Rent vs Buy: The bigger picture of your portfolio
The decision to buy property over renting it is a tricky one and I think it depends very much on the circumstances of how long you intend on staying there, how much of the property is funded with a loan, the return which you will get in the long run versus the return you would have received in other markets (impossible to know upfront) and the maintenance expenses you will have going forward (also very difficult to know). There is another factor that is very important and I don’t feel that it is taken into consideration enough when making this decision and that is your overall financial picture or portfolio.
If we take the portfolios of Michael Stanley and James Hope below we can see a very different picture:
Michael Stanley has greater diversity in his financial portfolio and the equity which he has in his property only contributes 15% to the total value of his portfolio. This means if this property had to produce some poor returns and even if he lost some of the equity he has on his property, his total financial portfolio would still be intact and remain strong given that this is only another piece of the puzzle of his total portfolio.
James Hope is a bit younger and since funding his first property with a very large deposit he has been channelling all extra savings into his bond. This property represents a significant portion of his total portfolio and a lot rides on this fact that this property needs to work out well for James given its weighting in his portfolio. Placing the majority of his capital into his property presents high concentration risk in this case since if the single area (or even street) which James has chosen sees demand shrink and returns to be muted, his total portfolio will be impacted quite significantly.
Just to touch on this return aspect a little more. I know a lot of people I speak to feel that property produces the most outrageous returns and have sometimes even confused residential property with listed property on the JSE (shares in commercial property companies).
So just to close that discussion the graphic below from FNB shows the inflation of house prices since 2008 or in other words returns of residential property year on year since 2008:
Now not to confuse it with the returns of other asset classes listed in the graphic below by Sanlam:
The returns of listed property (“SA Real Estate”) on the JSE, let me repeat that again, this is listed property companies whose business is commercial property on the JSE and the rest of the SA Equity market in this same period has produced returns considerably more than that residential property over the same period (although with higher volatility).
So you may tell me that your house has not performed like the average, maybe you got a valuation and determined your growth to be double that of the average, but this is exactly the point, these returns are so area specific and quite frankly rare to come by (given the average) at the moment that poor James Hope should be very worried with this responsibility of deciding which exact area to bet the farm on.
You may also feel that Michael Stanley has high exposures to the stock market if his retirement annuity, tax free savings account and the other investments he owns all have high equity exposure, however this exposure can be well diversified through different sectors and geographical locations he can use a few diverse ETF’s to give him local and offshore exposure to shares, listed property and even bonds. This means he is diversified across hundreds even thousands of countries, currencies and sectors.
I think before taking this big commitment we should take a bit more time to look at the bigger picture of ourselves financially and try to get ourselves into a position like the one Michael Stanley is in first so that we can sleep better knowing that one or two events isn’t going to make or break us.