Author Topic: Dutch Buy vs Rent: Bubble conundrum  (Read 3854 times)

ScroogeMcDutch

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Dutch Buy vs Rent: Bubble conundrum
« on: October 20, 2014, 09:37:37 AM »
Hello fellow mustachians,

Apologies for this very lengthy post – when I was writing it, it felt like I had to add more and more context. You can skip the “This is too long” until the “tl;dr” if you’d like :)

“THIS IS TOO LONG”

With all the mustachian knowledge here on the forum I would like to get my views on the Dutch real estate market challenged. Conventional wisdom in the Netherlands is that you should want to buy (the standard “you are throwing money away”-statement). Governmental intervention is done in such a way, that buying and living in your primary residence is promoted, unless you cannot afford to do so, in which case you can rent in a regulated part of the market and get subsidy to live there. My conundrum lies in the situation where you can afford to buy and to rent in the unregulated part of the market, as well as my calculations for buying real estate and landlording it. My view is that the Dutch real estate market is still a bubble waiting to deflate (even with -20% since 2008), and rent is not as bad as people make it seem to be. However, if I look at the monthly numbers again, it’s hard to argue against buying. I’ll break down the appropriate laws, facts and figures, and an example.

Appropriate laws

Mortgage rent deduction
If you have income from work, and you own your primary residence, you can deduce the interest part of your mortgage payment from your income. This comes down to a 42 or 50% tax break on interest payments. It is offset a little by municipal taxes and a so-called ‘eigenwoningsforfait’ which says you could have rented out that house as well, and missing out on that rent signifies income that should be taxed (0.7% of the value of the house is added to your income again). Don’t ask me why we made this as difficult as it is. In order to qualify for the mortgage rent deduction, the mortgage has to be paid off using annuities at least (faster is also allowed). This deduction is currently being restricted slightly, and has already gone through a few slight restrictions before, and a big one about 2 years ago.

Regulations of rents below € 700 monthly
If you want to rent a house below € 700,- (excluding utilities) you usually have to go to a corporation that owns these houses. These houses and rents are subsidized indirectly and as such, the corporations got a demand from the government to house people in them with a yearly income of € 34k or less. The rent is determined using a points-system, in which you get bonus points for size, age, location and so forth. The waiting lists for popular municipalities for such houses can be anywhere between 5 to 12 years, and if one is on the free market, it is not uncommon to have over a 1000 applicants for them.

Rents above € 700 are not regulated
These are the so-called freemarket rents. Even if using the regulated point system the rent would be below the 700 euro mark, if you rent it for more, the government imposes no additional rules. Typically landlords ask that potential tenants earn 4x the rent in brute income on a monthly basis.

There is a rent-subsidy for rents below € 700 if you have a front door
You can get a subsidy of up to € 328 per month if you rent a complete house. This means you have your own front door and do not share kitchen or toilet. A lot of students co-habitate houses here in the Netherlands and do not get this subsidy, even though renting a 20sqm/200sqft room in a popular city can easily set you back € 350,- per month.

Facts and Figures
  • The modal income for the Netherlands is € 33k (= ~2500 monthly) and the average household income is € 43.6k.
  • Building ground costs approximately € 400 - € 500 euro per square meter (~10sqft) and building ground is zoned by the municipal governments, for which this is a main source of income.
  • Appartments can range from € 100k for newish 40sqm or oldish 70sqm to € 200k for newish 100sqm. These usually have an additional service charge ranging between € 100 and € 300 per month. Of course, exceptions can be found.
  • Houses can be found ranging from €140k for oldish 70-80 sqm to € 190k for the average 100sqm “rijtjeshuis”. These houses will have anywhere between 70 and 100 sqm ground underneath them.
  • Prices in Amsterdam, Rotterdam, The Hague and Utrecht are about 20-40% higher than described above, where in low populated regions they can be about 20% lower.
  • Rent in the € 700 to € 900 range is very hard to find.
  • Housing prices exploded from 1995 to 2008, due to a few factors, but easier credit and the ability to count the 2nd income for mortgage were main factors in it. (See index below)
  • The Netherlands has 7.2 million homes, 4.1 of which are privately owned primary residences, 2.2 million of which are owned by corporations for (mostly) regulated rent, and 900k of which are owned by others and are for (mostly) unregulated rent.
  • More press for a law that allowed gifting up to € 100k tax free between parties injected about €5 billion into the market in 2014 only
  • Due to different taxes and services, there is about a 6% cost associated with buying a house.
  • About 30% of Dutch mortgages are aptly named to be ‘underwater’ in that the mortgage has a higher balance than the market worth of the house.
  • Households earning between 34k and 43k annually can hardly rent in the subsidized market or in the freemarket rent.
Index of housing prices in the Netherlands with 2010 index as 100
1995   37,6
2000   71,1
2005   94,4
2006   98,3
2007   102,5
2008   105,5
2009   102
2010   100
2011   97,6
2012   91,3
2013   85,3
2014 86,6

“TL;DR”

The examples below show how buying versus renting works out financially. The examples here are the ‘worst case’ you can find for renting, as it is the non-subsidized, market-go-crazy form of renting.

