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Rent or buy? The evidence is in

Jessica Irvine

There is perhaps no question more vexing for young Australians today than the decision whether to buy or rent a home.

Of course, for many, there is no choice at all. Lacking the substantial deposit required to enter the property market in many Australian cities, they rent by default.

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But for many, the logic of home-ownership is unquestionable. Rent money is dead money. Why pay off someone else's mortgage? Property prices always go up.

But this one-eyed view of property ownership overlooks some of the substantial costs involved. There's stamp duty, maintenance, local council charges, water bills and strata levies to consider. Plus the hundreds of thousands of dollars in interest payments.

 It is almost impossible to know exactly, in advance, what those relative costs and returns will be. With the benefit of hindsight, however, it is possible to look back and see what the returns to renting and buying have been in the past.

Which is exactly what two young economists, Dominic Crowley and Shuyun May Li, set out to do in a new research paper, motivated by Crowley's own experience at being outbid at an auction and deciding to rent instead.

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"Renting is often derided as an inferior choice with slogans such as 'rent money is dead money' and 'stop paying off someone else's mortgage'," they write. "However, it is not clear whether owning a home is superior to renting from a financial point of view. If a prospective buyer decides to rent, rather than buy, she could invest the difference in ongoing costs into other assets."

A recent study in the US found renting to be the superior investment strategy. A recent paper by the Australian Reserve Bank characterised the rent versus buy decision as an even call.

But the results from Crowley and Li's paper are more definitive, at least from a recent historical perspective.

So, which is it: buy or rent? Let me put you out of your misery first.

It's buy.

"Our results suggest that buying was financially more favourable than renting over much of the past three decades in all Australian capital cities."

That sound you hear is the collective thud of renters' hearts hitting the floor amid a smug chorus of "I told you so" from every home-owner and property spruiker in town.

But it's not quite so clear cut.

First, it is necessary to understand exactly what the economists have measured.

The economists tracked for each year between 1983 and 2005 whether it was financially better to purchase property and sell it after 10 years or to have continued renting and invest the same amount into a mix of shares and term deposits.

They construct two alternative scenarios. In one, a first home buyer puts down a 20 per cent deposit on a median-priced, free-standing and established home. For reasons of simplicity, they are assumed to take out an interest-only loan and make no additional repayments. Whether home-ownership encourages additional savings over renting is, therefore, not considered. At the end of the 10 years, they sell and realise a capital gain from which the upfront and ongoing costs (including interest) of property ownership (excluding strata fees) are deducted. The value of the future net gain is expressed in today's dollars.

In the second scenario, a person continues to rent and instead invests the deposit amount into a mix of shares and term deposits. The renter pays rent for 10 years on similar properties to the purchased property.  While the purchaser is assumed to stay put for the decade, the renter is assumed to move three times, incurring moving costs and a month of paying double rent each time. Dividends from shares are reinvested, but no additional savings are made – on par with the property purchaser making no extra repayments. At the end of the decade, the renter's investments are sold and capital gains tax applied. The value of the renter's net gain is also expressed in today's dollars.

The two values for the net present value of ownership and renting are computed for 23 years from 1983 to 2005, with results for each capital city.

For Sydney, buying emerges as the financially superior strategy in all but four years, comprising 1989-90 (when house prices had peaked and interest rates were very high) and again in 2003-04 which was the start of a decade of sluggish home price increases.

Similarly in Melbourne, buying was the superior strategy in all but six years. A similar story is true for the other capital cities.

Arguably there's something for everyone in this result.

Clearly, over the past three decades, the financial return to property ownership has, for an overwhelming majority of years, exceeded the return available to renters who invest in alternative asset classes.

But not in every year.

And it's important to remember this is a historical study.

It is a golden rule of investing, after all, that past financial performance is no guarantee of future performance.

The study period spans two distinct periods in which interest rates structurally fell.  Are interest rates really likely to halve again in the coming decade?

Real house prices have increased more than threefold since 1983, and more than fourfold in Sydney and Melbourne, vastly outstripping income gains. Is that sustainable?

The two economists attempt to be more forward looking. They construct 144 possible future scenarios. For Sydney, 100 per cent of those scenarios suggest buying remains the best strategy. For Melbourne, buying wins in about 70 per cent of scenarios. In other capital cities, it is an even call. But of course, there are an almost infinite number of scenarios that could eventuate.

So, what can we learn?

First, the authors conclude, timing is critical. The results shows that prices can fall or stagnate and it is sometimes better to rent. However, undeniably, buying has proved the superior strategy in more years than renting, at least in the period studied.

Second, the returns to property ownership are higher if you don't move as often, avoiding the costs of moving.

Third, if you do rent, the returns to share investing have been superior to other forms of saving.

So what advice do the economists have for would-be first home buyers?

"Prospective first home buyers should endeavour to forecast house price appreciation in the future when making their buy versus rent decision."

When it comes to investing, all you need is a time machine, or at least a crystal ball.

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