Calculated: Own a home or stay a tenant?

Part 3

In Part 1, we covered the basics and theory to make a financially sound buy or rent decision. You can find it here: https://app.getquin.com/activity/FoLdCxttXY

In the 2nd part, we transferred this theory into practice with a detailed calculation example. In the process, the tenant emerged as the clear winner. You can find part 2 here: https://app.getquin.com/activity/evjQvBldso

In this 3rd and last part, we will look at what influence changed parameters and variables have on the result. We will outline a possible scenario in which the buyer beats the tenant. We will also take a look at other properties and calculate the buy vs. rent decision for them.

tl;dr & Conclusion

Unsurprisingly, the cost of buying relative to the cost of renting has a very large impact on whether the renter or the buyer ends up better off. This ratio can differ significantly even in the same region for similar properties, which is why an individual comparison should be made for each property under consideration using the scheme presented in this series of articles. As mentioned in Part 1, we cannot live in the global average. An ETF allows us to save the global average for the stock market, but unfortunately this is not possible for the home. General statements of any "studies", in which regions buying or renting would allegedly be worthwhile, are to be seen accordingly critically. In addition, the assumptions made in such publications are not always transparent (e.g. how much return was calculated for the alternative investment). In addition, they are usually produced on behalf of an interest group (e.g. building societies) - do not trust any statistics that you have not falsified yourself. Speaking of the return of the alternative investment: for renting to be worthwhile, it must be decent and at the level of a world portfolio. An even combination of stocks, bonds, and overnight deposit accounts is unlikely to yield enough to beat the buyer.

Interestingly, with a purchase and the general conditions assumed, equity should be as low as possible - it simply works more effectively in the stock market than in a home. Of course, higher loan interest rates due to lower equity must be avoided. Because just the interest rate of the 1st loan has a noticeable influence on the final result - clearly stronger than with a follow-up financing. In addition, the costs of maintenance and modernization depress the buyer's return and should not be underestimated. After all, you want to live in a beautiful house for several decades and not in a ramshackle hovel. On the other hand, the effects of different rent increases and property value developments on the result should be self-explanatory.

To make the house purchase from the example in the 2nd part of the series of contributions financially attractive, the variables would have to be adjusted quite strongly in favor of the buyer. On the other hand, small adjustments in favor of the tenant are already sufficient to increase his capital by 1-2 million euros. The recommendation from Part 2 thus remains valid: Under the described or similar conditions, the purchase of a property should be refrained from from a purely financial point of view. The further examples show however that there are quite regions with offers, in which the fortune of the buyer is at the end higher or at least not completely so far under that of the tenant. In particular, it has a positive effect for the buyer if the tenant does not move over time to a property that suits his circumstances, but always lives in a similar property to the buyer. For example, because there is no desire to have children and the number of people living in the property always remains the same. As a tenant, on the other hand, you should take advantage of the simple option of moving in order to always live in a property that meets your needs - this can give you a clear economic advantage over the buyer, who will probably rarely if ever move.

What has happened so far

In this part, we'll focus on realistic scenarios 5 and 6 from Part 2. Ideally, you'll read through Part 2 again (https://app.getquin.com/activity/evjQvBldso) before you start with this last part. Otherwise, the short version is also available in this section.

General

• Property for sale: mid-terrace house for 750,000 euros
• Service charges: 9,07
• Surveyor: 2.000 Euro
• Provisions for maintenance and modernization: 300 Euro / month
• Loan 1: 2.65% interest, 2.5% repayment, 15 years term
• Loan 2: 4% interest, 8.149% repayment, 10 years term
• Property appreciation per year: 2.6%
• Inflation / Annual adjustment of provisions: 2%.

• Property for rent: Mid-terrace house for 1,970 euros cold rent
• Deposit: 4.400 Euro
• Rent increase every 4 years: 9.09% (2.2% per year)
• Performance world portfolio per year: 6%

• Equity capital: 200,000 euros
• Period considered: 60 years

Scenario 5

The tenant does not occupy the mid-terrace house continuously, but in an apartment adapted to his living circumstances. The buyer reduces the provisions in the last 10 years, otherwise the assumptions under General apply.

• Apartment for rent year 1-5: 1,528.82 euros, deposit 4,000 euros
• House for rent year 6-25: 2,196.45 euros, deposit 5,500 euros, moving costs 2,000 euros
• Apartment for rent year 26-60: 2.374,97 Euro, deposit 5.500 Euro, moving costs 3.000 Euro
• Rent increase every 4 years: 9.09% (2.2% per year)

• Assets buyer after 60 years: 2.9 million euros
• Assets tenant after 60 years: 7 million euros, growing deposit

Scenario 6

The buyer sells his house after 25 years, buys a smaller apartment (comparable with tenant) and invests the profit in a world portfolio. The general conditions for the mid-terrace house remain unchanged.

