Is buying a home a worthwhile investment?
Surely that’s a no-brainer. It’s obvious that owning your home puts you ahead financially. In addition to your property’s increased value, by owning your home you won’t be throwing money away on rent, won’t be subject to the whims of your landlord and won’t suffer the insecurity of possibly being forced to move more frequently than you would choose.
Actually you might be surprised to hear that it’s not really that simple, and the true answer to whether it is a smarter move to own one’s home or to rent is dependent on a long list of factors, both financial and emotional.
The negatives of renting are usually easily understood. Every month the tenant pays rent, and in Israel building maintenance fees (vaad bayit and arnona) and has nothing to show for it at the end of the month, while the landlord pockets the rent and often simultaneously watches the property increase in value. This renting downside can be thought of as the unrecoverable cost of a renter.
It would be incorrect, however, to compare these costs for the renter to a homeowner’s mortgage payments. A home-owner’s mortgage payment consists of both the cost of capital (or how much interest you pay) and principle payments which are long term savings for the homeowner (as the principle increases the equity ownership stake in the property). The clearly unrecoverable costs for the homeowner in Israel are the interest payments (averaging around 3% currently) and the property maintenance (usually close to 1% of the value of the property per year in the long run).
But there is another unrecoverable cost for homeowners: the cost of equity capital. In order to purchase a home, you need to make a down payment (in Israel often at least 30% of the value of your property) which is then tied up in your home, while you forfeit the potential gains you could make with that money. The larger the down payment, the lower the mortgage payment, but also the higher opportunity cost lost. The renter on the other hand can use those funds to invest in something that could potentially offer a better return.
You might ask, “but when you invest in your home you also expect to see your down payment equity go up in value”? Whereas that is true to an extent, in most cases in Israel real estate prices have historically gone up less than other asset classes, and therefore we need to assess the differential between stocks and real estate to determine the opportunity cost you generally lose by investing in real estate. A relatively short while ago the Bank of Israel issued a report showing the returns over thirty years of investment in housing versus the stock market. Interestingly, the profits from the stock market were significantly greater than those in the housing market – and that was taking into account the period from 2006 – 2016 during which time there was a disproportionate rise in property prices in Israel. The differential between stocks and real estate historically has been close to 3%, which conveniently matches the current cost of debt. That means that the total cost for both debt and equity financing (ie the unrecoverable cost for the homeowner) is approximately 3% or a total of 4% including property maintenance.
Now that we better understand the unrecoverable costs for both renters and homeowners we can begin to compare the two options. If your rent (your unrecoverable cost) is less than 4% of the value of a home (the approximate unrecoverable cost for a homeowner), it makes more sense to rent as the unrecoverable costs will be lower in the long run. In Israel, rents often are only 2-3% of the value of property, which means that paying rent is a more financially desirable option.
However this financial analysis ignores the qualitative or more emotional aspects of the decision, which include:
- The added stability of being able to stay in one location without fear of needing to find a new rental.
- The ability to design your home exactly the way you want it.
- The upside potential growth in the value of the property in specific locations.
- The number of years you anticipate living at this location.
Over the past few years the Finance Ministry in Israel has been trying to bring down property prices via innovative schemes. At the moment, prices have definitely stabilized, and in certain parts of the country they have even dropped. One of the reasons for this price stability is the increased number of building projects in some areas. However, rents in those areas have also dropped because of the larger number of properties available for rent.
In Israel there is often the option of ‘buying on paper’, or via a kvutzat rechisha (purchase group) which in theory is cheaper than buying an existing property. If you plan on taking that route just be aware that the end price is often far higher than anticipated in the beginning. Do your research before becoming involved and don’t be surprised if the construction takes far longer and ends up costing more than the initial projection.
Buying a home is always going to have an emotional element, but first do all the calculations to determine your financial advantage or disadvantage as a homeowner rather than tenant. Then factor in how important it is to you to own your home and add that to the equation. Once you have worked that out you can be more relaxed in the knowledge that whatever you decide you’ll be making an informed decision, taking into account all the relevant components. Either way, behatzlacha!