Is rent dead money?

Question

I have a question related to earlier advice you gave someone who was saving a deposit for their home.

Given the situation of increasing savings to save approx. $20,000 by mid-2006, even as a low deposit, would this not be better than taking three times as long to save $60,000 in which time, [given no certainty of the timing of a ‘top of the cycle’], a 20% deposit requirement would possibly increase faster than you could save it as house prices increase?

Even with an increased fee base, by passing across what currently is paid to someone else as rent into the person’s own mortgage investment, would not they still be better off?

Hope my question makes sense?

Cheers

Rob

Answer

Yours could be the ‘sixty four dollar’ questions for many. I agree with your comments that saving say $60,000 will take longer than saving $20,000, but not three times as long due to compounding returns, and that it is very difficult, with out the benefit of hindsight, to pick the top of any market cycle.

It is also agreed that housing prices has been, in some pockets, increasing at more than the rate which first home buyers might be able to accumulate a deposit. Therefore some may be tempted to just go for it and get a toe hold in the housing sector regardless of the economics or personal cost.

I will not fully address the issue of rent verses owning but do the sums yourself. From a cashflow perspective renting is much, much cheaper than owning in almost all circumstances. Where the variance starts to set in is the potential capital gain or accrual that the renter may miss out on. This is particularly so when we see pressure on construction prices, after all said and done supply and demand is the fundamental behind price.

My suggestion to not move on a low deposit approach but have a least 20% saved toward your dream home is more to do with servicing the loan or loans, and the effect of extreme indebtedness on family and lifestyle than the getting on the band wagon at all costs.

I find it difficult to agree with the view that folk cannot save for a deposit, say at your suggested rate of $20,000 per annum, with two incomes. However those very same folk suggest that they can service a loan of sometimes $500,000. The interest alone on this sum is around $41,250 per annum at today’s mortgage interest rates.

Hold my hand on this for a moment; rental in Auckland looks to be around $550 per week for anything half OK, or $28,600 per annum. Let us agree our landlord paid $450,000 for our renter four years back and it is worth on current market now $525,000 after selling expenses. His cashflow return is around 4.10% per annum after reasonable costs of management, repairs and maintenance and total ownership. The growth in value has been around 3.00% per annum after tax. Is this rent dead money? I think not.

However the reality of the situation is that saving is hard, waiting when prices seem to be running ahead of your efforts is soul numbing. And I know there are always other demands on your precious war-chest.

Let me assure you that property prices do not always rise and those that are well positioned to take advantage of a slower market can do very nicely thank you when folk that have been overeager suddenly find themselves stretched beyond capacity as interest rates rise, overtime slows up or the total costs of home ownership presents in stark relief.

It is my view more relationships fail due to financial pressure (as the core issue) than many believe. Take good care of your relationship’s, the cost of its failure is far, far greater than an extra year or two of renting while saving a more comfortable deposit – you will not regret it long term.

Original Article published November 2005