CHAPTER 3
Pros and Cons
The above data and tables seem to be a persuasive case for home ownership. But not everyone agrees. And it is always useful to look at a contrary position. Phil Ruthven is a well-known economics and social commentator. He argues owning a home as an investment is irrationaland unlikely to produce optimum investment results. He says home ownership is nice emotionally but most will be better off renting a home that suits us now and implementing a disciplined investment strategy based purely on rational grounds.
Mr Ruthven says this is particularly the case once the hidden costs of home ownership are considered, such as hours and dollars spent improving the home, rates and repairs, and stamp duty, legal fees and other transaction costs when we move every seven years.
There is some merit in what Mr Ruthven says. Especially if you move more than once every seven years or if your home is not in a well-performing suburb. In July 2014 the Reserve Bank released a report saying that house prices need to go up by more than 2.9% a year for buying to beat renting. While this report is now a few years old, the mathematics aren't.
On balance, though, many would not agree with Mr Ruthven. Fundamentally, the great advantage of home ownership is forced savings. Apart from super most people would not save a cent without regular home loan repayments. Indeed, the forced saving of a home loan and the legislated saving of super tend to be the only ways most people save. Yes, there may be ways of managing wealth that are more financially 'efficient' in the pure sense of that word. But few people actually manage their wealth in these other ways. If they do not buy a home, they don't invest elsewhere either. Over the two decades to December 2012 residential property earned 9.5% per annum. Most clients who owned properties did well and people who did not missed our. Those who own properties in the next two decades will probably do well too.
And on balance we expect the Reserve Bank's minimum required 2.9% price increase to be easily beaten by the better suburbs in most capital cities: 2.9% is not much higher than the inflation rate, and well below the historical rates of return actually generated in these markets. If prices simply do a little better than inflation, then buying will make more sense than renting over the long-term.
3.1
What are the advantages of home ownership?
The advantages of home ownership can be as much psychological as they are financial. It's all about the nesting instinct and territoriality: this is your home, and your home is your castle. Home ownership provides a sense of permanence and control that is important to overall psychological happiness.
Residential properties, and the loans used to buy them, are also a great way to save. Many people would not save a cent if it was not for the principal component of their home loan repayments. Later, when the home is paid off, the owners also save on rent. Loans are eventually repaid, leaving no more to pay. Rent is always due next month.
The family home, including improvements, is usually free of capital gains tax. The principal place of residence is excluded from the CGT net by dint of social policy and political survival. Improvements to the home are also CGT-free, so if a $100,000 improvement creates $150,000 of value, that extra $50,000 is tax-free. That's why backyard blitzes are so common before people put their homes up for sale.
For older people, or other Centrelink benefit recipients, the home is outside the assets and income test for the age pension.
Increasingly older clients without significant investments are using reverse mortgages to access the equity in their home without having to sell it. Reverse mortgages turn homes into tax-free reservoirs of wealth. Individuals can smooth consumption over their expected lifespan by building up the reservoir during their working years and running it down in retirement.
The Australian Master Financial Planning Guide 2015-16 (Walters Kluwers) recognises other advantages of housing. These include:
- Providing security and stability. The alternative to home ownership, renting, may involve the owner selling the property;
- Avoiding the stigma that some feel may attach to not owning a home;
- Providing lifestyle choice even where wealth creation is not the primary objective;
- Paying off the home loan is a form of personal saving; and
- Freedom to make personal changes to the property.
3.2
What are the disadvantages of home ownership?
Property can be expensive to buy and hold. Acquisition costs include stamp duty (typically around 5% of the cost), bank fees, solicitors' fees and titles office costs. Holding costs include council and water rates, interest, land tax, maintenance and repairs, and real estate agent's fees. These can be significant and are often ignored when people calculate the gains made on their homes.
Critics also list the opportunity cost on foregone investments and a lack of diversification, which means higher risk. (Although, historically neither has held true. Property is a top performing asset class: the ASX-Russell Report for 2017 says property averaged 10.2% in the two decades to December 2017, just ahead of Australian shares at 8.8%, so there is no significant opportunity cost. And any historical lack of diversification has been to the homeowners' advantage - who wants to diversify into a slightly lower-earning asset class?)
Critics say residential property is not a liquid asset. This has become less of a problem in the past 10 years because equity access loans (debt facilities linked to the value of the home) allow clients to 'cash out' some of the value of their home, whether for consumption, investment or business purposes.
The Australian Master Financial Planning Guide 2015-16 (Walters Kluwers) recognises other potential disadvantages as including:
- Property prices can fall, as well as rise:
- Demand for property may be lower in the future due to:
- Low inflation, which reduces the potential for high capital gains;
- Increasing unemployment rates;
- More people deferring the purchase of the first home;
- The high costs of buying and selling property, including legal fees and stamp duty;
- The opportunity cost on missing out on other better performing investments;
- Lack of diversification;
- Property not being suited to investment;
- Miss out on other tax concessions, even though homes are CGT free; and
- Homes are illiquid, ie hard to convert to cash.