The benefits of homeownership are well documented, so much so that it’s often assumed that owning your own home is part of everyone’s life goals and securing a mortgage to buy it, like a rite of passage.

But what if I told you that renting a two-million-dollar home for $8,000.00 a month could have significant benefits over purchasing that same home via a 25-year, 5.00% mortgage? Can’t believe it? I’ll explain.

We’ve all heard that if you can purchase a property with mortgage payments less than or equal to the amount you would pay in rent, you should purchase a property. I was once so inclined until making the decision myself and realizing that comparing a mortgage payment to rent isn’t a mango-to-mango comparison. 

The argument is often that renting is “dead money” whereas owning a property will increase your net worth and property “always appreciates”. This may be true in many circumstances, but not all, and we must probe the assumptions behind the “dead money” statement as well as evaluate the opportunity cost of property ownership.

The dead money or “sunk cost” (money that has already been spent and cannot be recovered) of renting is straightforward: it’s the monthly rental payments. For purchasing and owning a property, the sunk cost isn’t as clear-cut. It’s not in fact the mortgage payment as some may think, because your mortgage payments are installations to fully owning your home. So rather, sunk costs of property ownership are property taxes, maintenance costs and the cost of funds or capital. These are the costs we should compare to rent.

Let’s begin with property taxes, given that it’s a current ‘hot topic’ in T&T. A simple way to calculate it is to multiply the annual rental income by 2.70%. 

For example, our $2M house, renting at $96,000.00 per annum ($8,000 per month) will have a tax of $2,592.00 or 0.13% annually relative to the value of the house. 

Rounding down for conservatism, let’s use 0.10% as our first input to estimating the dead money component of property ownership. We’ll also assume you are a first-time homeowner, so the one-time Stamp Duty tax is waived.

Next, we’ll look at maintenance costs which cover a wide range of expenses, from replacing a roof to repainting a room and all the things in between. The data on average maintenance costs are not readily available but anecdotal consensus seems to hover around 1.00% of the value of the home annually. Most Trinbagonians prefer doing their own home repairs and major maintenance isn’t an annual expense, so again, we’ll conservatively estimate the annual cost of maintenance to be 0.50% (so, our $2M house is estimated to incur $10,000.00 annually for maintenance).

Finally, we need to estimate the “Total Cost of Capital” which is how you finance your home and is typically made up of two parts. Most property owners finance the purchase of their home using a mortgage. Let’s say a new homeowner finances the cost of their home via a 10% down-payment (Equity) and the remaining 90% through a mortgage (Debt). The Central Bank of Trinidad and Tobago Data Center (CBTTDC) reports Commercial Bank Residential Mortgage rates over the period 1991 to 2020 averaged 8.82% p.a., however many property seekers will be familiar with the Trinidad & Tobago Mortgage Finance Company’s 5.00% ‘special’ rates for first-time homeowners. So, let’s conservatively go with this lower cost.

For the purchase of the property, we assumed a 10% down-payment from your own funds. On this 10%, there exists a “Cost of Equity”. When you purchase a house, you are making a conscious decision to invest in a Real Estate asset, as opposed to renting and investing what would have otherwise been used for the down-payment in Stocks, Bonds, or the entire universe of other asset classes. This alternative creates an “opportunity cost”, which is a real economic cost incurred by the homeowner. To calculate this cost, we will estimate the expected return for both Real Estate and Stocks. 

Important to note: At Firstline, we do not use historical returns as an indicator for future returns, but for the purpose of this piece, a good place to start is with the historical returns. 

The Trinidad and Tobago Retail Housing Index (net of inflation) grew 60.65% between 1991 and 2020 (or 1.65% annually) as per the CBTTDC website. Over the same period, inflation increased by 379.94% (or 5.56% annually), both contributing to the increase in housing prices. Therefore, we’ll estimate the after-inflation Return for Real Estate to be 1.65% + 5.56% = 7.21% per annum.

If, over the same period, we invested in stocks as opposed to real estate, the Trinidad and Tobago Stock Exchange (TTSE) Composite Index grew 1517.48% or a Real Rate of Return of 10.07% annually. 

The Cost of Equity is estimated to be the difference between the expected Return on the TTSE Composite Index and the after-inflation Real Estate Housing Index which is 10.07% – 7.21% = 2.86%.

Remembering that we are calculating the pieces that we need to determine how much is the dead money component when purchasing a home, all we need next is to calculate the Total Cost of Capital. Since the Total Cost of Capital will be made up of 90% debt and 10% equity financing, simply multiply the % financed by debt and the cost of the debt, then add that to the percentage financed by equity multiplied by the cost of the equity. For clarity, check the table below for the equation. 

So, the Total Cost of Capital is an estimated 4.786%

We have all the pieces, now it’s time to calculate the true Total Cost of Dead Money. To do that, we are going to add our calculated Annual Property Tax (Input 1), our Annual Property Maintenance (Input 2), and the Total Cost of Capital (Input 3). When putting all of the data in, we can now estimate that our Total Cost of Dead Money related to property ownership is 5.386% annually. 

Now, it’s comparison time. Recall that rent is dead money that is easy to see. Homeownership also has its dead money which includes Property Taxes, Maintenance and the Cost of Capital which we’ve just calculated.

By way of example, take the value of the home you are considering purchasing, multiply it by 5.386% and divide by 12. If you can rent the same property for less than that, then renting is an understandable financial decision. 

A $2,000,000.00 home would be estimated to have $107,720.00 annually, or $8,976.67 monthly in dead money.

It can be calculated the other way too. If you find a rental property that you love for $8,000, multiply that by 12 and divide by 5.386%. This works out to $1,782,399. In other words, renting at $8,000 is financially equivalent in terms of dead money to owning a $1.782M home. 

There is no doubt that using 5.386% as an estimate for the dead money component of owning a home is extremely simplified. When we begin considering portfolio diversification, changes in tax rates, outstanding mortgage balances, interest rates, GDP, and other economic indicators, the dead money cost changes. 

For example, if your investment portfolio were less aggressive i.e. not 100% equity (the TTSE Composite Index used in our calculations), the Cost of Equity Capital decreases. If we think of this in terms of making a financial decision, it will mean adjusting your dead money cost downwards.

Let me put it this way: one of the largest costs of owning a home is the opportunity cost of equity capital.

If you paid $2,000,000 cash for your home purchase but it’s only a portion of your portfolio, then this real estate investment represents a diversification and all things being equal, is a sound financial decision. If you paid $2,000,000.00 cash for a home, and you have nothing left, that means you chose to invest in real estate rather than anything else – like specific stocks, bonds, mutual funds or you know, having your growing wealth managed at Firstline Securities Limited (ahem).

Similarly, if the 10% deposit for a house ($200,000.00) is your total investable portfolio, my hope is that after reading this article, you think further before deciding to invest it all in a home. The difference between investing in real estate solely than any other asset class or a combination of asset classes, is an opportunity cost which homeowners will incur.