• Apartment for sale year 26-60: 1.000.000 Euro + service charges
• World portfolio buyer year 26-60: 277,194.75 euros + increase in value
• Provisions + non-apportionable operating costs Year 26-60: 320 euros + adjustment for inflation

Since tenant and buyer occupy one apartment from year 26 onwards, both have to bear apportionable ancillary costs such as elevator maintenance, and not just the tenant, as in scenario 5. The rent relevant for the comparison is reduced accordingly during this period, while all other parameters remain unchanged.

• Apartment for rent Year 26-60: 2,331.90 euros (rent increase unchanged every 4 years)

• Assets buyer after 60 years: 2.5 million euros apartment + 2.1 million euros deposit = 4.6 million euros
• Tenant's assets after 60 years: 6.9 million euros, growing depot

How much return does maintenance cost?

The maintenance of 287.50 euros per month initially ensures that the value of the property is maintained. In other words, it ensures that the value of the property grows every year by the assumed 2.6%. Thus, the provisions for maintenance reduce the return on the property. Of course, no one wants to live in a run-down property, so we can't avoid maintenance. But it is certainly interesting to look at how much return maintenance costs us.

In the 1st year, the value of the mid-terrace house increases by 2.6% to 750,000 euros * 1.026 = 769,500 euros. For maintenance, the buyer puts aside 287.50 euros * 12 = 3,450 euros. So we have invested an additional 3,450 euros, which drops the return to 769,500 euros / (750,000 euros + 3,450 euros) ~ 2.13%. In the 59th year, the value of the property without modernizations has grown to 3,410,009.19 euros, and reaches the sum of 3,498,669.43 euros in the 60th year - provided that maintenance measures have been carried out throughout. The provisions for maintenance in the 60th year amount to 11,097.60 euros. The return on investment is thus approx. 2.27% in the last year.

Provisions for maintenance are necessary, but they noticeably reduce the return until the end. That the return adjusted for maintenance costs grows over time is also logical, since the assumed increase in the value of the property per year is higher than the annual adjustments to the provisions. Why? For example, because the price of the property also grows over time and significantly lower maintenance costs are necessary for this.

What influence do purchase price and rent have?

Purchase price and rent are of course two very important parameters, but they also depend on each other. If the purchase price increases, it is very likely that the rent will also increase. So we can't adjust these parameters independently of each other at will. Nevertheless, there are areas where the purchase price/rent ratio is different. First, however, let's look at the impact of lower purchase and rental costs if the purchase price-rent ratio remains the same.

The ratio between purchase price and annual cold rent is 750,000 euros / (1,970 euros * 12) = 31.7. If we keep this ratio, but assume lower prices - for example, a cold rent of 1,400 euros and a purchase price of 1,400 euros * 12 * 31.7 = 532,560 euros - we must of course also adjust the maintenance costs accordingly. Instead of 287.50 euros + 12.50 euros, we assume 217.50 euros for maintenance at this purchase price and retain the 12.50 euros for modernizations. In scenario 5, the deposit value at the end of the 60 years is only about 5.6 million euros (instead of 7 million), while the value of the property falls to about 2.1 million euros (instead of 2.9 million). The deposit value thus grows from 2.4 times the value of the real estate to 2.7 times. Also, the increase in the value of the deposit increases from 4.7% to 4.9% in the last year.

In scenario 6, a similar picture emerges. The house is worth 532,560 euros * 1.026^25 = 1,011,701.89 euros when it is sold after 25 years. To this must be added the modernizations in the unchanged amount of 6,891.74 euros, for a total sales value of 1,018,593.63 euros, which, after deducting the sales costs, yields proceeds of 976,636.87 euros. The new apartment has a value of 791,776.70 euros, which can be pushed to 750,000 euros. In addition, the ancillary purchase costs are added, resulting in a total price of 820,025 euros. After deducting the relocation costs of 3,000 euros, the buyer now has a more suitable apartment and a stock portfolio of 153,611.87 euros. The maintenance costs for the new apartment initially amount to 240 euros. The final value of the buyer's deposit is approximately 1.2 million euros. The value of the apartment is approximately 1.8 million euros. In total, therefore, the buyer has built up assets amounting to 3 million euros. In contrast, the tenant's assets amount to 5.5 million euros. The tenant thus increases his assets from 1.5 times those of the buyer to 1.8 times. The increase in the value of the portfolio also increases from 4.9% to 5% in the past year.

