Is there a price point beyond which it no longer makes sense to buy an apartment or house?

Question

I am in a very frustrating situation right now. I have accumulated a decent amount of value in cash and stocks. My wife and I however are still living in a rented small flat in our town in Austria where we are paying quite a high rent (600 EUR per month just for the rent without anything extra). We have been planning to buy a new or used apartment or if possible a house but real estate prices have been on the rise in Austria non stop since 2004/2005 to the point that in order to acquire even a small somewhat family friendly apartment, we have to pay around 300,000 EUR, with small houses even starting at 400,000 EUR.

Interest rates of course are quite low at the moment. However, fixed interest rate loans are allowed for a maximum of 20 years. We calculated that if we want to pay our current rent plus 100 EUR (700 EUR) a month as a monthly loan repayment, we would be able to get a 20-years loan of approximately 150,000 EUR which is half the amount we need to buy a small flat with one single bedroom for children. Which means that even with my decent savings, we cannot afford to buy even a small somewhat family friendly apartment for just one child (with one child bedroom).

At this point, the question arises — does it even make sense to buy an apartment to live in or is it now a better alternative to keep renting and wait for the real estate market to cool off? Median monthly income after taxes, pensions and healthcare in our region is 2,200 EUR by the way. How does a median income like that still allow homes to become this ridiculously expensive?

Answer 1

There are two ways to view this question. The simplest is the rough and ready approximation that you should be willing to buy a house for about 20 times the annual rent for a comparable house. With your rent of €600/month, that works out to a fair price of about €144,000, if the place you are thinking of buying is comparable to where you live now. If the place you are thinking of buying is an upgrade to where you live now (e.g. larger or better location), you would want to substitute the market rent for the new place for your current rent, but the principle is the same. Based on this crude approximation, buying looks very expensive compared to renting.

The other way to look at it is through the lens of discounted cash flow. The idea is you take a stream of present and future costs and returns, you discount them all to get the present value (costs will be negative, and returns will be positive), and you add them all up to get the net present value, which will be negative if the costs are more than the benefits, or positive if the benefits are more than the costs.

To do this calculation you have to pick a "discount rate", which is a measure of how valuable future returns are relative to current returns. There is no single "right" value for the discount rate, but numbers like 3% or 5% are common.

You currently have a stream of monthly payments (€600 / month) that, if nothing changes, will continue indefinitely (*). You are considering buying a house that will require monthly payments of €700 / month, for 20 years, plus an up-front payment that sounds like it will be another €150,000. Finally, you will have an asset that you will someday sell, perhaps in about 30 years (or perhaps sooner, this is another thing you have to guess at).

Calculating the present value is not hard, but it's a little tedious. There are calculators that you can put data into and get an answer out, or you can do a little programming using the formulas in the article I linked above.

Still, from the numbers above we can make some guesses about how the calculation will turn out. Buying the house involves a big up front payment, plus a larger monthly payment than continuing to rent. Therefore, if your rent were static, you would have to live in the house for a considerable period after it is paid off, or the house price would have to appreciate a lot, in order to come out ahead. If your rent were to go up, then you might come out ahead sooner, but it still doesn't look promising to me. Even if your rent goes up by 5% per year, it's not until the 4th year that your rent payments would be higher than the mortgage payment you are considering. You would need some very optimistic assumptions about appreciation in order for buying to be a better deal in less than 10 years or so.

So, to summarize, the crude approximation suggests renting is the better deal. The discounted cash flow is murkier due to all the unknowns you have to guess at (now you see why people have developed approximations and rules of thumb), but it broadly seems to agree with the 5% rule. In the end it's hard to reduce a decision like this to just numbers because there are a lot of intangible factors involved in buying a house, but your intuition that home prices are very high relative to rents in your area seems broadly correct.

(*) Your rent will probably actually go up in the future, but then again, so will the value of the house you are thinking of buying. As you can see, there is a lot of estimating involved in these calculations.

