What the RBA really said about renting versus buying

A Reserve Bank Research Discussion Paper on whether Australian housing is over-valued attracted considerable media attention. The bottom-line was that Australian housing is currently fairly valued, but that the average household might be better off renting now if, ‘as many observers have suggested,’ future real house price growth is less than the historical annual average rate of around 2.5% since 1955.

As it turns out, the ‘many observers’ actually referenced in the paper are the Reserve Bank itself, which makes one wonder whether the paper’s conclusion is part of its broader jaw-boning effort directed at talking down expectations for future house price appreciation.

In fact, the Reserve Bank’s paper makes an excellent case for being indifferent between renting or buying before the fact. The Bank makes use of the ‘user-cost’ approach, which focuses on the cost of occupying or renting a dwelling. This is in contrast to other widely cited but flawed measures of housing affordability that focus on the cost of acquiring rather than occupying a dwelling.

The user-cost of owner-occupation and renting should be equal in the long-run, because people can always substitute between the two if one becomes relatively more expensive.

The Reserve Bank shows that this has been true for Australia historically based on matched data for house prices and rents. In the short-run, there can be significant deviations from this long-run relationship. In principle, one could profitably substitute between owner-occupation and renting based on these deviations. But this is made difficult by the very high transaction costs associated with buying/selling and moving. It is these transaction costs that explain the short-run deviations in the first place, because they prevent a rapid adjustment to changes in the relative cost of owner-occupation and renting.

There will always be periods of time for which it is possible to show that, after the fact, a household might have been better off renting or buying. But before the fact, there is no reason to favour one over the other. We should be indifferent between renting and buying, especially at long time horizons.

A reduction in the transaction costs associated with buying and selling, for example, the abolition of stamp duty, would shorten this time horizon and bring the costs of renting and buying into an even closer relationship.

The bottom-line is, don’t sweat on the rent-buy decision.

Dr Stephen Kirchner is a research fellow at The Centre for Independent Studies, and author of Eight Housing Affordability Myths.