(00:00): So you've probably heard the
phrase that renting is money down the drain and you've been told your whole life that you should
get on the property ladder and buy a home because once you've bought a home, then you're saving
money and it's an investment and stuff and hey, at least you're not renting anymore and throwing all
that money away and setting it on fire. But it's actually much more complicated than that. Buying
and renting both have financial and psychological costs attached, and we need to take into account
all of those things when we're making the big buy versus rent decision. So that is what we
are talking about in this episode of Money Club, our ongoing series, where we discussed principles,
strategies, and tools that can help us along our journey towards financial independence.
Now for a long time, I also totally bought into this buying is better than renting mantra and I
followed the get on the property ladder by age X advice pretty religiously. When I started
working as a doctor, for example, I sold a bunch of Bitcoin at a loss of about $35,000
to buy a house in Cambridge with my brother and I also recently bought two flats in Manchester as
buy to let rental properties. But right now I am renting a ridiculously expensive flat in London,
so I've got plenty of experience from both the renting, throwing money down the drain and the
buying, making money, side of the equation. So the big question is it better to buy a
house early and hold it, i.e. buy in your 20s or 30s if you can, or is it better to rent,
invest your money somewhere else, and then potentially buy a house further down the line?
We're going to break this problem down into four main sections. Firstly, we'll talk about
the home buying bias, basically why everyone, especially your parents and grandparents,
think that buying is better than renting. Secondly, we'll talk about the S.M.O.R.E.S. Rule,
which is the mental model I'm going to use to break down this belief. Thirdly, using
the S.M.O.R.E.S. Rule, we're going to discuss the financial factors that factor into whether
we're going to buy or rent and fourthly again, using the S.M.O.R.E.S. Rule. We're going to look
at these psychological factors to consider when we are deciding whether to rent or to buy a place.
First, let's chat about why most of us have this home buying bias. The first factor is economic.
Now, historically house prices tend to appreciate, whereas you don't get anything back from renting.
So most people think that you are making some kind of investment when you're buying a house,
but that when you're renting, you are just burning through cash. I was talking to a
friend who grew up in Cambridge and he said that his mom bought their family house in
the centre of Cambridge for £18,000 back in the 1980s. As the city developed more
and more people want to live in Cambridge, so the housing market has done his thing,
the price has gone up over time and now that house is worth over £800,000, which is pretty good.
If that friend's mom had just rented all those years, then his family wouldn't have benefited
from this massive 10 X increase in their net worth over the last 30, 40 years. Okay, so
that's partly why we all think that OMG, renting is money down the drain, this is really bad,
but the decision about buy versus rent is a little bit more complicated than that,
which brings me onto our mental model for figuring out the pros and cons of buying versus renting.
Buying versus renting is an investment decision and that decision has two sides, one is financial
and the other one is psychological. The financial component is about making as much return from
your investment as possible and the psychological component is about making sure that your decision
makes you as happy as possible, which is a little bit harder to calculate. For example,
if buying a house means you need to move somewhere that you don't want to live and commute for an
extra hour on public transport, then you might be better off financially by buying a house,
but in terms of happiness, you'd be worse off there. With that kind of like balancing act in
mind, I've come up with my own framework for calculating the cost and benefits of
renting versus buying, which I'm going to call the S.M.O.R.E.S. Rule. Now each
lesser in the S.M.O.R.E.S. Rule stands for a factor that's important for us to consider
when applying the framework. So very briefly, S, for sunk costs. M for maintenance costs,
O for opportunity costs, R for roots versus wings, E for easiness and S for savings.
So whether we're buying or renting, we need to think about at least three types of financial
costs and these three costs make up the S and the M and the O bit of the S.M.O.R.E.S. Rule.
Now we're going to go through the costs in each of the cases of buying versus renting. The first
type of financial costs that we face are the sunk costs. These are the things that we pay
for as a one off, and we don't get any money back from them. When we think about buying a house,
most people think about the purchase price of the house. Like if the house is a $1 million property,
we think that the cost of buying the house is $1 million. The actual sunk costs are
the other fees that we have to pay on top of the $1 million to actually buy the house. These are
the costs that we don't get anything back from. And conveniently, there are four main types of
sunk costs when you are buying a house. The first is property taxes. Now, this is going to vary a
bit, depending on which country you're in because there are all sorts of different types of property
tax. Basically, it's a tax that you need to pay to the government when you buy a property.
