Thursday, 16 November 2006

Money

I have mentioned that Dorian and I are looking for a house to buy. We were wondering this afternoon whether we could ask the internet to give us some advice.

We know this sounds pathetic, and in a way it is, but we also know that some of the people who visit here from time to time have a great deal of experience and knowledge in this area and we hoped you might be willing to give us the benefit of it: we understand of course that the usual caveats about financial advice apply.

It's all still very tentative. What I think we have to do is work out whether buying a house is really the most cost-effective way to put a roof over our heads, or whether we'd be better off to keep renting and invest the difference which would have been sunk into mortgage maintenance.

Which of these options is better?

Option A: get $300,000 mortgage, buy house in Moreland, wait for gentrification to extend past Pentridge

Option B: keep renting, put the significant annual difference between rent and hypothetical mortgage repayments (about $12,000 per year) into more or less liquid assets (Dorian says art collection, but let's just say ethical investments and leave it at that for the present.)

Our sums say A, but only because we took a wild guess at what a house of that kind might be worth in 2016.

17 comments:

Ron said...

Can you put a price on the security of 'owning' your own home?

Just sayin' ...

cristy said...

My understanding is that on a purely financial calculation you are better off investing, but that on an economic calculation (where wealth = happiness and not money) you are better off buying a home.

A house means that if you run out of everything else in your old age you still have somewhere to live.
You also get to:
- feel stable,
- avoid the costs of moving house that are necessarily involved in renting,
- decorate/renovate as you please, and
- plant a garden that you know you can keep.

kate said...

I have nothing particular against 'owning' but feel the need to voice the opposing view.

Owning also involves maintenance - rather than just complaining to the landlord, which is a cost you should factor in if you're doing sums.

It depends where you want to live (as opposed to where you can afford) and the expenses inherent where you can afford to buy (will you need two cars?), and how long you want to live there (are you likely to get a great job offer in Sydney/New York/Paris that will require you to move and sell up before the place appreciates). Obviously a house is an 'all the eggs in one basket' arrangement, which might suit you (no ongoing investment research required) or might terrify you (what if Moreland doesn't get gentrified?).

If your circumstances change, like you drop to one income for a while, you can contain your living costs more easily when you're renting (you know how much it's going to cost til the end of the lease), whereas interest rates go up and down regardless of your ability to pay. But you know you're not going to get kicked out unless you stop paying, and moving is definitely a pain, and expensive.

Art is definitely fun to buy, but only counts as an investment if you are prepared to sell it when the market declares your purchase a winner. It can also be hit and miss, even for people who love it and know lots about it.

lucy tartan said...

You're all right which is what makes it a hard decision. The permanence aspect of buying carries a lot of weight with me but the prospect of not being able to scale back on work for family reasons is one that needs to be carefully thought through.

I think what we're trying to do here is establish whether the two options can be separated on purely financial grounds. If they come out looking about the same in terms of what each one will cost then we can think more clearly about which one will suit our life plans better.

We've rented for ages and have only moved twice. Only one of those moves was imposed on us from the landlord. I guess that's a fairly unusual record, though.

Zoe said...

With the scale back on work for family reasons thing, I think that many mortgages allow a period of lesser repayments after a certain time if one happens to get knocked up or crook or something.

Owy and I need people do die before we buy a house ;)

Kate said...

One thing is that if you sell the house in 2016 you'll still need to find somewhere else to live.

For instance, here in Perth real estate has gone gangbusters as we all boringly know. But even if you bought your house for $150 000 and now it's worth half a million, and you sell it and you've made a motsa, you still need somewhere to live.

Frankly we're in a situation where buying a house seems so impossible that option B is rapidly becoming our only option, which scares me because I do worry constantly about being booted out and having to find a new dog-friendly home.

So if you sell your house, you've either got to buy again somewhere cheaper or less desirable or find the perfect fixer-upperer or whatever to really capitalise on that money, or be prepared to rent forever on the proceeds, which isn't such a bad thing I don't think, but there you go.

I'm not sure if I'm expressing it at all well, but I think this is another factor to consider in a financial comparison.

Kate said...

Bugger that comment got all messed up. This bit was supposed to be last, not in the middle:


Frankly we're in a situation where buying a house seems so impossible that option B is rapidly becoming our only option, which scares me because I do worry constantly about being booted out and having to find a new dog-friendly home.

Pavlov's Cat said...

I was a renter until I was 44 and I say go with A. The real unknown here is that houses, like children, eat money and you may find yourself with major maintenance and repairs.

The upside of this is that you can at least get them done properly instead of some Dodgy Brothers quick fix by the landlord's second cousin that results in you being electrocuted in the next thunderstorm.

Moreland will gentrificate with time. And in the meantime I don't remember it being all that awful to begin with.

lucy tartan said...

It's not awful at all. (Except for the new housing estate that's actually inside the bluestone walls of Pentridge.) For the cost of servicing a mortgage to be recoverable house prices will have to rise. If we buy a house it will have to be a cheap one because it's not safe to borrow as much money as most houses seem to cost. The really unthinkably frightening risk implicit in entering mortgage world is not getting kicked out by the bank, but the thought of beings seduced by bribery into turning into a liberal voter.

Another Outspoken Female said...

