A friend (let’s call him Peter, which is nicer than his real name) has bagged a pay rise from the BBC. Well done Peter.
(Incidentally, Peter’s job is to shepherd the flocks of so-called ‘runners’ you find clogging up TV and film sets. If you’re ever at such a media palaver, you can easily spot the runners: they’re the ones standing still. ‘Loiterers’, ‘texters’, or ‘sullen coffee guzzlers’ would be more appropriate. That said, they’re young and paid bugger all, so we’ll let them off. Our warmongering ‘Defence Ministers’ are harder to forgive).
Peter is now thinking about buying a flat, afraid he’ll be the last person renting come the university reunion, and hankering for seagrass flooring. He’s also got an inheritance of around £40,000 to blow (my estimate – we are British, after all, and I reached my understanding of his financial position via a steady exchange of ‘ums’, ‘around’s, and frothy pints of Kronenburg).
Should Peter buy a flat, or continue renting?
We did the maths on (and in) the area where he currently lives, the invented land of ‘Brackenbury Village’ in Hammersmith. It’s a fairly nice slice of non-descript central London terraced housing, with a few good pubs and restaurants and the Goldhawk Road buffering residents from wild estates of Shepherd’s Bush to the north.
Cost of renting in W6
Using FindaProperty, we discovered the following typical one-bedroom flats in converted period properties to rent:
- Hammersmith Grove, £250 per week
- Carthew Road, £250 per week
- Studland Road £260 per week
- Brackenbury Road, £260 per week
- Hammersmith Grove, £260 per week
Let’s call it £1,050 per month to rent a one-bed flat.
Cost of buying in W6
We found several one-bedroom properties for sale in the same sort of streets in Brackenbury Village, of what appeared to be the same standard as the rented flats:
- Hammersmith Grove, £275,000
- Brackenbury Road, £285,000
- Hammersmith Grove (the sequel), £295,000
- Agate Road, £300,000)
Mortgage cost: Repayment
Let’s assume £290,000 as Peter’s purchase price, a three-year fixed mortgage at 5.85%, and that he puts down £40,000 as a deposit. According to one lender’s repayment mortgage calculator (sorry, no link until I figure out how to make some pennies from it – they’re making their billions without me adding to their coffers!):
Monthly repayment mortgage = £1,600
Mortgage cost: Interest Only
So already buying looks about 35% more expensive than renting. However, it’s not really a fair comparison, as even though Peter would take out a repayment mortgage, a truer comparison with rent is to compare with the cost of an interest only mortgage (since in both cases, as renter or interest only mortgage payer, the capital sum isn’t being repaid.)
Monthly interest only mortgage = £1,208.
That’s not as bad – only about 13% more than the cost of renting.
Loss of savings income
But wait, there’s more. Remember Peter put down £40,000 as a deposit? That’s money that was hitherto earning 6% interest in his online bank account, where it would continue to do so if he rented. I make it £2,500 a year in gross forgone interest, though Peter will pay tax on that, quite possibly at 40%. Let’s play safe and assume the interest income he loses by buying is £1,500 a year.
Monthly that works out at £125 per month, making buying about £275 more expensive than renting.
Cost of wear and tear
Still not all though… What happens when the roof falls in? Or the walls need repainting? Or the boiler goes? Estimates of the cost of maintaining a property run from 0% of the value of the property (amateur Buy To Let brigade) to 10% (overly cautious folk who keep their money in gold coins under double sprung mattresses).
Let’s call the cost of wear and tear / upgrading with the Jones’ at 0.5% per annum, and assume Peter does most of the work himself (whereas Peter the Renter puts his feet up and watches the landlord refitting the kitchen, or perhaps works overtime and saves for the property slump). Maintenance works out at (a hugely optimistic, I’d say) £1,450 a year, or £120 a month.
Buying looks some 40% pricier than renting
In total then, buying, even with an interest only mortgage, works out a conservative £395 a month more expensive than renting the equivalent property, or in percentage terms about 40% more expensive. It’s a similar premium to that I found comparing renting and buying larger London properties.
Don’t forget too that Peter would have to pay Stamp Duty tax of 3% on buying his one-bedroom flat (nearly £9,000 for the properties we’re looking at here) with legal and financing fees certain to push his costs over £10,000.
When it’s so much more expensive to buy than rent, why do people still buy? Because prices have gone up for a decade and they want some of that action, clearly.