How much you pay depends on how much the property costs and whether you're a first time buyer.
This comes in all sorts of shapes and sizes for different countries, like stamp duty in the UK,
which for most people is between 0% and 5% or general property tax in the U.S.,
which you pay to your state, which is usually between 0.2 and 2%. For example, this is what
property tax looks like in the UK, depending on if you're buying an extra property or your main home,
and whether you're buying a massive mansion or a small flat.
Second on the list. we have lawyer fees. You'll need to pay your solicitor to cover the cost of
all of the legal work associated with buying a house. This includes things like dealing with a
transfer of ownership, checking the paperwork is in order, checking whether are any environmental
factors that you need to do, like making sure your name is actually the thing on the deed,
making sure you have all the relevant planning permissions, anything that might give you a
massive pain in the bump further down the line. In the UK this usually costs between £1,000 and
£1500, depending on how much the property costs. And then thirdly we have the valuation fee. This
is what you pay to the mortgage lender to assess the value of the property
and to figure out how much they are prepared to lend you. Getting evaluation costs somewhere
between £150 and £1,500. Again, this is based on what sort of property you're going to get and the
type of mortgage you're getting and then there might also be some minor fees on top of that,
like mortgage arrangement fees. So fees that you might have to pay to arrange a mortgage or
surveyors fees, the money you have to pay to the surveyor. Overall, given that your property taxes
and stuff are likely to be maybe up to 5% of the home in the UK for any property above £250,000,
you can expect to pay more than 5% of the value of your home in sunk costs when you add on all the
lawyer fees, valuation fees and all that kind of stuff, and obviously if this figure varies
depending on which country you're in, but that is a very rough estimate for the UK and the U.S.
If you're renting the main sunk costs are a lot simpler. So firstly there is the rent you have
to pay, which here in London is about £1,400 a month for a one bedroom apartment and second,
you then have the cost of actually moving all your stuff into the apartment,
which can add up if you're moving quite a lot. The second type of cost that you get when buying
or renting are maintenance costs. Now these are things that you need to pay for to make
the place that you've bought or rented actually livable. There is this thing called the 1% rule,
which says that when you own a home, you should budget about 1% of the house price per year
for ongoing repair and maintenance costs, because all sorts of stuff can and will break
during the course of your home ownership, like a broken boiler, leaking drain pipes,
mould in the bathroom, all that kind of fun stuff. So if your house costs, for example, £300,000,
then you should budget around £3,000 per year for maintenance. Now, obviously the 1% rule is just
a very rough estimate, depending on how all your house is or it's conditioned or it's location, you
might need to put aside more or less than this, but it's a broad, rough brush stroke type figure.
If you're renting though, the maintenance costs are fairly low, if not zero, because upkeep is
technically the job of the landlord. That is one of the main perks of renting, but you do have
to pay a security deposit when moving in, so the landlord can make deductions if it turns out that
you've damaged a load of stuff or your dog has spilled red wine all over your sofa or anything
like that. The third type of cost you have to pay, especially when buying, is opportunity
costs. Now opportunity costs are kind of hidden and most people tend not to account for them
or even think about them. They're basically the potential benefits you miss out on by choosing one
thing over another. If, for example, you decide to study medicine for six years at University,
you cannot then also study computer science at the same time, at least in most universities. Not
getting to study computer science is then one of the opportunity costs of doing a medical degree.
So if I'm using my money to buy a house, I'm deciding to miss out on all of the other things
that I could have done with that money, like for example, backpacking around the world or paying to
go to business school, God forbid. Someone on my team, for example, my friend, Jamie, is thinking
of buying a house, but to do that he would have to sell all of his shares in Tesla, which he really
doesn't want to do because he thinks Tesla's going to go to the moon of the next 10 years.
