Thoughts on renting vs buying in Tokyo

14 Jan 2023 | #japan | #money | #housing

Recently I’ve been thinking a lot about buying either a house or an apartment (mansion), or whether renting makes more sense for now. The primary aim of this post is to collect my thoughts, and record the decision so that I can revisit it in the future. It might also help others considering the same question, but that’s not the main intention (e.g. I will focus exclusively on my use-case and not cover other locations or sizes).

Situation

Real estate comes in all shapes and sizes, and Tokyo is huge, so it is important to note the constraints of my situation. My family has the current need of a 3LDK (one bedroom, two workrooms), and the long-term need of at least a 4LDK, maybe 5LDK (1-2 kids planned).

Location-wise currently we live near Mitaka station, and really like it, so we are looking for places around here. Mitaka station is a limited express stop on the Chuo line, and the stating point of the Chuo Sobu/Tozei line. The Chuo express takes 18 minutes to Shinjuku and 32 minutes to Tokyo station.

Available options

I have been looking at Suumo and Homes for places, and these seem to be the possible options in the size we need (3-5LDK) up to 20 minutes from Mitaka station.

Renting

It seems that we can find suitable mansions (3LDK, less than 10 years old, less than 15 minutes to station) for around 250,000-270,000 yen/month including management fee.

Buying a normal apartment

A 5 year old or younger mansion 15-20 minutes walk from the station. 60-70 sqm, 3-4LDK, 70-80m yen. Management fee: 10,000 yen/month, repair fund: 20,000 yen/month (might be lower initially, but tend to go up with time).

Buying a normal house

A brand new house 20-25 minute from the station in a residential area. 80-90 sqm house with 2 floors on a 100-110 sqm land. 70-90m yen.

Buying a fancy apartment

Brand new mansion less than 5 minutes from the station. 3LDK, 70 sqm, 120m yen. Management fee: 30,000 yen/month, repair fund: 20,000 yen/month (might be lower initially, but tend to go up with time).

Buying a fancy house

A brand new house 10-15 minutes from the station. 90-95 sqm house with 2 floors on a 110-120 sqm land. 130-140m yen.

Buying land and building our own house

A suitable land (100-130 sqm) goes for 70-80m yen 10-20 minutes from the station. This usually allows a 40-50% building coverage ratio with a floor-area ratio of 80-100% allowing for a 2 story house with up to a 100 sqm overall floor space.

Building a decent house seems to be between 20-50m yen (although this is where I have the least reliable data, basing this on other people’s posts online).

Overall this means that building the house ourselves would come down to about the same price as buying a new house that’s already built. Thus this options is close to identical of buying a house, so I will not consider this separately.

Costs of renting vs buying

Renting

This is relatively simple:

• Monthly rent
• Monthly management fee
• Renewal fee, usually 1 month extra rent every 2 years

When moving, there are additional costs, usually coming down to 1 month rent key money (non-refundable), 1-2 month rent deposit (mostly refundable), 1 month rent as real estate agency fee, additional random fees (cleaning, key replacement, etc.). If one schedules the moving before the renewal, then the extra fees end up being around 2 months’ rent.

However most rental contracts can be renewed indefinitely, and I don’t feel it is fair to assume moving regularly, when the alternative is buying, which makes moving very costly. Thus I will only use the renewal fee in the calculation, and assume that one rents the same place for the entire duration of the simulation.

Buying a property

Online sources suggest that the extra costs of buying a property (tax, real estate agency fees, bank fees) add up to 6-7% of the property’s price.

Selling a property

Online sources suggest 4% of the sale price.

There is an additional capital gain tax on the gains, which is 41.1% if selling within 5 years and 20% if selling after. In further calculations I assume that the property value doesn’t go up, so I won’t be considering this.

Moreover the same 20% capital gain tax is levied on normal investments, thus when comparing with the alternative investment it would be the same.