If this confidence is punctured – as one day it must be, by a recession or an interest rate spike – then there could well be a hefty correction. Equally, if the property market sails on untroubled, then dove-ish wallflowers like Peter (and your author) could find themselves renting forever (Peter) or biting the bullet and paying even more of a premium to buy (your author, who is currently staring down the market like a mongoose sticking its tongue out at a 40-foot boa constrictor).
Personally, I think it’s a scandal that the government has allowed a trebling-in-a-decade property boom to turn home ownership from a common aspiration into a lottery. But friends query my card-carrying capitalist papers when I mount that particular charge, so I’ll explain why I think the market should be rejigged in favour of young homeowners versus Buy to Let investors another day.
No surprises here about W.London. It’s the most expensive region in the UK and the most popular to live in. I have owned and rented a flat in Hammersmtih for about 10 yrs. The rise in price has outstripped the rise in rent by a long long way. So it’s no surprise that the cost of owning far outweighs the cost of renting. We run a FREE property lettings website covering W.London and have over a 1000 users a week looking for rental accomodation in the area and it’s growing all the time. More and more people are renting rather buying. It may not be out of choice and is an issue of affordability. But the fact is, more and more people are renting whatever the reason.
http://www.heathrowlettings.com
I disagree.
My neighbour, aged 65, has lived in her flat for 40 years; she was given the opportunity to buy it for £7k in 1970 but declined, signing a long-term rental agreement instead.
In the meantime, the rent has increased from £20 to £600/month, which she will continue paying until she dies, let’s say another 25 years.
So, she regrets not having purchased the flat for £7k in 1970 using an interest-only mortgage.
True, it would have been painful initially. But today, the interest on £7k is very little and maybe she could pay it off completely without too much trouble.
She would then own a property worth £350k and could investigate an annuity which would give her an income until she dies.
But no, she originally choose to rent and is currently dealing with the fair-rent people as the landlord wants to increase her rent to £700/month, ouch!
@John – Interesting anecdote, thanks. I strongly believe in buying property is a wise move for most people, for the reasons you cite (although there are alternatives, such as saving the difference when renting is cheaper and investing it). The question periodically is timing – the housing market has seemed by most conventional measures seriously over-valued for 4-5 years, in a way that as far as I’m aware it didn’t in the 1970s though it probably did in the late 1980s. When the correction began, it was so threatening to the economy that policy began to move in a way to stave off or reverse property price declines, especially given what they’d already done at the margins in the US.
That may be another reason to always buy, as you suggest – in a society of homeowners, side with the majority!
But anyway, my understanding is that renting has usually been *more* expensive than buying, due to the fact a landlord typically makes a profit. This article is really about how that’s not currently (or in 2007, when it was written) the case. Perhaps that’s permanently changed due to expectations among landlords of capital gains to make up for subsidizing renters, but ‘permanently changed’ has a bad track record in the markets! 😉
Thanks for your comments, a good warning on the danger of being left behind.
I’m staggered that there has been no house price correction, at least in London.
I’m not sure what to conclude .. if the worst credit crunch for a generation didn’t do it, then are they about to take off upwards again? (even though they still look overvalued to me)
This article, written in 2007, is a useful reminder of the dangers of making assumptions without considering alternative scenarios.
The cost of a mortgage has halved and the rate of interest “Peter” could expect on his savings has fallen by two thirds to give a *negative* return if tax and inflation are taken into account. Meanwhile, the cost of properties in west London continue to slowly rise.
My nephew asked me my opinion when he decided to buy a much bigger property in 2008. Fortunately, the only advice I gave him was that he did all the sums. Too often the calculations for investment and finance are more complex than they at first appear. Perhaps time for a reassessment.
@qix — Thanks for your comment. Believe me, under-complicating my decisions about property is not something I could be accused of. 😉
I accept I got London property wrong (although it did wobble for a while) even though my general view on UK (and global for that matter) property was right. The facts are as they are — London prices are now back around or above 2007 levels.
But I don’t think the lowest interest rates for 300 years, the financial crisis threatening Europe, and the subsequent fact that 70% or so of prime London property has been bought with foreign money is anything anyone really had in their calculations back in 2007.
Even if you did foresee that the imminent financial calamity would cause rates to be slashed to 0.5%, I don’t think *anyone* would have expect the property market to hold up. Everyone has been amazed by the strength of UK employment throughout this recession, and by the speedy recovery of London property (and rents).
RE: Inflation destroying savings, I’d agree if Peter had all his savings in cash. But I wouldn’t suggest that was wise over 6 years. Moreover he could have bought even London property in 2009 at a 15-20% discount. So that’s a bit of a straw man — it was cheaper, for a while. Of course, he’d have had to jump, and I admit I thought prices would keep falling myself.