So for him buying a house is going to result in the opportunity cost of that money is no longer
in Tesla stock. Similar to me, when I bought my flat in Cambridge, the opportunity cost was having
to sell my shares in Bitcoin or my Bitcoins and realise a loss for the Bitcoin, whereas had I
actually kept that money in Bitcoin, it would've gone up so much more than the price of that house
did over the last four or five years. The buying a house with a mortgage costs a lot of money.
The two big financial costs that make up the price of the purchase are, number one,
the down payment, which is a percentage of the total value of the house that you pay
upfront from your bank account and usually this is roughly 20%, although some mortgages are 25%
and some mortgages are 5% and some are 10%, but 20% is a reasonable down payment value. And two,
we have mortgage repayments. This is basically the money that you borrow from the bank to cover
the other 80% of the cost of the house and then you need to pay interest on that money.
Now this is a huge financial commitment. If you buy, for example, a $1 million house with a down
payment of 20%, you'll need to pay $200,000 upfront and then suppose that the interest
on your mortgage is 5%. If you pay back your mortgage over 10 years, which is pretty quick,
then you would have to pay $8,485 per month and you'd end up paying the bank over $1 million by
the end of those 10 years, the initial $800,000, which is called the principle and then $218,000 on
top of that, just to cover the interest payments. All right, let's now look at the opportunity cost
of paying that money to buy a house. Now in most decent cities, it's a safe bet
that your house is going to grow in value over time. So suppose that house prices appreciate,
I increase at 5% each year. That means that one year later your $1 million house will be
worth $50,000 more, so buying the house is actually a pretty decent investment,
but if you're paying for the down payment and the mortgage payments, you're also letting go of the
opportunity to invest that money somewhere else. So for example, instead of paying the $200,000
down payment and mortgage repayments, you could have invested all that money in crypto and
hopefully made more money than the value that the house will have appreciated by within that year,
fingers crossed. So for example, I sold £35,000 of Bitcoin in 2018 to buy a house, but with the
benefit of hindsight, that was a really bad move. If I'd kept that money in Bitcoin, it would be
worth £175,000 today, which is £140,000 in profit, which is way more than how much my apartment in
Cambridge grew in value since 2018, where that figure is somewhere between maybe 5 and £20,000.
Alternatively, instead of buying crypto, you could have invested that £200,000 into
something steadier like stocks in the S&P 500. If you'd invested the £200,000 into an S&P 500 index
tracker at the yearly average growth of 7%, then you would have over £283,000 in five years time,
which is a profit of over £83,000. Of course, we've still got a factor in accommodation. Like
you cannot live inside £35,000 of Bitcoin or a stocks and shares investment account
unfortunately, but buying a house means that you don't then have to pay rent. You only have to pay
mortgage payments, which are gradually adding to your net worth by paying off the principle on the
property. So if we're weighing up the opportunity costs from renting versus buying, the main
question we really want to ask ourselves is number one, what would I be doing with that money instead
if I didn't put that money for a down payment for a house or two, what would I be doing with my
money instead if I didn't rent, and which of these options buying versus renting would get me more
money in two years or five years or 10 years time? All right, all of this is pretty abstract,
so let's try running the numbers using this cool rent versus buy model that my brother's
company Causal has built, which calculates whether we'll have more wealth in 30 years,
depending on if we buy or if we rent, and this is a pretty cool thing that you can use on your
own if you want to, I'll put a link down in the video description. Basically what you can do is
you can set all of the parameters that you care about when you're buying and all the parameters
that you care about when you're renting. So let's look at the demo example. Let's say
you're buying a house for $1 million. The down payment is 25%, so $250,000. The interest rate,
let's say, is 3.5%. The one off cost would be the sunk cost, so let's say that's 5% of the property
price. Let's say annual appreciation is between 1 and 2%, and the cool thing about Causal not
sponsored, they really should sponsor this video, but the cool thing about Causal is that you can
literally write 1 to 2 and it would figure out and do the uncertainty calculations in the background.
And finally, let's assume ongoing 0.5% property costs. So that's all the buying related numbers.
