Is paying rent money misspent?

Housing affordability has hit a new low, making it even harder for renters to jump onto the property ladder.

According to the Deposit Power Housing Affordability Report released in December, the proportion of income required to meet loan repayments increased 5.8 percentage points to 34.8% over 2010. The most dramatic decreases in housing affordability were recorded in New South Wales and Victoria.

The recent report follows predictions made earlier in the year by Australian Property Monitors that suggest home prices in Australia’s capital cities are about to boom. Median house prices in Sydney are expected to double in the next decade reaching $1.2 m by 2010, while Perth house prices are predicted to jump 12.3% over the next decade, followed by Brisbane (11.6%) and Melbourne (10%).

So where does this leave renters going forward? Is the pursuit of home ownership worth the financial burden, or would renters be better off putting their savings into other investments?

It’s a tough call – as one must balance the pros and cons to renting, as well as your own financial goals and lifestyle choices.

There are several positive aspects to renting. One big advantage is flexibility. Renters have the ability to pick up and move more easily and adjust their housing allowance should they suddenly lose their job.
As well, renters are not responsible for the property so any maintenance costs and renovations can be offloaded to the landlord.

Thirdly, because it is generally cheaper to rent than to own, renters can often afford to live in the area that is closer to the city or their place of work. As well, renters can usually obtain property that is larger or a step above what they could afford to buy.

And lastly, because renters are paying less each month for their housing they have the ability to sock away more of their savings into other investments.

But there are several disadvantages to renting – not the least of which is that renters have little control over how long they will be able to occupy the property. Their fate rests with the landlord who can at any time terminate the lease.

As well, there’s little incentive for renters to upgrade the property as they can only take advantage of the improvements while they live there. And in most cases, the landlord must be consulted on changes renters would like to make.

Another consideration is the rising cost of rent. According to RP Data-Rismark Indices over the 12 months to October gross weekly rents in capital cities increased 3.7% or $15/week to $433/week for the combined house and unit market. Despite fluctuations in interest rates – mortgage payments tend to average out to be about the same for the life of the loan.

And lastly, there is no end to paying rent. Homeowners usually pay off their mortgage in 25 to 30 years and at the end of that period they have built up a significant amount of equity in their home. Meanwhile renters have nothing.

Another method of weighing up the pros and cons of renting is to look at the numbers. Take a 30-year-old – with at least 30 more years of living ahead – that is looking to buy or rent their first home in Sydney where the median house price is almost $600,000.

If he were to rent the property at 5% of its worth (which is the expected annual return for most investments), he would be paying $30,000 per annum or $575 every week ($2500 per calendar month). So assuming rents double every 10 years – at the end of a 30-year period he will end up paying $2.1m and have no asset at the end of that period.

However if he were to buy the apartment, as a general rule he would need to come up with a deposit of at least 5% ($30,000). And assuming the First Home Owner Grant could cover the buying costs, he would end up borrowing the remaining $570,000. Monthly repayments for a 30-year loan at 6.45% would be about $3,585 or $826 a week. Over the life of the loan he will pay $720,265 in interest.
Assuming the value of the property doubled every 10 years, it would be worth $4.8m when the mortgage expired – and at that point he would own the asset.

Buying property is not a get rich quick scheme, but is considered a reliable long-term investment, whereas those looking for short or medium-term investments would be better off considering strategies such as managed funds or high-interest savings accounts.

But there is another option – would-be buyers could continue renting in their preferred location and buy an investment property in an up-and-coming suburb.

Not only do “rental investors” appear to reap both benefits of buying and renting, but they are eligible for tax deductions that are not available to owner/occupiers. However, they will have to pay tax on the property’s capital growth.

While there are lots of ways to create wealth for yourself and for your family – the only real mistake people can make is to do nothing.