Owning an apartment

Costs of owning an apartment:

• Monthly mortgage
• Management fee - usually 10,000 yen/month (but have seen 30,000 yen too for an expensive place, and 20,000 yens for older places)
• Repair fund - this is to pay for maintenance of the building and shared spaces. Tend to start low (5,000-10,000 yen) and go up to 20,000 yen after 20 year
• Renovating the inside of the apartment - I’m putting this at 40,000 yen/month, which equals to 4.8m yen for 10 year that should be enough to completely renovate the place (new ACs, new wallpaper, new kitchen, new bathroom) - though I can be completely off with this one
• Property tax - Mitaka City has a property tax rate of 1.4% and a city planning tax rate of 0.225%, so 1.6% of the book value of the property. There are some deductions, and this is based on the property value determined by the city. Based on discussions with a real estate agent this comes down to 150-250,000 yen/year for the first 10 years then higher (first 10 year for new mansions is half price). Afterwards as the value is depreciating, it will keep falling. I will simply use 200,000 yen/year for the entire duration for the normal mansion and 300,000 yen/year for the fancy one.

Owning a house

Costs of owning an house:

• Monthly mortgage
• Renovating the house - I’d put this at 60,000 yen/month, which equals to 7.2m yen for 10 year that should be enough to completely renovate the place. This is 720,000 yen/year, so assuming a building price of 40m yen, this is would mean 1.8% of the value of the building. Considering the 1% rule, this might be an overestimate, but taking into account the lower building lifespan of Japanese houses compared to western ones, I think it is a reasonable estimate.
• Property tax - same as with the apartment, but this is split into the land (keeps the value) and the house (depreciates quickly). Based on discussions with a real estate agent this is 16-170,000 yen/year initially then it goes up to 200,000 yen/year after 3-5 years (again initially it’s half price then doubles, but as the building has depreciated, it is less than double). I’ll use 200,000 yen/year for my calculations for the normal house, and 300,000 yen/year for the fancy one.

Mortgage interest

Based on reddit the most common mortgage for your own home is a 35-year variable rate mortgage, which might come at an interest rate around 0.475%. Meanwhile fixed rate mortgages seem to go around 1% (although they have been going up recently due to interest rate changes from the Bank of Japan).

These rates are super low. Borrowing 100m yen on 0.475% for 35 years will make you pay back 108m, while on 1% it will come down to 118m. (As a comparison, at 5% this would be 211m.) These low rates make longer loans affordable and relatively cheap - thus the very long 35 year term (compared to other countries).

This also makes down-payments financially a bad idea: even if one could pay 10m of the 100m loan as down payment, it would make more sense to take the entire amount as a loan (assuming they could get the same interest rate). With a 1% interest rate on the loan, the 10m extra will cost them 11.8m in 35 years with a monthly mortgage of 28,229 yen. Meanwhile investing the 10m on the stock market (which historically brought 10% nominal, 7% real return) and paying the monthly 28,229 yen from this investment would make it grow into 53m in 35 years. Even if we go with a more moderate 5% real rate of return, we would get 22m for essentially free after 35 years.

Again based on reddit one can get a mortgage for more than the value of the home to cover the other initial costs (taxes, real estate agency fees, etc.). If one can get it at the same super-low rate, then doing this is also beneficial over paying it by cash.

35 years

35 years is scary long. It’s longer than how long I have lived sofar.

If I would take a 35 year loan this year, then I would pay it off in 2058. I would be 65 by then, so might be getting ready to retire. If we had a kid 2 years from now, that kid would be 33 year old by then, older than how old I am now. Meaning I could become a grandparent before I pay off this loan.

Scary.

Calculations

Constraints

• Zero down-payment. Mortgage for the full price and initial costs - the reasoning for this is explained above
• Fixed interest rate at 1%
• Inflation is assumed to be 1% - this is required to increase rent, management fee, repair costs, while mortgage stays the same
• For the scenarios where I sell, I assume no change in the market (as I can’t predict the future), meaning:
  • The price of land increases with inflation (1% yearly)
  • The house depreciates linearly for 25 years, then it’s worth 0, while the land maintains its value
  • The mansion depreciates linearly for 50 years, then it’s worth 0. To simplify the calculation, the land that belongs to the mansion unit is not taken into account for future value.

