22 Feb 2019

Why it's better to rent property than buy - for now

The number of people wanting to buy property rather than rent is sharply increasing in cities where prices are plunging, unsold stock is growing and sentiment continues to weaken, according to market analysis by global investment bank Morgan Stanley.

During the 15 months since markets began to fall, there has been an increase of around 20 per cent in the number of Sydney households who think now is the right time to buy even as house price expectations hit new record lows, its analysis shows.

Chris Brycki, founder and chief executive of Stockspot, a fund manager, equity trader and investment adviser, believes the response is "irrational" and that many would be better off waiting until prices fell further.

"It's the second mouse that gets the cheese," says Brycki about buyers who are patient and watch the market.

"Buyers' response is irrational but understandable. Assets have gone up by 10, 20 or 30 per cent in recent years and the temptation is to jump in at the first dip. First falls do not mean it is time to buy."

Brycki says the time to buy is when there is "zero optimism". "Wait until the markets are bombed out," he says.

Major banks and financial conglomerates such as AMP and ANZ predict property prices will fall by up to 20 per cent from peak to trough, which means the market is about halfway to the bottom in some leading markets.

Investors and aspiring home owners are always debating the difficult question of whether it is best to rent or buy a house.

The question is more complex when buyers face a credit squeeze, property prices are falling the fastest in 35 years and there is oversupply in key markets.

Shane Oliver, chief economist with AMP Capital, says the decision to rent or buy depends on the "relative financial merits of each, individual preferences, individual circumstances and location".

"The first two are probably the big drivers. In many areas of Australia rents have not kept up with gains in house prices and so it has made sense to rent rather than buy, particularly in the poorly affordable cities of Sydney and Melbourne," Oliver says.

"Low interest rates and falling house prices in those cities are starting to correct that but I don't think we are there yet. Prices likely have more downside this year so it makes sense to rent and wait for better value. But even if it is cheaper to rent than buy, some strongly prefer owning to renting as it's a lifestyle choice around wanting a property you can call your own and renovate as you would like."

Brycki claims a balanced portfolio of stocks and bonds will return more than residential property over the next seven years, the expected cycle of the current downturn.

Others such as Mario Borg, a director of Strategic Finance, a property and financial consultancy, claim leveraged residential property is a long-term holding that will continue to outperform equities.

Institutional investor AMP Capital believes it will often come down to the property postcode and individual circumstances.

In Canberra, for example, defence postings, graduate intakes and the return of university students is causing a rental shortage, driving up rents by about 8 per cent.

By contrast more than 3 per cent of all rental property in Australia's largest cities are vacant, the highest since the post Olympic Games slump of 2004, according to SQM Research.

Australian property prices and shares have both returned about 11 per cent a year on average over the past 60 years, despite outperformance by either asset class during market peaks, says Brycki.

But different asset classes routinely get out of kilter before returning to the mean.

For example, average rental yields are about 2.7 per cent compared to about 5 per cent yield on ASX-listed stocks. They have historically been more closely aligned. While past performance is no guide to the future, it does provide some useful precedents.

Brycki says falling property values mean many people would be better off renting for the next seven years and investing the difference in a balanced portfolio. Seven years is his expected peak to trough of the downturn.

Stockspot's modelling compared a mix of investment and property returns to conclude renting (at the moment) beats buying by 8.4 per cent. This assumes growth of 5.5 per cent for property and 7.5 per cent for an investment portfolio (based on 60 per cent shares, including Australian and global, with 40 per cent in bonds and other defensive assets such as gold and cash).

"The market cycle, property yields and the current payback period all suggest now is not the best time to be buying," Brycki says. Renters will also have time to save a bigger deposit, which enables them to negotiate a better deal or saves taking out lenders' mortgage insurance.

His calculations take into account property ownership costs (estimated by the Reserve Bank of Australia to be about 2.6 per cent a year) and property transaction costs, including stamp duty.

Borg says property investors should be taking a longer-term perspective, say 30 years. His analysis is based on a property buyer borrowing $500,000 to buy a $550,000 property.

Borg claims property will outperform by about 35 per cent over the term of the loan, assuming returns of 7 per cent for property and 8 per cent on a balanced portfolio.

"How can property come out on top when it is assumed shares achieve a higher return?" he asks.

"It's all to do with compounding returns. You are effectively leveraging $50,000 cash into a $550,000 property. When you invest your money without gearing, the return is on the base cash amount only."

Borg adds that increasing equity in the property as the loan is repaid enables additional lending to fund other investments, such as shares or a managed fund.

SOURCE ; https://www.afr.com/real-estate/why-its-better-to-rent-than-buy-property--for-now-20190108-h19twg

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