One of my main themes this year in the Property Market section of the site has been empowerment: one of the most important things in rebuilding our property market is to give people the facts and the tools they need to make financially sound decisions about their money and their accommodation.
My St. Patrick’s Day post, A Nation (of Renters) Once Again?, compared a 25-year cashflow from buying and renting for a few types of houses. Based on current asking prices and rents, the general finding was that as you went up the food chain, from a two-up/two-down in Dublin 7 to a five-bedroom detached house in Blackrock, the maths looked more and more in favour of renting. For the five-bed in Blackrock, the choice was between a rent of €2,000 and a mortgage repayment of almost €7,000. The monthly savings would add up quite nicely over the lifetime of the mortgage.
The problem with the last post, however, was that it was all based off my world-view, i.e. what I thought was a reasonable benchmark for annual growth in house prices, rents, investments, etc. That, and I made a mistake! I left out the deposit from my calculations, which – given that if not used for a mortgage, a deposit is tens of thousands invested for a generation – swings the maths further in favour of renting.
All that is corrected in the form below, where you can put in a property you’re looking at and your assumptions about the world, and see how the numbers stack up. (Incidentally, if you’re not sure what loan-to-value means, it’s 100% minus your deposit. Typically, new buyers will have a loan-to-value of about 90%. Oh, and no commas in any of the numbers, please!) There’s a fuller discussion of what this does and doesn’t tell you (and assume) below, but that’s enough preamble. Here goes – when you’ve put in your numbers, press calculate and the results will appear just below:
- The average mortage interest rate during the 1980s was 12.1%. It was 8.6% during the 1990s. We’ve since joined the eurozone so we can expect lower interest rates. During the 2000s, it’s been 4.5%, which is probably on the low side. More prudent banks and less anaemic eurozone growth means we should be planning on something like 6% as the typical mortgage rate over the coming 30 or so years.
- International experience suggests that the average annual change in rents and house prices should broadly match general inflation. This was also the case in Ireland until the late 1990s. For example, real house prices (i.e. adjusting for inflation) were about the same in 1995 as they were in 1978, the earliest year of complete data for Ireland. The European Central Bank has a target level of inflation of 2%, so that’s a handy default value for the average rate of inflation in Ireland, including for houses and rents. One could argue that the ECB won’t be able to get it spot-on so it may average slightly higher, but equally one could argue that significant over-construction in Ireland during the 2000s will mean inflation in house prices and rents over the next generation will be slightly less than inflation elsewhere in the economy, so I’ve kept the default for both rental growth and house price growth at 2%.
- The default average annual return on investments of 6% is an average of a 3% rate on secure investments (such as savings accounts) and a 9% rate on equities. This represents a simplified mixed investment strategy over the two types of asset. The 3% rate on secure investments comes from a real rate of return of 1% (in line with historical averages), on top of Eurozone inflation of 2%. The 9% rate on equities is calculated using the so-called equity premium puzzle. Many economists have written on the fact that over the long-run, equities tend to outperform secure deposits by six percentage points on average, far more than one would expect. Six percentage points above 3% gives an average (but obviously volatile) return on equities of 9%.
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Remember, that’s based off the price you put in, which more than likely is significantly above the price suggested by the yield. If you’re curious, put in that price and see what you get.
So much for the assumptions. Can you really take something like this seriously? Here is a sort of FAQ for typical comments people have when they read something like the results from the calculator above. (With thanks to those on boards.ie who discussed the Nation of Renters post last month.)
1. How realistic is this? I can confidently state that even if 1,000 people followed this post to the letter, not one would end up at the end of their mortgage where this calculator suggests. This isn’t supposed to solve one of the biggest financial decisions in your life with a simple yes or no. It is meant to illuminate, reflect people’s own preferences and beliefs, and highlight to people where large sums of money are coming and going over the lifetime of their mortgage. One important point, for example, is that in reality, most people live according to their budget, not budget according to where they want to live; so a household earning €5,000 after tax per month will spend on average about €1,500 on accommodation. This calculator starts out not with your budget, but with where you want to live and goes from there.
2. How would I go about implementing this in practice? So, you’ve run some numbers based on what kind of mortgage you can afford per month and what type of property suits you best for that budget, and the numbers have come up in favour of renting. One way of sticking to this kind of plan would be to set up a standing order from your current account, for the amount of what would be your mortgage, with the gap between the rent and the mortgage going to your savings and investment plan. Otherwise, you might find that your “savings” end up getting consumed. Nothing wrong with that in theory, but it may not be consolation for 2040s you to know that 2010s you had a whale of time! For specifics on savings and investments, you’ll need a qualified financial advisor (or to be able to live with your decisions).
