Why Buying a House Might Not Be Worth It

So you’ve probably heard the phrase “renting is money down the drain” and you’ve probably been told your whole life, that you should get on the property ladder and buy a home, because once you’ve bought a home, then you’re saving money and it’s an investment and stuff, and hey, at least you’re not renting anymore and throwing all that money away.

Right so you’ve probably heard the phrase that renting is money down the drain and you’ve been told your whole life that you should get on the property ladder and buy a home because once you’ve bought a home then you’re saving money and it’s an investment and stuff and hey at least you’re not renting any more and throwing all that money away and selling it on

Fire but it’s actually much more complicated than that buying and renting both have financial and psychological costs attached and we need to take into account all of those things when we’re making the big buy versus rent decision so that is what we are talking about in this episode of money club our ongoing series where we discuss the principles strategies and

Tools that can help us along our journey towards financial independence now for a long time i also totally bought into this buying is better than renting mantra and i followed the get on the property ladder by age x advice pretty religiously when i started working as a doctor for example i sold a bunch of bitcoin at a loss of about thirty 35 000 to buy a house in

Cambridge with my brother and i also recently bought two flats in manchester as buy to let rental properties but right now i’m renting a ridiculously expensive flight in london so i’ve got plenty of experience from both the renting throwing money down the drain and the buying making money side of the equation so the big question is is it better to buy a house early

And hold it i.e buy in your 20s or 30s if you can or is it better to rent invest your money somewhere else and then potentially buy a house further down the line and we’re going to break this problem down into four main sections firstly we’ll talk about the home buying bias basically why everyone especially your parents and grandparents think that buying is better

Than renting secondly we’ll talk about the s’mores rule which is the mental model i’m going to use to break down this belief thirdly using the s’mores rule we’re going to discuss the financial factors that factor into whether we’re going to buy or rent and fourthly again using the smalls rule we’re going to look at these psychological factors to consider when we

Are deciding whether to rent or to buy a place first let’s chat about why most of us have this home buying bias the first factor is economic now historically house prices tend to appreciate whereas you don’t get anything back from renting so most people think that you’re making some kind of investment when you’re buying a house but that when you’re renting you’re

Just burning through cash i was talking to a friend who grew up in cambridge and he said that his mom bought their family house in the center of cambridge for 80 000 pounds back in the 1980s as the city developed more and more people want to live in cambridge and so the housing market has done its thing the price has gone up over time and now that house is worth

Over 800 000 pounds which is pretty good if that friend’s mom had just rented all those years then his family wouldn’t have benefited from this massive 10x increase in their net worth over the last 30 40 years okay so that’s partly why we all think that omg renting his money down the drain this is really bad but the decision about buy versus rent is a little bit

More complicated than that which brings me on to our mental model for figuring out the pros and cons of buying versus renting buying versus renting is an investment decision and that decision has two sides one is financial and the other one is psychological the financial component is about making as much return from your investment as possible and the psychological

Component is about making sure that your decision makes you as happy as possible which is a little bit harder to calculate for example if buying a house means you need to move somewhere that you don’t want to live and commute for an extra hour on public transport then you might be better off financially by buying a house but in terms of happiness you’d be worse off

There with that kind of like balancing act in mind i’ve come up with my own framework for calculating the costs and benefits of renting versus buying which i’m going to call the s’mores rule now each lesser in the s’mores rule stands for a factor that’s important for us to consider when applying the framework so very briefly s for some costs m for maintenance costs o

For opportunity costs are for roots versus wings e for easiness and s for savings okay so whether we’re buying or renting we need to think about at least three types of financial costs and these three costs make up the s and the m and the o bit of the s’mores rule now we’re going to go through the costs in each of the cases of buying versus renting the first type

Of financial cost that we face are the sunk costs these are the things that we pay for as a one-off and we don’t get any money back from them when we think about buying a house most people think about the purchase price of the house like if the house is a one million dollar property we think that the cost of buying the house is one million dollars the actual sunk