Answer 2

The calculation you are trying to make is laid out in some detail in the German context, that is mostly applicable to your situation, in the various books by Gerd Kommer (Kaufen oder Mieten etc.). I encourage you to read it. His end result is that in most cases, renting is financially more prudent than buying given the current market, assuming you take the difference between your rent and the mortage payments and stick it in an ETF or similar investment.

This has many reasons from the very renter friendly setting in Austria to the global market for investments. To answer your question about how this comes to pass: Houses are considered a safe investment by many investors and thus roughly correlate with the returns on bonds (simplified). That means a gross return of 2.5% (or a factor of 40 as real estate investors tend to phrase it) is considered OKish and roughly corresponds to slightly negative returns on long running bonds and also has expectations of raised rents in the future priced into it. If you want to pay off your house in 20 years, you are essentially assuming something in the 5% range of return, which is just way higher than the market currently bears. The end result is that it's probably not really feasible for the median income household to actually own a place in that setting. They are sadly simply priced out of the market.

Whether the market will cool off, as you imply, is a matter of speculation at least beyond the demographic point of view. I would tend to say that it will fall off once the boomer generation mostly passed away, which however will be too far in the future for you to sensibly wait for.

Answer 3

Instead of thinking about hypotheticals, lets run a basic scenario. My assumptions:

• Your rent is 600 EUR and will increase by 3% per year
• Real estate sale prices will increase by 3% per year on average
• Utilities are not included in your current rent and would be about the same whether you buy or rent (so we can exclude them from the calculus)
• Austrian real estate tax is 0.1% per year
• Mortgage rate is 2% over 30 years
• Downpayment is 10% of the house price
• You will lose roughly 5% of the house value when reselling due to various taxes/fees
• No PMI (mortgage insurance) is required in Austria
• Your alternative to buying is to put the cash into the S&P500 with a 7% projected growth rate
• Apartment maintenance costs are around 0.5% per year (quick guesstimate based on this page)

In this case according to my calculations, a 300k EUR apartment will be modestly more profitable compared to renting and putting your money in index funds. If you sell after 30 years, you will pocket a 16k EUR profit. If you can't get a 30 year/10% down mortgage, you will quickly start losing money instead.

This is primarily the case due to two factors:

1. Your current accommodation is very frugal
2. Buy-to-rent ratios in Austria are currently unfavorable, going up by 23% since 2010:

The primary questions I'd be asking myself are:

1. Can I guarantee being able to rent this apartment for 600 EUR/month (+inflation) for many decades to come?
2. As a corollary, will property prices grow slower or faster than rents in the future? My calculus assumes they'll grow at the same pace but this wasn't true in the past 12 years in Austria.
3. What's the minimum downpayment/maximum mortgage duration I can get from my bank? Anything worse than 10% down/30 years will be less profitable than what I've calculated as it reduces your leverage.
4. Will I want to move to a bigger apartment any time soon and how much it would cost me? If your choices are between a larger 1000 EUR rental and a 300k EUR apartment, purchasing becomes a lot more lucrative.
5. How much do you value owning a piece of property/land and all the freedoms that come with it?

Answer 4

Here's the issue that no one ever talks about. A piece of real estate always generates a rent. In an owner occupied home, you don't notice this because you pay and receive the rent. Essentially, you move the money from your left pocket to your right pocket, and the "transaction" is a wash. In this sense, a home is an asset that produces income.

Now that we have established that fact, you should treat your home as if it were an investment. Is the rent that you would get from purchasing higher than the interest payment from the mortgage? Remember, when you are in an owner occupied home, you pay both rent and a mortgage, but you get the rent from yourself. But the alternative if you own the asset is to turn around and rent it to someone else, for this exercise assume that you are two different people, the renter and the landlord. We'll look at it from just the landlord perspective. So the comparison you really want to make is the market rental income that you pay to yourself versus your expenses. Is this a profitable situation for you?

So take the market rent and subtract the interest payment from your mortgage, the principal is a transfer from your cash to your asset (the real estate) and doesn't do anything. Then subtract off any other expenses, like hoa dues, a monthly charge for repair and maintenance (1% per year is common), etc. Would you as a landlord be profitable if you bought this place to rent out? If the answer is yes, then you should consider buying it.

