21 February 2011

Never-ending capital growth

In my recent post, "Rent money is dead money", I highlighted that fact that there is lot more dead money when owning a house in comparison to renting. In the ‘Comments’ section, some people acknowledged this extra cost, but argued that house-price growth would more than offset this.

Anonymous, for example, said:

“Either way, a gap of $17,000 or $7,200 is a far cry from the appreciating gains a $500,000 property on average will give you. You do the maths!”


“If you want a good cost analysis of rent vs. buy, check out http://www.yourmortgage.com.au/calculators/rent_vs_buy/
Even in as little as a 7 year period, you will have a higher net wealth buy investing/buying a property compared to putting those savings into the bank.”

So I plugged some figures into the calculator and sure enough after just 7 years, I’d be better off owning, even after buying at these inflated prices.

Suspecting that a site called ‘Your Mortgage’ might be biased towards buying, I massaged the figures and still couldn’t find a scenario where renting was better. Getting desperate, I entered $0 as the rent amount. The result: “You need to buy a house now!!” – or wording to that effect. So even if I could get free accommodation for the rest of my life, apparently I’d still be better off paying for it!

Just as I was about to delete my internet browsing history so that my better half would never find this calculator to use against me, I scrolled down to the “assumptions” area.  And sure enough, they make the same mistake that Anonymous made, and that is to assume that house prices always go up – and not just at the rate of inflation (as occurs over the long term) but at a rate higher than both inflation and wages.  The website says:

“The appreciation rate on residential property is assumed to be 8%.”

You’ll often hear a similar claim from property spruikers – that house prices double every 10 years (which works out to 7.2% growth per year). And over the last couple of decades, this has been true. 

But is it reasonable to assume that this will continue indefinitely?

Well, let’s see what would happen to affordability if house prices continue to rise by 7.2% per year, while wages continue to rise by their long-term average of 5%. Here’s a spread sheet I whipped up.

You can see in the first row that the average wage is currently $60,000, and the average house price is $500,000. This means that you’ll need to work for 8 years in the average job to pay for an average house (up from the long-term average of 3 years). Of course, after first paying income tax on your salary and then adding all other costs associated with home ownership (and living), it would be about 3 times longer than that. But let’s keep this example simple.

Now let’s fast forward 100 years (the next highlighted row).  You can see that the average wage has grown to $4.8 million, while the average house price is $512 million – 106 times the average wage of the time. We will need some major medical advances to allow our great grandchildren to live long enough to pay back their home loan!

Fast forward another 100 years, and if house prices continue to outstrip wages growth by just 2.2% per year, the average wage will be $484 million, while the average house price will be $524 billion – or 1,363 times the average wage!

Of course that's ridiculous - but continual growth along the lines of the last 20 years is exactly what property spruikers are predicting and what the YourMortgage calculator is assuming.

Over the long term, house prices cannot rise faster than inflation and wages. True, they have over the last 20 years – resulting in house prices increasing to 8 times the average wage. But as the above example indicates, to assume that gap will continue to grow indefinitely when calculating whether it’s better to rent or buy is simply ludicrous.

Comments welcome.



  1. http://www.nytimes.com/interactive/business/buy-rent-calculator.html

    A much better Rent vs Buy calculator by the New York Times that lets you adjust anything you like.

  2. Chief Squirrel22/2/11 12:38 PM

    Hi Andy & Readers,

    There's a very useful, non-partisan Buy versus Rent calculator hosted at the NY Times.

    Sure it's American. Sure, you have to convert US terminology to Australian equivalents. (Annual Property Taxes becomes your local council rates; Down Payment = deposit etc)

    Punch in your relevant figures and you get a graphical view of how long you have to wait before buying becomes better then renting. There's even an advanced settings section where you can fine tune your input.

    What's most surprising about the resulting chart is not what happens when interest rates go up. Not what happens when you increase your deposit. Not even what happens when you buy a really expensive house.

    The chart gets scary when you punch in *realistic* growth percentages in the annual home price and annual rent sections. Growth only has to come down to around 3% (not that bad really) and the chart starts looking very bleak.

    I be really interested to know what results everybody gets!

  3. You can't put a negative figure in the 'Yearly appreciation on the home' box either (it just ignores the minus sign). But that's hardly surprising!

  4. Better still andy, work the house price and wage inflation assumptions of 8 and 5% back 100 or 200 years:

    You'll find that 200 years ago the average house could be purchased with 1.5 weeks average wages!!

    Hooray for bank silliness.

  5. Proof is always in the pudding. To see where we are going you have to look at where we have been. For most of you people discussing this debate you can only afford to look forward no more than about 30 years. After this retirement age starts to kick in. Now only the criminally insane would agree with charts above so let's not get excited. Sure, there will be some adjustments in years to come, but adjustments will be more along the lines of income growth and CPI outdoing property appreciation. Property prices will not simply crash 40% or so unless there is a catalyst, such as another GFC. Not very likely. Now I haven't entered the figures in myself but I bet even at 1% appreciation you are still better off buying. Anyone know?..................

