Émile-Victor is a co-founder at Marker.io, a tech startup from Brussels. He’s reached an age where many of his friends have bought an apartment or are considering to buy one, and he’s wondering whether he should too. But he also knows about passive investing and he’s not quite sure what to do. Is he better off purchasing a home or using the money to invest in the markets? Which will be the best investment for him in the end? Let’s find out!
Let’s compare two scenarios. In the first one, we purchase a house. We get a loan from the bank, make a down payment, pay our mortgage every month, and we have some maintenance and insurance expenses for the house. Because of inflation, house prices tend to rise over time. So we expect our house to be worth more than we paid for by the time we’ve fully paid off the mortgage.
In the second scenario, we opt to rent instead and use the remaining funds to passively invest. We invest all the costs that we make in the first scenario, i.e. the down payment, mortgage, and so on… in index funds. We calculated in “Why you should passively invest your savings” that we can expect a good yearly return when investing in index funds.
At the end of the mortgage period, we compare the value of our house from the first scenario to the value of our investments of the second scenario. Which one is higher?
Before we start the simulation, we have to collect some data and fill in some numbers.
Scenario 1: buy a house
In the first scenario, we are buying a house. We make the following assumptions:
- We are buying a 1-bedroom apartment in Brussels, Belgium that is being sold for €300,000.
- The bank requires us to make a down payment of €60,000, which equals to 20% of the value of the house.
- We have to take out a loan for the remaining €240,000. I picked a random Belgian bank, BNP Paribas Fortis, through which we can get a loan of 20 years at a fixed interest rate of 3.58%. This means that we have to make monthly payments of €1,402.
- We pay a one-time registration tax at the purchase of the house (“droit d’enregistrement” in French or “registratierechten” in Dutch). The tax differs per region in Belgium but is set at 12.5% in Brussels1, which equals to €37,500 for our apartment.
- We have about €1,500 of yearly costs for maintenance. This is for renovations, fixing things around the house, and so on. This cost is subject to inflation and we use the Consumer Price Index to measure its yearly increase in price. In Belgium, the CPI has increased an average of 2.04% per year since 1988.
- Our home insurance costs €150 per year. This is also subject to inflation.
- We pay a yearly property tax of €800, again subject to inflation.
Our costs of being a homeowner for the next 20 years, the duration of the mortgage, are regrouped in the table below.
|Year||Total yearly costs =
down payment +
registration tax +
While we are paying back the mortgage, we expect that the value of the apartment will appreciate. We will then make a profit the day that we sell it.
In Belgium, changes in the price of houses are measured by the house price index. Following the numbers published by the Belgian government2, we calculate that house prices have increased an average of 3.41% per year since 2005. We project our €300,000 house to be worth €556,755 in 2039, 20 years from now.
Scenario 2: rent and invest
Now let’s look at the other scenario, where instead of buying a house, we rent for 20 years and passively invest what we would have spent on buying the house.
We estimate that the rent of a 1-bedroom apartment in Brussels is around €1,020 per month3. Due to inflation, rent prices are also expected to rise every year. In Belgium, the changes in rent prices are measured with the health index, which we calculate to have been growing annually by an average of 1.75% since 19964.
We can now project how much our total costs will be for the next 20 years if we rent. Since we are not owners of the property, we don’t need to cover maintenance, insurance costs or property tax.
|Year||Monthly rent||Total yearly costs = rent|
In this scenario, we are going to invest whatever we’re not spending. Every year, we are going to take the costs if we had bought a house, subtract the rent, and invest what is left. Let’s see how much that is.
|Year||Amount invested during year =
costs from scenario 1 -
costs from scenario 2
The first year, instead of making a down payment to the bank, we can invest a lump sum. During the following years, we invest whatever amount is left after rent. We invest in a broad mix of 50% stocks (MSCI World index) and 50% bonds (FTSE World Government Bond index hedged to Euro). A backtest analysis tells us that this portfolio has earned an average 7.7% annual return since 1985.
We also need to take into account the transaction tax for every investment that we make. When investing in index funds, the transaction tax equals to 0.12% of the total amount invested.
Finally, we have the data needed to answer the question. In 2039, 20 years from now, we estimate that:
- the value of our house will be €556,755 (scenario 1)
- the value of our investments will be €759,930 (scenario 2)
It looks like we end up in a better position if we rent and invest (scenario 2). Especially the downpayment and registration tax make a big difference, because an investment made early on compounds to spectacular sums of money over time. However, but the numbers are actually close enough that both scenarios are considered equally “good” investments. Indeed, a small change in one of the two most important parameters, the growth of house prices and the return of our index fund, can significantly change the result of the simulation. The most significant assumptions of our simulation are:
- The prices of houses keep rising at 3.14%. There are signs that Belgian houses are overvalued5 because the average income of Belgians has not grown as much the house prices. If the increase in house prices slows down considerably, passive investing becomes a much better option.
- The return on passive investing stays at around 7.7%. If the markets don’t do as well for the next 20 years, property will be a better investment.
There is too much uncertainty around these two parameters to make a confident prediction that you’ll be better off with one scenario or the other. However, the simulation has shown that you can’t go wrong with either investing in a house or investing in index funds.
Run the simulation yourself
I did all the calculations on a Google Sheets spreadsheet. Feel free to make a copy and change the parameters according to your situation or country (go to “File” → “Make a copy”). The parameters that you can edit are indicated in green. Altering one of the parameters will instantly re-run the simulation.
Doing this exercise forced us to think about the important parameters underlying our decision. We saw that both the increase in house prices and returns from passive investing are the two main factors to take into account.
The simulation taught us that both passively investing and buying property are good investments. Because of the unpredictability of the future, it’s hard to predict at this point which one is really better for our wealth. The simulations show that the strategy of renting and investing is a better investment long term than buying a house as an investment. If you do decide to purchase a property then make sure you cover your mortgage payments and continue forming the habit of putting money away and passively investing it on the side to grow your nest egg and have diversification.
However, if we step away from viewing a house as an investment, having your own home provides a sense of independence and safety that passive investing cannot give you. Whatever happens in the world, you’ll have a place that is yours. This is an important criterion that cannot be reflected in a simulation.
July 7th 2020
We made the following updates to the analysis:
- We took into account the registration tax when purchasing a home. At a rate of 12.5% in Brussels, this is a non-negligible expense and it was an important omission from our part in our initial analysis.
- We removed the 0.15% tax on securities accounts. The Belgian constitutional court annulled the tax in October 2019 so it’s no longer relevant.
- We changed the investment portfolio of the scenario where we rent and invest. A portfolio of 100% equities is not realistic, nor recommended for most people. Instead, we switched to a portfolio consisting of 50% equities and 50% bonds.
- We included the *transaction tax of 0.12% for investments in the analysis.