Outcome

For every year I calculate the following:

• Remaining principal of the loan (if I sell that year, this is how much I need to pay the bank to close the mortgage)
• Remaining value of the property (based on the assumption above)
• Money received if selling (this is the remaining value minus the 4% fee of selling)
• Balance if selling and paying off the remaining principal with the money received from selling
• The opportunity cost compared to renting: if I pay less when renting, then I can invest this extra money and get a 5-7% real return. Meaning after selling the property I don’t only need to break even, I need to beat this as well to make it more beneficial than renting. I’ll be using 5% real return for this calculation, so 6% nominal return with the 1% inflation.

Renting

Monthly rent of 250,000 yen, 10,000 yen management fee and 1 month renewal fee every other year, resulting in a 270,417 yen cost per month, increased with inflation every year.

Buying a simple mansion

Price: 75,000,000 yen, which is 80,250,000 yen after the 7% initial costs resulting in a monthly mortgage of 226,534 yen. This is paid off after 35 years.

Additional costs are: management fee of 10,000 yen, building repair fund of 20,000 yen, inside repair saving of 40,000 yen and property tax of 16,667 yen, bringing the monthly non-mortgage fees to 86,667 yen. This is increased with inflation each year.

The overall initial monthly cost is 313,201 yen, which is 42,784 yen more than renting.

It takes 14 years for the resale value (minus fees) to overtake the remaining principal, meaning if I would to sell before that, then I would have to pay extra to the bank just to close the mortgage. However by this time time in the renting scenario I have invested the extra 42,784 yen (+ inflation) each month, and it has grown to 7,623,400 yen.

After 35 years the mortgage is paid off, and I can sell the mansion for 20,160,000 yen (after paying the selling fees). However by this time the invested 42,784 yen/month (+inflation) would have grown into 21,942,217 yen, making renting a slightly better decision even on the 35 year time-frame.

After 35 years the mortgage is fully paid off, so I can live for free (barring management fees and maintenance), so after an other 5 years the overall value of buying overtakes rent. (Even though at 35 year the difference is only 5% it takes 5 year to close that gap due to the value of the mansion continuing to decrease while the investment keeps growing 6% yearly.)

Conclusion: with the above assumptions you have to live in the mansion for at least 40 years to make it financially beneficial compared to renting

Tuning the parameters

What if rent is 10,000 yen more, so 260,000 yen instead of 250,000 yen?

Then buying a mansion makes sense after only 22 years, so almost half the time. This is mostly due to rent growing faster with inflation, and it will overtake the mortgage and fees after 16 years, from which point on the monthly cost of renting will be higher than the mortgage and fees offsetting the earlier savings in only 6 years.

What if the mansion still has half of its nominal value after 50 years instead of going down to zero?

Buying a mansion becomes financially beneficial after 10 years, and at 35 years the mansion’s resale value (minus fees) is at 46,080,000 yen, while the alternative investment only grew to 21,942,217 yen.

What if interest rate is only 0.3%? (This seems to be around the lowest variable rate currently. I’ll assume it stays the same for the entire time.)

The monthly mortgage is down to 201,302 yen from 226,534, making it more beneficial to buy after 13 years.

What if inflation is only 0.5%?

Then it takes 60 years for buying to make more sense than renting.

What if the price of mansion increases by 1% yearly (equal to the rate of inflation)? (Depreciation is still taken into account.)

Then it takes only 14 years for buying to overtake renting.

What if the price of mansion increases by 2% yearly (1% over inflation)?

Then it takes only 7 years for buying to be better.

What if the price of mansion decreases by 1% yearly?

Then it takes 43 years for buying to overtake renting. At this point the value of the mansion is close to zero, so this is mostly due to living rent free for the previous 8 years, while rent keeps going up with inflation.

Buying a simple house

Price: 90,000,000 yen, which splits into 70,200,000 yen for the land, and 19,800,000 yen for the building. This becomes 96,300,000 yen after the 7% initial costs resulting in a monthly mortgage of 271,841 yen. This is paid off after 35 years.

Additional costs are: repair saving of 60,000 yen and property tax of 16,667 yen, bringing the monthly non-mortgage fees to 76,667 yen. This is increased with inflation each year.