  6. Gary,

    I think you should put 1% appreciation into the NYT calculator.

    Under that scenario buying is significantly worse, even after 30 years. So is 3% if you assume rents increase at 3%.

  7. Sure, there will be some adjustments in years to come, but adjustments will be more along the lines of income growth and CPI outdoing property appreciation. Property prices will not simply crash 40% or so unless there is a catalyst, such as another GFC. Not very likely

    I think you're a bit over-optimistic Gary. From the above table everyone who's sane can see that the gap between property price growth and wage income and CPI growth could not sustainably be maintained forever. At certain point in the future (sooner or later, but I would bet it will be sooner), the adjustment as you said above will come.

    Now please think objectively: which is more logical and reasonable in the situation where buyers in general cannot afford current inflated price and the highly-leveraged global economy starts to de-leverage and slow-down: average wage to increase and catch-up with property price as per your scenario or the property price will be down to allow reasonable affordability ?

    When global economy still in big problem due to GFC burden of debt, where can it produce growth to increase average wage above current normal rate ? Plus the effect of baby-boomers starting to retire in next 20 years and trying to cash-out their non-liquid investment properties at the same time ? C'mon be reasonable for once.

  8. Gary - according to my input into the calculator, at 1% growth, you are not better off owning vs. renting.

    But more importantly for the property market, how long do you think negatively-geared property investors will put up with property appreciation that’s not keeping pace with inflation?

  9. When my wife asks me when we're going to buy a house again, I always give the same answer... "look at the charts on the zeta oz housing forum"... and then she is forced to agree with me that the housing bubble MUST pop, soon. I've been telling her this for years and I'm certain the crash day will come, soon. For anyone else in doubt, look at the charts in the gallery below.....
    Can anyone seriously look at those charts and tell me Australian property is not in the midst of the greatest ponzi bubble ever? Indeed I have been telling my wife the market will crash for years, and rightly so. That was the reason we sold our lovely home at the beginning of 2009. As for our landlord yes he's a pain, but I can't really complain too much since it was my decision to sell and rent, and my wife is the breadwinner anyway. I want to get a secure home again and I'm kind of regretting selling, but I refuse to buy in the current ridiculous market. Sadly my choice of shares have been dismal laggards in our share portfolio, and the money sitting in my wife's bank accounts is going backwards since I advised her to move into cash. Again, yes, prices need to crash before we can afford to get back in the market, but my wife earns good money, so hopefully we'll be OK?


    Aussie Property Bubble - Continual News Feed

  10. Clogwog, you said:
    “That was the reason we sold our lovely home at the beginning of 2009”.

    But under my post “Rent money is dead money”, you said:
    “If I had bought a house a few years ago, I might have got onto the ladder but now I'm priced out.”

    Sounds like you haven’t got your story straight. You wouldn’t be sneakily trying to direct traffic to your own website, would you??

  11. I think clogwog is spamming, see similar post here

  12. Your arithmatic in the above spread sheet is doesnt look right. Compounding interest annually:

    At Y100(1) = 60k(1.05)^^100 = 7,890k
    At Y100(2) = 500k(1.072)^^100 = 522,936k

    At Y200(1) = 60k(1.05)^^200 = 1,037,555k
    At Y200(2) = 500k(1.072)^^200 = 546,924,119k

    Andy, you must be an Accountant of some sort?
    But I get the picture :)

  13. Good pickup Anonymous! I did get that wrong. I think it was just a rounding error - but it does bring the number of years required to pay back the loan to "only" 527.

  14. Just Plugged my rental into NYC rent vs buy at current rates, never even got over the line of better to buy, only at 8% pa appreciation did it start to say I would be better of buying, in 16 years.

    Think I'll keep renting a little longer

  15. well said Peter.

    I think the Ozzie version of this calculator referenced earlier - compare to the NYC one - just goes to show how half baked the Ozzie property market is!

  16. Hi Andy. The person who posted as clogwog on your site is an impersonator. I'm Clogwog on CreditCrunch and was on GHPC. I also am on Aus property forum, but don't post there as it used to be a trollsite set up by banned bulls/trollz. I'm not convinced that that isn't still the case behind the thin veneer of respectability. These imitations have popped up for various bearish posters in both MSM comments and more specialist economic/housing sites. Clogwog

  17. Continuing, Usually to cuckoo stories would contain some truth mixed with utter bullshit and slanted in a way that would put the original author in a less flattering light. Often they would appear after a vigorous exchange with certain permabulls, which lead me to believe Shadow/Strindberg/Nasty/FrankCastle/etc. to be behind it. But really who cares.

    PS. Yes I did sell my house in early 2009 in Brisbane, put the proceeds in Shares and cash, and have nearly all my assets in cash( and fx) since the end of last year. Now waiting for a FX hedge to work out and thinking about looking at property again in late 2012 as an inflation hedge. Clogwog

  18. Hi Clogwog, thanks for clearing that up.



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