So it is of no use to the buyer to simply buy a cheaper property if it is located in a region where rents are also lower. On the contrary. This is due, among other things, to the higher (since unchanged) equity ratio. Equity works much better at the assumed rate of return on the stock market than in one's own property. This can be easily confirmed by increasing or decreasing the equity with all other parameters unchanged. The lower the equity, the better off the buyer is. However, since a lack of equity again has a negative effect on the interest on the loan or on the credit rating in general, the equity ratio cannot be reduced at will in the case of owner-occupation. In addition, this increases the monthly installment, which a buyer may no longer be able to afford.

If the purchase price-to-rent ratio is reduced to 25, the house can be purchased for 591,000 euros instead of 750,000 euros. If the remaining parameters remain unchanged, the tenant in scenario 5 ends up with a deposit value of about 2.75 million euros, which is still well above the value of the property of about 2.25 million euros. The tenant's deposit grows by approx. 3% until the final year.

The tenant in scenario 6 generates a deposit value of approx. 2.6 million euros with a purchase price/rent ratio of 25 and corresponding adjustment of the prices of the properties, which still increases by approx. 3.2% in the 60th year. After 60 years, the buyer owns a deposit of approx. 1.2 million euros and a property worth approx. 2 million euros. In other words, a total of 3.2 million euros. The buyer's assets are thus just under 25% higher than those of the tenant.

Not surprisingly, the purchase price/rent ratio has a very high influence on the overall result. This ratio fluctuates extremely within Germany alone. It can thus be stated that a statement as to whether buying or renting makes more sense is extremely dependent on regional conditions and the properties in question.

What influence does the yield of the portfolio have?

A very big influence! Even small changes to the average yield can have a significant impact on the result. If the average yield in scenario 6 is reduced from 6% to 5.8%, the tenant will only have 5.9 million euros available after 60 years instead of 6.9 million euros. With a 5.3% return, there would even be only about 4 million euros, which, however, would grow until the last year. Of course, in this case, the buyer's total assets also decrease to 2.5 million euros + 1.7 million euros = 4.2 million euros. However, if we assume a slightly higher return of 6.1%, the tenant's assets grow to around 7.5 million euros.

Of course, a similar picture emerges in scenario 5, where a return of 5.8% instead of 6% also ends up costing the tenant around 1 million euros. However, in order to generate lower total assets than the buyer, the average annual return must already fall to 4.9% - and even in this case, the tenant's assets grow into the final year.

We always calculate with average values - average rent increase, average value increase, average return on the stock market. But we all know that these average values can fluctuate extremely in the short term. What happens if the first few years on the stock market don't go as planned? What happens, for example, if the performance in the first 4 years on the stock market is negative, amounts to -3% per year and the assumed 6% is only generated from year 5 onwards? In scenario 5, this means that the tenant's portfolio shrinks from 7 million euros to almost 4.75 million euros after 60 years. However, this also means that we are saying goodbye to our estimated return of 6% per year, since the first few years deliver significantly lower returns. Strictly speaking, the average return is then only 0.97^4*1.06^56=x^60 => 5.375%. Due to the regression to the mean, these lean years should be followed by years with higher returns again to achieve the 6% on average. If the negative return of the first years can be compensated by a higher return in the following years, the tenant's wealth is even higher in the 60th year, because the tenant was able to buy shares cheaply in the first years. If, on the other hand, the world portfolio falls in the later years, this has a negative impact on the tenant's assets. However, this is nothing more than a matter of crystal ball reading, which is why we continue to calculate with the average value. But since a crash on the stock market in the later years can be painful, it is important to have a sufficiently large portfolio to be able to withstand these fluctuations. Incidentally, of course, the housing market or specifically the local situation of the buyer can also deteriorate drastically in recent years. So the risk is borne not only by the tenant, but also by the buyer.

Consequently, in order to beat the buyer as a tenant, we need a decent return. It must be clear to everyone that a tenant with a balanced combination of fixed deposits / overnight money, bonds and shares will very likely achieve too little return to beat a buyer.

What influence do appreciation and rent increases have?

If the purchase prices for real estate increase more or less in the future, this has no influence on the assets of the tenant. Only the value of the property changes. If, for example, property prices rise by an average of 3% instead of 2.6% per year, the value of the house will increase from 3.5 million euros to 4.4 million euros after 60 years without modernization and with constant maintenance. With a value development of only 2.2% per year, the value of the property after 60 years is only 2.75 million euros.

