it would have left $46,699.
    Rent of $600 a week for an upper quartile property would cost $31,200 a year, which would have left a cash surplus of $15,499.
    When the $4300 allowance for ownership costs such as rates and maintenance is added, the renter would be better off by $19,799 a year if they sold their house and invested the money.
    That's an extra $380.75 each week to spend after paying the rent.
    In moderately priced, Mt Maunganui/Papamoa, the total surplus would have been $7095 a year if it was taxed at 33c and $12,624 if taxed at 21c.
    In lowly priced Timaru, the surplus would have been $4508 a year if taxed at 33c and $6956 if taxed at 21c.
    So at this time last year people could have gained a significant financial advantage from selling their home and renting instead.
    But 12 months down the track, how does that proposition stack up?
    We did the same exercise based on median selling prices and rents in May this year. Surprisingly, median prices in Devonport and Papamoa had increased slightly compared with May last year, but this may have been a result of volatility in prices from month to month, rather than an upward trend.
    The median price in Timaru fell significantly, from $240,000 in May last year to $186,000 in May this year. Because Timaru prices had fallen for four months in a row this was likely to reflect a trend of falling prices in the city. Rents had increased slightly over the year in Devonport and Timaru, but remained the same in Papamoa.
    However, the really big change was in the interest rates banks were offering on term deposits. Down from 8.5% at this time last year to just 4.5% on an 18-month term this year.
    That almost cut in half the potential income people could earn from selling their home and investing the money.
    Because income had almost halved while rents had stayed the same or increased slightly, the net income from investing the money would not cover the rent in many instances. In most of our examples, interest income of 4.5% would not be enough to cover the rent, leaving people worse off than if they owned their home.
    However, last year the government threw fixed-interest investors a lifeline in the form of the Deposit Guarantee Scheme, which allowed them to access the higher returns available from participating finance companies, with the security of knowing their investment was government guaranteed.
    That would allow them to get a return of about 6% on money invested for 18 months.
    Although this would still mean a considerable reduction in interest income compared with the 8.5% available from bank deposits this time last year, it would generate enough cash to mean that many people would still be better off by renting and living off their investment income rather than having their money tied up in their house.
    In our Devonport example, the renter would be better off by $5565 a year ($107 a week) if their interest income was taxed at 33c, and $11,749 a year ($226 a week) if it was taxed at 21c.
    In Mt Maunganui/Papamoa, the difference between renting and owning was negligible ($12 a week) at the 33c tax rate, but increased to $5013 a year ($96 a week) at the 21c tax rate.
    In our Timaru example, the low amount of income provided by a house sale made renting the better proposition, even at the 21c tax rate, although not by much ($21.61 a week).
    What this means is that even in a very low interest rate environment such as the one we currently face, people who own a home in the middle to upper price ranges may be financially better off selling their home and investing the money. Those in mid to lower priced homes would probably be better off staying put.
    If someone had done this a year ago when we last looked at this issue, and invested the money in a term deposit for 18 months, they would still be getting the benefit of last year's higher interest rates.
    The outlook now is for longer-term interest rates to rise.
    So, when investors roll over that investment at the end of the year, they may be able to improve on the 6% currently on offer from government-guaranteed investments.
    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx

  • #2
    Very nice analysis but it of course ignores inflation...or possibly deflation!


    • #3
      Exactly gismo. And the North Shore home was probably bought for $200,000 many years ago and now worth $820,000 to the owner as they had the foresight to keep it.


      • #4
        The home ownership/renting proposition is not just a financial one, though - I'd rather have a mortgage free home and no debt (or, indeed, a mortgaged one) than have money in an investment that could disappear at a moment's notice and be subject to a landlord's whim and possibly precarious financial position.



        • #5
          The "big change"?

          Interest rates.

          What caused that?

          The Oct 08 peak of the credit crisis.

          Is the crisis over?

          If yes, then interest rates have to go back up.

          If no, then there will be a depression, and plummeting asset values.

          I have always hammered the "cost of renting v cost of buying" argument. But in Auckland, it's still about the same, at best. And the only reason why it's about the same is because of the strenuous effects of the central banks to avoid a depression.

          The current interest rates are "fool's gold" - unless you can get that rate for 30 years, which you can't.

          Do your sums at 9 % for a first mortgage. If it's still only 10% more to buy, then buy. If not, don't.


          • #6
            Nothing beats owning your own home (especially freehold).

            ....and I couldn't be bothered with those blimin landlords!