Example 1 of rent vs buy (relatively cheap apartment)
Let me take my own apartment as an example. The apartment is ~100 sqm located at the edge of a major city, near highways and was built in 2008. Rent is € 750,- without utilities and without service costs, or € 9000 annually. If I would follow the here often mentioned 2% or even 1% rule, it should be worth about € 75k, at the max. On the free market, I would expect this apartment from 2008 to be valued around € 140k at least, meaning rent was at 0,53%. Cost to acquire would be about 150k. In 2008 I know they were on the market for € 210k (which was an absolutely insane price even back then). Regardless, considering what rules of thumb are used on this forum, it is an absolute steal to rent.
However, should I decide to buy it with a 30 year fixed mortgage at 4% the costs would be approximately as follows:

150k mortgage @ 4% = € 6000,- interest in year 1

Monthly annuity payments would come to € 716,12 or € 8593,44 annually. “Eigenwoningforfait” equals 0.7% times the worth of the house, so € 1050 in this case. Taking these, the tax benefit would be € 6000 – € 1050 = € 4950 @42% tax rate = € 2079, bringing the net costs for living to € 8593,44 - € 2079 = € 6514,44 annually or € 542,87 monthly. Of course, in that monthly payment one would also be paying down the mortgage for about € 2500 in the first year. If the price of the apartment would remain constant, this would bring the net monthly costs to about € 320,-. Taking 1% as provision for maintenance, that would up to € 436,- or € 5240,- annually.

That is almost a € 4k per year difference in favor of buying, although considering MMM standards the rent is dirt cheap.

Example 2 of rent vs buy (expensive apartment)
This is another apartment that was both rented and sold. Apartment is located in the center of a major city and built in 2006. Rent was at € 1600 per month and sale price at € 469k, making rent 0,34%. The rent-price asked for these apartments was absolutely a steal. Using the same methodology as above, except in 52% bracket since something with that price is typically bought by people in the higher tax bracket.

Price to acquire – 490k, mortgage 30 years fixed @ 4%.

490k mortgage @ 4% = € 19600,- interest in year 1

Monthly annuity payments would come to € 2339,33 or € 28.071,96 annually. “Eigenwoningforfait” equals 0.7% times the worth of the house, so € 3283 in this case. Taking these, the tax benefit would be € 19600 – € 3283 = € 16317 @ 50% tax rate = € 8158.50, bringing the net costs for living to € 28071,96 - € 8158.50 = € 19913,46 annually or € 1659 monthly. Of course, in that monthly payment one would also be paying down the mortgage for about € 8500 in the first year. If the price of the apartment would remain constant, this would bring the net monthly costs to about € 950,-. Taking 1% as provision for maintenance, that would up to € 1340,- or € 16090,- annually. That would be about 3k per year cheaper to buy than to rent.

Note for apartment 2 is that you would need an income of about € 6400 monthly to be eligible to rent it, which is a very high brute-salary in the Netherlands (around 4% of households reach that threshold). These ‘rules’ which are imposed by the insurance companies and pensions funds owning those assets cause that there is basically hardly anything to rent long term that costs more than € 2500 monthly.


My conclusion – facepunch-time!

Phew – that took a while. If you’re still reading, thanks :)

If I look through the forces under law and regulations, price development and the facts and figures, everything about the price of real estate in the Netherlands makes me scream bubble. I would expect, combined with the deflationary situation in the Eurozone, that the prices will deflate further.

As I haven’t taken possible appreciation or depreciation into account in the monthly numbers, depreciation can make the ones for buying more negative. In the first equation, all other things equal, the buying situation could accommodate for 2.5% depreciation yearly to have the same net costs. In the second one, the room is only 0.7% due to the strange rent that was asked for these apartments. In most calculations the room would be about 2.5%.

I hope the post wasn’t too confusing. I tried to describe the Dutch situation as well as I could. Unfortunately I probably won’t be able to stay where I live now, as my girlfriend and I are looking to live together soon, and the city I live in currently likely won’t be a viable option for her.