Costs are the other fees that we have to pay on top of the one million dollars to actually buy the house these are the costs that we don’t get anything back from and conveniently there are four main types of sunk cost when you’re buying a house the first is property taxes now this is gonna vary a bit depending on which country you’re in because there are all sorts

Of different types of property tax basically it’s a tax that you need to pay to the government when you buy a property how much you pay depends on how much the property costs and whether you’re a first-time buyer this comes in all sorts of shapes and sizes for different countries like staff duty in the uk which for most people is between zero percent and five percent

Or general property tax in the us which you pay to your state which is usually between 0.2 and 2 percent for example this is what property tax looks like in the uk depending on if you’re buying an extra property or your main home and whether you’re buying a massive mansion or a small flat second on the list we have lawyer fees you’ll need to pay your solicitor to

Cover the cost of all of the legal work associated with buying a house this includes things like dealing with the transfer of ownership checking the paperwork and all that checker we’re checking whether any environmental factors that you need to do like making sure your name is actually the thing on the deed making sure you have all the relevant planning permissions

Anything that might give you a massive pain in the bum further down the line in the uk this usually costs between a thousand pounds and fifteen hundred pounds depending on how much the property costs and then thirdly we have the valuation fee this is what you pay to the mortgage lender to assess the value of the property and to figure out how much they are prepared

To lend you getting a valuation costs somewhere between 150 pounds and 1500 pounds again this is based on what sort of property you’re gonna get and the type of mortgage you’re getting and then there might also be some minor fees on top of that like mortgage arrangement fees for fees that you might have to pay to arrange a mortgage or surveyor’s fees the money you

Have to pay to the surveyor overall given that your property taxes and stuff are likely to be maybe up to five percent of the home in the uk for any property above 250 000 pounds you can expect to pay more than five percent of the value of your home in some costs when you add on all the lawyer fees valuation fees and all that kind of stuff and obviously this figure

Varies depending on which country you’re in but that is a very rough estimate for the uk and the us if you’re renting the main sunk costs are a lot simpler so firstly there is the rent you have to pay which here in london is about 1400 pounds a month for a one bedroom apartment and second you then have the cost of actually moving all your stuff into the apartment

Which can add up if you’re moving quite a lot the second type of cost that you get when buying or renting are maintenance costs and these are things that you need to pay for to make the place that you’ve bought or rented actually livable there is this thing called the one percent rule which says that when you own a home you should budget about one percent of the

House price per year for ongoing repair and maintenance costs because all sorts of stuff can and will break during the course of your home ownership like a broken boiler leaking drain pipes mould in the bathroom all that kind of fun stuff so if your house costs for example 300 000 pounds then you should budget around 3 000 pounds per year for maintenance now

Obviously the 1 rule is just a very rough estimate depending on how old your house is or its condition or its location you might need to put aside more or less than this but it’s a broad rough brushstroke type figure if you’re renting though the maintenance costs are fairly low if not zero because upkeep is technically the job of the landlord that is one of the

Main perks of renting but you do have to pay a security deposit when moving in and so the landlord can make deductions if it turns out that you’ve damaged like a load of stuff or your dog has spilled red wine all over your sofa or anything like that the third type of cost you have to pay especially when buying is opportunity costs now opportunity costs are kind

Of hidden and most people tend not to account for them or even think about them they’re basically the potential benefits you miss out on by choosing one thing over another if for example you decide to study medicine for six years at university you cannot then also study computer science at the same time at least in most universities not getting to study computer

Science is then one of the opportunity costs of doing a medical degree and so if i’m using my money to buy a house i’m deciding to miss out on all of the other things that i could have done with that money like for example backpacking around the world or paying to go to business school you know god forbid someone on my team for example my friend jamie is thinking