The overall initial monthly cost is 348,508 yen, which is 78,091 yen more than renting.

It takes only 5 years for the resale value (minus fees) to overtake the remaining principal, meaning if I would to sell before that, then I would have to pay extra to the bank just to close the mortgage. However by this time time in the renting scenario I have invested the extra 78,091 yen each month, and it has grown to 4,899,647 yen. This 5 year is much shorter than the mansion’s 14 year, mostly as the land is assumed to appreciate with inflation, while the mortgage stays fixed, making the overall depreciation less than the mansion’s.

After 8 years buying is more beneficial than renting, again mostly due to the land’s value increasing with inflation.

After 35 years the mortgage is paid off, and the land still has a resale value of 96,422,370 yen (yearly 1% increase, minus 4% selling fee), while in case of renting and investing the monthly 78,091 yen difference (plus inflation), that investment would have only grown to 69,881,681 yen. So about 28% less. Comparable, but less.

Interestingly even after 50 years (so 15 years after the mortgage is paid off), the difference remains very similar: the resale value of the land is 111,943,378 yen, while the alternative investment has grown to 84,448,793 yen (25% less). Again even though the mortgage is paid off, the alternative investment grows faster than the value of the house land slowly closing the gap.

Conclusion: with the above assumptions you have to live in the house for at least 8 years to make it financially beneficial compared to renting, however even after living in the house for 50 years, you are only 33% better off than renting

Tuning the parameters

What if rent is 10,000 yen more, so 260,000 yen instead of 250,000 yen?

After 7 years buying is more beneficial, and after 35 years the resale value of the land is 96,422,370 yen while the alternative investment only grew to 52,922,561 yen (46% less).

What if interest rate is only 0.3%?

Mortgage is down to 241,562 yen from 271,841 yen making buying beneficial from the 5th year. After 35 years this makes the alternative investment worth 26,963,178 yen while the house’s resale value is 96,422,370 yen.

What if inflation is only 0.5%?

Then it takes 12 years for buying to make more sense than renting (up from 8 years at 1% inflation).

What if the price of the land increases by 2% yearly (1% over inflation)?

Then it takes only 5 years for buying to be better, and by 35 years the resale value of the land is at 137,472,088 yen, while the alternative investment only grew to 69,881,681 yen (49% less).

What if the nominal price of land stays the same (so it doesn’t increase with inflation)?

After 7 years the resale value passes the remaining principal (minus selling fees), but it never overtakes the alternative investment. At 35 year the resale value is 67,392,000 yen (the purchase price of 70,200,000 yen minus fees), while the alternative investment has grown to 69,881,681 yen. Very close.

What if the nominal price of the land decreases by 1% yearly (-2% over inflation)?

After 10 years the resale value passes the remaining principal (minus selling fees). At 35 years the resale value is 46,932,680 yen, while the alternative investment has grown to 69,881,681 yen. By this time the land lost 30% of it’s nominal value (down to 47m from 70m), while in real terms (accounted for the 1% inflation) it has lost half of its value (70m increased by 1% for 35 years is 100m).

A pessimistic outlook: inflation is at 0.5%, and the nominal price of the land decreases by 1% yearly?

After 10 years the resale value passes the remaining principal (minus selling fees). At 35 years the resale value is 46,932,680 yen, while the alternative investment has grown to 79,790,081 yen.

A super pessimistic outlook: inflation is at 0.5%, and the nominal price of the land decreases by 2% yearly?

If selling after 5 years, we would still owe the bank 8m. If selling after 10 years, we would still need to pay the bank an extra 5m out of pocket. After 18 years the resale value passes the remaining principal minus selling fees. At 35 years the resale value is 32,564,699 yen, while the alternative investment has grown to 79,790,081 yen. By this time the land lost half of it’s nominal value (down to 34m from 70m), while in real terms it has lost 60% of its value (70m increased by 0.5% for 35 years is 83m).

Buying a fancy mansion

Price: 120,000,000 yen, which is 128,400,000 yen after the 7% initial costs resulting in a monthly mortgage of 362,455 yen. This is paid off after 35 years.

