How housing stories create fire: Part deux

About a month ago I wrote an article about how the stories we tell each other help promote increasing house prices through misinformation.

My $100,000 increase in house price was actually a big loss due to $273,000 in home ownership costs.

You can read the full article here.

From that article I received a couple of interesting comments from some of my smart readers and thought I would turn my responses into a follow up article.

The comments are paraphrased as below:

1/. But you didn’t consider the rent you would have paid if you didn’t own.

2/. Your apartment only went up in price by $100,000 when the national average was a $270,000 increase.

These type of comments are typical of the narrative people tell themselves so that they can prop up housing more than it deserves.

I probably didn’t help the analysis by using my apartment as an example for these two reasons:

  • It was part home, part rental which muddies the water. I am only talking about home ownership not being a good investment. Buying a rental is something completely different and can be a great investment if done right.

  • Apartments do tend to have far lower price movements than houses. There are more houses than apartments so it’s a fair point.

Let’s have a look at the numbers now and how they may change under the given scenarios.

1/. What about the rent you would have paid?

Yes, it is true. If I did not own the apartment I would have had to rent instead. The commenter mentioned that I needed to add the $135,000 rent I would have paid were I not a homeowner to my calculations. Thus turning my $18,000 loss from owning a home to a $117,000 gain of owning over renting. Therefore I did not make a loss after all according to the post.

Sounds great! But there is one massive oversight.

If I were renting instead, then I would not have had all those home ownership costs that add no value to the property. Rates, body corporate fees, maintenance/repairs, and mortgage interest. If you recall the original post, my 10 year home ownership costs were $273,000.

So while they are correct in that I need to add the cost of renting to my calculations, I also must add the cost of home ownership for a full comparison of whether it was better to rent or buy.

*** The rent vs buy argument was not my initial intention of the article by the way. I just wanted to show how I made a big loss on my house purchase.***

So, back to the comparison then….

We are currently at a difference of $138,000 in favour of renting. $273,000 home ownership costs minus $135,000 renting costs.

If I were renting I would have also had the $60,000 house deposit to invest. I will assume a 10 year rate of return of 5%. This gives us a $38,000 return.

We are now at a difference of $173,000 in favour of renting.

I would have also had more money every month to invest. Mortgage payments were $390 per week. Rent payments for a bedroom would have been $260 a week. Giving me an extra $130 a week if I were renting instead. 10 years of investing this amount would have given me $89,000 after 10 years that I wouldn’t have had owning.

The difference is now $262,000 in favour of renting.

In my scenario of home ownership though I also had the benefit of renting out the other bedroom. At one stage when I moved out I rented two rooms. I received $175,000 in rental income over the 10 year period of home ownership.

The difference has been reduced back to $87,000 in favour of renting.

So not only did I lose $18,000 through my 10 year home ownership journey, but I would have been $87,000 better off renting and investing the difference. And this is during a period of abnormally high property price growth.

This is due to capital gains and rental income not being enough to offset the costs of home ownership, which were much higher than the costs of renting.

I am not against home ownership. These are just the numbers.

I think home ownership is a great thing. But I don’t want people going in to it thinking it is a huge profit maker. To have any chance of coming out of home ownership on the positive end, long term is the key. 10 years is not really long enough to own a home. More time is needed to reduce some of the costs.

After 10 years, mortgage interest payments become less. Buying and selling costs have also had more time to be spread.

The other thing to consider in this what if comparison is the renter was very good and invested all their spare change. If you didn’t have a mortgage to commit to would this be a reality? I think for me it would be now, but for someone that hasn’t formed the savings habit it may not be, such as 28 year old me!

2/. Apartments don’t increase in value as much as houses

The other comment that got my attention was that the $100,000 increase in my apartment value was actually not typical of that 10 year period. I agree with this. Apartments don’t go up or down in value as quickly as houses.

They mentioned a more typical increase was $270,000, so we will use this amount. Seems fair.

An extra $170,000 than my apartment thank you very much.

Not so fast though.

We are talking about home ownership so we must calculate the costs on a house bought for $420,000 and sold 10 years later for $690,000. $270,000 more than we paid. Surely that will be a large profit?

We will assume a 4.5% mortgage, a 20% deposit, a 30 year home loan, and best approximation of rates, insuarance, repairs and maintenance.

10 year home ownership costs:

  • Mortgage interest - $137,396

  • Opportunity cost of not investing the $84,000 deposit - $50,311 profit (assuming 5% returns)

  • Rates - $15,000

  • Home insurance - $15,000

  • Repairs and maintenance - $63,000

  • Sales costs - $20,700 (3% of house price)

Total cost of 10 year home ownership - $301,407.

If we deduct this from the $270,000 in capital gains, then we are left with negative $31,407 in this example. Even with a $270,000 increase in house price in just 10 years.

Houses are money pits. Look at all the costs that add no value to property. Rates, insurance, mortgage interest. All dead money.

Final thoughts

It is often said that home ownership is the best decision you can make. Renters in New Zealand are made to feel like second class citizens sometimes. This is because of the misconception that renting is dead money that goes to the landlord.

Well as we discussed, your own house also has a lot of dead money too.

Owning a house is a great aspiration to have. I just think it is wise to take your time with the decision. There is nothing wrong with renting if you are disciplined enough to save the difference between renting and owning costs. Only when you are ready, have run the numbers, and are willing to live in a house for at least 10 to 15 years should you consider buying. Long term, owning a house will generally be a great decision.

The other common trend is the constant need to move up the ladder. People think they have made huge profits when they haven’t, as we have seen in these typical examples. They then use these ‘fake profits’ to buy bigger and better houses, making their real losses even bigger.

If you are absolutely terrible with money though, owning a house can be a great decision. To have those committed, regular mortgage payments that would have been wasted had you not own a house.

For some it isn’t even about the money. Some people just want a house to call their own and will pay almost any price for that. That isn’t me, but I understand a lot of people feel that way. My way of looking at that though is using the example of chocolate. I love chocolate, but I wouldn’t pay $100 for a block. I still want value for money, no matter how much I want something.

You can’t on one hand say that renting is dead money and then be willing to pay any price for a house. You either care about the money or you don’t.

All I ask is that you run your own numbers and don’t base your decision off the so called housing success stories you hear. Especially now with such high house prices. These stories aren’t usually true as they hide a lot of the details. Look beyond the sugar coated version for a more realistic version.

I made a loss on my house and that doesn’t make for a sexy story. But it is true and more stories like mine need to be shared to help cool this overheated housing market that people are so desperate to get onto.

And finally, thanks to the readers of this blog. I enjoyed the comments that sparked this article. Although it may seem I am picking apart the comments, I’m not. They were valid comments and added to the conversation.

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