It is very likely that if real estate prices rise more strongly, rents will also rise more strongly. These have a direct impact on the tenant's wealth. If we assume average rent increases of 3% instead of 2.2%, this results in a tenant's chapter growing to the last year of only 4.25 million euros in scenario 5 and 4.15 million euros in scenario 6. If, on the other hand, rents increase less than assumed, namely only at 1.5%, this results in a tenant's portfolio value of around 9 million euros in scenario 5 and 8.9 million euros in scenario 6.

What influence do the conditions of the loans have?

Realistically, we will not see falling interest rates in the near future. Even the 2.65% assumed in the example for the first loan seems almost too low. However, the conditions for the second loan may well be lower again. Since the buyer's assets considered here are not affected by changing interest rate conditions, we take a look at the change in the tenant's assets.

If we assume an interest rate of 3.5% for the first loan and otherwise unchanged conditions, the tenant's assets grow by more than €1.5 million to around €8.6 million in scenario 5. In scenario 6, a similar picture emerges with a final value of the deposit of approx. 8.45 million euros. This increase can no longer even be offset by completely interest-free follow-up financing (e.g. in the form of a loan within the family). If we calculate with 0% interest and 10% repayment for the follow-up financing, the tenant still ends up with higher assets of approx. 7.85 million euros in scenario 5 and 7.75 million euros in scenario 6.

If we stick with the original assumption of 2.65% interest on the first loan and hope for an interest rate of 1% for the follow-up financing instead of the estimated 4% from the example, the tenant's final wealth falls to 6.45 million euros in scenario 5 and 6.35 million euros in scenario 6. However, if the buyer somehow manages to push the interest rate on the first loan down to 1%, the tenant's assets fall to around 3.95 million euros in scenario 5 and to 3.85 million euros in scenario 6 - despite an interest rate of 4% for the follow-up financing.

We note: The conditions for the first loan have a far greater impact on the final result than the conditions for the follow-up financing. Realistically, however, the conditions for the first loan are more likely to rise than fall in the foreseeable future, making the purchase of a property less attractive - even if we hope for very good conditions for the follow-up financing.

What has to happen for the buyer to win?

For the buyer to win, we need to tweak a few parameters. However, we will not change the initial rent or the purchase price, as these are taken from real existing offers and their adjustment would not be realistic. Likewise, we will not adjust the cost of the initial loan, as the chance of getting better terms in the near future is very unlikely.

Assumption: housing becomes scarcer, rents rise more significantly, interest rates fall. In this scenario, the interest rate for the follow-up financing could fall from 4% to 2%, for example. In addition, rents could increase at 2.8% instead of 2.2% per year. In addition, a broker is waived, dropping the 3.57% broker fee to 0%. With these assumptions, the tenant's final wealth in Scenario 6 is 3.9 million euros. Although it also grows in the final year, it is significantly (about 15%) lower than the buyer's wealth. In scenario 6, these assumptions thus lead to a slight advantage for the buyer. In scenario 5, however, this is still not enough. For the buyer to win in scenario 5 as well, the rent would have to be increased by an average of 3% per year. The tenant will also feel these increases every 2 years instead of every 4 years. If the interest rate for the follow-up financing then falls to 1%, the buyer is also the winner in scenario 5. It should be emphasized that even under these assumptions, the tenant's deposit grows until the last year.

Assumption: Rents rise somewhat more strongly, the global economy cannot repeat the performance of recent decades. In this scenario, we assume slightly higher rent increases and that the tenant's deposit does not reach the 6% return per year. For the buyer to narrowly win the comparison in scenarios 5 and 6, rent increases would have to rise to 2.6% and the annual return on the deposit would have to fall to 5.4%.

Thus, significant adjustments to the assumptions are needed for the buyer to emerge as the winner. In particular, the estimated return on the portfolio must be adjusted downward a good bit if one does not want to change the other variables unrealistically much. However, the average return of a world portfolio is probably the one that can be predicted with the greatest certainty under all assumptions.

What if things work out better for the tenant instead?

But it can just as easily work out better for the tenant. Even small changes can significantly increase the tenant's wealth. Assume rent increases are only passed on to the tenant every 5 years instead of 4 and average 2.1% instead of 2.2% per year. If, in addition, the deposit grows by 6.1% instead of 6% per year, the tenant's final wealth in scenario 5 is already 8 million instead of 7 million euros. With a deposit growth of 6.2% and rent increases of 2%, the tenant's wealth can even be increased to 9 million euros. These adjustments do not seem so improbable to me either. Especially the better performance of the world portfolio.

