Should I buy or rent?

Originally posted on

Housing is easily the biggest expense in my annual budget and I’m not the only one to find this. According to a recent report by housing charity Shelter, 16.5% of British households spend more than 40% of their income on housing costs — one of the highest rates in Europe. Making the right choice on how I consume housing is important and anything I do to lower the cost will help me achieve financial independence faster.

There seem to be a lot of myths about housing, in particular the idea that renting is “a trap” and that buying a property is the only sensible emotional and financial choice. The fact that 61% of private renters expect to buy a home in the future (1) tells me what the public thinks about owning versus renting. However, having always been a contrarian I don’t gain a lot of satisfaction from following the crowd and would prefer to work out the best approach for myself.

Leaving aside the emotional reasons for owning a house over renting (2), I think the choice between buying or renting a house comes down to a simple question:

What is the expected return on my savings if I buy versus rent?

Both buying and renting have a set of incomes and costs. This leads to expected returns which will be different depending on the unique circumstances at the time you start:

Since you have to live somewhere, by definition you are giving someone an income stream. This is either your landlord (in the form of rent) or if you own your home, you (in the form of imputed rent (3)). In addition, you are likely to have some savings, which you can either invest, earning interest and/or capital gains, or buy a house, earning the imputed rent.

If you own then your deposit is locked up in the house, not earning dividends from share investments or interest income from bond investments. This is the opportunity cost of owning a house.

The key to knowing whether to buy or to rent is where you get the highest return for a given level of risk. To help me work this out for myself, I created a “buy or rent?” model. This model looks at how the relative returns (measured by net asset values) increase if you buy versus rent and invest over time.

The first step is to key in all the inputs. I’ve done this for something akin to the average flat in central London (sadly a two bedroom flat really does cost half a million pounds):

Other key inputs include your expected rate of return on your deposit savings in other assets (such as equities or bonds), and what you think will happen to both house prices and rental costs.

Once all those assumptions are made, the main event is on the next sheet.

As you can see, based on my inputs buying trumps renting over 5 years and 10 years by some margin. The return on the first year is much worse than renting though. This is because of the excessive costs of buying a house, mostly stamp duty.

Over 5 years, the returns from buying at 15.3% are double the returns of investing my savings in a portfolio of alternative investments. Note that the annualised return drops over 10 years to 14.1%, but the returns in the rental scenario have dropped more to 5.4%. This is because while the amount of leverage in the house drops (lowering the rate at which the equity grows) the impact of rent inflation has reduced the growth of the savings in the rental scenario faster.

This is not just a hypothetical example. This is real analysis I did before making an offer on a flat in London just a few weeks ago. I’m glad to say the offer has been accepted, but even more glad that I made the offer knowing that I had properly explore the alternative ways to grow my assets.

This approach could easily be extended to take account of other changes and circumstances. Going to be moving a lot for work over the next five years? Reduce the time period or add in more transaction costs. Think that interest rates are going to stay low? Put in a variable rate mortgage. Kept all your savings in an ISA? Drop the tax rate on the savings return rate. Think it’s unfair to compare equity returns to the returns on a highly leveraged property? Fair cop! Just adjust the returns on equity to suit.

I’ve made this model accessible on Google Drive. Feel free to download and play around with it yourself. If you have any feedback, please let me know.


(1) From the English Housing Survey Headline Report 2013–14

(2) Again, the English Housing Survey tells us that the average happiness of private renters is not much different to that of house owners:

(3) The lack of tax on imputed rent is one of major reasons why buying a house is so attractive in the UK (the lack of capital gains tax on capital gains being the other one).