Of buying a house but to do that he would have to sell all of his shares in tesla which he really doesn’t want to do because he thinks tesla is going to go to the moon over the next 10 years and so for him buying a house is going to result in the opportunity cost of that money is no longer in tesla stock similar to me when i bought my flat in cambridge the opportunity

Cost was having to sell my shares in bitcoin or my bitcoins and realize a loss for the bitcoin whereas had i actually kept that money in bitcoin it would have gone up so much more than the price of that house did over the last four or five years but buying a house with a mortgage costs a lot of money the two big financial costs that make up the price of the purchase

Are number one the down payment which is a percentage of the total value of the house that you pay up front from your bank account and usually you this is roughly 20 although some mortgages are 25 and some mortgages are five and some are ten but twenty percent is a reasonable down payment value and two we have mortgage repayments this is basically the money that you

Borrow from the bank to cover the other eighty percent of the cost of the house and then you need to pay interest on that money now this is a huge financial commitment if you buy for example a one million dollar house with a down payment of 20 you’ll need to pay 200 000 up front and then suppose that the interest on your mortgage is 5 if you pay back your mortgage

Over 10 years which is pretty quick then you would have to pay 8 485 per month and you’d end up paying the bank over 1 million dollars by the end of those 10 years the initial 800 000 which is called the principal and then 218 000 on top of that just to cover the interest payments all right let’s now look at the opportunity cost of paying that money to buy a house

Now in most decent cities it’s a safe bet that your house is going to grow in value over time so suppose that house prices appreciate ie increase at five percent each year that means that one year later your one million dollar house will be worth fifty thousand dollars more and so buying the house is actually pretty decent investment but if you’re paying for the

Down payment and the mortgage payments you’re also letting go of the opportunity to invest that money somewhere else so for example instead of paying the 200 000 down payment and mortgage repayments you could have invested all that money in crypto and hopefully made more money than the value that the house will have appreciated by within that year fingers crossed

So for example i sold 35 000 pounds of bitcoin in 2018 to buy a house but with the benefit of hindsight that was a really bad move if i’d kept that money in bitcoin it would be worth 175 000 pounds today which is 140 000 pounds in profit which is way more than how much my apartment in cambridge grew in value since 2018 where that figure is somewhere between maybe

Five and twenty thousand pounds alternatively instead of buying crypto you could have invested that two hundred thousand pounds into something steadier like stocks in the s p 500 if you’d invested the 200 000 pounds into an s p 500 index tracker at the yearly average growth of seven percent then you would have over two hundred and eighty three thousand pounds in

Five years time which is a profit of over eighty three thousand pounds of course we’ve still got a factor in accommodation like you cannot live inside thirty five thousand pounds of bitcoin or a stocks and shares investment account unfortunately but buying a house means that you don’t then have to pay rent you only have to pay mortgage payments which are gradually

Adding to your net worth by paying off the principal on the property so if we’re weighing up the opportunity costs from renting versus buying the main question we really want to ask ourselves is number one what would i be doing with that money instead if i didn’t put that money for a down payment for a house or two what would i be doing with my money instead if i

Didn’t rent and which of these options buying versus renting would get me more money in two years or five years or 10 years time alright all of this is pretty abstract so let’s try running the numbers using this cool rent versus buy model that my brother’s company causal has built which calculates whether we’ll have more wealth in 30 years depending on if we buy

Or if we rent and this is a pretty cool thing that you can use on your own if you want to i’ll put a link down in the video description but basically what you can do is you can set all of the parameters that you care about when you’re buying and all the parameters that you care about when you’re renting so let’s look at the demo example let’s say you’re buying a

House for one million dollars the down payment is 25 so 250 000 the interest rate let’s say is 3.5 percent the one of cost would be the sunk cost so let’s say that’s five percent of the property price let’s say annual appreciation is between one and two percent and the cool thing about causal not sponsored they really should sponsor this video but the cool thing