A single household in Berlin

To conclude this series of articles, we take another look at other residential regions and situations. In doing so, we stick to the realistic assumptions from Part 2, but adjust the purchase costs, ancillary purchase costs, rental prices and relocations accordingly. We start with a single household in Berlin - typical of the very well-off @getquin -workers like @Eunoia or @mariechristines . Our single expects to occupy a 3-room apartment with 90sqm for the next 60 years. Since 60 years is a long time, the apartment should be as modern as possible when buying. Does buying or renting make more sense?

The challenge in Berlin is the incredibly wide range of prices for renting and buying - even for similar properties in the same neighborhood. Fortunately, I was able to find 2 apartments on immoscout in the same apartment complex with identical cut and furnishings. Once to buy and once to rent. We are talking about 95m² and 3 rooms on the first floor near Ku'damm. Year of construction is 2018, heated with district heating. The cold rent is 2,590 euros (7,770 euros deposit), the purchase price is 1,090,000 euros. The buyers bring an equity of 250,000 euros. A screenshot of the properties can be found in the attachment.

We assume that the buyer can still push the price of the apartment to 1,000,000 euros. Brokerage fee, land register entry and notary costs are identical throughout Germany, only the land transfer tax is higher in Berlin with 6% than in Bavaria. Maintenance reserves are formed in the amount of 237.50 euros + 12.50 euros for modernizations, makes initially 250 euros. Since it is an apartment, these maintenance costs must be paid until the last year. In addition, the buyer must set aside an additional 20 euros (+ inflation adjustments) for non-apportionable incidental costs of an apartment (e.g. costs for a property management).

After 60 years, the tenant's deposit value is about 5 million euros and grows until the last year. The value of the property amounts to approx. 4.7 million euros. The result here is therefore much tighter, but this scenario also clearly goes to the tenant due to the higher flexibility, the constant portfolio growth and the non-existent cluster risk.

A childless couple with a desire for a garden and space in the countryside

So far, we've tended to take a look at modern and expensive properties. For the last example, we take a look at Rhineland-Palatinate, in the area around Pirmasens (many thanks @Der_Leeh for the inspiration). A childless couple longs for a quiet life in the countryside and also has no problem with doing their own hands on the dream house. So it may be a little older. But please with enough space.

In contrast to Berlin, there are only a few offers around Pirmasens, which does not make the comparison any easier. Nevertheless, I found 2 halfway comparable objects on Immoscout (screenshots attached to the article). They are detached single-family houses with about 113m² (rent) and 115m² (purchase) living space, 5 (rent) and 6 (purchase) rooms and 235m² (rent) and 431m² (purchase) plots. The apartment house was built in 1957 and last modernized in 2021 - among other things, the bathroom including underfloor heating was renewed. The house for sale was built in 1948 and is partly in need of renovation. For example, the large bathroom must be renewed.

The cost of the house for sale is 178,000 euros. Even if the purchase price can still be pushed, modernizations and renovations are imminent, which is why total costs of 185,000 euros are calculated. The buyers bring along 20,000 euro own capital funds, the land acquisition tax amounts to 5% in Rhineland-Palatinate. For maintenance, lower production costs but a higher percentage are expected. These amount initially to 1,300 euros * 0.025 / 12 * 115 = 311.46 euros. The reserves for modernizations should be set correspondingly higher due to the age of the property. In total, reserves of 375 euros are initially formed, which are reduced to 150 euros / month after 50 years. For the rental house, 850 euros per month and a one-time deposit of 2,550 euros are due. The remaining general conditions are taken from the example in Part 2.

In this scenario, the tenant's deposit actually falls to 0 euros in the 60th year. The tenant's savings are (just) not sufficient to pay the rent in the period under consideration. Accordingly, the buyer is probably better off in this case. Why presumably? Because the house is already 74 years old. In 60 years, the house would be 134 years old, which is a very old age for a house, even with good and correspondingly costly maintenance. It is very likely that the house could still be occupied by the buyers in the last few years, but would have to be demolished afterwards. The demolition costs would have to be offset against the rural land prices.

End part 3

Thank you for reading my three really really long posts and commenting diligently ( @InvestmentPapa I never rant about the length of your posts again). Personally, I am also facing the decision whether I should not rather put my saved equity for a property for own use into a world portfolio. So this series of posts has not been entirely altruistic. The exchange with you has brought me a bit further here and also calculating through the various examples and adjusting the parameters has made it clear to me that this is a very individual decision per property.

Should you have any tips for / questions to me or have found errors: Drop them in the comments. Also, feel free to just leave me a carrot🥕 if you liked the series of posts. Otherwise: Don't worry, I promise you that there will be lighter fare from me again in the near future 😉.

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