Why Buying Is Not Always Better Than Renting - Ali Abdaal - video Dailymotion

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Transcript

00:00Right, so you've probably heard the phrase that renting is money down the drain and you've been

00:03told your whole life that you should get on the property ladder and buy a home because once you've

00:06bought a home then you're saving money and it's an investment and stuff and hey at least you're

00:10not renting anymore and throwing all that money away and setting it on fire. But it's actually

00:13much more complicated than that. Buying and renting both have financial and psychological

00:17costs attached and we need to take into account all of those things when we're making the big

00:20buy versus rent decision. So that is what we are talking about in this episode of Money Club,

00:25our ongoing series where we discuss the principles, strategies and tools that can help us along our

00:29journey towards financial independence. Now for a long time I also totally bought into this buying

00:34is better than renting mantra and I followed the get on the property ladder by age x advice pretty

00:38religiously. When I started working as a doctor for example I sold a bunch of bitcoin at a loss

00:42of about $35,000 to buy a house in Cambridge with my brother and I also recently bought two flats

00:47in Manchester as buy to let rental properties. But right now I am renting a ridiculously expensive

00:52flat in London so I've got plenty of experience from both the renting, throwing money down the

00:55drain and the buying making money side of the equation. So the big question is is it better to

00:59buy a house early and hold it i.e. buy in your 20s or 30s if you can or is it better to rent,

01:05invest your money somewhere else and then potentially buy a house further down the line.

01:08And we're going to break this problem down into four main sections. Firstly we'll talk about the

01:12home buying bias, basically why everyone especially your parents and grandparents think that buying is

01:17better than renting. Secondly we'll talk about the s'mores rule which is the mental model I'm going

01:20to use to break down this belief. Thirdly using the s'mores rule we're going to discuss the financial

01:24factors that factor into whether we're going to buy or rent. And fourthly again using the s'mores

01:28rule we're going to look at the psychological factors to consider when we are deciding whether

01:32to rent or to buy a place. First let's chat about why most of us have this home buying bias.

01:39The first factor is economic. Now historically house prices tend to appreciate whereas you don't

01:44get anything back from renting. So most people think that you're making some kind of investment

01:47when you're buying a house but that when you're renting you're just burning through cash. I was

01:50talking to a friend who grew up in Cambridge and he said that his mom bought their family house in

01:54the centre of Cambridge for £80,000 back in the 1980s. As the city developed more and more people

01:58want to live in Cambridge and so the housing market has done its thing. The price has gone up over time

02:02and now that house is worth over £800,000 which is pretty good. If that friend's mom had just

02:07rented all those years then his family wouldn't have benefited from this massive 10x increase in

02:11their net worth over the last 30-40 years. Okay so that's partly why we all think that OMG renting

02:15is money down the drain this is really bad but the decision about buy versus rent is a little bit

02:20more complicated than that. Which brings me on to our mental model for figuring out the pros and

02:24cons of buying versus renting. Buying versus renting is an investment decision and that decision has

02:30two sides. One is financial and the other one is psychological. The financial component is about

02:34making as much return from your investment as possible and the psychological component is about

02:38making sure that your decision makes you as happy as possible which is a little bit harder to

02:42calculate. For example if buying a house means you need to move somewhere that you don't want to live

02:46and commute for an extra hour on public transport then you might be better off financially by buying

02:50a house but in terms of happiness you'd be worse off there. With that kind of like balancing act

02:54in mind I've come up with my own framework for calculating the costs and benefits of renting

02:58versus buying which I'm going to call the SMORES RULE. Now each letter in the SMORES RULE stands

03:02for a factor that's important for us to consider when applying the framework. So very briefly S

03:06for some costs, M for maintenance costs, O for opportunity costs, R for roots versus wings,

03:11E for easiness and S for savings. Okay so whether we're buying or renting we need to think about at

03:17least three types of financial costs and these three costs make up the S and the M and the O bit

03:22of the SMORES RULE. Now we're going to go through the costs in each of the cases of buying versus

03:26renting. The first type of financial cost that we face are the sunk costs. These are the things that

03:30we pay for as a one-off and we don't get any money back from them. When we think about buying a house

03:34most people think about the purchase price of the house. Like if the house is a 1 million dollar

03:38property we think that the cost of buying the house is 1 million dollars. The actual sunk costs

03:42are the other fees that we have to pay on top of the 1 million dollars to actually buy the house.

