Rent or buy : A little considered fact that makes it easy to decide Rent or Buy - Rent or Buy Weekly Personal Finance: News with ViewsWant to keep up with what's important for your personal finances in 10 minutes? 6 articles selected from UK with context delivered in your inbox. I will never give away, trade or sell your email address. You can unsubscribe at any time. Full view

Rent or Buy

Rent or buy : A little considered fact that makes it easy to decide

By Rajkanwar Batra

Rent or buy is not an easy decision to make. Property in general is a topic which makes people emotional. Those who have profited from it and own a house or two are usually seen pointing at studies showing how house prices are forecast to grow by x percent in next few years.

Those who have yet to buy one, are however seen pointing at sky high ratio of house price to average income (in comparison to historical averages). Many think probably correctly that the coming increase in interest rates will be devastating for the property prices.

Some believe that property always goes up in value. Personally I am not so sure.

I frequently quote the example of my friend (a PHD from Oxford no less). In 2007 he decided to buy a new built flat in a locality in London which has a resident gang of its own!. His logic “I am trying to get on the property ladder. I will live in this flat for a couple of years before flipping it and upgrading”.

I tried to dissuade him at the time but with no luck.

I caught up with him in 2009. In his words “He is terribly stuck with the flat. Price has gone down below purchase prices. His girlfriend hates the locality and feels unsafe in the place.”

Another friend bought a flat with his girlfriend but split up with her a couple of years later. He ended up losing £15,000 on the price decline and transaction costs.

However, most of the people I know who applied a bit of thinking to their property investments are however laughing their way to the bank. It’s not difficult to see the reason why.

The first and foremost it should be recognised that property is a long-term game, your investment horizon needs to be at-least 5 years. In fact 10 years is much more realistic.

Anything less and you are not investing, you are speculating. That is only good when you can engineer a situation where you speculate with other people’s money and share in the gains only. Behold the whole investment banking and active fund management industry!

Provided your investment horizon is around 10 years a generally hated phenomenon known as “inflation effect” should mean your possibility of having a loss on property investment is low and gain reasonably high.

Let’s consider an example.

I buy a flat today for £100,000 for my personal residence. Let’s assume that if I rented this flat, I would have to pay annual rent equal to 5% of the fair market value. Let’s assume rent and house price goes up by the inflation which averages 2% over next 10 years.

Most importantly let’s assume that I don’t buy the flat when the market is in bubble territory or in a location which is  declining*.

The table below shows the expected gain/loss position year by year for next ten years.

Rent vs Buy

As we can see if sold at the end of first 2 years I would end up making a loss. But after that my expected profit on the transaction keeps going up. In 10 years I can expect to make a gain of £25 k. Although not shown above over 30 year this approaches north of £ 100 k.

Obviously in real life things don’t happen in a straight line and there are always risks in investment. The house prices could stagnate for long periods, the Government could decide to build a big waste burning plant nearby etc etc.

But if nothing particularly nasty happens the inflation effect makes rent or buy decision rather easy for me.

*In a future blog post I would talk about the indicators of a declining property market and how to spot a bubble.

Disclaimer: I own a flat in London which has increased considerably in value since I purchased it at the start of 2009.
What is your views? Do you have had any experience with property investment? I    would love to hear from your. Please leave your comments below.

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Written by Rajkanwar batra