3. What about people living in their homes after they’ve paid their mortgage off? A related point to this is: “I don’t fancy the prospect of being turfed out by my landlord in my sixties and having to find somewhere else to live.” First things first, tenants in Ireland have more rights than is popularly believed, including in relation to notice of eviction, particularly if you’ve been in situ for more than ten years. That said, this is a valid point – someone who buys and has their home paid of by 60 has less monthly outgoings than someone who is still renting. A couple of points are relevant here, though. Firstly, your invested deposit alone would be able to pay your rent at the end of the period for perhaps 10 years or maybe more (depending on the yield). Secondly, the downside to investing exlusively in your home is that it’s not liquid. Emergencies, growing health expenditure, etc, can’t be paid for by using your accumulated wealth lying in your house. Someone who has the same amount saved up in savings can make it as liquid as they like (and presumably by retirement would have made it quite liquid). Lastly – and this is still an unpopular point in Ireland – a renter can live somewhere appropriate to their needs. So instead of having estates of family homes in the suburbs populated by elderly couples, while commuter towns rise further out of town, people would be much more likely to live where suits them best.
4. What about the value of knowing you own your home and the freedom to alter it at will? Funnily enough, this is probably not as important – in a monetary sense – as one might think. If you think about it, though, it’s actually a balance of two (monetary) factors. Firstly, how much would you as a renter be prepared to pay on top your rent each month, to buy a stake in the property (e.g. after one year, you’d own 4% of the house)? Secondly, on the flip side, how much “insurance” would you be prepared to pay on top your mortgage every month, in order to be able to walk away from the mortgage (and the house) at any point with your equity intact, if circumstances changed (e.g. unemployment, negative equity)? More than likely, these balance each other out. The value purely of the freedom to alter your home at will, even if you didn’t, is not easy to calculate. The best thing you can do is look at the final result above and ask yourself would you accept that amount in return for signing a contract that said you couldn’t build an extension, etc., but could leave whenever you wanted to.
5. Wouldn’t a nation of renters destroy jobs? Or: “Are you trying to con people into renting?!” Call me paranoid, but I thought I’d nip this one in the bud. This line of thought goes: “People who buy homes sustain employment in construction, banks, estate agents, architects, etc – turning us all into renters would damage a backbone of our economy.” A country of 1.6 million households needs 1.6 million homes, regardless of who owns them. An epidemic of long-term renting might bring some adjustment costs, but ultimately there would still be homes bought, sold, repaired and improved. A more interesting research question is whether homeowners are better citizens – the argument being that owner-occupiers invest in local amenities. This idea is contested by Richard Florida, who suggests there are benefits from having a mobile society. But I digress…
I hope you found the calculator interesting and maybe even educating. Please use the space below for any comments, questions and potential bugs or errors.
Jagdip Singh ,
Excellent contribution Ronan.
Could you explain the calculation for part of the calculation “So how much better off financially would you be, if you bought this property at the current price, as opposed to renting it out? -€1,054,799 – where a negative number means you would be financially better off renting and investing, rather than buying.” Could you explain the arithmetic for calculating the -€1054799 (obviously by reference to headings).
LorcanRK ,
Great idea Ronan.
But, is this working correctly? I inputted the following: €200,000 house price, €800 rent, 80% ltv and 25 year mortgage.
I got some very strange results.
Ronan Lyons ,
Hi LorcanRK, in what way strange? The price is quite good in a yield sense (4.4%) so the gap between the typical mortgage repayment and the current rent is quite small. If you’ve kept the defaults, your house would be worth €330k by end of period, while your savings would be worth €45k (deposit) and €171k (rental savings until year 13 and then run-down of savings after that, as inflation would have taken your rent above the mortgage repayment). With a price that low, it would make sense to buy instead of rent, if you’re staying for the long-haul.
I put an earlier version of the calculator up on Google Docs, so you can see some of the black box here:
https://spreadsheets.google.com/ccc?key=0AnnEvMs5mzPBdDc3emZlb1N1ek9oaExSVnV5LVJXNnc&hl=en_GB
Hopefully an examination of that spreadsheet and its formulae helps with your query too Jagdip, thanks for the comments,
R
LorcanRK ,
Ronan, thanks for the response.
I think there may be an issue with the outputs. The reported price at the end of the 25 years is €328 (not, €328,000). My mortgage payment (again according to the outputs) would be €1.03 (not €1,030). These figures then throw off the rest of the calculations. Perhaps a problem with they way the numbers are extracted from the spreadsheet?
