From: Nick Renton [ner@nickrenton.com]
Sent: 27 September 2003 21:04
To: housing@pc.gov.au
Subject: Supplementary Submission to the Inquiry on First Home Ownership

This submission comments on the questions raised on pages 11 and 12 of the 
September 2003 Issues Paper.

RELATIVE COSTS OF RENTING VERSUS OWNING

* BACKGROUND

Investors are constantly faced with the need to choose between alternatives 
- for example, whether to buy now or to buy later; whether to acquire 
shares or to acquire property; whether to borrow or use only their own 
funds; whether to make an offer for property X or for property Y; and so 
on.

Even if a home is regarded as an investment the question of choice still 
remains: is it wise to put any available money into an owner-occupied house 
or would it be better to invest this sum in some other way and live in 
premises owned by someone else?

There is no clear-cut answer to this dilemma, in part because every person 
has different tastes, different objectives and different budgetary 
requirements. Furthermore, single persons might have a totally different 
perspective on this subject than families.

Thus the relative advantages of buying and renting a house which are 
discussed below will carry different weights according to the individual 
circumstances.

Furthermore, in purely financial terms, comparisons may need to be made 
between the investment returns on any available funds, the interest rates 
on any borrowed sums and the rent levels applying to the type of premises 
being considered - and these can all vary from time to time and from place 
to place.

However, non-financial considerations are naturally also very relevant in 
the case of a home - a factor which does not normally apply in the case of 
other types of investment. To that extent, buying a house can also be 
viewed as just acquiring an item of discretionary expenditure, although 
admittedly a fairly large one.

In the discussion which follows the word "house" includes both a 
stand-alone house and an apartment.

* ADVANTAGES OF BUYING A HOUSE

Many people will judge a house mainly in terms of its lifestyle attributes 
rather than its merits as a pure investment. However, both aspects are 
clearly relevant and are accordingly considered below.

A house which is actually owned by the persons who live in it, rather than 
by a landlord who sees himself primarily as an investor-owner, can readily 
be tailored to better meet the needs and wishes of its occupants.

In addition, all money spent by owner-occupiers on enhancements benefits 
those persons permanently instead of providing windfall gains to the owner 
of the premises at the end of the lease.

Apart from that, physical changes to their house can readily be made by 
owner-occupiers in order to accommodate unusual tastes. For understandable 
commercial reasons landlords would probably refuse permission for 
alterations that could adversely affect their subsequent resale or 
reletting opportunities.

Ownership of a home also gives security of tenure - occupiers cannot be 
thrown out merely because a landlord wants to use the premises in some 
other way or because a landlord has sold out to a successor who wants 
vacant possession as soon as the existing lease permits this.

Another attraction is the exemption for a principal residence from capital 
gains tax. The fact that the imputed rent is not taxed in this country is 
also very relevant.

For persons or couples eligible for grants under the Federal Government's 
First Home Owners' Scheme - a scheme which might not always be there - 
buying rather than renting presents another plus.

For some persons planning their retirement the favourable treatment of a 
home under the means test would also be of value - quite apart from the 
enhanced standard of living which the ownership of a home which is fully 
paid for can give to all persons in retirement.

A house can give its owners protection from inflation - although, of 
course, other equity assets can do this do as well and the hedge is not 
perfect. If owners have large mortgages then they can even benefit from 
inflation. But persons who are leasing other people's premises inevitably 
face increases in their rent payments each year or so, which can be painful 
during periods of high inflation or market shortages.

Apart from that, payments in respect of a house can be regarded as an 
unofficial form of superannuation contributions, while rent paid to a 
landlord is to that extent wasted.

Some people might see another advantage in owning rather than renting - 
they can deliberately buy a cheap house in poor condition and accept the 
inconvenience of this while they make physical improvements to it. This 
can, for example, be very relevant if the purchaser is a handyman (although 
painting can be done by almost anybody). This can provide convenient part 
time work, possibly for both partners of a marriage, in a form which in 
addition legally avoids income tax, as the improvements can often be 
achieved for the cost of the materials involved, with the labour being 
unpaid.

Buying offers a greater choice of housing stock - in some localities there 
may be few, if any, houses for rent.

Some people like the forced saving aspect involved in building up a deposit 
for a loan and then paying it off. Such people may not make committed 
payments without the discipline of this type of self-imposed pressure and 
would otherwise fritter away the money on unnecessary consumption items.

Finally, an owner-occupied home is widely regarded as an excellent security 
for a loan. Even where a house is still subject to an existing mortgage 
which was put in place for its original purchase after some years a further 
loan can in practice readily be arranged against the owner's equity in it.

Of course, the question of whether such deals - which can prejudice the 
tenure if things go wrong - are wise as distinct from merely being possible 
is another matter.

