Buy or rent – What is the right choice?

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Buy or rent of real estate? You will have to ask yourself this question not just once in your life. But how do you find out which is the right choice? What suits your life better? You can find out more in the article.

Preface

In Romania, almost 96% of the population lives in their own apartments or houses. This puts them at the top of the list in Europe. In 2018, about 58 percent of citizens in Germany lived for rent. The other 42 percent live in their own homes.

Why are there the different views on the issue of purchasing or renting? This can have quite different causes, such as:

  • Where and how someone grew up
  • Because parents/acquaintances urge you to do so
  • Some have a firm conviction, but without knowing why
  • Media influence

But mostly these reasons are only emotional and not really well founded. After we quickly spend half a million dollars or even a whole million for a house or an apartment, we should think about it carefully. I would make such a far-reaching decision of buy or rent only rationally. The good thing is that this can be calculated quite easily for real estate. But do not worry, it is not so difficult. In fact, there are tools and utilities that help you to calculate the return on investment in real estate.

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Buy or rent – opinions on the world wide web

If we look at different sources on the Internet, we will see the following. Let’s assume that you read several reports about investing on blogs or financial news sites or watch videos on YouTube. Then you will notice that it is often not an objective opinion. Most of the time, the sites or the YouTuber want to sell you something. They tell them that investing in stocks, for example, would be a better choice than buying an apartment or a house.

In contrast, websites that deal with real estate will probably tell you the opposite. They want to sell you either a service or something. So it’s in their interest that you buy residential property. Then they can make money from that somehow.

But how do you find out what is the right choice? To do this, I would first like to explain to you the advantages and disadvantages. After that, we’ll look at how to calculate it. Finally, it’s your turn to decide. Buy or rent, so which is better?

Development of purchase and rental prices

If you look at the graph above, what do you see? The two curves are going up pretty symmetrically except for the years around 2007, but what does that mean? What is this real estate price index? I’ll try to explain. The price index shows how the prices of the different variants shown have evolved over the 44 year period. The prices in 1975 were set to 100 and then the price development was shown in points accordingly.

The cost of buying a property has increased a bit more than the costs for renting over that period. In an ideal world the prices should rise more or less symmetrically. Starting around 2000 the purchase prices raised way more than the renting prices. The peak in the prices for real estate in 2007 resulted in an enormous crisis all around the world. An after that both prices have converged again.

What is much more exciting to see, however, is that rental prices and purchase prices move relatively the same way.

However, in the last 5 years we see a tendency that the purchase prices have increased again much more in relation to the rents. This means that real estate is relatively expensive at the moment and renting is cheaper.

In my opinion, there are two scenarios for the next few years.

  1. Rents are rising to align with the increased cost of real estate.
  2. Purchase prices fall or move sideways for a while and so the curves level out again.

Buy or rent – general food for thought

Buying a property can cost a lot of money. Depending on how good your financial situation is, you may have to pay it off for 30 to 40 years before you own the property. In addition, the installments to the bank are often so high that there is not much left at the end of the month. A vacation or another big expense is often only possible once a year, and there is no thought of saving. But what happens when a repair or something similar is due? How can the family cope and are the restrictions worth it?

Against it one hears nevertheless very often the following argument. Once the house is paid off, then you have something for retirement. Your costs are lower and you can then enjoy this period of life. But what do you want alone without your children with a huge house in old age? The garden and the house must be kept in schuss and also cleaned regularly. How long will you be able to do that before you are too old?

Of course, it makes a difference whether you buy a house or an apartment. Not only the price of a house is usually more expensive, but also the cost of maintenance and repairs. With an apartment, you share many costs with the other owners. For example, if the roof of the apartment building needs to be replaced, then you only have to pay a percentage. You should always keep this in mind.

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Purchase of a property

The decision to buy or rent a house or an apartment is usually made only once in a lifetime. Therefore, you should consider it well and not let yourself be guided by emotions. Hence, you should internalize all the advantages and disadvantages once before making a purchase decision.

Purchase advantages

In most cases, it is true that a property represents a security in old age. This is of course related to how the market value develops. However, the prices of a property are also subject to fluctuations. Just like on the stock market, prices rise and fall. Between the years 2000 and 2007, real estate prices were rising very a lot. The purchase prices went down al lot after that, but since then they have risen again strongly. However, one cannot always generalize this so simply. The price of an apartment in a San Francisco is probably more stable than that of an apartment in a sparsely populated area in Utah.

With the purchase of a property, you make a financial investment, which you must compare with other investments. The average return over the last 45 years for real estate was around 4.6% per year. I think this is not bad values. Gold rose by 4.6% and stocks by about 7.5% in the same period. But real estate is far less subject to fluctuations than stocks, ETFs and funds. But the compound interest effect strikes here, too. Every percent return counts.

When building a family house, you have the opportunity to design the floor plan yourself. An architect will help you to design your house and garden in such a way that it corresponds to your wishes. If you decide to choose a new apartment or a terraced house, then you have fewer opportunities to involve yourself.

In your own property, you do not have to be afraid of rent increases. It makes sense for you to sign a loan agreement with the bank, which runs until the loan is paid off, when the interest rates are suitable. Then you always have to pay the same installment to the bank over the next few years.

It is not possible to demand termination of own use and no one can kick you out of the property.

Purchase disadvantages

To buy property you should bring a certain amount of money. This equity capital should be as high as possible if you want to live in the property yourself. If you want to rent it out, it is the other way around. At least you should bring 15% of the purchase price and the additional purchase costs. If we assume that you are planning to buy an apartment for $500,000. The additional purchase costs are approx. 5%. So you need (5% + 15%) x $500,000 = $100,000. That is a lot of money.

