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I found a really good article summarising some of the pros and cons when I was mulling over the pros and cons of buying last year. Unfortunately the article doesn't seem to be online any more, so forgive me for pasting it in here:
Is buying a house the wrong move for you?
Thursday, June 15, 2006
By Chris Gilchrist
Are you rushing to get on the property ladder as soon as possible and stretching yourself financially to do it? Perhaps you would be better off renting.
Don't get me wrong, I'm a believer in residential property as a long-term investment. But I think it's very important to be realistic about the short-term outlook. I don't believe I will make any money out of owning my home for the next few years, or if I do, it will be quite marginal. 'So why own your home?' you may ask, and I'll come back to that later.
First, let's explore the financial consequences of a static property market over the next five years - and don't think this is unlikely, because after the huge rise we've seen over the past five years, it's certainly possible. Prices fell by 25% in the last property recession that started in 1989, and while I don't say that is likely over the next five years, the most important thing you can do to improve your wealth over the long term is not to project the recent past into the future - this consistently leads to the biggest losses.
Add up the costs
OK, so we imagine a flat property market over five years, and we assume you are buying a £300,000 house with a £250,000 mortgage, putting down £50,000 of your own money as a deposit.
Your initial costs of purchase will be about £12,000, of which £9,000 will go to the Treasury in Stamp Duty and the rest to the professional pirates (lawyers, valuers and surveyors). Over the next five years, you should expect to spend an average of £500 or so a year on repairs and maintenance, a total of £2,500.
Short-term buying soon adds up
You will also pay about £300 a year for buildings insurance, another £1,500 over five years. Add all these costs and they amount to £16,000. Now suppose you want to sell: it will set you back about £6,000 in estate agents and lawyers' fees. So your total costs of buying, selling and ownership over 5 years are £22,000.
Now if you have a 25-year repayment mortgage and pay 5% interest you will pay off £29,000 of a £250,000 mortgage in the first five years and only owe £221,000. So, setting these two figures against each other, you are theoretically £7,000 ahead.
And the invisible costs too
But wait a minute. In many areas, especially London, renting is cheaper than owning. You might well be able to rent that £300,000 home for £1,260 per month instead of the £1,460 the mortgage repayments will set you back- so there is another cost, this time adding up to £2,400 a year or £12,000 over the five-year term.
Finally, suppose you hadn't bought - you could have invested your £50,0000 at a fixed return of 5% and earned £14,000 on it over five years. Add back these last two 'costs' and instead of being in profit you are now £19,000 worse off from buying rather than renting.
Small changes in prices can make a big difference
The reason many people don't think about the costs like this is that they are borrowing such a big proportion of the value of their property that a small percentage change in its value outweighs all these costs. If the value of the property rises by just 5% over five years, that's £15,000 and you are almost back in the black again. A 10% rise - less than 2% a year over five years - and you are in profit.
Of course there will be big regional variations in these figures, and the costs of ownership are lower for less valuable properties, partly because of lower stamp duty and smaller gaps between the costs of ownership and renting. Still, if you're contemplating a move from renting to ownership, I believe you should run your own figures to work out your own potential profits or losses using different assumptions for property price trends.
The least likely scenario is the past
Of course it's possible that homeowners will make a nice profit over the next five years - I don't know for sure what will happen any more than you do. Except that the only way you can reasonably expect a repeat of the past five years with a 100% rise in property prices is for us to suffer a wave of inflation almost certainly accompanied by economic disaster. Today, the least likely scenario is a continuation of the boom (again, think about how easy it is just to project the past into the future without considering the implications).
So the possibility of a flat property market isn't something you should ignore, though don't expect any estate agent in the land to give it more than a microsecond's thought. Like any bandwagon, residential property has so many people cheering it on (including the vast majority of journalists who write about it) that the positive case is bound to get most coverage.
Why I still favour ownership
By now you may be asking why I bother owning a house at all. I seem to have made out a good case for renting rather than owning. So here are the reasons why I still expect to own my home in five years' time:
Control: I value being able to do what I want with my property, to make it my home rather than somewhere I live, and am prepared to pay for that.
Flexibility: I am confident that if I wanted to move, I could rent my property and get enough to cover my mortgage.
Improvement: over a five-year period, I believe I can add more to the resale value of my home than what I spend on it.
Value: in the long run, I believe property values will rise at a somewhat faster rate than inflation, so for me, with an intended ownership term of 10 years or more, a period of stable prices is not a problem.
Diversification: I have a bigger chunk of my personal wealth in financial assets (pension funds, shares, ISAs etc) than in property, so my financial exposure to a fall in property prices is limited.
Safety first
The most important thing you can do to reduce risk in property ownership is to think about rentability. If it all goes wrong, the best-located properties (shops, schools, transport) are always the easiest to let.
Worst bets are residential areas where many people work for one local employer or set of employers (the Thames Valley in general suffered after 2000 because of the number of technology-related businesses that fired people). And sadly, a bog-standard design property is always going to sell or rent more easily than an interesting one-off.
Only hindsight ever provides clarity about financial decisions. We make most of them in fog and the only issue is how thick it is. At least if you weigh up all the factors I've outlined here before making a decision you'll have less cause for regret, whatever the outcome - which just about sums up my definition of grown-up financial planning. |
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