Not trying to duck your point — as I say, we’re not where I expected.
And I definitely agree nothing is obvious in investing. (A point I have made repeatedly about other asset classes over the past few years! 🙂 ).
@The Investor. I wouldn’t want you to take my comments as being unduly critical. Many people were saying much the same as your article with just as much certainty. It just always intrigues me that there’s generally so much certainty that may not be justified.
As you say, assumptions on property prices were based on other assumptions about the economy and the political and economic decisions that would be taken in the years ahead but turned out to be wrong.
I kept to your assumption of cash only because your article referred to Peter’s loss of 6% interest on his bank account. Whether it would have been wise to remain in cash would have depended how important it was to Peter to buy a property.
Had he invested in equities at the time of your article, September 2007, just before the FTSE went on to fall 45%, then he wouldn’t have been in a particularly favourable position with a halved deposit to buy his flat in 2009 even if prices had fallen by 15-20%. (According to the Land Registry property prices in reality fell just 10% in Greater London in the 2 years following Sept 2007 and from imperfect memory considerably less in the inner boroughs.)
Of course if he’d stayed in cash at the equity peak, and if he’d bought in at the bottom, and if he’d anticipated the upside for bonds, and if he’d bought property at the optimum time, and if… and if… Who knows?
What’s clear is that we all make our judgements in the light of our own experience. I’m very, very old yet one of the few things I’ve learned is that I’m not nearly as smart as I’d hoped and that the unexpected happens… er, more than I expected.
One of my earliest assumptions while attending a Church of England school at the age of 10 was that, with great strides in education, by the time I was this old religion and superstition would be almost forgotten in the UK. Made perfect sense to me and others around me, and yet, to some extent due to changed demographics, numbers in the UK following the various traditional religions may be increasing and alternative superstitions are more widely followed than in any point in my lifetime.
What also struck me in your piece was that you considered the costs of owning property but not the value. The freedoms and pleasures that come with owning our homes wasn’t mentioned.
In my parents time most people rented their homes. It seemed to make sense. I watched as they chased their landlord for repairs and bemoaned the alterations and improvements they wanted but couldn’t carry out. They were only forced into buying their own home in their 50s when their rented home was suddenly (and unexpectedly) sold to a new and unpleasant landlord. They’d paid rent for much of their lives with nothing to show for it.
In that light, I vowed not to marry (an essential requirement then before raising a family) until I could buy a property. To do so I had to move from central London and buy a hovel in the cheaper suburbs. I rebuilt the hovel in my spare time and by the time I was 29 I was able to buy a large detached house in my preferred area. I paid off the mortgage well before I was 40 when the government scrapped MIRAS and so ended the tax advantage of having one. With no rent or mortgage since I had a healthy surplus income to invest which grew to more than I’ll ever need.
But most importantly, our house is ours. My wife can have the kitchens and alterations she wants with the costs, with luck, offset by the increase in value. The absolute value is of no interest to us apart from giving us the option to buy and live anywhere in the UK we choose.
So do the maths by all means but recognise the fragility of many apparently reasonable assumptions and don’t fail to factor in what can’t be expressed by numbers.
And the other annoyingly simplistic assumption that I see everywhere is that because equities have risen by an average of x% since 1900 then we can assume with certainty the same rate until the end of time. But that’s another debate.
It’s our human instinct to colour our judgement by what we prefer to believe. Thanks very much for your site. Lots of thought-provoking stuff to challenge the hard sell of the investment industry elsewhere. I’ll be reading more. 🙂
@qix — Many thanks for your extended reply, which I greatly enjoyed reading. Your points are well made and well taken, and I see where you’re coming from more clearly now.
I couldn’t agree more one should be humble in the face of uncertainty. To some extent, the post above represents the hubris of a man six years younger, perhaps, who hadn’t been fully chastised yet by the London property market. The way it has played out has been one of the greatest learning experiences of my life.
In some ways it makes life difficult that the blog format records your past views like this — short of deletion, there’s no escaping them! 😉 I think it’s much more valuable though for readers to see everyone is flawed, and that goes doubly for myself.
You might be amused to see I am currently being baited for (supposedly!) being too bullish about London property on another thread.
I think your comments apply in full force to many of those there, especially: “It’s our human instinct to colour our judgement by what we prefer to believe.” Feel free to take the fight to them!
Glad you’re enjoying the site, and hope to see you around again in the future.