Bruce trotted out the old mantra here:
This rather assumes all that equity in houses is down to house price rises... But actually some equity is the original deposit and some is what's been paid back in real cash. In times such as these of low/no house price inflation, most or all the equity is made up of the above.
That statement is simply not true, or at best it relates to the exception rather than the rule.
To save adjusting for inflation, I downloaded the inflation adjusted average house prices since 1975 from the Nationwide. I assumed an initial deposit of 20% of the house price and a repayment mortgage over 25 years with an average interest rate of 6% to give us the cash expense side of things.
But those mortgage repayments serve two purposes: they pay off the loan and they provide you with somewhere to live. The average rental income of an average UK house is (say) £8,000 a year (being the average from the RPPI less £3,000 annual 'running costs', i.e. things you wouldn't have to pay if you were a tenant), so as I included total mortgage repayments (including interest) as an expense, I deducted the value of the rental income/the rent you saved by buying not owning.
Thus it appears that there are very few people for whom it is true that "housing equity = deposit + total mortgage payments". In fact, if you bought before the year 2000, the net cash cost of buying a house has been less than zero so far - you'd have been better off buying than renting even if house prices now fell to £nil, so having a lot of 'equity'* is just lots and lots of icing on the cake.
People who bought since 2003 are suffering a loss (they would have been better off renting and saving up the difference between mortgage repayments and rents). Click to enlarge:
* I use the term loosely - this generation's 'equity' is merely the next generation's extra debt burden, it's not real wealth any more than the value of a slave is 'wealth'.
Sunday, 30 January 2011
Home-Owner-Ist Myth Of The Week
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7 comments:
You can work this the other way around. Suppose you kept your 20% deposit and invested it. Then rented a house. Very broadly the rent for a house is roughly equivalent to the rent (interest) you pay on the mortgage money you borrow to buy the house. Then you save each month the equivalent to the capital component of what would have been your mortgage payment (or endowment premium investment component). After 25 years of this, assuming a notional compund rate of return of say 6% you will have a capital sum large enough to pay out an income that will be sufficient to pay the rent on the house you would have bought.
All this is distorted over the short run - say 5 to 10 years - by political meddling with interest rates etc. But markets being what they are they cannot keep this up and stuff corrects. Witness recent developments.
Question is why would you buy a 'commodity' house rather than rent it given the above. Why?
L, if we had low inflation, no taxation of earned or investment income and low and stable house prices, that would be true, in other words, your net cost of owning (minus notional rental income) would always be plus/minus zero.
But...
1. Your investment income is subject to pretty savage tax rates (call it 50%) but the deemed rental income is tax free (as are capital gains on housing).
2.For most starting points, the mortgage (incl. capital repayments) is cheaper than or no more expensive than the rent you'd have to pay (which is why apart from a blip around 1990, most home owners have a zero or negative opportunity cost)
3. Over the last ten years, Home-Owner-Ism has gone completely mad and has been a central plank of government economic policy and it's no different under the Lib-Cons. Most people think that higher house prices make us collectively wealthier (when the truth is they make us slightly poorer).
I agree that we're getting poorer in terms of square footage. A solicitor would afford a small terrace originally intended for a milkman in London.
Say someone buys a house in their twenties and pays the mortgage off in 25 years (or less) and they live in it until well into their seventies. Twenty years rent free to add to the calculations here - that's without realising the asset and downsizing.
I appreciate that the house can be sold to pay for care home fees - that being one of the iniquities of the welfare system - but any banked money accrued by the renter would be demanded to pay for it too.
(PS, isn't £3000 pa costs an over estimate ?)
EK, actually on average we aren't getting that much poorer in terms of square footage, it's just that pensioners live in three-bed semi's and young couples can only afford a flat. Sixty years ago this would have been the other way round.
I could work the figures backwards to 1950 or something, but the calculations then get very tricky.
Yes, £3,000 is a wild overestimate, but the average rent of £11,000 also seemed to be on the high side.
Some places are OK to rent in, other aren't. Here it resembles a cartel.
All the estate agents offer the landlords guaranteed rents. All of them rent on fixed 6 month contracts, not minimum terms of 6 months, they are fixed.
Every 6 months they have the option to ask you for more rent and charge you another tenancy fee.
If you want to move for a new job or something at any time in the middle of these fixed 6 month periods you have to pay all the rent up to the end of it.
So you lose a lot of the flexibility associated with renting on more 'normal' minimum term, 1 months notice contracts.
Of course, the could solve the supply/demand imbalance and create more employment/GDP growth by building higher here. Fat chance of that though, would destroy underlying land values.
Houses go like hot cakes here on 4% - 5% rental yields, mostly to multiple landlords I epxect.
Assuming no house price inflation it is axiomatic that deposit plus repaid capital equals equity.
That one might accumulate a similar or greater capital sum by renting and saving is also axiomatic.
Neither is, of itself, a reason to buy rather than rent or rent rather than buy.
Were there no house price inflation (above general inflation) some would still prefer to buy and some would still prefer to rent because there are many reasons other than capital accumulation behind the decision.
I don't agree that mortgage repayments serve two purposes. They serve three. During the course of the loan they serve the two purposes you identified but the game changes once the loan has been repayed. At that time the owner no longer has a notional rent to pay and therefore, on the figures used in your example, saves £8,000 a year for the rest of his life.
Buy at age 30, repay at age 55, live to 70 and you have gained £120,000 even if your property has not increased in value at a rate higher than bread, cars or battery operated boyfriends for lonely ladies. That gain of £120,000 is equivalent to £4,800 for each year of the 25-year loan. It could be argued that this is also a form of equity accruing to purchasers but not renters.
SL, sorry to hear that, but that's the same everywhere with AST's isn't it?
"They could solve the supply/demand imbalance and create more employment/GDP growth by building higher here. Fat chance of that though, would destroy underlying land values."
Agreed with first sentence. But second sentence is wrong - making planning permission more generous increases land values (whether it increases the value of an individual flat is a separate issue).
TFB, yes there is a third point as well, but to include value of future rental income would be double counting as that is reflected in price of house. But you illustrate that people would still buy houses even if prices were gently declining or even if there were less income tax and more tax on homeownership.
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