Let's look at the renting related numbers, and let's assume that you might be paying $2,000 a
month in rent and the rent is going to increase annually by annual appreciation, so that's all
taken care of and let's assume if you put that money in the stock market, your return would
be somewhere between -2% and 8%, so it factors the uncertainty and it takes that into account.
Now, in that scenario, if we look at what's happening further down the line in the year 2049,
you'd actually be about twice as wealthy if you were renting rather than buying.
So with these assumptions that we've got here, your wealth is twice as much
if you just rented and put your money in stocks and shares rather than if you bought a house,
which is pretty interesting. Now, the key thing to remember here is that your manage will vary and
the solution to every single buyer versus rent dilemma is to run the numbers for yourself and see
what happens. So the key thing here is that our assumptions within buying is we're assuming that
the house that we buy is going to appreciate annually by somewhere between 1% and 2%.
But let's change that assumption. Let's say actually house prices in the south of
England increased by somewhere between 3% and 10% every year. So I'm going to write
3 to 10 and now the model is going to figure out what would these numbers look like if that was my
assumption instead, boom, and all of a sudden it's way better to be a buyer than it is to be a renter
because this 3% to 10% increase in the house price over time is going to massively contribute to your
compounding wealth over the long term. So we can see by in the year '29, our wealth from buying the
house will be somewhere between $3.5 million and $15 million, depending on the different
uncertainty estimates, whereas our wealth from being a renter would be $400,000 to $2.8 million.
I'm now going to pop some numbers in here, which are the numbers that I'm thinking about when it
comes to buying or renting a place in London, which is genuinely the decision that I'm facing
right now. So if the house that I buy is for £1,500 or $1,500 or whatever the thing is,
the down payment will be 20% for $300,000. Let's say the interest rate I can get on my mortgage
is 2%... Actually, let's call it 2% to 4% because that might might vary over time. Let's say 5%, one
off costs, 1% to 5% annual appreciation because I like to be conservative with that kind of estimate
and let's assume 1% annual ongoing property costs. Then renting, let's assume I might want
to rent a place that's £4,000 a month and let's assume the S&P 500 will return minus -2% to 8%.
Here is what this model looks like over time and you'll see actually that for the first
10 years there's actually not that much difference between me as a buyer versus
me as a renter and really the true values over time where, in theory, if I were to buy a place
in London with all of these estimates, my wealth would be somewhere between $2.5 and $6 million
or £, whereas if I were to rent instead, it would be somewhere between $600,000 and $4 million. You
can see that these uncertainty estimates actually overlap and that's one of the cool things about
Causal, it shows you the uncertainty inherent in your calculations because things like inflation
rates might change things like S&P 500 performance might change, so it factors all that into account
because it's not as simple as renting is always money down the drain because for
the first 10 years of this model, it's basically equivalent and really it's only the compounding
overtime that makes a difference here. So overall, moral of the story is when
it comes to the financial stuff, don't believe the myth that buying is just
better than renting on in all cases, run the numbers for yourself and see what happens,
So we've discussed the cold, hard financial side of renting versus buying and the Causal
calculator is pretty good, but it doesn't take it into account the psychological
factors and that's where the R and S part of the S.M.O.R.E.S. Rule really comes into play. Now,
the first psychological factor to consider within the S.M.O.R.E.S. Rule is something
that I call the roots versus wings effect. Now, one of the big benefits of buying a house is that
you're putting down roots somewhere. You get this feeling of security and stability because you know
that you have a roof over your head, there's no landlord and you know that it is your proper home.
Now, I really didn't appreciate how important this effect is. It turns out that moving houses is one
of the more stressful experiences that we as human beings can actually go through. On the flip side,
if you're the type of person who wants to live a life where you're moving around every two to three
years, or maybe even sooner than that, then buying a house might actually stop you from doing this
and this is the wings part of the roots versus wings effect. Although, yes, we do grow roots
when we buy a house, but if we've sunk most of our money into actually buying that house, then we can
lose our wings, i.e., our ability to just take off and do something else away from that place.
