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Rent vs Buy Modelling: Is it better to buy or rent a home?
Topic Started: 1 Dec 2011, 04:54 PM (4,169 Views)
micnugget
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Hi all,

I was bored at work so decided to try and model renting vs buying and see which one made finanical sense over the long run. Obviously there are a whole bunch of assumptions to be made so I'll list them here:

House Price = $400,000
Yield = 5%
Inferred Rent (yr) = 20,000
Inflation = 3%
Deposit = $50,000
Buying Costs (taxes etc) = $20,000
Yearly Holding Costs (rates etc) = $2000
Interest Rate (loan) = 7.5%
Loan Amount = $350,000
Term = 25 Years
Interest Rate (Savings) = 6.5%
Marginal Tax Rate = 40%

I also assumed that the person put any of the difference between their rent and their mortgage into a savings account at the above rate, but being taxed at 40%.
House Price, Rent, Holding Costs all rise with inflation.

Here's what I found after 25 years:

Renter:
Rent paid (total) = $729185
Money in the bank = $452274

Mortgagee:
Mortgage Paid = $775941
Holding costs paid = $72918+ $20,000 initial
Money in the Bank = $19038
House value (100% equity) = $813117

Please don't let this degenerate into the typical bullsh*t you normally see on this forum, but it seems that with my assumptions that the mortagagee is well ahead, mainly due to inflation doing it's thing. I thought this was pretty surprising considering everything.

Can people take a look at my assumptions and see if I've done anything wrong? Also feel free to comment on the implications.

I plan to mess with the assumptions (change the inflation rate, yield etc) and see what that does too.

Other interesting point - it took 20 years for the rent to become more than the mortgage plus the holding costs.

Note: I was pretty lazy in the way I calculated interest (did it yearly) so there may be small changes in the actual figures due to that.
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georgie
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I think u failed to take into account the opportunity cost of the money in the bank for the renter. I think someone who takes their finances seriously in making the decision to rent over buy unlike the mass's will have some way of turning that unspent money on productive investments.
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hoofarted
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Did you factor in the lost money by not earning interest on the deposit? Ie. when calculating the money the renter has saved, did you give him a $70k start as well?

Also, interest is compounded monthly and this can make a significant difference.
Edited by hoofarted, 1 Dec 2011, 05:27 PM.
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Frank Castle
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Business As Usual

georgie
1 Dec 2011, 05:22 PM
I think u failed to take into account the opportunity cost of the money in the bank for the renter. I think someone who takes their finances seriously in making the decision to rent over buy unlike the mass's will have some way of turning that unspent money on productive investments.
Like buy some of those shares than went infinity and beyond?

http://www.dailyfinance.com/photos/25-worst-performing-stocks-of-the-past-decade/4017344/
The forum is a better place with the forum fuckwits and their spank socks on ignore
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georgie
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Frank Castle
1 Dec 2011, 05:31 PM
Like buy some of those shares than went infinity and beyond?

http://www.dailyfinance.com/photos/25-worst-performing-stocks-of-the-past-decade/4017344/
You know there is more to investing than just shares and property. You can start a business, you can collect art, there is a whole array of things that can make you money.

Obviously property has made monery for you but the days of making money lots of money are gone. Sure there is money in property but what has just passed us in the last 10 years won't come around for a long long time.

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micnugget
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Yeah I gave the renter a 70k head start on their savings.

I know what your saying georgie - 6.5% in the bank getting taxed at 40% isn't the best alternate investment but it was what I saw as an 'average' investment with low risk.
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Catweasel
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micnugget
1 Dec 2011, 05:51 PM
Yeah I gave the renter a 70k head start on their savings.

I know what your saying georgie - 6.5% in the bank getting taxed at 40% isn't the best alternate investment but it was what I saw as an 'average' investment with low risk.
Catweasel say can the chicken mcnugget post its spreadsheet for a catweasel, mouzealots, and bear cult to do the scrutiny?
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efy6rph
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With compounded Interest the renter has $1.25M in the bank (assuming no tax????).
Also if the renter is a saver their contribution will increase with CPI each year so this is the worst case result.

You have also not accounted for capital losses , or at least provided the "option",
From a bearish perspective, assuming it is 30% overvalued, you'd be looking at 315K now, if that keeps up with CPI it will sell for around $600K in 25 years.

So from a Bears perspective you could have a minimum $1.25M in the bank, or a house worth $600K.

From a Bulls perspective you could have $1.25M in the bank or a $942K house.

If the renter increases their contribution by CPI they will have around $1.5M after 25 years.

Either way renting wins hands down.
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peter fraser
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efy6rph
1 Dec 2011, 06:56 PM
With compounded Interest the renter has $1.25M in the bank (assuming no tax????).
Also if the renter is a saver their contribution will increase with CPI each year so this is the worst case result.

You have also not accounted for capital losses , or at least provided the "option",
From a bearish perspective, assuming it is 30% overvalued, you'd be looking at 315K now, if that keeps up with CPI it will sell for around $600K in 25 years.

So from a Bears perspective you could have a minimum $1.25M in the bank, or a house worth $600K.

From a Bulls perspective you could have $1.25M in the bank or a $942K house.

If the renter increases their contribution by CPI they will have around $1.5M after 25 years.

Either way renting wins hands down.
A lot of the variable input into the equation really are variables, so during some cycles with high interest rates or low price rises, or perhaps low returns on investments, all of the above could turn either way.

However one glaring point that should be mentioned, if the loan was over 25 years that mortgagee can now save all of their income after deducting living expenses, whilst the renter has to pay rent on top of basic living expenses. So how do you see the dynamic changing over the second 25 years when rents increase, but the home owner is immune to that cost.

life doesn't end after 25 years.




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georgie
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peter fraser
1 Dec 2011, 07:11 PM
A lot of the variable input into the equation really are variables, so during some cycles with high interest rates or low price rises, or perhaps low returns on investments, all of the above could turn either way.

However one glaring point that should be mentioned, if the loan was over 25 years that mortgagee can now save all of their income after deducting living expenses, whilst the renter has to pay rent on top of basic living expenses. So how do you see the dynamic changing over the second 25 years when rents increase, but the home owner is immune to that cost.

life doesn't end after 25 years.


Your looking at this the wrong way. The text book says you buy a property and repay the mortgage over 25 years. In life, well currently with the new generation buying and living in one house with one mortgage for 25 years will not exist for the majority. People tend to live in one house for an average of 7 years then move on.

Now, people who have a mortage and are 7 years in will hopefully pay off the remainder of the mortgage with the capital they have accumulated when the property is sold. When people buy elsewhere they usually upgrade. No one downgrades unless your old and looking for a smaller home or relocating for work. So, this means your debt and your repayments litetrally stay the same over a 25 year period as you keep upgrading. If you downgrade unless you are spending the money elsewhere it means the property market has gone down and you have sustained a loss.

Renting means you can have the lifestyle of moving with ease and save the costs of stamp duty and interest repyaments, interest repyaments are 99% of the time more than the weekly rental of a property in the first 5-10 years. If people stayed in one house for 25 years they would be better off buying but as we know, with the new generation, everyone will be moving frequently so in the long term renting is better because you save on the costs eg stamp duty, solicitor fee's & agents fee's and the renewed interest costs on the upgrading.



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