Kernel came out with an article over the weekend that renters could be $600,000 better off in retirement than homeowners.
This definitely piqued my interest.
I have written numerous articles in the past about how renters can be better off than homeowners too. But my articles tended to find that the homeowner ends up better off over periods of 17 years plus using my assumptions. Renters only doing well over periods of less than 17 years in general. After which point, buying a house would prove to be the best move financially, as rental income increases year on year, whereas mortgage payments remain relatively fixed. Then after the mortgage is paid off that is where the homeowner really streaks ahead, due to a massive reduction in housing costs (basically free rent with a few annual costs) and the renter continues to pay more with each passing year.
Of course, a study is only as good as the assumptions used. You can find out more about my research here.
So, to have someone come out and say something completely different to my own findings had me interested and questioning my sanity!
So I have run some numbers again, using some of Kernel’s assumptions. One of the problems with articles like the one published by Stuff, is that we don’t know what assumptions were used by Kernel.
What we do know (not much):
Starting age 23
Annual salary (although we don’t know if this is pre or post tax; We will assume post tax)
Took out KiwiSaver at age 33 to buy a house vs continuing to invest and rent
What we don’t know (it’s a lot):
What priced house the homeowner bought
How much of pay is contributed to KiwiSaver
How much personal annual expenses are
How much was assumed the homeowner spent on homeownership expenses such as rates, maintenance and insurance
How much salary increases per year
How much rental costs increase per year
What mortgage interest rate was used
What mortgage term was used
How much it was assumed house prices increased
What returns were used on investments
What inflation rate was used
So we will try and plug in some of these gaps using assumptions that bring us to Kernel’s end figures of $8.3 million in net worth for the homeowner and $8.9 million for the renter at age 65:
We will assume $55,000 is the post tax, post KiwiSaver salary, increasing annually with inflation
Inflation of 2.5%
3% of pay goes to KiwiSaver
Annual spending of $44,000 a year, increasing with inflation.
We will assume house is bought for $800,000 using a combination of KiwiSaver and non KiwiSaver investments.
We will assume a 20% deposit and a 30 year mortgage at an interest rate of 6%.
We will assume home ownership costs (outside of the mortgage) of $16,000 a year increasing with inflation
We will assume when the homeowner buys there is a reduction in rental expense of $30,000 a year. Note, this is well less than the $46,000 a year mortgage so very conservative in favour of the renter.
We will assume the rental expense for the renter increases with inflation
House price increases with inflation. Just 2.5% per year – Well less than average (again in favour of the renter). This is to get to Kernel’s homeowner with $8.3 million at age 65 figure.
Investment returns after fees and taxes of 8.5% to get to Kernel’s $8.9 million at age 65 figure. Very favourable for the renter too, as over a lifetime, you would expect average returns to be lower than this. This is 6 percentage points every year in the hand above inflation.
I don’t know about you but some of these assumptions seem incredibly unrealistic in favour of the renter. Note, that Kernel’s assumptions would have been different in terms of percentages, but the differences would be similar to get to the same end numbers.
First of all, it compared a home owner spending $62,000 a year. Whereas the renter was spending less than half that at $30,000 a year. It’s not fair to compare one person wanting a $62,000 a year property and another person wanting a $30,000 a year property. The renter will either want to rent a much nicer property to put them closer with the homebuyer, or the homebuyer will buy a cheaper house to put them closer to the renter’s housing experience. Or a bit of both. Same people but living in different standards makes for a poor comparison from the get go.
Secondly, the investment return assumptions are incredibly high. Not everyone invests in high growth assets their whole life, especially prior to retirement. Then you have tax which takes a huge amount off your investment returns. To get a return of 8.5% you would likely need pre tax, pre fee investment returns of well over 10% or 8 percentage points more than inflation in this example.
Finally, assuming house price increases to match inflation and increase at a rate of around 8% less vs investing (10.5% vs 2.5%) is highly dubious. Sure, house prices may not rise by as much as they have in the last 20 or so years, but to use such a low figure historically speaking is very biased. Likewise, rental costs typically increase higher than inflation too.
So there we have it. They would have had to use similar assumptions to above to get to their headline statement that a renter could be $600,000 better off at age 65. I don’t agree obviously.
As many of you know about the power of compound interest and how small changes can produce outsized results over the long term, let’s look what happens if we make some very small changes that don’t favour the renter quite so much, but still not in favour of the home owner.
We will reduce investment returns to 7% and increase house price increase assumption to just 4% per year.
The renter will have $6.2 million in equity and the home buyer will have $6.9 million in equity. The home owner going from $600,000 worse off at age 65 to $700,000 better off with just a couple of small changes. This doesn’t even factor in the other factors favouring the renter such as high savings rate and more willing to live in worse conditions than the home owner.
Who knows what will eventuate in the future regarding investment vs house price returns. But I think the assumptions used in the Stuff article are blatantly unrealistic and proves the point that you really should question everything.
What were the assumptions used? And who were making the assumptions and what do they stand to gain?
The other point is that who really cares in this example who was better off. What does it matter whether you have $6.2 million or $6.9 million. Both the renter and the homeowner I am sure will be fine and have well enough.
What is more important is making the decision that suits you the most and lets you live the life you want to live.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here