Saturday, May 30, 2009

Rent v Buy

A lot gets written about whether it is better to rent or to buy your home. Some people seem to hold very strong views on the subject - often coloured by personal experience or recent declines in asset values. My own view is that there is no universally correct answer to that question - each case must be considered on its own merits. As an exercise, I ran the numbers on whether it would make sense to buy or rent our home based on current market conditions.

I assumed:

1. that the purchase price was the same as a comparable unit which was sold in mid-May;
2. that we would spend the same amount on fit out as we did when we actually purchased in mid-2005;
3. stamp duty is at 3.75%;
4. agency is the standard 1%;
5. legal fees and registration costs were HK$20,000 (probably a bit high);
6. interest cost was 1.0% pa (yes, you can get mortgages at that rate in Hong Kong at the moment - but they are floating);
7. I used the most recent rental of a comparable unit in our building (also in mid-May);
8. I used actual management fees, rates and government rent numbers (ignoring the recent waivers).

I then ran the numbers for zero gearing, 50% gearing and 70% gearing. To make the maths easy, I assumed financing was interest only and that I would be a long term occupant of the property.

The results were interesting:

(i) at zero gearing: the return on equity was 2.6%;
(ii) at 50% gearing: the return on equity was 4.1%;
(iii) at 70% gearing: the return on equity was 5.7%.

While these are unexceptional and unexciting numbers, at least they are positive and, with these sorts of numbers, you either have to assume that there will be some sort appreciation in the value of the property or that you want to have some money invested in real estate for reasons other than maximising your return on investment. That said, so long as interest rates remain low buying with these numbers is unlikely to cause you any financial harm.

Needless to say the results are highly sensitive to assumptions as to future (i) changes in prices (ii) changes in interest rates and (iii) changes in rental levels. They also change significantly if you can negotiate any kind of discount off the price I used in my calculations. In effect, investing in property (including an owner occupied home) is no different from any other investment - you have to make guesses about the future in order to evaluate the financial merits of buying and the price you pay is crucial in determining your return on investment.

As a general proposition, the cheaper the property the more the numbers favour owning over renting. At the luxury end of the market, the reverse is true.

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