12 July 2013

Weighing up the dream of home ownership

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wighing up the dream of home ownershipThe unbreakable bond the fictional Kerrigans had with their airport-perimeter house in iconic Aussie flick The Castle took The Great Australian Dream to extremes.

Yet in the real world, the pendulum appears to be swinging the other way for many who avoid the time-honoured goal of owning a home in favour of renting.

Deciding between a mortgage or a lease is increasingly a matter of personal preference as much as a symptom of strained finances. There are pros and cons to renting just as there are pros and cons to owning your own home; the decision to rent or buy is rarely made on the economics alone.

Gen Y unlikely to commit

For commitment-shy Generation Y, the notion of owning a quarter-acre block with a house that will inevitably need money spent on maintenance and time spent on the garden is not always desirable. Add to that the increased flexibility and freedom that comes with renting and it’s hard to make the case for ownership.

If they are not renting, then Gen Y are likely to still be in the family home until they start their own families, social demographers say.1

Once they leave the nest Gen Y may be more inclined to rent than buy, at least until the residential market shows a consistent ability to add capital gain, providing them with increased financial incentive. The past two years have seen the median value of homes dip from a peak in 2009–10, and experience a modest growth in 2010–11 before declining 3.3 percent last financial year.2

Sluggish house prices not all bad news

Property analysts RP Data suggest a bleak picture with an average yearly increase in home values across Australia of just 1.9 per cent for the past five years.3  By the time the extra costs of owning a home are factored in, such as interest and council rates, insurance and repairs, investing in a house may not produce a positive capital value.

On the reverse side of the coin, however, sluggish house prices have led to a few inner-city suburbs being cheaper to buy into than to rent in. Plus, those who take the plunge are building equity in an asset that tenants are not.4

In the past year, Australian rental rates have climbed 4.2 per cent for houses and 2.9 per cent for units. Coupled with low interest rates for mortgages and depressed house prices, it is easy to see why renting could be even more of a turn-off for those who value the security of knowing they will never be evicted by a landlord.

For people in the wealth accumulation years, stability can be a deciding factor in the debate whether to rent or buy. The anxiety caused by the thought of having to uproot young children and change schools can be very stressful for families.

Green shoots appearing

While some analysts predict it will be a long time before the housing market can expect to make up foregone capital gains, some green shoots have begun to emerge this year.

March’s RP Data – Rismark Home Value Index revealed that dwelling prices in Melbourne, the country’s second largest housing market, firmed 1.5 per cent in February. This compares to an average 0.3 per cent around the nation. January also saw an average Australia-wide jump of 1.2 per cent.5 Clearance rates in Melbourne and Sydney are also beginning to improve.

Making an objective assessment

While it’s difficult to make a purely financial decision about whether to rent or buy, there are some ways to be objective in your assessment.

Commonly used in the US and UK, a ‘back of the envelope’ buy-to-rent ratio can be applied to figure out if homes on the market are fairly priced. It works by comparing a property for sale with a similar rental property in the same location. The ratio is obtained by dividing the sale price by the yearly rent figure for the second house. A price of $700,000 divided by yearly rent of $35,000 equals a ratio of 20. The rule-of-thumb that applies is that price-to-rent ratio of 16 to 20 typically indicates it is better to rent, 1 to 15 indicates it is best to buy, and 21 or more is a clear signal to avoid buying and rent instead.

Of course, this formula is simplistic and doesn’t take into account ongoing costs of owning a home.

Timing a decision to rent or buy can never be a precise science given the variables involved. It is best to identify what matters to you most and this will usually provide the answer you are looking for. At the end of the day, The Great Australian Dream is different for everyone.

 

1 Lifewise, 2012, viewed 10 December, 2012, http://www.lifewise.org.au/today-from-lifewise/are-australians-risking-it-all/

2 Lifewise, 2012, viewed 10 December, 2012, http://www.lifewise.org.au/insurance-101/your-income-your-greatest-asset

3 Lifewise, 2012, viewed 10 December, 2012, http://www.lifewise.org.au/today-from-lifewise/are-australians-risking-it-all/

4 http://www.business.gov.au/BusinessTopics/Occupationalhealthandsafety/pages/Workerscompensationinyourstateorterritory.aspx

The author is an employee of Verante Financial Planning in Castle Hill, Corporate Authorised Representative of Magnitude Group Limited, Licence No 221557, Magnitude Group Limited ABN 54 086 266 202.

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