Rent or Buy? What's better?

I often come across articles in the press about property ownership and how the great Australian dream is slowly slipping away from the next generation.  No doubt this debate has been around for decades but when property prices rise sharply (per current cycle) you tend to get more and more journalists writing about this very topic.

So it got me thinking.  Is it better to buy or rent?  In order to give a balanced view, I ran some numbers.  This way you can make up your own mind.

Assumptions for my analysis:

Buying a home:

Purchase price of a home $550k (current median price)

Capital growth on home 7% (consistent with long-term running average)

Average interest rate on home loan 7% (currently 5%)

Renting:

Weekly rent on average $500 pwk

Annual provision for not paying council rates and water $5k pa

Deposit of $50k plus purchase costs

Running the numbers...

Buying your own home:

If buying a home for $550k in today's market, and you achieve compounding growth of 7% pa, over 30 years your property will be worth a staggering $4.48m.  In today's dollars that's $1.79m (accounting for inflation).

If you borrowed $500k to buy a $550k home today, your home loan repayment commitments would equate to $752 pwk, plus you would need a further $5k pa (or $96 pwk) for bills such as council rates and water.  Total annual outlay $44k, which means you need to earn $55k before tax.  Total weekly commitment $848 (i.e. $752 + $96).

The interest over 30 years would equate to $734k (ouch!).

Renting:

Rather than buy your own home you decide to rent instead.  This provides you $348 of cash to invest assuming you pay $500 in rent (i.e. $848 weekly commitment for owning your own home less $500 pwk rent).

If you invest the $348 weekly savings into shares (not indexed), assuming a return of 8% (long-term average), after 30 years you'll amass an amount of $3.13m. Or in today's dollars $1.25m (accounting for inflation).

In summary...

As you can see, there is a big difference in the final value of your portfolio.  Putting your money into property today will make you an extra $1.35m in the future.

One may ask, how can property come out on top when our assumptions are based on property achieving 7% pa and shares achieving 8% pa?

The answer is simple.  It's all to do with the power (or magic) of compounding returns!

You see if you invest your $50k cash deposit today (plus purchase costs) and the bank also invests in the property with you by lending you $500k, then effectively you are leveraging your $50k cash into a $550k property.  When you invest your money without gearing (no leverage), the return is on the base cash amount only.

Putting dollars and cents aside, there is also the satisfaction of calling your place "home"; your own castle so to speak!

Of course if you decide to rent (for lifestyle purposes) but you are actively investing in property at the same time, then this can be just as powerful as you are still benefiting from leverage and compounding returns over time.

If you've been sitting on the fence waiting for the right time to buy your home (or more property), then the best time to buy is always "now".  Time doesn't wait for anyone and opportunity cost cannot be reversed.

I have been in this game long enough to see many people price themselves out of the market by waiting, or having to substitute on their preferred location as they can no longer afford to buy in the suburb of their choice.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.