Monday, July 21, 2014

Barefoot Investor Email

Below is a email sent out by Scott Pape (Barefoot Investor & Channel 7 Finance commentator) Makes some interesting points about Renting V's Buying, but also an interesting observation about how anyone who is critical of buying housing is attacked by Spruikers......



G'day .....,

 
I copped a bit of hate mail this week.

My crime?

I got on the telly and talked about a new report that suggested it was better to rent than buy.

Cue the crazies: there’s a lot of emotion when it comes to buying property. I think of it as a slightly less bogan version of the rivalry between Holden and Ford (or Kim and Kanye) and this week I managed to get both sides’ back up.

However, I was trumped by the normally poker-faced boffins at the Reserve Bank of Australia (RBA). They rarely speculate on where house prices are going — they don’t have to, they influence prices by setting interest rate policy.

Yet this week the RBA released research that found that over the past 60 years there wasn’t much of a difference between renting and owning.

Okay, go back and read that last sentence again, just so you take it in. It sounds like bulldust, right?

After all, we’ve just lived through the mother of all housing booms — in which your parents bought their home 30 years ago for the cost of a Kia Rio and it’s now worth the same as a Rolls-Royce Phantom.

What gives?

Well, it all comes down to the costs of home ownership, which I’ll tackle in a moment (send your hate mail to scott@barefootinvestor.com). Yet the most intriguing part of the study was the RBA researchers suggesting that if property prices slow, “the average homebuyer would be financially better off renting”.

Boo-yah.

Reading between the lines, that’s a warning shot. The boffins are telling first home buyers to curb their expectations about the future riches they should expect from buying a bunch of bricks.

But let’s get back to the hate mail.

Renting Your Way to Riches

On the telly I interviewed one of Australia’s most respected and successful economists, Phil Ruthven, founder and chief of IBISWorld.

Ruthven’s a man of extraordinary intellect and insight, but what makes him especially interesting is that he made a conscious decision to rent his home.
Years ago he crunched the numbers and worked out he’d be streets ahead by selling his home and renting instead.

And here’s the kicker: Ruthven isn’t a doom and gloom merchant on property. (In fact, Ruthven is more optimistic about the future of property prices than I am.)

The reason Ruthven believes home ownership is a dud deal is because of the significant costs. He argues that rent money may well be dead money, but so too is interest.

Let’s say Phil saves up a $50,000 deposit and buys a $550,000 home. He takes out a $500,000 home-loan over 25 years and pays a (long-term average) 7 per cent interest rate.

Over the next 25 years he’ll end up paying more money in interest to the bank than he’ll pay to actually buy the home: the total repayments will be $1.06 million, including a whopping $563,000 in non-tax-deductible interest.

And it gets worse. That figure doesn’t factor in the significant out-of-pocket costs homeowners pay. It begins with stamp duty and legal fees, continues with the wear and tear on the property (which works out long term to be around 5 per cent of the value of the property each year) and ends with the selling costs.

On Ruthven’s calculations, if you were to buy an average home for $550,000, fifteen years later you could expect to sell it for a $350,000 profit -- after stripping away your many start-up, ongoing and selling costs. However, if you rented a similar home and invested the same amount in the share market, you’d come out with a $1.25 million profit over the same period.

Now before you get too carried away and rush out to sell your house, consider this: in all my time of being Barefoot I know only one person who has actually done this — Phil Ruthven.

For the rest of us, buying a home isn’t just a financial decision, it’s an emotional one. After all, it’s a place where you raise your family. It’s your castle. Personally, buying my first little apartment was one of the proudest moments of my life — and it beat the pants off any win I’ve ever had in the share market.

Kicking the Buckets

Let’s be honest: all forecasts on future prices are a guess — no-one has a crystal ball — but everyone has an opinion. Here’s mine.

As a (relatively) young person buying into one of the most expensive property markets on the planet, I went in with my eyes wide open: the last 20 years of boom-time gains are unlikely to match those of the next 20.

That’s because there was a significant structural shift that caused prices to boom: the banks were deregulated in the mid-80s, which led in part to the biggest borrowing binge in history. That ‘Get Out of Jail Free’ card has already been played by the Baby Boomers and I’m on the wrong side of the boom.

Either way, I’m a strong believer in home ownership, for all the reasons I’ve already listed. But here’s the real point: I’m wary of having all my eggs in the one basket — or bucket.

That’s why my wealth-building strategy focuses on dividing my income into three separate wealth buckets: a Blow Bucket (for daily expenses and mortgage repayments), a Mojo Bucket (for emergencies) and a Grow Bucket (for wealth-building through the share market).

Phil might argue that I’m getting a dud deal, but I see it as the best of both worlds.

Tread Your Own Path!