I have been lucky with when and where I bought, purely from being in the right place (walking home a different way from having a coffee in fitzroy), at the right time (australia day weekend, when there was the one and only open inspection for a house being sold privately). The same house if sold at auction would have cost so much more and been unaffordable. At that point I had put in some bids on houses, but all were compromises being in a place that I didn't really want to live. I suggest its worth you both making a list of what you really want in how and where you live, give it 6 weeks and see if the property comes to you.

Stranger things have happened.

din said...

Something to factor into the financial calculations in favour of buying (at least according to my dodgy maths)... on average wages rises with inflation, as do rents (unless you've found an exceptional landlord). A morgage however is fixed. So as a percentage of your income, paying off a house becomes less scary over time.

Anonymous said...

Wow Laura, tough question. Kate made the point that summed it up for me: home ownership means you can have whatever pets you want.

Boris

worldpeace and a speedboat said...

buy. you'll want to sooner or later, and sooner means getting the mortgage over and done with quicker.

live on one wage, pay the house off with the other.

you will love the security. 12 years later you'll only feel a bit exasperated that you haven't finished renovating (who me? nooo).

do your homework to find out exactly what you want, where you want it, how much you're willing to spend, and if you're being realistic, you will find it. don't be in a rush, and try to not make too emotional a decision (but still really like the house you choose).

do it! enjoy it!

TimT said...

I had no idea what the estate inside Pentridge was like. Outside, I'd imagine the fact that they still have barbed wire on their walls would put most people off! Good luck in the quest to buy a house, anyway. Creeping gentrification hasn't quite reached Moreland yet, but it will get there sooner or later ... there's only a few blocks, after all, separating us from Brunswick.

Susoz said...

I've been a longterm renter after owning and now an owner again. I think you're right to look at the finances only as the first level of decision-making. Money, after all, is only there to help you live the life you want to live. I don't know what the areas you mentioned are like. What I'd say is only buy a house that you like in an area you like. There's no point buying a house for 'security' and then being miserable yet secure. Otoh, since we bought again after 11 years renting, it has been a relief to not have to give any thought to the landord, no matter how nice the landlord was.

Fyodor said...

Bit late to this one, I’m afraid, but I feel compelled to comment in order to encourage More of This Sort of Thing. It’s not fractional reserve banking, but it’s a start.

Plenty of good comment above about the non-financial aspects of the situation, and these are very important to consider.

However, sticking to the purely financial aspects, you’re not comparing apples with apples. Option A involves borrowing money to invest in an asset. Option B does not involve borrowing. This may seem like a trivial difference, but makes a huge difference to financial returns. Leverage can be very powerful in improving the final return on any investment asset, whether property or shares, and is usually totally overlooked by many people when considering the return they make on their own home. The more correct comparison would be to borrow $300,000 in Option B via a margin loan and invest in shares or managed funds.

That said, what’s correct and what’s likely are often totally different. Most people are not prepared for the administration and stress involved in managing a leveraged portfolio, so I’m not sure it’s something you’re that likely to consider. Tax effects and accounting also make it a lot more demanding as an investment than just shoving your money in bricks and mortar and using your mortgage payments as a means of forced saving.

As you’ve implied, the key variable in this sort of analysis is the rate of return you think you can get from house price appreciation and, in the alternative case, from equities. I’m loath to make any predictions on this score, but I will note the following:

1) the Melbourne property market boom in the late 1990s and early 2000s is unlikely to be repeated soon, based on past cycles. While I’ve seen many property developers state that they believe the Melbourne market has turned and is trending up, a period of very low gains in house prices looks likely for the next few years. That is, I wouldn’t expect much in the way of capital gains any time soon, but things look unlikely to get worse.

2) Equities have just had three of the best years in the last two decades. It is unlikely for such conditions to continue and, on a longer-term basis (i.e. next 10 years), an average return from equities of, say, 7-9% (including dividend yield of 3-4%) is more likely. That’s an average, as there will probably be negative years and really good years – which you have to be psychologically prepared for if you’re investing in such a volatile asset class. A good rule for equities is not to invest unless you’re emotionally prepared to wear a loss in any given year – you need to have a confident, long-term attitude if you want to sleep at night.

3) Interest rates are probably near their peak – the economy is slowing and inflation seems largely under control, thus the RBA is more likely to reduce rates significantly from here than raise them. This means borrowing costs may fall over the next 1-2 years, which makes geared investments like property more attractive.

4) Be wary of “ethical” investing. By restricting yourself to investing only in stocks of which you approve ethically you constrain your ability to produce returns. You don’t care who your bank lends your deposits to, so why do you care if your fund manager invests in mining or gambling stocks? If you want a warm inner glow from investing, that’s fine, but be aware that it is costing you money, and that is how you should look at it.

The point I’d stress most here is that it’s quite easy to produce a dispassionate calculation of prospective returns on any range of assumptions, but it’s quite different living with the choices you’ve made. Don’t invest in equities unless you’ve educated yourself about the market, have an investment plan and, MOST IMPORTANTLY, know yourself well enough to determine whether you are going to be comfortable having a material proportion of your savings in an asset class that is volatile. It’s often the emotional side where many people get it wrong.

Sorry the comment's so long - got on a bit of a roll. Good luck with your plans.

lucy tartan said...

Thanks Fyodor. *very* much appreciated.