Additional costs are: management fee of 30,000 yen, building repair fund of 20,000 yen, inside repair saving of 40,000 yen and property tax of 25,000 yen, bringing the monthly non-mortgage fees to 115,000 yen. This is increased with inflation each year.

The overall initial monthly cost is 477,455 yen, which is 164,254 yen more than renting.

As this mansion is close to the station, I assume that even after 50 years it will still keep half of it’s nominal price. Until then, depreciation is linear.

It takes 7 years for the resale value (minus fees) to overtake the remaining principal, meaning if I would to sell before that, then I would have to pay extra to the bank just to close the mortgage. However by this time time in the renting scenario I have invested the extra 164,254 yen (+ inflation) each month, and it has grown to 20,252,937 yen.

After 35 years the mortgage is paid off, and I can sell the mansion for 73,728,000 yen (after paying the selling fees). However by this time the alternative investment would have grown into 260,731,682 yen, making renting a much worse financial decision. (On the other hand I spent that 35 years in a fancy mansion right at the station saving me ~2*10 minutes each day, amounting to almost half year of time saved.)

After 35 years the mortgage is fully paid off, so I can live for free (barring management fees and maintenance), but the mansion’s value never takes over the alternative investment.

Conclusion: a fancy mansion is not a good investment on purely financial grounds due to the high monthly costs and loosing out on what that money could have earned if invested on the stock market (assuming the depreciation model is correct).

Buying a fancy house

Price: 135,000,000 yen, which splits into 108,000,000 yen for the land, and 27,000,000 yen for the building. This becomes 144,450,000 yen after the 7% initial costs resulting in a monthly mortgage of 407,762 yen. This is paid off after 35 years.

Additional costs are: repair saving of 60,000 yen and property tax of 25,000 yen, bringing the monthly non-mortgage fees to 85,000 yen. This is increased with inflation each year.

The overall initial monthly cost is 492,762 yen, which is 144,254 yen more than renting.

It takes only 5 years for the resale value (minus fees) to overtake the remaining principal. However by this time time in the renting scenario I have invested the extra cash each month, and it has grown to 14,674,185 yen.

After 35 years the mortgage is paid off, and the land still has a resale value of 148,342,107 yen (yearly 1% increase, minus 4% selling fee), while in case of renting and investing the monthly difference, that investment would have grown to 276,109,635 yen.

Again the value of living in a fancy house is not so much the financial benefit, rather the better quality of life. (Though research has shown that experiences bring more happiness than material things, as we tend to get used to better stuff quickly, so the fancy house might not bring us so much happiness than getting a cheaper home and going skiing/surfing every other weekend.)

Conclusion: a fancy house is also not a good financial investment if the appreciation assumptions are correct

Tuning the parameters

I did not consider the fancy options seriously, so I did not play with the parameters so much. So only checking one scenario: the fancy house has a great location, so the land might appreciate faster than inflation.

What if the real price of the land increases by 2% yearly (1% over inflation)?

Buying becomes financially better only after 10 years, however after 20 years renting comes ahead again (the invested amount grows to the point where the 6% rate of return overtakes the 1%).

What if the price of the land increases by 3% yearly (2% over inflation)?

Buying becomes financially better only after 5 years, however after 40 years renting still overtakes buying.

Conclusion

• a small change to rent (e.g. 10,000 yen) makes a big change in the calculation. This also means that if one invests just slightly less than planned, then renting might come out worse. (This is actually a common argument for buying: you will not miss a mortgage payment, but you might lower your monthly investment to buy that fancy car or go on that exotic vacation. However this only really makes sense if a significant portion of your investment is coming from the savings of renting, as otherwise lifestyle creep will eat into your investing even if you buy.)
• a significant benefit of buying comes from inflation: rent increases, but mortgage stays the same
• buying expensive real estate only makes sense if their value goes up significantly, or for the luxury. Otherwise their monthly increased costs would be better spent invested elsewhere.

Small changes to the model (e.g. 10.000 yen difference in rent, 1% vs 0.5% inflation, +/-1% change in the value of land) makes either renting or buying more beneficial, so at the end of the day, I don’t have a clear winner.