We have seen a growing trend in our brokerage of people getting mortgage approvals (mainly first time buyers) and not drawing down, this might indicate some pent up demand in housing – which if it comes will be regular houses as opposed to apartments – or it indicates fear of buying in general.
The thing that is pervasive is the ‘price’ of housing, and the idea is to wait until we reach the bottom. That is a perfectly rational concept, and when you are not purchasing over a long term then the price now (we’ll take from financial market vernacular and call it the ‘spot price’ of housing) is the main thing to focus on.
However, that is only one part of the ‘price’ because the majority of new buyers are not buying for cash. The other price is the price of money, the financing costs. We indicated in our annual outlook that banks would, in 2011 alone, increase rates by a further 100bps or 1%, that any bank which isn’t government owned will have variable rates in the region of 5% come the end of the year.
So what does that mean? If you believe in another 10% price drop then do the calculations, or whatever percentage drop you want to use, the proxy is really down to your own belief of where the bottom is or may be. We’ll take a look at a further 10% in a Dublin market (for no reason other than that we are familiar with that market).
A house that is costing €250,000 today falls – in line with the assumption – by 10%, to €225,000 and the person instead (by waiting until 2012 to buy) takes out a mortgage of the same term as a person who buys today.
Our belief that fixed rates will be temporarily removed from the market would lead us to believe that in 2012 a long term fixed rate won’t be available, so the figures will be based on the following:
2011 loan: 90% of €250,000 using a 4.39% rate over 25 years
2012 loan: 90% of €225,000 using a rate that will be c. 5.2% (no fix in line with our projections) over 25 years
Cost of the 2011 loan: 1st 5 years: €82,500
Cost of the 2012 loan: 1st 5 years €80,460
so the net difference – and don’t forget that the person buying in 2012 gets no TRS in 2011 wheras the person in 2011 does, we are not factoring in the rent paid during the year of waiting for a price drop, nor are we considering that rates may go up even more if the ECB move higher.
Equally, don’t forget that the balance in year 5 is vital: for the 2011 loan it’ll be €219,000 for the one done in 2012 it will be €200,000 and in that respect you are onto a winner.
But long term capital differences of that amount (remember that this is skewed on the front end of the loan because we haven’t factored in ‘rent’ nor on the back side because there will be a year when the renter is paying a mortgage during which the buyer is mortgage free) don’t seem to make that much of a difference when you look at it over a 20yr+ term. And of course, several pro-buyer factors have not been included.
The real argument is therefore: should you buy at all or rent? The long term financing costs versus the long term renting costs are below, we factor in a 1.5% increase every year in a rent that starts at €1,000 p.m.
2011 buyer total cost of credit over 25yrs: €376,000+€82,500 = €458,500
2012 buyer total cost of credit over 25yrs: €344,000+€80,500+€12,000* = €436,500
Renter total cost of rent over 25yrs: 331,000
*(we add on €12,000 for rent paid in year 1)
(in this calculation we took the balance at year 6 and applied a 6% rate for both mortgages from that point on in order to make the calculations the same)
So it is clear that buying makes no sense from a ‘cost’ perspective. And that waiting to buy is also a winning strategy even if you get hit with a higher funding cost in one year, but don’t forget the assumptions!
1. TRS is not factored in in 2011 in our figures – and the person buying in 2012 will miss out on two years of TRS at the end of it (2017).
2. The ECB could push up rates and the idea of them settling at 5.2% over the 5yr period for the 2012 buyer could turn out to be fairly conservative.
3. Our example is based on a house in Dublin which has already had significant price drops, if you don’t get your 10% price drop then the calculations here don’t work out.
4. Rent prices may go up by more than 1.5% p.a. We accept that they are heading down now but there is evidence of a floor forming (in cities) and this is likely a secondary rather than secular trend.
5. The renter still has to live somewhere! The buyer will be rent free in 25 years, if the buyer was 30 at the outset then from age 55 to 80 (taking an average life expectancy – which will probably be higher in the future) then you have to add on another 25 years of full rent costs at the end. Even if they saved the difference every month (€600 p.m. and never spent a penny of it) they would have only €300,000 in year 25 and it is unlikely that you can buy a house in full for cash for that price given today’s valuations.
So rent or buy? It’s actually not very cut and dry, we would suggest that you weigh up the odds and make a decision based upon what you want in your life and the cost that is incurred depending on your perspective – the main lesson is that price and cost are two different things they are not the same and you can’t compare ‘value’ on the basis of a headline price alone.