Home-owning Expenses far Outweigh Renting
BNZ chief economist Mike Jones says high interest rates have widened the wedge between the costs of renting and buying.
20 September 2023
Owning a home exceeds renting by about $38,000 a year in average expenses, according to BNZ chief economist Mike Jones’ back-of-the-envelope numbers.
He says it’s clear high interest rates have widened the wedge between the costs of renting vs. buying.
In his latest Eco-Pulse publication, Jones says the bank is often asked about the relative cost of renting vs. buying. “It’s a difficult question to provide a straight answer on. They’re inherently different propositions,” he says.
However, Jones crunched numbers on a couple of hypothetical examples to test the cost of buying vs. renting.
He says leasing a property for a set period is a lower risk, operational-type expense. Buying a house represents (for most) a large, leveraged balance sheet exposure that opens up a bunch of extra risks and opportunities. At the least, he says, it’s important to get as close as possible to an “apples with apples” cost comparison. His examples:
- A home is purchased at the median house price, currently 780,000, financed with a 20 per cent deposit and the remaining 80 per cent as interest-only debt. Interest costs are split equally across floating and two-year fixed mortgage rates. To this he added maintenance, rates, and insurance costs at an assumed annual rate of 1.5 per cent of the national median house price.
- A new tenancy is entered into at the median rent of $550 per week. To make it a fair comparison, the 20 per cent house deposit deployed in the “buy” example above is left earning interest in the bank. These after-tax interest returns partially offset total rent costs. “For clarity we’ve split the effect out.”
The results are averages and approximations, and hence clearly won’t reflect all situations, Jones says. But we can draw the following high-level conclusions:
- In terms of operational costs – the cash leaving a bank account each week – the costs of servicing a new house purchase are much more expensive than equivalent rent costs. On our numbers that’s always the case, but particularly so at present. Current cash ownership costs for a new purchase have increased to about 50 per cent of average household incomes, compared to about 30 per cent in 2020. Rent costs, by comparison, have nudged up to an average 24 per cent of household incomes, or 18 per cent once interest earnings are added back in (we’ve assumed for comparability that renters park a 20 per cent house deposit in the bank. This makes the comparison fair, but of course may not reflect reality).
- Over the past five years, higher buy costs have been driven in roughly equal parts by big increases in mortgage rates, which are cyclical, and higher house prices, which are less so. Rents have risen rapidly too, but not by as much as debt servicing costs.
- The divergence is largest in Auckland (63 per cent of income to service a new home vs. 24 per cent of income to rent, or 16 per cent when savings income is added in) but is observable in all regions. Average servicing costs remain lowest in Canterbury, reflecting lower house prices.
Despite all of the above, Jones says it’s not necessarily the case that renting will turn out to be the most cost-effective option over the long-term. “First, inflation tends to deflate the value of borrowers’ debt over time, while rent payments tend to rise with inflation. But more importantly, what happens to house prices ends up being the key swing factor. And no-one knows what’s going to happen there.
“For example, the average expense associated with purchasing the median New Zealand home exceeds that of renting by just over $38,000 p.a. That’s seemingly a large number to overcome. But if house prices were to rise by about 5 per cent over the coming year, this shortfall would be entirely offset by a positive house price revaluation (admittedly a paper “gain” rather than cash). In contrast, if house prices were to go in the other direction it would dramatically increase the shortfall.”
He says plotting the concept of the rate of house price inflation required to “break even” can be seen on the chart below.
He says that is consistent with earlier analysis. “It shows, on average, positive rates of house price appreciation are always required to break even. The current estimate of such is well above average and the highest since 2008.
“Finally, all this number crunching is all well and good, but it risks missing the point for some. We’ve deliberately focused on the financials here and excluded all the big non-financial and circumstantial considerations involved in a buy/rent decision.
“It’s hard to put values in the spreadsheet for things like security of tenure and being able to hang your pictures up or renovate.” He says when it comes down to it, these may well end up being the most important in the decision.
Annual rental price inflation for new tenancies punched up to 6.2 per cent last month, from 4.1 per cent in July, while house prices notched up their fourth consecutive monthly increase, rising 2.4 per cent since the market turned in April.
A boom it ain’t, Jones says, but the run-rate of monthly price increases is still ahead of what was expected this side of the election.
“One of the strongest drivers of higher rent and house price inflation is migration, which has hit the highest level on record. Net annual inflows squeaked past 96,000 in July. That was despite long-term departures rising to an 11-year high of 112,000.
Yes, there are clear signs the monthly pace of inward migration is now slowing, Jones says. “But at a time of tight housing supply, the extra population growth is likely to sustain solid rates of rental and house price inflation over the coming 12 months.”