Are you financially better off renting or buying a house?

PHOTO: First Home Buyers. FILE

The answer may not be as obvious as you think.

As a country, we have been so thoroughly convinced that home ownership is the only way to be financially secure that we rarely ask any more questions. We just assume that the sooner we get on board the property ladder, the better. But I want to put that question back on the table. Is it really always financially better to buy than to rent?

What I’ve done is a back-of-the-envelope calculation that doesn’t account for the details of anyone’s personal situation. Unfortunately, I think this is still more analysis than most people do before they decide to buy a home because they believe it to be a good investment.

To make this a fair comparison, I’ve assumed that in both cases you’ve saved enough for a 20% deposit and can choose whether or not to buy.

For the buying scenario, we need to consider how the value of the house increases over time, as well as the cost of borrowing. We also need to take into account the additional costs homeowners face like maintenance, insurance and rates.

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For the renting scenario, we need to look at the cost of renting as well as the returns the renter can make on the deposit that they didn’t put into the housing market. On top of that, we need to allow for additional investments they can make if they’re paying less in rent than their mortgage payments would be.

Property in New Zealand appreciates less than you might think

This may come as a surprise, but property in New Zealand appreciates in value at a lower rate than the stock market.

With rock bottom interest rates and easy access to borrowing during the pandemic, we’ve seen annual house price increases of more than 20% over the past few years. Recency bias might convince us that’s normal, but over the past 30 years, house prices have increased at an average rate of about 7% per year across New Zealand.

This has been highest in Otago, where the annualised growth of house prices has been 7.55% since 1992. Meanwhile, the West Coast has had the lowest annualised growth of 4.84%.

By contrast, the NZX 50 (which is the main stock market index in New Zealand) has had an average annualised return of about 9.8% since its inception in 2003. Of course, returns on shares are taxed, so let’s round the returns on the NZX 50 down to 8% to roughly account for taxes and fees. Even so, over the long term, residential property prices in every region of the country increase less than the NZX 50.

This means that a renter who takes the money they could have used as a deposit and invests it in the stock market instead is, on average, going to make a higher return on that money than a homeowner.

How much of a gap is there between rent and mortgage payments?

This higher return also applies to any additional money that a renter can invest if their rent is cheaper than a mortgage payment would be. A mortgage payment for the median house bought in New Zealand in June 2022 with a 20% deposit and a 5.5% interest rate would be $890 per week. The average rent across the country is $516 per week, leaving an extra $374 for the renter to invest.

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The gap between rent and mortgage payments varies a lot by region. In Auckland and the Tasman region, the average rent is less than half of a mortgage payment on the average property. Meanwhile, the West Coast is the only region where the average rent is more than what a mortgage payment would be.

Leverage – property’s secret weapon

So far, I’ve highlighted the higher returns provided by the stock market, which mostly benefits the renter in this situation. However, one of the huge advantages of buying property is the ability to use leverage.

Leverage means investing money you’ve borrowed. It allows you to make returns on more money than you can save (it also introduces risk, but let’s put that to one side for now) and for most people it’s more or less unique to property. No-one will lend me $600,000 at a 5.5% interest rate to invest in the stock market, but most banks would be quite happy to sign me up for a mortgage with those terms.

As long as the house increases in value at a higher rate than the interest they’re paying, leverage benefits the homeowner. This benefit is the increase in the property value, minus the cost of the debt.

Other costs of home ownership

Unlike renters, homeowners need to pay rates, insure the building and pay for maintenance. I have estimated these to cost 1.5% of the property value annually.

That’s a reasonable estimate for a fairly modern home with an average insurance premium. If your home needs lots of repairs and is in a high risk earthquake or flood zone, you might need to pay more.

So is it better to rent or buy?

Across New Zealand, buying the median house in June 2022 would put you ahead of the average renter by just over $3,000 over the course of a year. However, this varies significantly by region.

Most notably, renting is a better financial choice than buying in our largest city. A buyer in Auckland would be $6,723 worse off than a renter after a year. The Nelson and Tasman regions also come out in favour of the renter. In Nelson, the difference is $3,098, while in the Tasman region, a buyer would be $7,084 worse off than a renter after a year – the biggest loss for homeowners across New Zealand.

Meanwhile, on the West Coast, in Gisborne and the Hawke’s Bay, buyers are better off by about $15,000 a year. In our capital city, buying would put you ahead of renting by $2,270.

Many other regions come out in favour of the owner, but only just. In Canterbury, the difference is $525, while in the Waikato, the average buyer would benefit by $838 in a year. With such a slim margin, the particulars of your situation become really important.