Guest contributor: Jay L. Abramoff
This article presents a couple of figures, some facts, and a few ideas. It is not trying to convince Olim or anyone else to rent property in which to live. Doing so could drive up rental prices, which would not be in the author’s best financial interest.
A community’s housing price-to-rent ratio can be the most significant indicator when determining whether renting or purchasing a property is the healthier financial choice. In most communities in Israel, the price-to-rent ratio is about 30 and has been growing for at least 20 years. According to this Forbes.com article and other resources, that means renting costs significantly less than purchasing a comparable property in which to live.
For example, if the average purchase price for a three-bedroom apartment is 2 million NIS, and the middle of the average monthly rent is 5,500 NIS, here is the price-to-rent ratio calculation:
2 million ÷ (5,500 × 12) = 30.30
Turning that price-to-rent ratio on its head, purchasing a property in which to live generates an annual gross rent dividend of just 3.3%. After subtracting transaction fees, mortgage interest, maintenance costs, and other housing expenses such as income tax if relevant, the annual net rent dividend can drop into negative territory.
Looking beyond the price-to-rent ratio, purchasing a property in which to live can involve:
- Saving up for the down payment: In Israel, that can mean saving hundreds of thousands of shekels. Not exposing that savings to short-term market volatility can mean earning little interest, dividends, or capital gain on it, even if it is invested in a diversified manner.
- Opportunity cost: Then, using that money for a down payment means not investing it in healthier, more diversified options. That restricts investment flexibility and delays complete financial independence.
- Asset concentration: For most people, after purchasing a property in which to live, that property can represent a high and unhealthy percentage of their net worth concentrated on a single asset. Similarly, the mortgage payments can represent a high and unhealthy percentage of their current and future disposable income; the author has heard people call this struggling.
- Lack of liquidity: A purchased property is not liquid and usually cannot be partially sold.
- Higher scaling costs: When homeowners decide to move to smaller or larger properties, doing so involves transaction fees significantly higher than moving from one rented property to another. Those fees cut into and can completely wipe out the already-low rent dividend.
- Lack of geographic flexibility: Housing property in Israel is usually not mobile. When homeowners move and rent out the purchased properties, they only earn that low rent dividend on the property.
- Locked in for life: In most cases, to avoid appreciation tax (Mas Shevach) liability from a sold property, the seller must purchase another property within a specified period of time.
- Unrealized value: Appreciation value on a purchased property can only be realized after selling it, and then only if the seller moves either to a smaller, less-expensive property in the same housing market or to a lower-cost-of-housing area. This wouldn’t be such a significant issue if the purchased property didn’t represent such a high and unhealthy percentage of the owner’s net worth.
- No passive income: Unlike a diversified investment portfolio, a purchased property in which the homeowner lives usually cannot generate passive income. Even if the purchased property is rented out, the passive income it generates is only equal to that low rent dividend. In other words, a diversified investment portfolio worth 2 million NIS is financially healthier than living in a purchased property worth 2 million NIS. The diversified investment portfolio can generate a healthy stream of passive income that can be flexibly used to pay rent, other expenses, or reinvested. The purchased property usually does not generate any passive income.
Certainly, there are issues and challenges with renting, financial and otherwise. Those issues can be mitigated by choosing and embracing a rent-friendly lifestyle. That does not mean, for example, deciding not to have any children simply to avoid moving them every few years. On the other hand, it could mean, for a couple that has already decided to wait a few years before having children to establish some financial independence, also deciding to accelerate that financial independence by renting instead of buying.
A rent-friendly lifestyle can mean living with roommates. It can mean not accepting or acquiring items that take up space at home. It can mean moving to live closer to work, and riding a bicycle or walking to and from work. It can mean living in properties that simply are unavailable for purchase. It can mean all sorts of wonderful, healthy things.
As an example and to wrap up this article, the author brings to your attention an Oleh from Canada he met a while back. She decided to rent a three-bedroom apartment and to sublet two of the bedrooms, keeping her own housing expenses quite low. Now that is a healthy financial choice.
According to this website, for the 2019 tax year, the first 5,090 NIS of rental income can be exempt from income tax, but is not exempt from property tax (Arnona). However, in most cases, tenants pay the property tax; therefore, it does not affect the rent dividend.
Additional reading and resources:
- Calculators for mortgage costs and rental costs on the HaOtzar Sheli (My Finances) section of the Finance Ministry website (in Hebrew)
- Why your house is a terrible investment and The Simple Path to Wealth: Your road map to financial independence and a rich, free life, both by J L Collins.
This article is for informative purposes only and in no way is to be construed as financial or legal advice. Jay L. Abramoff is not a financial or legal professional. He is a technical writer by nature and profession; he is also Mustachian by nature. Since making aliyah in 1997, he has rented apartments and other living units (Yehidot Di’ur). Should you have any questions or comments regarding this article, feel free to contact Jay by email at email@example.com
Update: April 16, 2019