The place we would be moving to has a bit higher prices than described above, for both rent and real estate price. We are looking to rent in the beginning, but the huge difference in costs when I look at it from the buyers perspective made me reconsider. My current rent comes in at about 40% of my net-income, and moving to that new area, even after combining incomes, we will still probably be at around 40% of combined income going to rent. Going to one of the <€700 subsidized rent is unfortunately not a possibility for me as I earn more than that threshold per year. From a market perspective, it still looks like a disaster waiting to happen on the Dutch real estate market. It looks very unhealthy.

Can I get some opinions and advice on this?

skunkfunk

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #1 on: October 20, 2014, 01:33:48 PM »
Buying is always going to carry more risk. I mean, I guess the market could sky-rocket and kill you on the other side, but you seem more worried about depreciation?

If you buy, are you going to be worried for years to come?

jnc

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #2 on: October 20, 2014, 03:25:50 PM »
We moved to the Netherlands in the last year and looking to but in Utrecht.
I think the prices have started moving up at least in our city.
I think the real estate bubble already burst here though I have not seem dramatic examples of properties losing a ton of value like you mention. In my limited experience, it seems to me dutch people borrowed the maximum so now even if their property is slightly less valued, they can't sell it without paying money out of pocket, money which they do not have since they bought the most expensive property they could afford.

Anyway I personally would not be buying my own house if I could not put down at least 20% of the house price. If you don't have the discipline to save that money ,  you should probably not be buying a property. Situation is different if it is a leveraged investment property.

The other thing I would mention is make sure you can count all costs of ownership such as tax, insurance and maintenance. It was not clear to me whether you factored that in or not.

Best of luck.
« Last Edit: October 20, 2014, 03:28:01 PM by jnc »

ScroogeMcDutch

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #3 on: October 20, 2014, 11:57:13 PM »
I took those into account the best I could, something like municipal taxes are obviously local. We would have the assets to put 20% down without too much of a hassle, and I get non-bank financing for another 100k, which would put a large range of the housing market in our reach.

I am just worried that the house prices are still inflated, if you compare them to the rents. I do not understand the large discrepancy between the two.

train_writer

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #4 on: October 22, 2014, 08:51:53 AM »
Poof that was a lenghthy post. I am hesitant what is smarter, but personally, I bought a house as we were tired of our landlords on the 'free market' and love our new city. I can anticipate on an annual 3% depreciation of housing value, as our mortgage is an annuity. We now pay 700 euros minus 160 euros tax deduction = 540 for a modest brick house.

EDIT: Of course, this is not in Utrecht city centre.
« Last Edit: October 22, 2014, 08:56:57 AM by train_writer »

Captain and Mrs Slow

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #5 on: October 26, 2014, 02:11:05 AM »
Quote
Rent was at € 1600 per month and sale price at € 469k, making rent 0,34%
K

Can you explain how you got this number, I get 1600 x 12 / 469K = 4% yeild

A gross 4% on a property is quite good, in many places you're lucky to get 1 to 2%

The tax aspect of the purchase was quite interesting, in Germany interest is not tax deductible.

I've been in the NL a few times and my impression is everyone lives in small houses vs apartments for the Germans. So what about costs for maintenance of common areas, is everyone responsible for their own area?

Rob

train_writer

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #6 on: October 26, 2014, 02:53:06 AM »
I've been in the NL a few times and my impression is everyone lives in small houses vs apartments for the Germans. So what about costs for maintenance of common areas, is everyone responsible for their own area?
Rob

You either pay a monthly fee for common services -including a common saving account for maintenance- or you are assigned a piece of street you have to keep tidy, which is the situation for small houses eg where I live.

ScroogeMcDutch

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #7 on: October 26, 2014, 06:18:50 AM »
Quote
Rent was at € 1600 per month and sale price at € 469k, making rent 0,34%
K

Can you explain how you got this number, I get 1600 x 12 / 469K = 4% yeild

A gross 4% on a property is quite good, in many places you're lucky to get 1 to 2%

The tax aspect of the purchase was quite interesting, in Germany interest is not tax deductible.

I've been in the NL a few times and my impression is everyone lives in small houses vs apartments for the Germans. So what about costs for maintenance of common areas, is everyone responsible for their own area?

Rob

The 0.34% was due to the rule of thumb that is used on this forum more often that a rental property should bring in at least 1% of it's value in rent each month or 12% annually in gross income, or it is not a good investment. 4% or 0.34% seems way too low to cover expenses and risks for the rental agency.

