Renting or buying an even money call says RBA

By Michael Janda

The research paper finds that if house prices were to keep growing at the average rate of the past sixty years, then buying a house now would be about as costly as renting.

However, if house price growth were to slow in the future - as suggested by many forecasters, including the Reserve Bank‘s head of financial stability Luci Ellis - then the average household would be financially better off renting than buying.

Another potential flaw in the research is the interest rate used - in the research, the Reserve Bank assumes a real interest rate of 3. 3 per cent, which it calculates using 10-year fixed mortgage rates with the risk premium subtracted.

As an illustration of why the findings of this report need to be treated cautiously, the authors note that studies using a similar methodology in the United States, “find house prices were undervalued near the peak of the US housing boom”, which preceded (and precipitated) the global financial crisis.

However, the same measure of house prices has only risen 1. 7 per cent a year over the past decade - if this growth rate was to be maintained, it would currently be 19 per cent cheaper to rent than to buy.

The study finds real house prices, also adjusted for the quality and size of the dwelling, rose 2. 4 per cent a year on average over the past sixty years.

However, given that the world is in a uniquely low interest rate environment currently, even the long term 10-year fixed mortgage rate has been skewed downwards from more typical levels, although the RBA data shows it is not at record lows.

As the typical variable rate mortgage runs over 25 years, there is a considerable risk that average interest rates will be higher than those the bank has used, making home ownership less attractive than its calculations suggest.

The authors note that there are factors that will skew the buy or rent equation for each household, such as how much a household values owning rather than renting their home (which may justify a premium for ownership), and how often a household expects to move (due to the costs associated with buying, selling and moving).

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