For example, for me, buying a house in Cambridge actually kept me living there way longer than I
really needed to and to be honest, I kind of wish I'd moved to London a little bit earlier
rather than staying in Cambridge, but it was the psychological fact of, "Oh, I own this flat over
here," that made me feel as if I needed to stay, because it was the better financial decision.
Now, the second psychological factor is easiness, and this is the E of the S.M.O.R.E.S. Rule. This
basically describes how convenient life is to rent versus buy. Now, there are some conveniences
you get from renting that you just don't get from buying. If you're like me, you probably appreciate
the fact that when you rent, at least if it's in a decent place, you can quite easily get people to
come over and fix things when your toilet isn't working or your boiler isn't working, or the
ventilation system is broken. You just send an email or a text to the landlord and usually,
if they are good, they will sort things out without you having to physically call up a
plumber or a carpenter or whatever to get things done. But if, for example, you're an alpha male
and you know how to use a hammer and a nail to fix things or if you don't mind that extra
bit of time and effort that it spends doing it yourself or finding the right person to do it,
then this convenience factor or this easiness factor probably doesn't mean very much to you.
Now, if you own your house, there are also a few massive conveniences for that. For a start,
you can make as many structural changes or painting or decorating as you like without
having the landlord breathing down your neck and worrying about your security deposit. You also
then have the convenience of feeling rooted, like knowing that, "Okay, I've got this place, and I
know I won't have to move for a while," which is an ease and convenience factor. Then there's also
the idea to think about that when you're renting, you actually could rent a fully furnished place.
This is what I've done in London, and it's so convenient not having to lug furniture around
and just being able to move into a place. All of the things are there, the sofa, the beds,
the bedding, the towels, the plates, the knives, and forks and all that crap, which meant that
moving to London was so easy for me because I was renting a fully furnished place rather than how
it would've been if I were trying to buy a place instead. So you can't underestimate that when it
comes to the ease and the convenience as well. Now, the final psychological factor to think
about is savings versus mortgage repayments. Now, this is the second S in the S.M.O.R.E.S. Rule. Now
buying a house is what some economists like to call a saving commitment device. If for example,
you take out a mortgage to buy your house, which most of us are likely to do, then you need to make
your mortgage payments every month to make sure that your house doesn't get reclaimed by the bank,
and this actually forces you to save enough money every month to be able to make those mortgage
repayments. Now, some of those payments are going to be interest, i.e., you're literally throwing
money down the drain because you're paying for the bank to give you the money to buy the house, but
some of that is likely to be the principle, i.e. you're literally repaying back the loan, so you're
forced to save money and put it into the house over time by virtue of your mortgage payments.
So if you're the kind of person who will struggle with committing to saving X percent a year and
saving in the stock market, or in crypto, or building up your net worth that way, then
buying a house could be a reasonable forced saving device that makes you keep your spending in check
and invest in your net worth over time. In theory, yes, we could save the same amount of money if
we just rented and invested the surplus in the stock market, but in reality, if we're renting
and we don't have a serious commitment, like being forced to pay off a mortgage, then most of us are
unlikely to ever save up the equivalent of a down payment plus monthly mortgage because honestly,
most of us are just not wired to save that much without a specific goal and a deadline breathing
down the neck. So making these serious financial commitment to buy can benefit us in the long run,
because it locks us into a pattern of building up our net worth through mortgage payments.
So if you have been on the fence about buying versus renting, or even if you haven't,
but you know, you might make that decision further down the line, hopefully this video has given you
a little bit of food for thought. Do think about the components of the S.M.O.R.E.S. Rule and do
try running the numbers for yourself because buying is better than renting and renting is
money down the drain is just absolutely not true. It all depends on what the
numbers and what the assumptions are over time. If you like this video, you should definitely
check out this one over here, which is my Ultimate Beginner's Guide to Investing in Stocks and Shares
where we talk all about how that works and how you can potentially be wealthier by renting and
investing in stocks than you could by buying your own property. So definitely check out that video.
Thank you so much for watching and hopefully I'll see you in the next one. Bye-bye.