03:46These are the costs that we don't get anything back from and conveniently there are four main

03:50types of sunk cost when you're buying a house. The first is property taxes. Now this is going to vary

03:55a bit depending on which country you're in because there are all sorts of different types of property

03:58tax. Basically it's a tax that you need to pay to the government when you buy a property. How much

04:01you pay depends on how much the property costs and whether you're a first-time buyer. This comes in

04:05all sorts of shapes and sizes for different countries like staff duty in the UK which for

04:09most people is between 0% and 5% or general property tax in the US which you pay to your state

04:14which is usually between 0.2 and 2%. For example this is what property tax looks like in the UK

04:18depending on if you're buying an extra property or your main home and whether you're buying a

04:22massive mansion or a small flat. Second on the list we have lawyer fees. You'll need to pay your

04:26solicitor to cover the cost of all of the legal work associated with buying a house. This includes

04:30things like dealing with a transfer of ownership, checking the paperwork is in order, checking

04:34whether any environmental factors that you need to do like making sure your name is actually the

04:38thing on the deed, making sure you have all the relevant planning permissions, anything that might

04:42give you a massive pain in the bum further down the line. In the UK this usually costs between

04:45£1,000 and £1,500 depending on how much the property costs. And then thirdly we have the

04:49valuation fee. This is what you pay to the mortgage lender to assess the value of the property and to

04:54figure out how much they are prepared to lend you. Getting a valuation costs somewhere between £150

04:58and £1,500. Again this is based on what sort of property you're going to get and the type of

05:02mortgage you're getting. And then there might also be some minor fees on top of that like mortgage

05:06arrangement fees. So fees that you might have to pay to arrange a mortgage or surveyor's fees. The

05:10money you have to pay to the surveyor. Overall given that your property taxes and stuff are

05:14likely to be maybe up to 5% of the home in the UK for any property above £250,000 you can expect to

05:19pay more than 5% of the value of your home in sunk costs when you add on all the lawyer fees, valuation

05:24fees and all that kind of stuff. And obviously this figure varies depending on which country

05:28you're in but that is a very rough estimate for the UK and the US. If you're renting the main sunk

05:32costs are a lot simpler. So firstly there is the rent you have to pay which here in London is about

05:35£1,400 a month for a one-bedroom apartment. And second you then have the cost of actually moving

05:40all your stuff into the apartment which can add up if you're moving quite a lot. The second type

05:43of cost that you get when buying or renting are maintenance costs. Now these are things that you

05:47need to pay for to make the place that you've bought or rented actually livable. There is this

05:50thing called the 1% rule which says that when you own a home you should budget about 1% of the house

05:55price per year for ongoing repair and maintenance costs because all sorts of stuff can and will

06:00break during the course of your home ownership like a broken boiler, leaking drain pipes, mould

06:05in the bathroom, all that kind of fun stuff. So if your house costs for example £300,000 then you

06:09should budget around £3,000 per year for maintenance. Now obviously the 1% rule is just a

06:13very rough estimate depending on how old your house is or its condition or its location. You

06:17might need to put aside more or less than this but it's a broad rough brush stroke type figure. If

06:22you're renting though the maintenance costs are fairly low if not zero because upkeep is technically

06:26the job of the landlord. That is one of the main perks of renting but you do have to pay a security

06:30deposit when moving in and so the landlord can make deductions if it turns out that you've damaged

06:35like a load of stuff or your dog has spilled red wine all over your sofa or anything like that.

06:39The third type of cost you have to pay especially when buying is opportunity costs. Now opportunity

06:43costs are kind of hidden and most people tend not to account for them or even think about them.