About calls is that you can literally write one to two and it would figure out and do the uncertainty calculations in the background and finally let’s assume ongoing 0.5 property costs so that’s all the buying related numbers let’s look at the renting related numbers and let’s assume that you might be paying two thousand dollars a month in rent and the rent is

Going to increase annually by annual appreciation so that’s all taken care of and let’s assume if you put that money in the stock market your return would be somewhere between minus two and eight percent so it factors the uncertainty and it takes that into account now in that scenario if we look at like what’s happening further down the line in the year 2049 you’d

Actually be about twice as wealthy if you were renting rather than buying so with these assumptions that we’ve got here your wealth is twice as much if you just rented and put your money in stocks and shares rather than if you bought a house which is pretty interesting now the key thing to remember here is that your mileage will vary and the solution to every single

Buy versus rent dilemma is to run the numbers for yourself and see what happens so the key thing here is that our assumptions within buying is we’re assuming that the house that we buy is going to appreciate annually by somewhere between one and two percent but let’s change that assumption let’s say actually you know house prices in the south of england increase

By somewhere between three and ten percent every year so i’m going to write three to ten and now the model is going to figure out what would these numbers look like if that was my assumption instead boom and all of a sudden it’s way better to be a buyer than it is to be a renter because this three to ten percent increase in in the house price over time is going

To massively contribute to your compounding wealth over the long term so we can see by in the year 29 our wealth from buying the house will be somewhere between 3.5 million and 15 million depending on the different uncertainty estimates whereas our wealth from being a renter would be 400 000 to 2.8 million dollars i’m not going to pop some numbers in here which

Is the numbers that i’m kind of thinking about when it comes to buying or renting a place in london which is generally the decision that i’m facing right now okay so if the house that i buy is for 1500 pounds or dollars or whatever the thing is uh the down payment will be 20 for 300 000. let’s say the interest rate i can get on my mortgage is two percent actually

Let’s call it two to four percent because that might vary over time let’s say five percent one of costs one to five percent annual appreciation because i like to be conservative with that kind of estimate and let’s assume one percent annual ongoing property costs and then renting let’s assume i might want to rent a place that’s four thousand pounds a month and

Let’s assume the s p 500 will return minus two to eight percent here is what this model looks like over time and you’ll see actually that for the first like you know 10 years there’s actually not that much difference between me as a buyer versus me as a renter and really the true values over time where you know in theory if i were to buy a place in london with

All of these estimates my wealth would be somewhere between two point five and six million dollars four pounds whereas if i were to rent instead it would be somewhere between six hundred thousand and four million and you can see that these uncertainty estimates actually overlap and that’s what one of the cool things about calls that it shows you the uncertainty

Inherent in your calculations because things like inflation rates might change things like s p 500 performance might change so it factors all that into account you can see it’s it’s it’s not as simple as renting is always money down the drain because for the first 10 years of this model it’s basically equivalent and really it’s only the compounding over time that

Makes a difference here so overall moral of the story is when it comes to the financial stuff don’t believe the myth that buying is just better than renting on in all cases run the numbers for yourself and see what happens right so we’ve discussed the cold hard financial side of renting versus buying and the causal calculator is pretty good but it doesn’t take into

Account the psychological factors and that’s where the res part of the smalls rule really comes into play now the first psychological fact to consider within the s’mores rule is something that i call the roots versus wings effect now one of the big benefits of buying a house is that you’re putting down roots somewhere you get this feeling of security and stability

Because you know that you have a roof over your head there’s no landlord and you know that it is your proper home now i really didn’t appreciate how important this effect is it turns out that moving houses is one of the more stressful experiences that we as human beings can actually go through on the flip side if you’re the type of person who wants to live a life

Where you’re moving around every two to three years or maybe even sooner than that then buying a house might actually stop you from doing this and this is the wings part of the roots versus wings effect although yes we do grow roots when we buy a house but if we’ve sunk most of our money into actually buying the house then we can lose our wings i.e our ability to

