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%.
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.