06:47They're basically the potential benefits you miss out on by choosing one thing over another. If for

06:51example you decide to study medicine for six years at university you cannot then also study computer

06:55science at the same time at least in most universities. Not getting to study computer

06:58science is then one of the opportunity costs of doing a medical degree and so if I'm using my

07:02money to buy a house I'm deciding to miss out on all of the other things that I could have done

07:06with that money like for example backpacking around the world or paying to go to business

07:10school you know god forbid. Someone on my team for example my friend Jamie is thinking of buying a

07:14house but to do that he would have to sell all of his shares in Tesla which he really doesn't want

07:17to do because he thinks Tesla's going to go to the moon over the next 10 years and so for him

07:21buying a house is going to result in the opportunity cost of that money is no longer in

07:25Tesla stock. Similar to me when I bought my flat in Cambridge the opportunity cost was having to

07:30sell my shares in Bitcoin or my Bitcoins and realize a loss for the Bitcoin whereas had I

07:34actually kept that money in Bitcoin it would have gone up so much more than the price of that house

07:38did over the last four or five years. Buying a house with a mortgage costs a lot of money. The

07:41two big financial costs that make up the price of the purchase are number one the down payment

07:45which is a percentage of the total value of the house that you pay up front from your bank account

07:49and usually this is roughly 20% although some mortgages are 25 and some mortgages are 5 and

07:54some are 10 but 20% is a reasonable down payment value and two we have mortgage repayments. This is

07:59basically the money that you borrow from the bank to cover the other 80% of the cost of the house

08:03and then you need to pay interest on that money. Now this is a huge financial commitment. If you

08:08buy for example a 1 million dollar house with a down payment of 20% you'll need to pay $200,000

08:13up front and then suppose that the interest on your mortgage is 5%. If you pay back your mortgage

08:18over 10 years which is pretty quick then you would have to pay $8,485 per month and you'd end

08:24up paying the bank over 1 million dollars by the end of those 10 years. The initial $800,000 which

08:28is called the principal and then $218,000 on top of that just to cover the interest payments. All

08:33right let's now look at the opportunity cost of paying that money to buy a house. Now in most

08:37decent cities it's a safe bet that your house is going to grow in value over time so suppose that

08:41house prices appreciate i.e. increase at 5% each year that means that one year later your 1 million

08:47dollar house will be worth $50,000 more and so buying the house is actually a pretty decent

08:51investment. But if you're paying for the down payment and the mortgage payments you're also

08:54letting go of the opportunity to invest that money somewhere else. So for example instead of

08:58paying the $200,000 down payment and mortgage repayments you could have invested all that money

09:03in crypto and hopefully made more money than the value that the house will have appreciated by

09:07within that year. Fingers crossed. So for example I sold £35,000 of bitcoin in 2018 to buy a house

09:12but with the benefit of hindsight that was a really bad move. If I'd kept that money in bitcoin it

09:16would be worth £175,000 today which is £140,000 in profit which is way more than how much my

09:23apartment in Cambridge grew in value since 2018 where that figure is somewhere between maybe £5,000

09:27and £20,000. Alternatively instead of buying crypto you could have invested that £200,000

09:32into something steadier like stocks in the S&P 500. If you'd invested the £200,000 into an S&P

09:37500 index tracker at the yearly average growth of 7% then you would have over £283,000 in five

09:43years time which is a profit of over £83,000. Of course we've still got to factor in accommodation

09:48like you cannot live inside £35,000 of bitcoin or a stocks and shares investment account

09:53unfortunately but buying a house means that you don't then have to pay rent. You only have to

09:56pay mortgage payments which are gradually adding to your net worth by paying off the principal on

10:00the property. So if we're weighing up the opportunity costs from renting versus buying

10:03the main question we really want to ask ourselves is number one what would I be doing with that

10:07money instead if I didn't put that money for a down payment for a house or two what would I be

10:13doing with my money instead if I didn't rent and which of these options buying versus renting would

10:17get me more money in two years or five years or 10 years time. All right all of this is pretty

10:21abstract so let's try running the numbers using this cool rent versus buy model that my brother's

10:26company Causal has built which calculates whether we'll have more wealth in 30 years depending on

10:31if we buy or if we rent. And this is a pretty cool thing that you can use on your own if you want to

10:34I'll put a link down in the video description but basically what you can do is you can set all of

10:38the parameters that you care about when you're buying and all the parameters that you care about

10:41when you're renting. So let's look at the demo example let's say you're buying a house for one

10:45million dollars the down payment is 25 percent so 250,000 dollars the interest rate let's say is 3.5

10:51percent the one-off cost would be the sunk cost so let's say that's five percent of the property

10:54price let's say annual appreciation is between one and two percent and the cool thing about Causal

10:59not sponsored they really should sponsor this video but the cool thing about Causal is that