Even when a house is not put up as a specific security its ownership 
enhances the owner's credit rating.

* ADVANTAGES OF RENTING A HOUSE

Owning a house does not make much sense for persons whose jobs necessitate 
relocating at frequent intervals. In contrast, renting suitable premises in 
such circumstances avoids the considerable costs of buying and selling real 
estate and of refinancing any loan on mortgage. It also avoids the hassle 
of putting a house on the market and looking for potential purchasers.

Furthermore, being a renter can make it easier for a person to accept a job 
offer or a promotion in a different locality, safe in the knowledge that 
the hassle and monetary risk involved in selling an existing home will not 
be a consideration.

Renting also avoids the direct costs of rates, land tax, repairs, 
maintenance, depreciation and insurance. No doubt some of these costs are 
built into the rent, but market forces tend to limit the extent to which 
this can be done.

Not buying a house frees up capital which can be invested in  assets chosen 
purely on their investment potential. Similarly, the money which is then 
not needed for periodical loan repayments can also be applied to long term 
investments.

Naturally, such a strategy requires a certain amount of self-discipline to 
enable its purposes to be achieved. To illustrate: A family which might 
have devoted, say, 25 to 30 per cent of its income to servicing a home loan 
should be willing to make a similar savings commitment even when following 
a different investment plan.

Renting is, of course, also very suitable for persons:

* who are in need of immediate housing but who lack the necessary cash for 
a deposit
* who want to try out living in a particular locality before making a long 
term commitment to it
* who lack the time or interest in maintaining a house and garden.

* CRITERIA

The criteria for buying a house to be lived in and buying a house as an 
investment are rather different.

When buying a house for oneself the aim would be to acquire a property that 
satisfies the known needs and preferences of the specific family that is to 
reside there. Likely future increases in the market value of the property, 
while important, are usually not the main consideration.

When buying a house to be occupied by others it is much more relevant to 
consider two other factors. Is the type of building, its condition and its 
location such that:

* it will appeal to as wide a range of potential tenants and purchasers as 
practicable
* the prospects of capital appreciation are as high as possible?

Houses with unusual features which might delight some individuals but which 
would be regarded as negatives by most other people do not usually make 
sound investments.

Prudent investors will have regard to the available net returns after 
allowing for likely expenses, in comparison with those available from 
competing investments. Prospective owner-occupiers for the long term, in 
contrast, may be willing to pay a premium for something which appeals to 
them - even if, in strict economic terms, such a purchase would amount to 
overcapitalising.

Persons wanting a home are restricted to buying residential property and 
furthermore doing so in a particular locality. Investors, on the other 
hand, can buy property of any category in any locality. They also have the 
choice of acquiring other classes of asset instead if they think that this 
will give them a higher return and/or involve less risk.

* ARITHMETICAL ASPECTS

The relative figures for comparing buying and renting a house will 
naturally vary with the assumptions made. It is, as always, necessary to 
compare like with like in dollar terms - although for the lifestyle and 
other reasons discussed above this cannot give the complete picture.

In pure arithmetical terms the results will usually favour the option of 
renting a house to be used as the principal residence and using the capital 
thus freed up for one or more unconnected investments. The other option - 
actually buying a house which is to be lived in - will generally seem less 
attractive.

There are several reasons for this:

* the gross returns available from such investments will usually be higher 
than the unreasonably low yields which in practice seem to be acceptable to 
most residential landlords
* an investor gets income tax deductions for depreciation and loan 
interest, whereas an owner-occupier does not
* a residential tenant is usually not liable for outgo such as maintenance, 
repairs, building insurance, rates and land tax.

A numerical example follows. It assumes that in both cases a sum equal to 
two-thirds of the value of the asset is to be borrowed and that the growth 
prospects from inflation and other factors are identical in the two 
scenarios.

                                           BUYING          RENTING

                                             $                $

* CAPITAL

Residence                                300,000                0
Non-residential investment property            0          300,000
Loan                                    -200,000         -200,000

Equity                                   100,000          100,000

* REVENUE

Investment income @ 8%                         0           24,000
Loan interest @ 6%                       -12,000          -12,000

Sub-total                                -12,000           12,000
Income tax @ 31.5%                             0           -3,780
Rent                                           0          -15,000
Outgo                                     -4,000                0

Net income                               -16,000           -6,780

Although some of the above assumptions are arbitrary the figures help to 
put into perspective a view sometimes expressed, namely that paying rent to 
a landlord amounts to paying away "dead" money.

   ,-._|\   Nick Renton  194 Kilby Road  Kew East 3102  Australia
  /  Oz  \       Telephone and Fax 613 9859 4958  [BH & AH]
  \_,--.x/         http://nickrenton.com (about 70 pages)
        v                     ner@nickrenton.com