The next step is to take your hypothetical net income (from the real estate) and compare it to the purchase price. What is your annual yield on investment? Is that yield higher than the interest rate that you will be paying the bank? If so, then you can proceed. Is it higher than other investments like stocks? No, then you should consider not buying it.

That is the way to think about whether or not a piece of property works. Now, as for the affordability of buying and being able to make the monthly payments work in your budget. IF principal and interest is less than 33% of your take home pay, then go for it. You may have to cut back in other areas of your life, eat out less, etc. But here's the thing, a good chunk of the money that you are paying each month is a transfer from your checking account to the real estate asset. PRINCIPAL PAYMENTS ARE NOT AN EXPENSE, THEY ARE INVESTMENTS! Interest payments are expenses. In a sense it is forced savings, so don't worry too much about them as long as you can still eat, and pay the other bills, you are fine. 33% of net pay, should be doable for nearly anyone. Plus as inflation happens, your wages will go up and making mortgage payments will get easier.

It sounds like you need a mindset shift from a consumer mindset to an investment mindset when it comes to housing. The shift in mindset should help you feel more comfortable with purchasing, if A) it fits your lifestyle and B) the investment makes sense.

Answer 5

Not really. If renting or buying were clearly preferable, then that's what everybody would do (roughly). Instead they are just different, and different people at different points in their life might prefer one over the other.

The finances between buying and renting, while quite different, are mostly a wash overall. Either choice can go well or poorly for you depending on how things work out. Lots to argue about there - but that's how you know it's a close call. If it were obvious, then it would be, well, obvious :-)

Renting is much more flexible, with very little commitment required, but you have the risk that your rent will trend upward over time. You also don't have any of the responsibilities of ownership. You are just paying a monthly fee for a service provided to you by your landlord. There's a lot to love about this.

Buying requires a much greater commitment from you, requires a large cash outlay up-front, is much less flexible as far as moving around, and entails all the responsibilities of ownership. But you have full control over the property and can do whatever you want, and you are not subject to further increases in the cost.

I think if you know where you want to live long-term and have a stable lifestyle (meaning either you already have a spouse or plans NOT to have a spouse) then it makes sense to buy. Otherwise it makes more sense to rent.

Answer 6

Governments are choosing to support even median income families, recently, in both renting and homeowning. You might look for these subsidies.

The city of Vienna lists housing subsidies here. For a US comparison, the city of Boston lists housing subsidies here.

Answer 7

Answering the question:

How does a median income like that still allow homes to become this ridiculously >expensive?

A couple earning your stated median income each, 4.400€, with 60.000€ in savings (20% of your stated 300.000€ price tag), can afford to pay a 20 year, 2% fixed mortgage monthly payment of 1.214€.

I say, they can afford it, in the sense of 1.214 € being less than 1/3 of the monthly income which is normally considered the limit of a prudent monthly debt repayment by the banks.

On a note to the other question:

does it even make sense to buy an apartment to live in or is it now a better >alternative to keep renting and wait for the real estate market to cool off?

The alternatives that you have for your money to be placed is of crucial importance. If your are going to invest your money in stocks, the risk is far, far higher than if it is invested in your home. Even in cash it is not safe, as inflation will eat ir away.

So, how you allocate your money depends mostly on your personal risk management preferences.

Answer 8

Is it now a better alternative to keep renting and wait for the real estate market to cool off?

According to the given data - renting is preferred (financially).

However, if one is feeling compelled to own a home, I'd also consider:

• Building a new house
• Taking a larger mortgage (with variable interest)
• Make an extra effort to increase income/saving to reach at least 50% of the house/apartment price.

How does a median income like that still allow homes to become this ridiculously expensive?

Note that the renting price you mentioned is rather cheap if you compare it to other developed countries.

It may be infuriating, but buying real-estate is probably not for a single person with median income.

Answer 9

Seems like you are in an area where renting is cheaper than buying. That's great for you (see others answers for more details).

Another alternative to consider is to continue renting your flat and invest your money by buying a flat somewhere else more profitable solely for letting.

This way, you can keep the flexibility from renting, and still use the leverage effect which is the real reason (in my opinion) that makes buying and letting very efficient.

