Where's the value in a home?

By MARY HOLM

Q. I'm in a dilemma. In the past 15 years of owning various houses we have always considered our home and mortgage as a sort of forced savings plan.

Having recently sold, we have been out looking for a new family home to accommodate three children and ourselves.

Meanwhile, we have invested the $650,000 net proceeds of the sale in three-month term investments netting 10 per cent after tax, and have rented a house of similar value for $27,000 a year.

Ironically, our investments are short-term first mortgages in the property market, up to 65 per cent of property value.

It's pretty easy to do the maths ($65,000 minus $27,000) and realise we are nearly $40,000 a year better off by renting - not to mention an end to maintenance worries.

Looking at the numbers, it appears that I should continue renting and forget buying a house. Am I missing something here? Are there some pitfalls in my thinking that I've overlooked?

If not, why on earth would anyone want to own a house, especially if the housing outlook over the next five years isn't much better?

A. First, your investment sounds almost too good to be true, and certainly too good to be safe. Are you sure it's bringing in 10 per cent after tax - which amounts to around 15 or 16 per cent before tax?

Assuming that's correct, we then add on a few per cent for the firm that takes your money and lends out the mortgages.

That means that some people out there are paying perhaps 18 per cent on first mortgages.

Who on earth would pay that much, when the banks are offering loans for almost 10 per cent less? People the banks don't want to know about, that's who. People who are quite likely not to pay back the money.

No doubt you take comfort from the fact that the loans are only up to 65 per cent of the property value. If the borrowers don't pay them back, the lender can foreclose.

But foreclosure is messy. It takes a while, and there are all sorts of legal and other costs. The net proceeds can be well below the market value of the property.

You might end up getting all your money back; you might not. In the meantime, there will probably be delays on your interest payments, perhaps for many months.

For all that, you might be lucky and your investments might be fine. If that's the case, are you right? Is it wiser to rent than buy?

You say you're gaining $40,000 a year - which seems about right when you take into account that you don't have to pay rates, insurance and maintenance.

Compare that with the capital gain you could expect if you owned a $650,000 house.

Figures from Quotable Value NZ show that, in the past couple of years, gains have been pretty tiny, at less than 1 per cent.

But we don't need to go back far to see a different story. Between 1993 and 1994, the average house sale price rose more than 12 per cent, and in the following couple of years it rose around 10 per cent a year.

Over all, from 1990 to 1998 - the last year in which there is complete data - the average sale price rose almost 6 per cent a year.

No one knows if that average rate will continue. Many factors affect it, such as inflation, interest rates and immigration. Similarly, no one knows if you will continue to make 10 per cent on your mortgage investment. So let's just work with what we've got.

A 6 per cent gain in the value of a $650,000 house is $39,000. It's not a lot different from $40,000.

You also need to consider your rental situation. Just as we looked at who was on the other side of the mortgage investment, let's look at who is on the other side of the property you rent.

Your landlord is bringing in $27,000 on a property worth around $650,000. The return is not much more than 4 per cent. And that's before rates, insurance and maintenance. She or he is probably not thrilled.

Even if your landlord sticks with the property, lots of other landlords are probably unhappy with the present market, and some will pull out.

If the supply of rental properties falls, rents will rise. Your $40,000 annual gain might well dwindle.

It's important, too, to consider non-financial issues. Sure, you've got no maintenance worries. But unless you have a long-term lease, you have the worry that your family will be kicked out every now and then. With three children, that's not easy.

Okay, you might be saying, but we seem to doing pretty well at the moment. Why not stick with it until the market turns, and rents rise or house values rise or investment returns fall?

The only trouble is that it's hard to tell when a market is turning. It might change direction for a while, then resume its old course. You can't be sure a trend has set in until it's well and truly happened.

By then, for instance, the price of a similar house might be $750,000 or more. For all your $40,000 gains, you might be worse off.

All in all - given that one way or another you have to accommodate your family and you've got the money to do it mortgage-free - I reckon you should buy another house.

The worst that can happen is house values won't rise much. Your present plan is quite a lot riskier, financially and in other ways.

Risk is fine with other savings, but not with the roof over your kids' heads.

Q. I have come to appreciate your weekly column and, while I often disagree with your conclusions, I do respect the educational aspects of your hard work.

That said, I am driven to write to you on two counts of disappointment, both of which relate to the cartoon/illustration that accompanies your column.

First, the cartoon frequently trivialises the nature of one or more points which you make - often in a childlike manner and detracting from the complexity and gravity of financial decision-making. (Take the case of the financial planner lighting cigars with a client's $100 bill, to name just one instance.)

Second, this cartoon takes up valuable editorial space.

My request is to see more in-depth/varied case histories for your attention and, to this end, for you to encourage your editor to see your column for what it is worth - the high value that your regular (and loyal) audience places on the topics that you cover.

After all, you are the only moderate alternative to Gareth Morgan's observations!

A. You don't understand. The cartoon isn't there for your enjoyment, but mine.

I get so bogged down in in-depth/varied case histories, the complexity and gravity of financial decision-making, and - worst of all - balancing the radical Dr Morgan, that the Herald art department feels it needs to brighten my life.

The high point of my weekend is when I open the paper on Saturday morning and see what trivialised, childlike picture the artist has come up with.

Got a question about money? Send it to Money Matters, Business Herald, PO Box 32, Auckland; or maryh@journalist.com Please note: Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number in case we need more information. Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.