Renting Vs Buying a Home | The 4% Rule

Homeownership is a goal we all aim for, but does it always makes financial sense?

Rent Vs Buy: The 4% Rule. Is it better to rent or buy? This simple rule will help you decide.

We'll also walk through all the costs involved with homeownership, so you can also work out a precise calculation fo whether it makes sense for you to rent or buy.

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00:00 Objectives
03:15 One Off Costs
04:27 Maintenance
05:11 Cost of Debt
06:10 Cost of Capital
10:59 Conclusions

[JamesShack]

Hopefully this video builds on Ben Felix's original, both in offering a European perspective and explaining some of the key points in more detail. Please check out his channel if you haven't already!

[ZohoExpert]

Absolutely love your videos!!

However, I own several rental properties and I manage well over 100 rental properties for other investors. Across these properties the average maintenance costs (including safety certificates that owner-occupier don't need) are 1% to 5% of rental income (nowhere near 28%!). I budget 10% because I'm super careful, but the reality is usually closer to 3%.

Another thing to consider is tenants do not care for properties the same way as owner-occupiers. Landlords have to pay contractors to do simple tasks that owner-occupiers would usually do themselves (unblock drains, replace keys, etc.). Therefore, maintenance costs for owner-occupiers should be a lot lower than for rented properties.

Also, the usual deposit on a rental property is 25%, therefore, the capital appreciation (which, like the stock market, has always been positive over the medium to long term - a lot more than 2% in my experience) is leveraged by 75% of the banks money. E.g your ROI is much higher if your property appreciates by 7% a year than if you held stock that increased by 7% a year. The stock market would have to appreciate by 4x as much as the house value just to equal the leveraged capital appreciation in the property.

Finally you have the rental income and cashflow. If you have purchased a "good" rental property your gross profit after mortgage costs should be at least 50% of the rent (in my personal properties it is approx 70%). Therefore, I'm making an approx 15% return on my capital (the 25% deposit, stamp duty, etc.) just from rental income. Then on top of this I'm getting leveraged capital appreciation of 8% (if the housing market appreciates at just 2% a year like you estimate, but in reality, it's appreciating a lot more).

I have 3x as much money invested in stocks than I have tied up in deposits in rental properties, but my rental properties make a hell of a lot more money every year and are FAR less volatile than the stock market (but to be fair I have previously tried to pick winners and now I'm only investing in funds and holding onto losers I think will recover).

Now I understand that your video is coming from the perspective of should you own your own home or rent. But a lot of the same principles apply. For example in the last 3.5 years my own home has gained about 30% I'm value (twice my initial deposit) and my mortgage costs are half what my rent would be for the same house.

As I say, I love your videos, please keep making such great content. I just wanted to give you a much more detailed understanding of the value of property investments.

Would love to collaborate sometime if you wanted to make more content on this topic.

[AmandaIrwin]

I just bought a first time home, same home I rented for 7 years. My rent was £700, mortgage and rates (Northern Ireland) is £545. So a great saving, but a joy to know in 30 years it’s something to leave behind for my child. I still have the same oil/electric etc costs. In my case I think owning is great as I don’t plan on ever moving away, so thankfully don’t need the flexibility of that 🥳

[christiannoone]

Hi James, it would be great to have an updated video on this now given the situation the UK is in with rates and what the next few years at least look like. You mentioned the cost of debt calculation to be 2% in this when it’s actually more like 5-6% currently so surely the weight is severely towards renting now?

[wonsunparque]

You calculated the return of owning a piece of real estate based on the total value of the home. However, for people who took out a mortgage, the initial capital that they put in is just the down payment, say 20%. That means, assuming the return of the real estate is 2% like you said, the real return of their capital is actually 10%. (They are using capital of 20% of the real estate value to gain 100% of the real estate appreciation) You have to use that 10% return to calculate cost of capital. Otherwise, it is not a fair comparison. Yes, you can argue that people can use that capital to invest in stocks and take out margin or bet on options, but that risk is significantly higher, interests rate is probably higher, and you are also subject to margin calls. Also, I am not an expert in this but I don't know how many banks are willing to give out margin that's 400% of their clients' capital. I'm not sure how many people in UK buy a property with an all-cash transaction, but I assume that more people have to leverage some to purchase a home than not.