Answer 10

If you're trying to answer the fairly specific question of "is renting or buying cheaper in my area", there are two key numbers, that are loosely comparable, and can both vary significantly with time and between different areas: the rental yield and mortgage interest rates.

The rental yield is the fraction of the cost of a home you'd pay in rent during the year. It's generally a number of most interest to landlords, but if you know how much homes similar to your sell for, you can calculate it easily enough. Assuming your home is worth €300000, your €600 a month rent equates to a 4.8% rental yield (which is about what I'd expect).

Based on the other numbers you've put, it sounds like interest rates in your area are around 1.2% (which is a little lower than I'd expect, so my calculations may be off, and feel free to refer to numbers you've seen from mortgage lenders).

The loose sense in which these two numbers are comparable, is that if you took out an interest-only mortgage on a property, you'd be paying the interest rate and accruing no equity, roughly the same as if you were renting (although of course interest only mortgages are not a good idea if eventual ownership is your goal, and it's riskier, since you're on the hook for the cost of the house, even if house prices go down), and anything that you pay over that (whether into the mortgage, or into a savings account, or into another investment) is built equity either way. In some overheated markets, rental yields can be not much more than interest rates, or even slightly lower, whereas in markets where there's a lot of demand for rented accomodation (such as university towns) rental yield can be quite a lot higher.

It does sound like in your area, interest rates are relatively low right now, compared to rental yields. A mortgage may seem expensive, but due to low interest rates right now, the bulk of that cost is going to building equity - even if interest were zero right now, paying or saving €150000 over 20 years would still cost you €625 a month. So a mortgage is relatively cheap in your area right now, at least in terms of the interest, but the cost of building the equity is unavoidable, since you want to own your home outright at the end.

Answer 11

A couple considerations that, at present, haven't been addressed. What are the laws surrounding what your landlord can do? I know some jurisdictions tie the hands of landlords so that they can't unilaterally decide not to renew your lease or to raise rent to an amount commensurate with the for purchase market. As your own math shows, you are living at a huge discount to the broader real estate market. I'm guessing you're enjoying some rent control. Have you looked at what it would cost to rent a similar place? I'm guessing if you used those numbers in your buy vs rent calculation, it'd be much closer. If you are indeed getting a big discount to the prevailing market because of rent control then you may be able to cut a deal with your landlord where they pay you out to leave to make the math for buying better.

Answer 12

Answering the question posed by the thread title directly, I'm saying "no".

The key words from the question are "point" and "sense".

The word "sense" is a fuzzy term. There are prices at which you should obviously buy, and there are prices at which you should obviously walk. In between these there is a grey area, not a "point".

Answer 13

tl;dr: Rent money is gone, mortgage payments are an investment

I bought an appartment (in Germany) when I was fairly young and had landed a good job, and it was one of the best decisions I've ever made.

At the moment, you lose 600 € every month. This money simply disappears.

If you would pay the same money for mortgage, in the first few years, a large part of it disappears as interest and a small amount pays down the mortgage. But that amount increases as the mortgage is paid down, and this money isn't gone, it is turned into capital (your ownership of the place).

The main question is where you think the real estate market is going to go in the near future. If you think there will be a crash or considerable down turn, wait for that. If you think it will continue to go up, buy before it becomes even more expensive.

As a long-term trend, real estate prices almost always go up. Unless there's war, revolution or other such major events. That is why there is not a price beyond which real estate makes no sense - however there is a point where you can't afford it anymore, and there is a point where the return-on-investment is in such a far future that you don't care. (e.g. old money families often buy real estate that will be a good investment - in their children's time)

There are various calculators online, or a bank can help you as well, to make an estimate of how much you can afford to pay for mortgage. Do that, and then check if you can get a nice place for that money. Even more than in renting, buying is about being able to make compromises and finding good ways to finance the place.

Keep in mind that while mortgage is for 10-20 years, you typically calculate with 30 years - you will simply carry the remaining mortgage into a new contract.

Also keep in mind that most prices are negotiable. People might advertise their place for 400k but be willing to sell for 350k.