My name is Anders Bøgebeck. My mission is to help you become a better investor and trader. Why is this important? We are not only helping ourselves by becoming financially free. Along the way we help society by either allocating capital the right places or creating better products and services. That's why I want to help you achieve the life you desire!
You often hear in the mainstream media and among friends, that a house is the best investment that someone ever can make. This post will be an eyeopener to those people, who believe this myth. One of the most important decisions a young person/couple can make is the decision of where and how to live. Signing a big consumer loan can be devastating for your financial future. You have to know the fallacies to be on the smarter side of the decision. In the takeaway, you will see why rent is not a waste of money. I will walk you through:
1. The math behind buying a house (+hidden costs)
To understand the following calculations, it is important to introduce the concept of Return on Equity (ROE). It is the single most important figure to know as an investor. What is the percentage return of my own money? If it is 50%, you are doubling your wealth nearly every other year. Buying a house for yourself is not really a return on your money, because you are working hard for providing your own return. A true passive ROE is sitting doing nothing, while money is coming to you. So it can be viewed as savings in bricks. But the question is then: how large will the savings be each year? This is what, I will walk you through. The numbers are in DKK with exchange rate 6.7 USD/DKK (Danish Kroner, the author's country) and the federal and local government taxations will vary from country to country. But nevermind, the numbers will still be pretty accurate. The numbers below are actual numbers taken from a local bank at the time of writing.
|Purchase price||3,000,000||This is the ask price the seller wants for the house|
|Mortgage (80%)||2,352,887||You get the mortgage of 80%, 30 year fixed rate.|
|Bank loan (15%)||497,570||The rest of the credit is an expensive bank loan, which you pay off first. That is, there will be no amortization of the mortgage the first 10 years.|
|Own money (5%)||150,000||The money you put down. This will be the number I refer to as how much savings you make in the house relative to the money you put down.|
|How much money do you instantly lose when you buy? Assuming you sell instantly.|
|Costs for mortage||99,113|
|Costs for bank loan||22,230|
|The amount you lose||121,343||The cost of flipping a house can be very expensive and is a very dangerous practice. You basically need to buy the house to keep it for many years.|
|What is your equity after 10 years paying down the bank loan solely?|
|Equity after 10 years||548,000||(Purchase price - bank loan)|
|What is the increase in equity?||398,000||(548,000-150,000)|
|What is the average yearly increase in equity?||39,800||398,000 / 10. Below are the costs you need to extract from this increase in equity to get a clear picture of the real savings in bricks. You don't pay all four by renting.|
|1. Real estate wealth tax||-22,000||1 % of the property "value". To be fair, the property "value" is usually lower than price. However, this is a nasty number, which eats most of your savings. The government really wants a piece of your wealth!|
|2. Property tax||-24,000||2,4% of the land value. The land value is estimated to be 1,000,000 for a house with a nice garden in a suburban area.|
|3. House insurance||-7,200||600*12|
|4. Maintenance||-7,200||600*12. Some years may be worse than others.|
|Actual average yearly savings||-39,875||Yes, you actually lose money and do not save a dime by buying a house! It's all gone by taxation. However, from year 10-30 you do keep some of your savings. But the huge losses from year 0-10 really offset the gains.|
|Actual average savings percentage||-26,6%||Keep in mind that 1, 2, 3, 4 and 5 you completely save if you rent your home. This is a huge cost saver!|
|So what about the annual savings amount after you have paid the bank loan off in 10 years and start to pay down your mortgage? Let's look at your equity after 30 years.|
|Equity after 30 years||3,000,000|
|What is the increase in equity?||2,452,000||(3,000,000 - 548,000)|
|What is the average yearly savings after 10 years?||122,600||(2,452,000 / 20). Okay, so we start building up some savings after 10 years. But first, we must extract the costs 1, 2, 3, 4 and 5 from above.|
|Yearly costs from above||-60,400|
|Interest on mortgage||-48,642|
|After 10 years, your monthly payments increase substantially, because you did not make any amortization on the mortgage the first 10 years. This loss is what is called opportunity cost in financial terms and it must be accounted for as a hidden cost. This basically means, that you have less money available to invest in stocks for instance. The montly payments increase from 8,836 to 11,750. That is a loss of -2,914 * 12 = 34,968 in opportunity cost yearly.|
|Total average savings amount yearly after 10 years||13,558||Great, so you do get some savings after 10 years. However, you only get to keep 13,558 out of 122,600!|
|Actual average savings percentage||9%||So after 10 years, you save up 9% of your initial down payment of 150,000. To understand your actual equity after 30 years, we must multiply 10 years of losses and then add 20 years of gains to your total equity.|
|Equity after 10 years||-265.8%|
|Equity after 30 years||-85.1%|
|This means that your initial down payment has turned into real equity of 22,350. 150,000*0.149. This means, that 30 years of saving and working hard every day has only turned your 150,000 into 22,350! That is much worse than just paying the rent and save up the rest. This concludes, that you do not waste your money on rent.|
Below is a summation of the numbers in the table from above.
|30 year overview|
|Price of house||3,000,000|
|Interest paid totally||1,165,590|
|Property and wealth taxes||1,380,000|
This all means, that you end up paying double the amount of the initial price of the house. So you thought that saving up in bricks actually got you 3,000,000. However, you paid nearly 6,000,000 to get 3,000,000 and you end up with a net drawdown of -2,977,860.
2. Risks of buying a house
So your house is not an asset because you get nothing in return. Therefore, it is a liability. But what about the risks you incur when deciding to buy? You don't have these risks when renting.
3. Why the real estate market does not always go up and why people believe it
It is not a good idea to buy a house based on the idea that the real estate market always goes up. Check out the graph below. It shows how the interest rate for a 30 year fixed rate mortgage has been on a long-term downtrend for almost 40 years.
Real estate prices and this interest rate move in opposite directions, because with lower interest rates loans get cheaper for housing. You could ask yourself if this interest rate can go to 0 %, -5% or -10%? At some point there is just a floor for this interest rate. When people cannot afford to buy a single-family home anymore, there is a huge downside risk for real estate prices. The reason why people say, that real estate always appreciates is because of this chart and inflation. The dollar has lost 62% of its value since 1982. Check out this link: https://www.usinflationcalculator.com/. However, that was all in the past. Past results are no guarantee of future results, just like for stocks.
Hopefully, you have realized that buying a house is neither a good investment nor a good savings vehicle. You avoid all the risks of buying a house by renting. By renting, you will save more money and use that money to put in investments, which generate great returns. That is called opportunity cost: what is the cost of wasting money in unproductive investments? The equity in the house you only realize if you sell or refinance (larger drawdown by taking on more debt). Therefore you could very well double your drawdown by buying versus renting.
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