11:02you can literally write one to two and it would figure out and do the uncertainty calculations

11:06in the background and finally let's assume ongoing 0.5 percent property costs so that's all

11:11the buying related numbers let's look at the renting related numbers and let's assume that

11:14you might be paying two thousand dollars a month in rent and the rent is going to increase annually

11:18by annual appreciation so that's all taken care of and let's assume if you put that money in the

11:22stock market your return would be somewhere between minus two and eight percent so it factors the

11:27uncertainty and it takes that into account now in that scenario if we look at like what's happening

11:32further down the line in the year 2049 you'd actually be about twice as wealthy if you were

11:36renting rather than buying so with these assumptions that we've got here your wealth

11:41is twice as much if you just rented and put your money in stocks and shares rather than if you

11:45bought a house which is pretty interesting now the key thing to remember here is that your mileage

11:49will vary and the solution to every single buy versus rent dilemma is to run the numbers for

11:54yourself and see what happens so the key thing here is that our assumptions within buying is

11:59we're assuming that the house that we buy is going to appreciate annually by somewhere between

12:04one and two percent but let's change that assumption let's say actually you know house

12:08prices in the south of england increase by somewhere between three and ten percent every year

12:14so i'm going to write three to ten and now the model is going to figure out what would these

12:19numbers look like if that was my assumption instead boom and all of a sudden it's way better

12:23to be a buyer than it is to be a renter because this three to ten percent increase in in the house

12:28price over time is going to massively contribute to your compounding wealth over the long term so

12:32we can see by in the year 29 our wealth from buying the house will be somewhere between 3.5

12:36million and 15 million depending on the different uncertainty estimates whereas our wealth from

12:40being a renter would be 400 000 to 2.8 million dollars i'm now going to plop some numbers in

12:44here which are the numbers that i'm kind of thinking about when it comes to buying or renting

12:48a place in london which is genuinely the decision that i'm facing right now okay so if the house

12:51that i buy is for 1500 pounds or dollars or whatever the thing is uh the down payment will

12:55be 20 for 300 000 let's say the interest rate i can get on my mortgage is two percent actually

12:59let's call it two to four percent because that might vary over time let's say five percent one

13:03off costs one to five percent annual appreciation because i like to be conservative with that kind

13:07of estimate and let's assume one percent annual ongoing property costs and then renting let's

13:11assume i might want to rent a place that's four thousand pounds a month and let's assume the s&p

13:15500 will return minus two to eight percent here is what this model looks like over time and you'll

13:21see actually that for the first like you know 10 years there's actually not that much difference

13:25between me as a buyer versus me as a renter and really the true value is over time where you know

13:32in theory if i were to buy a place in london with all of these estimates my wealth would be somewhere

13:37between 2.5 and 6 million dollars four pounds whereas if i were to rent instead it would be

13:42somewhere between 600 000 and 4 million and you can see that these uncertainty estimates actually

13:47overlap and that's one of the cool things about causal it shows you the uncertainty inherent in

13:51your calculations because things like inflation rates might change things like s&p 500 performance

13:56might change so it factors all that into account you can see it's it's it's not as simple as renting

14:01is always money down the drain because for the first 10 years of this model it's basically

14:05equivalent and really it's only the compounding over time that makes a difference here so overall

14:09moral of the story is when it comes to the financial stuff don't believe the myth that

14:12buying is just better than renting on in all cases run the numbers for yourself and see what happens

14:18all right so we've discussed the cold hard financial side of renting versus buying and

14:22the causal calculator is pretty good but it doesn't take into account the psychological

14:26factors and that's where the res part of the smalls rule really comes into play now the first

14:31psychological factor to consider within the smalls rule is something that i call the roots versus

14:35wings effect now one of the big benefits of buying a house is that you're putting down roots somewhere

14:39you get this feeling of security and stability because you know that you have a roof over your

14:43head there's no landlord and you know that it is your proper home now i really didn't appreciate

14:48how important this effect is it turns out that moving houses is one of the more stressful

14:52experiences that we as human beings can actually go through on the flip side if you're the type of

14:55person who wants to live a life where you're moving around every two to three years or maybe even

14:59sooner than that then buying a house might actually stop you from doing this and this is the wings

15:04part of the roots versus wings effect although yes we do grow roots when we buy a house but if we've

