From: fofp@castle.ed.ac.uk (M Holmes)
Newsgroups: soc.culture.british
Subject: Re: Salaries
Date: 13 Oct 92 14:22:32 GMT
Organization: Edinburgh University

hiscrp@nuscc.nus.sg (C R Pennell) writes:


>Question:
>	Assume a basic salary of 17,000 pounds a year. Before tax.
>	Assume that there is sufficient capital to buy house without
>having to take out a mortgage.
>	Is the salary enough to live on in S.W. England (husband, wife
>two small children)?
>	What do people think (restrain yourself, Laurence)?

I think you'd save an awful lot of money by investing that capital to
increase your income, and renting instead.

Here's something I did last month on the real costs of home ownership:

---------------------------------------------------------------------------


A consideration of the real cost of house ownership as compared to renting.
===========================================================================

An attempt to quantify the real annual cost of home ownership.


Definition of variables:
------------------------

V  - Current value of property
R  - Current mortgage rate
M  - Value of the outstanding mortgage
C  - Amortised costs  [1]
H  - House price inflation index
I  - Retail Price Inflation index

Notes
-----
[1] This would include:

(a) Transaction costs of buying/selling/moving not incurred by renting.
(b) Insurance of buildings
(c) Transaction costs of mortgage. e.g. Mortgage Indemnity Insurance
(d) Capital costs of furnishings 
(e) Repairs costs

These to be amortised over the period of ownership and annualised at a
percentage rate of the property value. A reasonable estimate would be 1.5%



Costs of Ownership (per annum):
-------------------------------

(a) Mortgage interest payments   [1]                  M * R
(b) Opportunity cost of capital  [2]                  (V - M) * R
(c) Amortised transaction costs                       V * C

Notes:
------

[1] This is calculated as the interest-only payment on the outstanding
mortgage.  The endowment payment on an endowment mortgage is invested on
behalf of the property owner and ultimately paid back in cash.  This
cannot thus be properly counted as part of the recurrent cost of
ownership.  Since anyone renting a property could equally undertake the
same investment, the endowment is not an issue in the comparison.  Note
that this scotches the argument that "a mortgage leads to ownership and
renting doesn't" since what is owned at the end is precisely this
endowment.  Similar arguments apply to the repayment part of a repayment
mortgage.  Issues of housing capital gains/losses will be addressed
within the recurrent costs argument. 

[2]  The cost of ownership includes the opportunity cost of the capital
within the value of the property which is wholly owned (i.e. the
difference between the property value and the mortgage value).  This
would be the expected rate of return on the capital if invested in
a vehicle with the same risk as property. Most businesses would expect a
return sigificantly better than base rates since they must pay
considerably higher than base rates for their loans. To simplify the
calculation though, opportunity cost is estimated to be the same rate as
the mortgage rate (R above). This is probably a conservative estimate.
From the point of view of a mortgage company, the return on the loan it
has made is by definition the mortgage rate, and since their money is
used to buy property, the risk is roughly equal.

Note that the lower limit for this factor should be zero. There is a
special case where the mortgage value is greater than the house value.
This will be addressed as an amendment to the equation below.


Benefits of ownership (per annum):
----------------------------------

(a) House value appreciation  [1]                    V * (H - I) 
(b) Debt deflation  [2]                              M * I / (1+I)
(c) Mortgage Interest relief (MIR)  [3]              min (30000, M) * R/4

Notes:
------

[1]  This is the house value increase in real terms. A property must
increase at least as much as inflation to hold its investment value. Any
gain over and above inflation is a recurrent benefit of house ownership.
Note that this factor can be negative.

[2] A further benefit to house owners is that any outstanding mortgage
on the property is reduced in real terms by inflation.  The debt will be
reduced in real terms by the formula M*(1-1/(1+I)) which is equivalent
to M*I/(1+I).  This is is properly counted as a recurrent benefit of
house ownership. 

[3] The tax subsidy towards house ownership is paid at the rate of one
quarter of the interest due on either 30,000 Pounds or the entire
mortgage outstanding, whichever is the lesser value.



Calculation:
------------

So the equation covering the annual costs of house price ownership
would be:

((M*R) + ((V-M)*R) + (V*C)) - ((V*(H-I)) + (M*I)/(1+I) + (min(M, 30000)*R/4)) 

or, cancelling out:

V*(R+C+I-H) - M*I/(1+I) - min(M,30000)*R/4   [1]                       {A}

This can be compared to the 6% - 8% cost of renting as
advised in a recent FT article.

Notes:
======

[1]  In the case where the mortgage value is greater than that of the
property (M > V), the opportunity cost on capital should not be
permitted to be negative. The equation for this special case is:

V*(C+I-H) + M*(R-I/(1+I)) - min(M,30000)*R/4                           {B}



Example:
--------

Using current average figures in the UK:

V = 60000             Average house value (approx)
M = 30000             Say a 50% outstanding mortgage 
I = 4%                Current Underlying Inflation rate
C = 1.5%              Estimated
H = -7.5%             Average House price index
R = 10%               Slightly below current average mortgage rate

So annual cost (formula {A})  =

60000 * (0.10 + 0.015 + 0.04 - (-0.075)) - 30000 * 0.04/1.04 - 30000 * 0.10/4

= 11896 Pounds per annum

or 19.8% of the property value.

Which compares rather badly to the 7% estimate for renting.


(C) Friends of Fernando Poo     Sep 1992
Newsgroups: soc.culture.british