[jackpowell]

One major downside to renting is stability. My mother has rented her whole life and been moved on when properties have sold etc. She recently was evicted after 8 years in a lovely house in her village with 3 kids at home and pushed into a really crap council house far away from her community as the landlord sold up. A devestating surprise on the run up to christmas too. The LL was also pretty crap with maintenance too. The stresses this caused were enormous, and while house prices in the past were in the realm of affordable, they're not now, particularly as she's too old for a long mortgage. I know this isn't really relevant to probably most of your audience, but its a look at how the situation could unfold down the line.

Great video as always!

[felipevillar]

I think you forgot about the effect of leverage from the mortgage debt which, for most, would tilt the decision towards buying.

[SupremeST]

One thing that you could do to mitigate the yearly (hidden costs) of homeownership is let the rooms in your house to lodgers. It’s legal to do this with a regular mortgage (so long as you comply w the tax implications) and you let your mortgage broker know in advance. This is something that you typically cannot do whilst renting, and you can always invest in the stock market in addition to paying off your mortgage however most people are aware of that and will still find this video handy like I did!

[goober-llwx]

I'd love to see this one updated for today's rates! So much change in 2 years...

[Sarkne]

Hi James, this is a great video and I agree with pretty much all points. One point perhaps overlooked is that if you are buying a house with 85% leverage and if you do expect 2% real growth rate in the long run, then your return on your equity is closer to 12-13% p.a. due to the effects of leverage. I fully appreciate 85% LTV’s make things a lot riskier if you’re caught trying to refinance in a downturn or if rates rise. You just can’t really get the same long term debt effect in stocks.

[jimmybacas]

This channel is one of Youtube's best kept secrets! I'm sure that will change in the near future 👍

[tristenbell]

Interesting, though not sure if I've missed something?

On a house worth £300k today, with £60k deposit.

Rent Option
£1000pm @ 3.3% of value with a great landlord who never increased rent over 20 years = £240k in rent
They invested the £60k @ 5% compound return and made £159k which is in the bank
They also squirreled away most of the difference in mortgage cost and saved further bringing total in the bank to c £230k
They have that to buy a new home or have to continue to rent and realistically either will be a lot more at this stage

Mortgage Option
£1325 initially on a 250k loan with total interest at 2.5% average at £68k
House value at 2% increase annually is now £445k, the full equity of course being theirs.
They don't have £230k in the bank but have a £445k house.

The difference here is nearly twice AND they have no further payments to make

[philtester]

I think you nailed it. Only additional comment I’d contribute is about how renting makes it easier to diversify your investment. Buying a house is usually a huge leveraged investment in a single asset the value of which could be reduced by unexpected changes such as the surrounding area becoming less attractive due to building development, changes to school catchment areas, reputation or even just anti-social neighbours!

[Azel]

Great video. One thing I will say is do NOT buy a home if you don't have an emergency fund or if you don't have leftover money after paying rent. I just bought a new home and within a month, we got hit by record-breaking cold and our heat pump broke. Normally a landlord will cover that, but I had to call an emergency tech on Christmas day and he charged $300 just to come take a look, plus thousands to replace. There is also property tax, increase in utilities if you're upsizing, and other costs mentioned in the video. Renting is much cheaper!

[chrisiles]

I’ve always seen buying a home as a way of giving my kid/s an asset and a financial step up on the ladder. I won’t ever see the benefit but if I can set them up financially with options that’s important to me personally

[chrisbowers]

The key advantage to buying comes when the mortgage is paid off - no rent much lower housing costs. It is much better to have bought a house in retirement than to be paying rent.

[PAZPERDEE]

Let’s not forget if you rent your landlord can kick you out if he wants to sell (with the right notice period), the costs involved with moving again and again isn’t cheap, another good video and raised some good points for me, call me old fashioned but I’d prefer the stability of my own home, thanks James

[matthewfaulkner]

A mortgage interest rate of 2% has a real cost of 0% after inflation. Also a real return of 2% on your property is an 8% return on investment in the 75% LTV scenario. So cost of capital is negative.

[coopert]

The Bank of England attributing most of the house price growth to a general trend of lowering interest rates through the decades was very sobering to listen to. I currently rent, but using a S&S LISA to hedge the opportunity cost/cost of capital against buying a house. Have never run the maths, but I'll presume that it'll works in the long run.

Subscribed!

[lillian]

Our current rent is basically exactly 4% of the cost of our home (just purchased) each year. We took into consideration that rent raises 5-10% in our area each year so in a few years the numbers will be a no brained to have bought!