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Tuesday, December 20, 2005

Prices & rent v. buy

An economics lecturer in Auckland has posted this analysis on the housing issue:

I compared buying a $400,000 property versus renting it for $400 per week. These are realistic prices and rents in Auckland at the moment. Under the buying option I assumed a 10% deposit (i.e. $40,000) with the remaining $360,000 borrowed on a 25-year mortgage. Under the renting option I assumed that the difference between the mortgage payments and the $400 per week rent was invested (together with the deposit). Under buying I also assumed annual maintenance, insurance and property taxes of 1% per annum.

Putting this together with reasonable assumptions about growth rates of property values, growth rates of rentals, mortgage and savings interest rates revealed that after 25 years I'd be marginally better off if I rent rather than I buy...

I also used a simple econometric model to generate forecasts of real housing prices. On the Reserve Bank Website you can get data on a nominal house price index back to the late 1970s. By combining this with a consumer price index I calculated a real house price index (which I set to 100 at the beginning of my data series -- in the 4th quarter of 1979). I then used a relatively simple model to generate forecasts of this index. The forecasts look like this:

The following graph shows annual growth rates:

That's all very optimistic. If immigration continues to climb (and other people are talking about this too) then the demand that creates the price increases will still be there. The easy option of creating consumption by adding consumptive units is the thinking of a simplistic government choosing the most simplistic option. They don't care that it causes house prices to rise and now we have an even lower rate of home ownership than the UK! They don't care that it causes inflation of everything else as well - and they especially don't care for the infrastructural and social problems that occur because of it.

BAD: Inflation is too high, interest rates (because of the inflation) are too high, the exchange rate is too high (because of the interest rates), house prices are too high (because of immigration).
GOOD: Near full employment and are at capacity ie, max. production in many areas.

The problem I think is that the Reserve Bank kills off productive growth and rewards or encourages consumptive (ie. "plasma screen") growth through it's narrow policy rules and it's assumption that it is operating monetary policy successfully by expanding credit based on housing valuations. I beg to differ.


At 21/12/05 11:48 am, Anonymous RR said...

Anecdotally i believe price growth is as much being driven by aging Baby Boomers worried about retirement funding, and buying investment property with debt (typically 100% of the purchase price)in order to debt-fund their dotage, as from immigration. These investors tend to occupy the same market as first home buyers, therefore squeezing affordibility, contributing to the lowering of the home ownership rate. That figure used to be three-quarters of us, now it's two-thirds. This trend will likely continue until they all cash-up between 2010 and 2020. Perhaps it's as well in some ways there is an increasing number of landlords (with umpteen incentives under present law) to provide housing for the burgeoning number of tenants, who, in another era, may have been home owners themselves, either sooner or at all. Having said that, I'm sure many people who buy their own home, at their own expense because they're living in it, don't appreciate that they'll be paying back three times what they borrowed, over 25 years. You'd have to hope it triples in value over that time, just so you're even on the "investment". Who wants to be only even on an investment after 25 years?


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