Mostly, the installments to the bank are higher than a rent would be. Thus, the owner must be more frugal. On top of that he has to build up reserves for maintenance and so on. As described above, the costs of buying a house are significantly higher. A heating system or windows, for example, must be renewed every 20 to 30 years. This quickly results in costs amounting to a 5-digit sum.

Furthermore, repairs must be paid for by yourself. There is no landlord who will take care of that. If the sink is clogged or the heating system is broken, then you have to pay the amount due.

Moving is not so easy anymore. If you want to move, then you have to think about it carefully. You have to weigh up whether it makes sense to rent out the apartment or house. Will the rent cover the costs for the bank? Do you have to pay on top of it if necessary? Therefore, you should ask yourself this before buying. Of course, you could also sell. What is the market situation and does a sale make sense at that moment? How are any profits to be taxed?

Then we come to the next problem. What do you do with the long-term loan? If you live in the apartment/house for many years, then you simply pay it off. But as soon as you want to sell or rent, then this credit can restrict you.

Overview of the advantages and disadvantages of buying real estate

Here is an overview of the advantages and disadvantages of buying:

Advantages Buying

  • Protection in old age
  • Investment
  • Design possibilities of the real estate
  • No rent increases
  • No termination of own use

Disadvantages Buying

  • High equity
  • Build reserves for maintenance
  • Pay for repairs yourself
  • No flexible moving
  • Pay off long term loan

Renting a property

If you decide to rent an apartment or a house, you certainly have your reasons. But have you ever thought about the pros and cons of buy or rent and decided on the basis or was it a gut decision?

Advantages for renting

If you are looking for flexibility, renting can be the right choice for you. You don’t have to tie yourself down and you are much freer. Whether you’re looking for a new challenge in a new city or a new country, all you have to do is cancel your lease and you’re on your way.

In addition, you do not need to have saved money to rent. You only have to pay the deposit of 2 or 3 net rents. Then you have to find the right property and you can move in.

The owner takes care of most of the repairs and maintenance. If there is a problem, you just have to contact the property management or the owner directly. They will take care of things and you don’t have to do anything else. In some leases there is a deductible of 50 to 100€ per year. But this is bearable.

Instead of putting your money into property, a tenant can invest his capital in a different way. Your assets are not invested with a large amount in one property. You can spread and diversify your capital more broadly. For example, you can buy an apartment to rent out with way less equity. There are also p2p real estate platforms where you buy part of a property or co-finance it. The returns there are quite substantial. You could then still invest the rest in stocks, ETFs, funds or general peer-to-peer lending. I would like to refer you to my investment comparison if you would like to know more about this.

Disadvantages when renting

You can not influence the layout of the property yourself and you have to choose one that suits your wishes. As a rule, you will always have to make compromises. You will probably not find a rental property that is exactly as you dreamed it would be.

The rent will most likely increase over the years. While there is a rent schedule and other laws that limit rent increases, you can not avoid it. You have to assume as property prices go up, rents will go up.

You can only escape a notice of termination for own use in very specific cases of hardship. The rights of tenants are very good all over the world, but you can still be shooed out of the property. The owner only has to give urgent reasons and very often gets away with it. You are the one affected and have to look for another place to stay, which is often much more expensive.

If you want to rent out parts of your property on AirBnB or want to have a subtenant, you are dependent on the favor of the owner. The owner may or may not agree to the project. If you want to create additional income, then you are not so free. Instead, you have to hope that the owner agrees.

Overview of the advantages and disadvantages of renting

Here is an overview of the advantages and disadvantages of renting:

Advantages renting

  • High flexibility in case of relocation
  • No equity required
  • Owner takes over repairs
  • Can invest money elsewhere

Disadvantages renting

  • No influence on the floor plan
  • Rent increases possible
  • Notice of termination of own use possible
  • Not very flexible with AirBnB, etc.

Buy or rent – My opinion

When I’m faced with the decision to buy or rent, I don’t let myself be guided by emotions. Instead, I always try to make the decision based on whether it is a good investment. I would always buy an object if I expect a high return on my investment. Since I want to be as flexible as possible, the investment has to fit my life. That means the property must either be easy to rent out or sell at a profit.

But how do I determine if this is true for a property? There are a few simple yield calculations that you should do before you buy. With that, you can then see if it is a good investment and you should buy or rent. If a property is too expensive, then I definitely leave it alone, no matter how beautiful it is. The important thing is that you see the property as an investment.

Buy and rent is always good in my opinion if you can buy and rent on the right terms. I own a few apartments that I rent out very profitably. Of course, you also have to take into account that there is always work involved an also risk.

If you have less capital, but still want to invest in real estate. Then I can recommend real estate p2p lending. Yields of 4 to 12% can be earned there. Make sure that your investments are secured with a first ranking loan. This means that they fund like a bank and get their money back first if the borrower is insolvent. Another option are REITs.

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Summary – buy or rent

Herewith I would like to summarize once again the topic of buy or rent:

  • Do not let your emotions guide you
  • If you want to buy, then they always see it as an investment
  • Make a plan what you want your future to look like
  • Decide whether buy or rent suits you better
  • Find out about alternative forms of investment

Finally, I would like to share with you my other articles on the subject. This post about buy or rent was only the first step to make a decision. If you want to go deeper into the topic, then you should read the following articles about real estate:


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