It is quite possible the percentages are lower in Europe than they are in the US though, but at the same time, why would it be so different?

Captain and Mrs Slow

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #8 on: October 26, 2014, 11:44:38 AM »
Interesting, never heard of the 1% rule, I personally tend to look at rental yield and whether the property is cash flow positive or negative. When you read about housing market the most oft quote ratio is Price to Rent Ratio and that is the one I’m most familiar with. Generally speaking

1-15 better to buy
15-20 better off renting
15+ bubble territory
Toronto On is north of 30
Vancouver BC is a bubblicious  58

Ryan Price (link at end) did a great article the cash flow rule, to quote “Generally, you can count on a property to cash-flow easily if the income is 1% of the purchase price ($1750 in our case).  This property was at a very comfortable 1.09%.  Depending on the property, you can be as low as 0.7% and still have a feasible property on your hands.  Any lower than that and you’ll have a hard time getting the property to pay for itself.” He goes on to say, and I agree, properties like this are extremely rare and properties  (1.09%) in good locations like this are like winning the lottery. More typical is the average condo investor in Toronto, typically it rents for half of what it costs to buy (5% down 25 year mortgage) so what -1%.

Quote
“....due to the rule of thumb that is used on this forum more often that a rental property should bring in at least 1% of it's value in rent each month or 12% annually in gross income”

This is so far from historical averages I'm stunned that anyone would believe this is normal. Kind of like the millennials in Canada thinking that it’s normal for house prices to go up forever! The only reason why the number is so high is that the US (and Holland) are still recovering from the effects of a massive housing bubble! Once things return to normal the ratio will decline to historical averages.

Financial Samurai (again link below) did what I consider a more realistic case study, in this case San Francisco. His number was .5 (5% gross yield) and he bought at the low end of the market. Once the market recovers it will return to a more normal 1-2 percent PER YEAR.

Also while the % rule is a good one it shouldn’t be confused with Yield or ROI. Typically good quality dividend stocks will yield between 2 and 4%, but the long term ROI in the stock market is around 7%. Rental yields  as mentioned tend to average 2-4% (higher lower depending on location) and long term ROI is at best the inflation rate.  So again the idea that one should expect a 12+ percent return in the housing market is at best delusional, at worse very dangerous to your financial health. But having said that if you can get find a property like that than nab it, this is a once in a life time opportunity!!!!!!

Ryan Price  Our First Income Property

http://www.ryanprice.ca/2012/01/16/how-we-bought-our-first-income-property-part-iii-due-dilligence/#disqus_thread


Financial Samurai  Real Estate: My Favorite Investment Asset Class To Build Wealth

http://www.financialsamurai.com/real-estate-is-my-favorite-investment-asset-class/


I'll respond to your comments about the Dutch housing market in another post.

BTW found your post quite interesting,particularly the tax ramifications (bit of a German tax nerd) of a house purchase thanks!


« Last Edit: October 26, 2014, 12:05:28 PM by Captain and Mrs Slow »

Captain and Mrs Slow

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #9 on: October 26, 2014, 01:02:11 PM »

ScroogeMcDutch

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Re: Dutch Buy vs Rent: Bubble conundrum
« Reply #10 on: October 27, 2014, 03:02:42 AM »
Explanation of that 1% / 2% rule of MMM on http://www.mrmoneymustache.com/2011/10/10/lets-buy-a-foreclosure-episode-2-what-is-the-50-2-rule/

The price to rent ratio for appt 1 would be 1:15, and for appt 2 would be 1:24, and to be honest I doubt it would be possible to find something below 1:15 in the part of the rent market over 700 euros per month.

What baffles me is the difference in net costs between buying and renting, which is obviously due to the tax breaks you get for owning your own residence. It just seems like there is still a lot of air in the house prices, and there is a big push from banks, government and municipalities to keep that price at it's current level. While I can imagine a scenario with the bubble deflating due to inflation, that only works if there is a notable inflation and not the deflation/inflation scenario ranging from -0.5% to 0.5% we have currently. However, currently about half of the younger households (age <50) are underwater on their mortgage compared to the housevalue, and the group over 50 is only 10%. That older group tends to have a lot of overvalue in their homes compared to their mortgage, which is mostly attributable to the large rise in prices at the end of the 90s.

I suppose I can see and understand the appreciation of the value of land in the more expensive cities, but all in all the situation still confuses me and leaves me in a pickle on what to do in the medium term (2-5 years)