The answer may not be as obvious as you think.
As a country, we have been so thoroughly convinced that home ownership is the only way to be financially secure that we rarely ask any more questions. We just assume that the sooner we get on board the property ladder, the better. But I want to put that question back on the table. Is it really always financially better to buy than to rent?
What I’ve done is a back-of-the-envelope calculation that doesn’t account for the details of anyone’s personal situation. Unfortunately, I think this is still more analysis than most people do before they decide to buy a home because they believe it to be a good investment.
To make this a fair comparison, I’ve assumed that in both cases you’ve saved enough for a 20% deposit and can choose whether or not to buy.
For the buying scenario, we need to consider how the value of the house increases over time, as well as the cost of borrowing. We also need to take into account the additional costs homeowners face like maintenance, insurance and rates.
For the renting scenario, we need to look at the cost of renting as well as the returns the renter can make on the deposit that they didn’t put into the housing market. On top of that, we need to allow for additional investments they can make if they’re paying less in rent than their mortgage payments would be.
Property in New Zealand appreciates less than you might think
This may come as a surprise, but property in New Zealand appreciates in value at a lower rate than the stock market.
With rock bottom interest rates and easy access to borrowing during the pandemic, we’ve seen annual house price increases of more than 20% over the past few years. Recency bias might convince us that’s normal, but over the past 30 years, house prices have increased at an average rate of about 7% per year across New Zealand.
This has been highest in Otago, where the annualised growth of house prices has been 7.55% since 1992. Meanwhile, the West Coast has had the lowest annualised growth of 4.84%.
By contrast, the NZX 50 (which is the main stock market index in New Zealand) has had an average annualised return of about 9.8% since its inception in 2003. Of course, returns on shares are taxed, so let’s round the returns on the NZX 50 down to 8% to roughly account for taxes and fees. Even so, over the long term, residential property prices in every region of the country increase less than the NZX 50.
This means that a renter who takes the money they could have used as a deposit and invests it in the stock market instead is, on average, going to make a higher return on that money than a homeowner.
How much of a gap is there between rent and mortgage payments?
This higher return also applies to any additional money that a renter can invest if their rent is cheaper than a mortgage payment would be. A mortgage payment for the median house bought in New Zealand in June 2022 with a 20% deposit and a 5.5% interest rate would be $890 per week. The average rent across the country is $516 per week, leaving an extra $374 for the renter to invest.
The gap between rent and mortgage payments varies a lot by region. In Auckland and the Tasman region, the average rent is less than half of a mortgage payment on the average property. Meanwhile, the West Coast is the only region where the average rent is more than what a mortgage payment would be.
Leverage – property’s secret weapon
So far, I’ve highlighted the higher returns provided by the stock market, which mostly benefits the renter in this situation. However, one of the huge advantages of buying property is the ability to use leverage.
Leverage means investing money you’ve borrowed. It allows you to make returns on more money than you can save (it also introduces risk, but let’s put that to one side for now) and for most people it’s more or less unique to property. No-one will lend me $600,000 at a 5.5% interest rate to invest in the stock market, but most banks would be quite happy to sign me up for a mortgage with those terms.
As long as the house increases in value at a higher rate than the interest they’re paying, leverage benefits the homeowner. This benefit is the increase in the property value, minus the cost of the debt.
Other costs of home ownership
Unlike renters, homeowners need to pay rates, insure the building and pay for maintenance. I have estimated these to cost 1.5% of the property value annually.
That’s a reasonable estimate for a fairly modern home with an average insurance premium. If your home needs lots of repairs and is in a high risk earthquake or flood zone, you might need to pay more.
So is it better to rent or buy?
Across New Zealand, buying the median house in June 2022 would put you ahead of the average renter by just over $3,000 over the course of a year. However, this varies significantly by region.
Most notably, renting is a better financial choice than buying in our largest city. A buyer in Auckland would be $6,723 worse off than a renter after a year. The Nelson and Tasman regions also come out in favour of the renter. In Nelson, the difference is $3,098, while in the Tasman region, a buyer would be $7,084 worse off than a renter after a year - the biggest loss for homeowners across New Zealand.
Meanwhile, on the West Coast, in Gisborne and the Hawke’s Bay, buyers are better off by about $15,000 a year. In our capital city, buying would put you ahead of renting by $2,270.
Many other regions come out in favour of the owner, but only just. In Canterbury, the difference is $525, while in the Waikato, the average buyer would benefit by $838 in a year. With such a slim margin, the particulars of your situation become really important.
Your particular situation matters
With that in mind, I’d like to highlight two aspects of someone’s situation that make a big difference here.
The first is the assumption that a renter will invest the difference between what a mortgage payment would be and how much rent they’re paying. Many people who would never miss a mortgage payment would struggle to invest that same money every week. It’s so much easier to spend it when you have the choice. Similarly, a downturn in the stock market can scare people off from investing.
If you’re someone who can’t save or invest unless a bank knocks on your door every week and makes you do it, a mortgage may be a good way to guarantee that you’re looking out for your future self.
Secondly, I haven’t accounted for the transaction costs of buying and selling a house. Between the real estate agent's commission, legal fees, professional photography and last minute repairs and cleaning, it’s normal to spend 5% of the sale price in the process of selling.
That’s $42,500 for the median house in New Zealand, or more than 13 times the annual advantage the average homeowner has over the average renter for the country as a whole. If you’re not going to stay put in one place for a long time, these costs will probably swamp whatever financial advantage you might have had over a renter.
How does this play out over time?
My analysis has focused on a one-year period. Surely buying is the better financial choice over the long term, right? The numbers continue to play out in a fairly similar way, actually.
Net worth is a summary of someone’s financial position – it compares the value of what they own with the total amount that they owe. In the owners case, this would take the value of their house and subtract the amount they owe the bank. In the renters case it would include the alternative investments they have made instead of buying a house.
If we assume annual rent increases of 4%, over a 30-year period, someone who bought the median house across New Zealand does come out ahead of the average renter. Their net worth would be just under $7m, compared to just under $6m for our renter (remember, in this scenario the renter has invested their deposit and additional cash flow instead of buying a home). If they sell their house and spend 5% in the process, this difference in net worth shrinks to about 650k.
In Auckland, where renting comes out ahead in our one-year snapshot, the difference over 30 years is smaller. After 30 years, an owner has a net worth that is $350k or 3.8% higher than a renter. If the owner sells, the 5% spent in the process means the owner has a net worth that is about $125k below that of the renter.
The takeaway
At the end of the day, I’m not here to tell you whether to rent or buy. But I am here to say that the idea that home ownership is always a better financial choice than renting is wrong. I want people to really think about what is best for them, and not fall into home ownership because of peer pressure and the assumption that buying any house must be better than renting.
In reality, the decision to rent or buy is often driven by non-financial reasons. These have a big impact on our quality of life, and that matters.
Ironically, non-financial factors also often determine whether the finances of home ownership make sense for you personally. How often are you going to move? Is a better paying job available elsewhere? What’s your risk tolerance like when it comes to investing? Are you diligent enough to save without a bank reminding you every week?
The idea that you shouldn’t rent unless you absolutely have to because it’s throwing money away is nonsensical. Let’s look at the facts rather than buying into the one-size-fits-all approach that has taken over so much of the conversation about renting and buying in New Zealand.
We're covering all things renting this week on The Spinoff. Read all the coverage here.
