Renting vs buying but what about the third option?

Exploring a thrid (hybrid) option, instead of just renting vs buying.

Whenever you read in the media about property, the question should I rent or buy comes up quite often. I have not read about anyone talking about the third option, which is a hybrid option between the two. South Africa, unique in its economic environment with extreme inequality, low growth, and high unemployment makes property investing a very subjective case and each person should assess their scenario for a better outcome. In the long run, South African house prices have grown on average by 10.5% but are countered by a high inflation rate of 7.9% leaving the investor with a 2.6% growth after inflation. This is hardly a good investment, which can easily be outperformed by other asset classes such as equity.

The real magic in property investing is the use of leverage. Using the banks' money to buy the property, having tenants repay your bond, an agent doing all the grunt work, and inflation eroding the monthly installment value over time as you watch your rental income increase. 

Society has conditioned us that owning your own home is a great investment, so much that renting has almost become taboo in conversations. With the typical response of oh, youre just repaying someone elses bond remarks. Like all paths that lead to financial independence, following the Joneses wont lead you there and by following this third strategy you will be far ahead of the Joneses in the long run. 

This article aims to discuss the pros and cons of renting vs buying as a primary residence. And then looking at each scenario in detail with an example of what is to be expected over 20 years.  

Property amendments: 

Tenants are bound by a contract or lease agreement stating what they are allowed to do on the property. This could hamper small changes being made to a property to suit your wants and needs as you would need the consent of the owner. With this comes a feeling of it's not my place and none of the security that comes with owning a property. Owners have full control over their property and can make changes as it suits their wants and needs. 

This is a con of renting property and a pro for buying property.

Flexibility: 

When life happens and you need to move location, change jobs, or feel like a new area to live in, renting makes this possible as you are not bound to one property and after giving sufficient notice, you can vacate the property. Owners need to sell their property first, considering the amount they spent and what they could get for their property. Finding a buyer and considering potential over-capitalisation, will hamper your flexibility of movement.

This is a pro for renting property and a con for buying property.

Financial scenario: 

Buying a home is expensive whereas renting is more affordable. Renting provides a lot of bang for your buck as you are likely to find houses to rent for almost half of what the monthly bond installment plus added costs would be on the property allowing you to live in areas where you typically cant afford to buy. As renting is more affordable it gives the renter more disposable income to save for a deposit or invest. 

This is a pro for renting property and a con for buying property.

Responsibility:

As a tenant, you have minimal liability as per your lease agreement. The property owner carries all responsibility for damages to the property, maintenance, rates, and levies accounts. The tenant is liable for insurance for their contents if they choose and the owner is responsible for property insurance. 

This is a pro for renting property and a con for buying property. 

Costs: 

Buying property is expensive, big items are deposits, lawyers fees, transfer costs, and bond registration costs followed by rates and levies, maintenance, and agent fees all of which erode the returns of the property. Renting does not bother with all these costs as the price you pay is set. There could be an extra water and lights bill for your account. 

This is a pro for renting property and a con for buying property.

Planning: 

Renters are at the mercy of owners when it comes to annual price increases, or if a lease is coming to an end. There is less room for planning as the owner has the final say. Owning the property gives you a monthly amount to be repaid to the bank until the end of the term. If you live on the property, you can do so for how long you wish without the fear of not having your lease renewed. 

This is a con for renting property and a pro for buying property.

Purchasing power: 

Purchasing power refers to the amount of property you can buy with your household income. The banks generally work with the 30% rule as a guideline, where your bond repayments should not be more than 30% of your income. Renting does not attach debt/loan to your name meaning that you retain your purchasing power to buy a property. If you buy your primary residence, you might use all your purchasing power and wont be able to buy a secondary property for investing purposes. 

This is a pro for renting property and a con for buying property. 

Creating Freedom: 

Renting does not create any financial independence for yourself unless you have a plan to invest your surplus cash and purchasing power. As with buying a property, after the loan term, the property belongs to the owner, and wealth was created in the process. If your property grows due to buying in the right location, then further equity will be created in your property than can be used for secondary loans or bigger profit when selling.

This is a con of renting property and a pro for buying property. 

But what about the third option

The third option requires you to invest in smaller properties for rental purposes while you rent your primary residence or home. By renting you retain your purchasing power and can keep on investing in investment properties. By doing this you are truly creating income-generating assets for financial freedom. Buying your primary residence is whats called a lifestyle asset. It is an asset that might create wealth over time, but you are the one repaying all the debt over your mortgage term. This means your house is not an income-generating asset. At Finsesh we love debt that other people repay for you. 

Lets look at an example

Family X earns a household income of R90 000pm with a monthly tax of R27 500 giving you a take-home pay of R62 271. The family lives frugally and only has expenses of R15 000pm and is looking to buy or rent property as their primary residence. According to the 30% rule, they can service a bond of roughly R30 000pm. Using the Ooba calculator suite it shows that the family qualifies for R3m and a bond installment of R27 000pm repayment. Lets assume they have 2 options, buying their home or renting a home and buying investment properties. 

Option 1: 

Family X buys an R3m home and makes a 20% deposit, they bought it off plot and plan, so no transfer duties applied, and we ignore bond costs. At the end of the 20-year term, the home is theirs and in total, they have repaid R5 182 422 to the bank using the Ooba repayment calculator. Considering levies and taxes (R3281pm estimation) over this period and maintenance at 2% of the cost (R60 000) per year adding a further R1 987 440 to their account over 20 years. Lets assume the home was in a good area and grew at a rate of 8% over 20 years and ignoring inflation for the future value, making the property value after 20 years R13 982 871 while costing them R7 169 862. A profit of R6 813 009.

Option 2: 

Family X rents an R3m home for R15000pm. They buy 3 investment properties of R1m each which after paying a 20% deposit and after all fees (bond repayment, levies, rates, agent fees, and maintenance) break even on profits in the first year. The property income for the three properties is R9000 each (R27 000pm combined) Over the 20 years your property income grew, and your property value increased assuming the same growth rate as in option 1, the three properties' value combined would also be worth R13 982 871(as per above) The rental income increased by 5% every year earning a total income of R10 713 369 while investment property expenses (R8 706 001 total) increased by 3% over 20 years earning a profit from the rental income of R2 007 367. Their cost of renting the house was R15 000pm increasing by 5% annually equalling R5 951 872.  A profit of R10 038 366. A whopping R3 225 357 more than option 1!

Best of all option 2 tenants repaid an R27 000pm (in today's value) income source for the rest of their lives creating an income generating asset paying for their lifestyle, whereas option 1 only has an asset but no income to supplement their expenses. Family X in option 2 is now financially independent. This article avoids some technical details like taxes, growth in salary, and personal aspect but illustrates that if you are willing to put up with the cons of renting, in the long run, it will be very lucrative for you and your family. The third option is a true hybrid by taking the biggest cons of renting property, which is creating financial freedom, and turning renting property into a pro over the long run. 

Onward to Financial Independence 

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