Just take off and do something else away from that place for example for me buying a house in cambridge actually kept me living there way longer than i really needed to and to be honest i kind of wish i’d moved to london a little bit earlier rather than staying in cambridge but it was the psychological fact of uh i own this flat over here that made me feel as if i

Needed to stay because it was the better financial decision now the second psychological factor is easiness and this is the e of the s’mores rule this basically describes how convenient life is to rent versus buy now there are some conveniences you get from renting that you just don’t get from buying if you’re like me you probably appreciate the fact that when you

Rent at least if it’s in a decent place you can quite easily to get people to come over and fix things when your toilet isn’t working or your boiler isn’t working or the ventilation system is broken you just send an email or text to the landlord and usually if they are good they will sort things out without you having to physically call up a plumber or a carpenter

Or whatever to get things done but if for example you’re an alpha male and you know how to use a hammer and a nail to fix things or if you don’t mind that extra bit of time and effort that it spends doing it yourself or finding the right person to do it then this convenience factor or this easiness factor probably doesn’t mean very much to you now if you own your

House there are also a few massive conveniences for that for a start you can make as many structural changes or painting or decorating as you’d like without having the landlord breathing down your neck and worrying about your security deposit you also then have the convenience of feeling rooted like knowing that okay i’ve got this place and i know i won’t have to

Move for a while which is an ease and convenience factor and then there’s also the idea to think about that when you’re renting you actually could rent a fully furnished place this is what i’ve done in london and so it’s so convenient not having to lug furniture around and just being able to move into a place all of the things are there the sofa the beds the bedding

The towels the plates knives and forks and all that crap which meant that moving to london was so easy for me because i was renting a fully furnished place rather than how it would have been if i were trying to buy a place instead so you can’t underestimate that when it comes to the ease and the convenience as well now the final psychological factor to think about

Is savings versus mortgage repayments now this is the second s in the s’mores rule now buying a house is what some economists like to call a saving commitment device if for example you take out a mortgage to buy your house which most of us are likely to do then you need to make your mortgage payments every month to make sure that your house doesn’t get reclaimed

By the bank and this actually forces you to save enough money every month to be able to make those mortgage repayments now some of those payments are going to be interest you literally throwing money down the drain because you’re paying for the bank to give you the money to buy the house but some of that is likely to be the principle i.e you’re literally repaying

Back the loan and so you’re sort of forced to save money and put it into the house over time by virtue of your mortgage payments and so if you’re the kind of person who’ll struggle with committing to saving x percent a year and saving in the stock market or in crypto or building up your net worth that way then buying a house could be a reasonable forced saving

Device that makes you keep your spending in check and invest in your net worth over time in theory yes we could save the same amount of money if we just rented and invested the surplus in the stock market but in reality if we’re renting and we don’t have a serious commitment like being forced to pay off a mortgage then most of us are unlikely to ever save up the

Equivalent of a down payment plus monthly mortgage because honestly most of us are just not wired to save that much without a specific goal and a deadline breathing down the neck so making the serious financial commitment to buy can benefit us in the long run because it locks us into a pattern of building up our net worth through mortgage payments right so if you

Have been on the fence about buying versus renting or even if you haven’t but you know you might make that decision further down the line hopefully this video has given you a little bit of food for thought do think about the components of the s’mores rule and do try running the numbers for yourself because buying is better than renting and renting his money down

The drain is just absolutely not true it all depends on what the numbers and what the assumptions are over time if you like this video you should definitely check out this one over here which is my ultimate beginner’s guide to investing in stocks and shares where we talk about all about how that works and how you can potentially be wealthier by renting and investing

In stocks than you could by buying your own property so definitely check out that video thank you so much for watching and hopefully i’ll see you in the next one bye

Transcribed from video
Why Buying a House Might Not Be Worth It By Ali Abdaal