The discussion between the advantages and disadvantages associated with the purchase and rental of houses has been an ongoing discussion. Our readers have asked us which alternative we consider most interesting, and it is an increasingly frequent question when we think that the cost of money is low (is it?).
Is the Answer Black or White?
From the study we conducted on this issue, we found that there is no clear consensus on the best alternative, being certain that each case is different and that in order to make the best decision you must do some math.
First of all, it is important to note that I am not an expert in the real estate market. I have my own house purchased and I have a second house purchased for rent, both with bank financing.
Having made this note, I will try to address the advantages and disadvantages of each of the modalities and make a financial analysis of the decision. It remains to be stressed that the purchase of a house for housing should not be seen as an investment but rather for the utility that is associated with it.
Is it Worth Buying a House?
The majority of people who tell me about the logic of buying housing defend this alternative for three reasons:
- We are paying for an asset that ends up being for us, even if only after several (many) years;
- The benefit to the bank is often well below the rent paid to a landlord;
- The house will end up valuing and its owner ends up gaining from that valuation (debatable, even more looking at the number of houses for sale and the impact of demography on the demand for houses in the long term);
It is a fact that the purchase of a home results in the future possession of that asset. However, buying a home has an opportunity cost that needs to be measured. In practice, when you put the money in your home you will not be able to put it in alternative investments that ended up generating income. It remains to ask: it is interesting to own, but at what price?
We cannot devalue the costs of owning a home
It is also a fact that the benefit to the bank often ends up being less than the rent we pay to a landlord. However, as we will see below, the cost of a home includes many other costs such as taxes, improvement works, insurance, condominium, among others. These other costs are too relevant to be ignored.
The right valuation of real estate will not be a fact. If it is true that for many years houses have benefited from a nice appreciation these days it will no longer be valid. In fact, the appreciation of real estate depends on numerous factors, including supply / demand and demography, geography, quality of construction. Many of the houses purchased at the beginning of the decade, especially in some geographical areas, have lost a lot of value.
Finally, a note for the idea that money is not that cheap. If you have an old mortgage loan, you will certainly benefit from excellent financing conditions. However, if you intend to enter into a new credit agreement, be aware that your spread (which has a final impact on the supported interest rate) will be around 3% -4%, although it seems to us that mortgage loans may be return.
Costs and Disadvantages of Home Buying
Although there are advantages to buying a house for own housing (I did not mention it earlier but we have a house of our kind, with our decoration and layout and seeing it grow with the family is also positive, despite having no value). note the existence of costs and other disadvantages associated with buying a home:
Tax burden – The simple act of buying a home entails a cost that represents between 6% and 10% of the property’s value. In other words, a € 100,000 house will have a cost between deed, property tax and the like of € 6,000 (money that could be invested to earn interest). In addition to this amount, we have the property tax and other municipal taxes that also weigh in your budget;
Bureaucracy – The purchase and maintenance of a home has a significant bureaucratic burden associated with it;
Maintenance costs – Buying a home implies maintaining it over the years. Paintings, broken pipes, works in the condominium, infiltrations, among others. All these works are in charge of the owner of the house;
Insurance – When buying a home, you must support life insurance (whose premium increases with your age) and multi-risk insurance.
Poor mobility – Buying a home is associated with a medium / long term commitment. In practice, if you buy a home you will tend to be “stuck” in that home. In a situation of unemployment, geographic change in employment, family growth, poor neighborhood, etc., you will not be able to change easily.
How to Analyze the Value of Your Income
If you live in a rented house, we suggest that you look at your income based on the market value of the house. This way, you will be able to look objectively at the value of the rent. Imagine the following case:
- Market value of the house – € 150,000;
- Rent amount – € 600 / month, which implies € 7,200 per year;
- Estimated annual cost – € 1,500
- Assuming this, know that your landlord’s annual return is 3.8% [(7,200-1500) / 150,000]. What to conclude? It concludes that the rent is reasonable. If you live in a € 100,000 house, the return value is 5.7%, so there will be some space to negotiate.
How to Financially Evaluate the Purchase Decision?
When looking at the purchase decision you should look at the value of the utility of living in the home. In practice, if you lived in a house for 3 years and sold it for the same amount as the purchase price, did you earn or lose money?
A small example, taken from my “Personal Finance Manual” can help to clarify this situation:
Imagine that you buy a house for € 250,000 and that, in initial expenses and other costs, you pay approximately 10% of the initial purchase price. Imagine also that you sell the house, within five years, for € 300,000. In this way, you will achieve a profit of € 25,000, which gives, assuming a tax rate of 30%, a net profit of taxes of € 17,500. Doing some quick math, we learn that the total rate of return is 7% and that the annual return will be close to 1.4%.
It does not take a genius to realize that this rate of return is very low and that, in most years, it is not enough to meet the increase in the general price level. Clearly, this would be a terrible investment.
But are we reasonable in assuming only those values? Shouldn’t we also consider the utility we get from living in our home?
And how should we evaluate this utility? One of the main reasons for buying a house is to live there. In doing so, we avoid paying a home rental to its owner. Thus, the best way to assess the usefulness of home buying will be by the amount of rent that we fail to pay. In this case, we assume that the monthly rent for a house with the same characteristics would be € 900. Thus, we would incur an annual cost of € 10,800, which would amount to a value in five years of € 54,000. This is the value that we would attribute to the use of the house, for housing purposes.
What is your opinion? What is more advantageous?