I am a big fan of Ben Felix, and one of his videos really made me think about the question of whether it’s better to buy or rent a property. His statement: If the annual rent is less than 5% of the property purchase price, renting is cheaper. However, he also mentions that this rule of thumb is a significant simplification. The video:
Brief Summary:
- The comparison between renting and a mortgage payment contains a logical flaw.
His argument is that you should compare costs that are non-recoverable. - In the case of renting, it’s relatively simple: you sum up the rent over a period and get the costs that you can’t get back.
- In the case of an owner-occupied property, however, it’s different because…
- The acquisition costs are non-recoverable (brokerage fees if paid, notary, property transfer tax, etc.)
- The interest payments are non-recoverable.
- The maintenance costs are non-recoverable.
- And now it gets interesting: the capital costs are non-recoverable.
What does this mean? If I invest €150,000 of equity into a property financing, I no longer have the opportunity to invest that €150,000 elsewhere. Let’s assume I would have achieved a 6% return after taxes over 20 years (the FAZ talks about 8.5% before taxes, but let’s calculate conservatively), then we get about €331,000 that I didn’t earn because the money is tied up in the property. At the same time, I (hopefully) have an increase in the value of my property. Let’s assume the property is worth €600,000 at the beginning, and we assume a value increase of 3% per year, then in 20 years, I would have €484,000.
Additionally, there are maintenance costs of about 1% per year, which totals €120,000 (not including the value increase, but ideally that should be considered). On top of that, there are the acquisition costs as mentioned earlier, which add up to €50,000. The interest costs for a loan with a 3% rate over 20 years would be about €220,000. Then there are the taxes, which we’ll estimate at €200 per year, totalling €4,000 over 20 years. The total costs therefore come to €725,000. Against this, we have the €484,000 increase in the property’s value, but also the fact that the loan is not even half paid off, with €246,000 still owed to the bank. So, if I were to sell the property now, I would only have a profit of €238,000 that could offset the €725,000 costs. My net costs would be €487,000.
In comparison, if I could rent the same apartment for €2,000 per month and account for a 1% rent increase per year, I would spend about €528,500. This also challenges the statement that renting is better if the annual rent is under 5% of the property’s purchase price, as with €2,000 rent, we are far below the 5% threshold, yet the costs are higher. But it doesn’t have to be like that.
The model has many pitfalls. Historical data on property or stock market returns don’t necessarily predict the future. We’ve experienced three crashes in the last 20 years, while the FAZ looked at a much longer period. The model also assumes I don’t make early repayments, which would reduce my interest costs, but at the same time lead to higher opportunity costs. The effect of spreading acquisition costs like notary fees over a longer period if I stay in the property longer could be negated by higher opportunity costs from other investments. This can happen, but it’s not guaranteed.
Can we generally say whether buying or renting is better? No, we always make assumptions about how alternative investments and property values will evolve. And other factors, such as the following, aren’t considered:
- With the property, I am tied down (even if I could rent it out if I had to move elsewhere).
- I have no landlord who can evict me or just annoy me (although maybe the other co-owners in a condominium could do that).
- I pass on a value to my heirs, who won’t have to worry about all the points mentioned above.
Ben Felix’s video has once again shown me that there are no simple answers to complex questions. At the same time, providing such complex answers doesn’t necessarily make you popular.