15:08sunk most of our money into actually buying that house then we can lose our wings i.e our ability

15:13to just take off and do something else away from that place for example for me buying a house in

15:17cambridge actually kept me living there way longer than i really needed to and to be honest i kind of

15:22wish i'd moved to london a little bit earlier rather than staying in cambridge but it was the

15:25psychological factor of oh i own this flat over here that made me feel as if i needed to stay

15:30because it was the better financial decision now the second psychological factor is easiness and

15:34this is the e of the s'mores rule this basically describes how convenient life is to rent versus

15:39buy now there are some conveniences you get from renting that you just don't get from buying if

15:44you're like me you probably appreciate the fact that when you rent at least if it's in a decent

15:48place you can quite easily to get people to come over and fix things when your toilet isn't working

15:52or your boiler isn't working or the ventilation system is broken you just send an email or text

15:57to the landlord and usually if they are good they will sort things out without you having to physically

16:01call up a plumber or a carpenter or whatever to get things done but if for example you're an alpha

16:06male and you know how to use a hammer and a nail to fix things or if you don't mind that extra bit

16:10of time and effort that it spends doing it yourself or finding the right person to do it

16:13then this convenience factor or this easiness factor probably doesn't mean very much to you

16:17now if you own your house there are also a few massive conveniences for that for a start you

16:21can make as many structural changes or painting or decorating as you like without having the landlord

16:25breathing down your neck and worrying about your security deposit you also then have the convenience

16:29of feeling rooted like knowing that okay i've got this place and i know i won't have to move for a

16:33while which is an ease and convenience factor and then there's also the idea to think about that

16:37when you're renting you actually could rent a fully furnished place this is what i've done in

16:41london and so it's so convenient not having to lug furniture around and just being able to move into

16:45a place all of the things are there the sofa the beds the bedding the towels the plates

16:50knives and forks and all that crap which meant that moving to london was so easy for me because

16:54i was renting a fully furnished place rather than how it would have been if i were trying to buy a

16:58place instead so you can't underestimate that when it comes to the ease and the convenience as well

17:02now the final psychological factor to think about is savings versus mortgage repayments now this is

17:07the second s in the smores rule now buying a house is what some economists like to call a saving

17:11commitment device if for example you take out a mortgage to buy your house which most of us are

17:15likely to do then you need to make your mortgage payments every month to make sure that your house

17:19doesn't get reclaimed by the bank and this actually forces you to save enough money every month to be

17:24able to make those mortgage repayments now some of those payments are going to be interest you're

17:27literally throwing money down the drain because you're paying for the bank to give you the money

17:30to buy the house but some of that is likely to be the principle i.e you're literally repaying back

17:34the loan and so you're sort of forced to save money and put it into the house over time by

17:39virtue of your mortgage payments and so if you're the kind of person who'll struggle with committing

17:43to saving x percent a year and saving in the stock market or in crypto or building up your net worth

17:47that way then buying a house could be a reasonable forced saving device that makes you keep your

17:52spending in check and invest in your net worth over time in theory yes we could save the same

17:56amount of money if we just rented and invested the surplus in the stock market but in reality

18:00if we're renting and we don't have a serious commitment like being forced to pay off a mortgage

18:04then most of us are unlikely to ever save up the equivalent of a down payment plus monthly mortgage

18:08because honestly most of us are just not wired to save that much without a specific goal and a

18:12deadline breathing down the neck so making the serious financial commitment to buy can benefit

18:17us in the long run because it locks us into a pattern of building up our net worth through

18:21mortgage payments right so if you have been on the fence about buying versus renting or even if you

18:24haven't but you know you might make that decision further down the line hopefully this video has

18:28given you a little bit of food for thought do think about the components of the s'mores rule

18:32and do try running the numbers for yourself because buying is better than renting and renting

18:36is money down the drain is just absolutely not true it all depends on what the numbers and what

18:41the assumptions are over time if you like this video you should definitely check out this one

18:44over here which is my ultimate beginner's guide to investing in stocks and shares where we talk

18:47about all about how that works and how you can potentially be wealthier by renting and investing

18:53in stocks than you could by buying your own property so definitely check out that video

18:56thank you so much for watching and i hopefully i'll see you in the next one bye

Why Buying Is Not Always Better Than Renting - Ali Abdaal

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