Kevin ,
You should also add the extra maintenance costs of owning one’s own home i.e. insurance, mortguage protection, repairs, etc….
Ronan Lyons ,
Ah, did you put in your percentages in the form 0.05 for 5%? If you leave them as 5, rather than 0.05, it should be OK. User-testing suggested 5 with a % symbol after is more intuitive.
EDIT: This turned out to be an issue with commas – for the moment at least, don’t use commas in any of the fields (in particular price) no matter how pretty they look!
Jagdip Singh ,
Ronan, having entered the same data on the spreadsheet – house value 650k, monthly rent 650, 25 years mortgage and 80% LTV and keeping the inflations and return % as above there is a difference between the spreadsheet and above. The future value of the property is the same on spreadsheet and above. However the value of the investments is 1593206 and the gap is -526812 per the spreadsheet and 1778424 and -1269973 above.
Also stamp duty?
Ronan Lyons ,
It was the penultimate version of the spreadsheet, so I’ll have a look later and see where the difference is – safe to say, any changes since were improvements!
Stamp duty not included, and neither is capital gains tax, as I’m not an expert in those areas. Might talk to someone who is though, and see if we can include some tax elements in version 2.0.
R
Rents as an indicator of property prices « Nama Wine Lake ,
[…] a very helpful calculator to help residential property buyers in their rent-v-buy decisions. You can find the calculator here. There may be some bugs to iron out though Ronan has also produced a google docs spreadsheet and […]
Hugh ,
Well Done Ronan, another excellent piece of work. It is a hard thing to quantify, but another argument in favour of renting versus buying would be to look at the cost of moving home: don’t most people move home roughly every 7 years (leaving out employment factors, simple life style changes prompt moves, e.g. children, relationship breakdown, responsibilities to care for parents). If you were to add in a cost factor of on average 2 home changes over 20 years, it would be a significant additional cost.
H
Jagdip Singh ,
Ronan, you might also consider a poll button so that people can indicate whether the particular property under consideration was cheaper to rent or to buy. All of my results came out strongly in favour of renting – David McWilliams in today’s Independent asserts that prices need to drop 45% so that rent-v-buy comes into equilibrium, and whilst his approach appears to be more simplistic than your calculations, it reinforces the view that we are nowhere near “the bottom”.
Rapesco ,
Unrealistic.Too many assumptions.People will not save the difference from renting let alone invest at 6%. Come on man! Never gonna happen. If you rent long term (i.e 30 years)you’re gonna wake up some morning when your 55-60 with no house still paying rent. Let’s see you pay 750-900 (or more) a month on a pension. Dangerous calculator to believe.
Ronan Lyons ,
@Rapesco
I’m not sure why it’s perfectly possible for someone to have a standing order for €1,200 a month for their mortgage, but entirely “dangerous” to suggest that the same person could have two standing orders, one €800 for their rent and the other €400 into a 10-year savings account or personal investment plan? Particularly when lots of people already have that second standing order for their pension!
It would certainly be dangerous for someone to read this, say “I’m better off renting” and forget to lock some money away for savings. But one assumption – that they could put money away – is hardly ‘unrealistic’ or ‘too many’.
Rapesco ,
Ronan, you seem ok. A bit on the pro rent side but ok. I’m just saying. I’m not gonna look at my 50k for 30 years and watch it grow. The difference between paying a mortgage and saving the surplus from renting is that you don’t have the choice with the mortgage. You’re locked in. Saving is entirely optional. I can cancel that standing order anytime. People are flawed and stupid particularly when it comes to money. I’d like to know someone who’s done this just to see if it’s possible in real life, i.e Joe Bloggs sat on his 50k for 30 years and rented he also saved x amount without fail and now he’s laughing his head off at the rest of us.Do you know of a Joe Bloggs?
Seamus Coffey ,
@Rapesco
What about the benefit people get from spending the money now? That has to be taken into account. People might be flawed when it comes to money but they are not stupid.
Any money gained by renting instead of buying may not necessarily be saved to fund future expenditure or pay rent in the future, but we can be sure they won’t burn it.
Brian ,
Good calculator. I think you have to include some allowance for stamp and furnishings/upkeep that you would pay if you bought but wouldn’t if you rented. Also not sure about the logic of the long term interest rate being the same as the long term investment return – I would expect long term investment returns to exceed long term interest rates. Good work though.
links for 2010-04-22 | andy.edmonds.be ,
[…] Your very own rent-or-buy calculator | Ronan Lyons (tags: rent buy calculator) This was written by andy. Posted on Friday, April 23, 2010, at 1:04 am. Filed under Delicious. Bookmark the permalink. Follow comments here with the RSS feed. Post a comment or leave a trackback. […]
Furrylugs ,
Great tool Ronan. One of the guys put it up on David McWilliams site and it just saved a friend of mine 38k.
