Harry Geels: Three advantages of owning your own home
This column was originally written in Dutch. This is an English translation.
By Harry Geels
In discussions about taxation, there is often talk of ‘windfalls’ from home ownership – in other words, price rises that come for free. This claim is incorrect, but homeowners do enjoy a number of significant tax and institutional advantages.
In my previous column, I attempted to refute the argument that simple taxable windfalls arise from (the sharp rise in prices of) homes. This sparked a lively debate, during which several people also sought to refute or qualify the underlying calculations. As I had based my analysis on a specific case involving mortgage financing, some commentators rightly pointed out that I should also have applied an inflation adjustment to the debt incurred. This would have painted a somewhat rosier picture for the homeowner, which I acknowledge.
It was also argued that maintenance and renovation costs depend heavily on the condition of the property, so my conclusions could not be generalised. That is also correct. On the other hand, I had also left out another cost item, namely the buyer’s costs, although these were indirectly factored into the financing costs because, at the time, they could be co-financed in this case. Incidentally, my aim was not to provide an exact calculation. I wanted to demonstrate that by no means does every homeowner automatically become very wealthy.
Comparison with tenants
Another perspective on the matter concerns the comparison with renting. I did not make this comparison in my previous column because I was focusing purely on the widely held myth of getting rich for free through home ownership. In this column, I want to bring the comparison between buying and renting into sharp focus. After all, this too is relevant in the context of the discussion about potentially increasing taxation on home ownership. I have revisited the old case study of the owner-occupied home and compared it with a tenant who would have rented over the same period of just over 26 years.
To make the comparison as economically accurate as possible, I have also had the tenant take out a loan of €250,000. As renting does not involve buying a house, the borrowed amount is invested in a share portfolio. The aim is not to model a realistic household budget, but to compare the financial leverage enjoyed by the homeowner with a comparable level of leverage that the tenant could utilise.
To determine the rent, I have assumed an initial rent based on an initial yield of 5 per cent on a property comparable to the one purchased in the example (5 per cent of €250,000, or €1,042 per month). The rent then increased by 2.7% each year, in line with the average rent increase reported by Statistics Netherlands (CBS) over the period in question. Finally, for taxes and maintenance costs, I have applied a simple rule that these are twice as high for the buyer as for the tenant.
In this scenario, the tenant appears to be worse off. This is mainly because a securities-backed loan is considerably more expensive than a mortgage. However, if we disregard both the mortgage and the securities-backed loan, the differences between renting and buying turn out to be surprisingly small. In other words: if someone had already had €250,000 in equity in 1999, the choice between buying or renting (and investing) makes little difference in this scenario. Despite the substantial nominal increase in the property’s price, the tenant does not fall behind, as the initial capital can be invested.
Three advantages of home ownership
In a situation where someone has sufficient equity to choose freely between buying and renting, buying does not automatically prove to be more advantageous. This conclusion is remarkable, as the owner of a home is favoured in various ways. The first advantage is almost always mentioned in the political debate: mortgage interest relief. This has been factored into the example.
The second advantage concerns the tax-free allowance for the owner-occupied home (in Box 1). As the investment portfolio grows, the tenant must pay increasingly higher capital gains tax. Without this tax, the tenant in this example would end up with an investment portfolio of over €1.7 million. In that case, renting would even appear to be more favourable than buying. This second benefit of home ownership, like the mortgage interest relief, is regarded by some as unjustified. That is why it is regularly proposed that the owner-occupied home be transferred, in whole or in part, to box 3.
A third advantage lies in the financing structure surrounding homes. Banks generally charge a considerably higher interest rate on investments than on homes. From a financial perspective, this is interesting, as a home ultimately represents an investment too, albeit a highly illiquid one. Moreover, when buying a home, one is effectively financing a single, illiquid asset, whereas a global share portfolio is spread across thousands of companies. The fact that mortgage financing is available at relatively attractive rates therefore constitutes a significant institutional advantage of home ownership. The National Mortgage Guarantee plays a role in this.
Conclusion
When the proposition of ‘simple profit on one’s own home’ is not considered in isolation (as I did in my previous column), but is set against the alternative of renting and investing, a much more nuanced picture emerges. In the case described here, the differences between buying and renting turn out to be surprisingly small as soon as both parties have sufficient equity.
This outcome is remarkable, given that home ownership in the Netherlands already enjoys tax and institutional advantages, such as mortgage interest relief, the special treatment under Box 1 and relatively cheap mortgage financing. Without these advantages, renting actually appears to be the more favourable option in this case study. This makes it difficult to sustain the popular notion of home ownership as a source of easy and virtually risk-free windfall gains.
This article contains the personal opinion of Harry Geels
