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No bubble in sight, no property winners either

by Bernard Kellerman | 18 Jul 2014

The old arguments of rent versus buy have been re-ignited by a Reserve Bank of Australia research paper that seemed to sit on the back fence when deciding who was better off — renters or home-buyers? And the question of tax deductions puts investors in a class of their own.

A Reserve Bank of Australia research discussion paper titled “Is Housing Overvalued?” was published earlier this week. The analysts Ryan Fox (a renter) and Peter Tulip (a homeowner), examined whether it costs more to own a home or to rent, and argued this comparison is a useful criterion for assessing housing overvaluation. 

They used new Australian data, which includes prices and rents for matched properties, and that allowed them to value housing in comparable levels. 

They did this, the researchers said, as it "enables us to hold housing quality constant and hence assess the level of overvaluation".

“We find that if real house prices grow at their historical average pace, then owning a home is about as expensive as renting. If prices grow more slowly, as some forecasters predict, the framework used in this paper suggests that the average home buyer would be financially better off renting,” they wrote in the summary of their paper.

In for the long run

On the RBA's numbers, which covered the period from 1955, the conclusion drawn is that buying a property is cheaper only if house prices keep growing at the average rate of the past six decades — and homeowners stay in their houses for many years — either eight years if the recent average of 2.4 per cent growth is maintained, or 30 years in the long-run average of 1.7 per cent growth holds true.

They split house prices into contributions from rents, interest rates and expected capital gains, aiming to see if there are patterns that can help policymakers detect housing bubbles. “Recent data do not show signs of a bubble,” they added.

(It's handy to note here that Nobel prize winner Joseph Stiglitz explains the existence of a bubble as: "if the reason that the price is high today is only because investors believe that the selling price will be high tomorrow — when 'fundamental' factors do not seem to justify such a price — then a bubble exists".)

"Put slightly differently, we examine whether house prices are in line with rents. A broader study could examine whether housing prices and rents are jointly over or undervalued relative to other consumer prices," they said.

In a further tweaking of the numbers, the RBA only examined purchases by owner-occupiers, who account for two-thirds of all dwellings. "Investors make similar decisions, but these are complicated by taxes," they said.

Financial factors, not emotions

Third, they looked at whether households are financially better off buying or renting their house and by how much. 

"The decision to buy rather than rent also reflects subjective factors that are difficult to measure such as security of tenure, freedom to renovate, access to finance, pride of ownership, the risk of capital losses and the flexibility of moving. 

"However, although these considerations are important at an individual level, at an aggregate level they seem to cancel out," the analysts contended.

"In contrast to other studies, we do not explicitly include a ‘risk premium’. It is not clear that the financial risks of home ownership should outweigh renters’ insecurity of tenure and uncertainty regarding future rents, or how this might be quantified," the RBA analysts noted.

Nevertheless, it was on this final point that several investment advisers and market took issue. 

"The paper is looking at purely financial aspects, which is not the reality for the majority of the population," said David Henderson, a chartered accountant who has a client base of small and medium sized enterprise owners. 

"When we're dealing with clients, they're taking a very emotional view, with the drive to own their own home."

He also noted that there is an increasing number of baby boomers wanting to downsize and invest the excess in areas such as self-managed super. "Someone in that age bracket definitely doesn't want to risk being kicked out of their own home [as a renter]. The factors that can't be taken into account are huge."

The weight of dead money

Real estate agents, too, will always be quick to call rental payments "dead money" and in this regard that get a degree of support from financial advisers. 

"One thing the RBA researchers have left out is that while renting works out to be just cheaper than buying, it does change over time," he observed. 

And he has a good anecdotal argument — there have been several times in the last 15 years alone when the choices will cross over. Another break-even point was recently achieved. 

In April 2014 the cost of owning was the same as renting, 4.2 per cent of the value of the house. That is, houses are fairly valued, according to the RBA's report.

"No doubt there are times when it does go the other way, and overall, it is cheaper to rent than to buy, but the difference is not that much," said Louis Christopher, managing director of property analysis firm SQM Research. "It’s about whether an individual has the strength to save the difference that you would pay for a loan on a like for like property — and that’s the big problem. 

"Housing is like enforced savings, from that point of view. If that money was invested in the sharemarket, they would be better off, it's true.”

Save v spend, not rent v buy

"Where the RBA’s numbers fall apart is for the people who chose the renting option but do not save the difference, and spend it. What taking on a mortgage does, whether we like it or not, is to enforce savings, in many respects," said Christopher.

"We’re not exactly a nation of savers and, generally, we will spend our disposable income."

And, by way of comparison — admittedly very broad one — the US Federal Reserve has also observed after running a similar exercise that, aside from the recent financial turmoil, the long run annual return from its share market has been 11 per cent, versus 2.7 per cent for house prices. 

Notably, the US allows tax deductions for mortgages, so property investors can be brought into the mix. The conclusions arrived at by the Fed's analysts are much the same as those proposed buy their RBA counterparts — it's an individual choice.



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