Thanks for the effort in publishing this.
Maith a Fear.
Brigid ,
Thank you for putting together the calculator. It was really interesting to get feedback from it.
Can I ask your advice. I have a 340,000 mortgage on my house. If I sold it now I would just about cover the mortgage. If we sold now we would rent and wait a year or two and then buy. If we don’t sell we risk serious negative equity in the next year or two as house property prices decline.
We have a tracker mortgage of ecb+1%. There is 30 years left on the mortgage and payments now are 1,300 but in the last few years they have been as high as 1,950. If they went that high again we would be in trouble. We have both had paycuts and my husband’s job is at risk, mine is fairly safe. We have a pre-schooler and a baby. It is our family home and only property.
My basic question is sell now, rent and see where the market goes or wait risk negative equity but keep our tracker mortgage?
Any advice would be so so gratefully received.
B
Can buy, won’t buy « Nama Wine Lake ,
[…] 2. Rental prices are still dropping and in the State rental prices and property prices have gotten out of equilibrium whereby it is generally more financially attractive to rent. Take a look at the economist Ronan Lyon’s rent-v-buy calculator here. […]
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[…] Your very own rent-or-buy calculator | Ronan Lyons This is a very useful calculator to emphasise the returns on purchasing a house. […]
Derek Brawn - Swindle??? ,
[…] Indo push free alternatives based in Ireland, rather than ones you have to pay for? Like this one: Your very own rent-or-buy calculator I think Irish Mortgage Brokers have one too. Would love to know if there are more Irish-based ones […]
Rent Or Buy?? | MortgageLine Blog ,
[…] In the following example I have used the rent or buy calculator that Economist Ronan Lyons has kindly made available in his blog post http://www.ronanlyons.com/2010/04/20/your-very-own-rent-or-buy-calculator/ […]
Rent or Buy?? - MortgageLine ,
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[…] more scientific way – one I’ve gone through before in my rent-or-buy calculator – is to look at the annual rental cost for the property you’re interested in. If you want to […]
wyn rees ,
Ronan:
Can you simplify this for an old age pensioner who lives in a very large Country House (no mortgage).
I may attempt to rent my property instead of selling it.
My property is listed, 30,000 sq.ft/190 acres and was worth 3.9 million Euro a few years ago.
I looked through the equations in your write- up and came to the conclusion that I was too bloody old to work the numbers.
My question is: If I were to rent this estate out how much do I charge ??
Best Regards,
Wyn
Ronan Lyons ,
Hi Wyn,
Apologies – the calculator was originally designed for the other end of the cycle (someone buying rather than selling)! Hence, the idea is to show people if the price they’re thinking of paying is in line with the rent they would pay otherwise.
For someone selling, I would normally advise them to check the rents of comparable properties, however, I fear that yours is not in a particularly common segment! So, to use the maths to help you out, the idea for you is to think of a price that you might be prepared to sell for. Then to get the annual rental income, multiply it by x/100, where x is “a fair yield”. Generally, “a fair yield” might be something like 10% for a one-bedroom apartment but could be as low as 5-6% for a family home and even lower the larger the property. (The precise reasons for this difference are unclear and the subject of some of my research at Oxford – it may come down to people wanting to lock in nearby amenities when they settle down.)
So, in theory, a property that might now be worth €1.5m (Allsop’s auction suggests that we should be factoring in a fall of 60% from the peak) would get – at a 5% yield – about €75,000 in rental income a year. This translates into a monthly rent of €6,250. (For listed properties, you might find that the rent is slightly higher, as the tenant enjoys the prestige of a listed property but you still bear the costs.) If it were closer to a 3.5% yield, though, the monthly rent would be in the region of €4,500. Clearly, if you’re not in a huge hurry, you’re better off starting too high and working down to find demand, then the other way around.
I hope that helps, but if you’ve any more questions but want to follow up in a less public forum, feel free to pop me an email (ronanlyons@gmail.com).
Ronan.
Mick Lydon ,
Thanks for that Ronan very useful and informative…
Fearghal ,
Thanks, very useful resource.
Seeems to be a problem with the inputs for change in house price (and maybe the others too). It ignores everything after the decimal, so 1.99 gives the same result as 1