New research by StrideUp quantifies the ‘opportunity cost’ experienced by UK renters who often overlook or underestimate this expense while saving to buy their first home. While both interest rates and house prices are currently going through a tumultuous period, the longer term trend presents a picture where many renters are losing out.
The trajectory of house prices when combined with the increasing rental costs prohibit many people from being able to break out of the rental cycle. In other words, as individuals continue to rent while saving for a deposit, the house prices in their area continue to rise. By not being able to buy early, they are forced into a cycle of rising rents and house prices – and the prospect of buying a home gets further and further away.
This article will cover what the opportunity cost is, how it affects renters, and how rising rents are exacerbating the housing crisis.
Discover the invisible costs of renting
For many renters the case for saving for a deposit and waiting to meet the mortgage criteria of high street banks is simple. The cost of renting is weighed up against the cost of a mortgage and while rent is more expensive, the difference between is seen as palatably small. There is a path to purchasing a home assuming conditions and prices remain the same.
StrideUp, however, found that when all factors are taken into account and the opportunity cost for first-time buyers is calculated, the price of renting may be twice as much as many observers thought.
What is the opportunity cost for renters?
The opportunity cost is the amount that house prices increase while a person is renting.
For example, a person may decide to rent for four years and gradually save for a 10% deposit on a house which costs £300,000. By year three they have saved £25,000 – a great achievement – but that same house now costs £330,000. In the same year their landlord puts up the rent to reflect the changed market value of the rental property, so now the renter cannot save as much each month. Their saving momentum slows, and after six years, they still don’t have enough saved to secure the house they want.
Thousands of people are in this position across the UK, waiting to save up for a standard deposit but finding the goal posts moved every time they get close. The cost-of-living crisis is only making things worse – inflation is set to hit 18% in 2023, the highest since 1976 when the Pound depreciated 20%
What does the opportunity cost mean for first-time buyers?
The opportunity cost leads to a double bind for first-time buyers – the longer they rent, the more house prices are likely to increase, but as rents rise at a similar rate, it’s even harder to save for a deposit. In fact, the average rent in the UK is now £1,127, up 9.5% from the same time last year.
Furthermore, StrideUp’s analysis highlights that both the property types and the location of homes favoured by first-time buyers are uniquely affected by the opportunity cost phenomenon. Across the UK two and three bedroom homes experienced significant increases in both rental costs and house prices. Properties in cities were also particularly affected.
Recent rising interest rates are also causing mortgages to become more expensive for those who already own homes. Homeowners are also being hit by the rising cost of living, with some opting to downsize to avoid defaulting on their payments.
What are rental yields?
Rental yields provide a more accurate picture of the cost of renting than rental costs as the latter are naturally higher for larger or nicer properties. Rental yield is calculated as a percentage, by taking the cost of renting a property for a year and dividing it by the amount the property is worth.
For example, if you pay £20,000 each year in rent for a three bedroom house, and the property was bought for £300,000, that would give a rental yield of 6.6%. Rental yield is the return a property investor or landlord is likely to make on a property through rent. It also gives an accurate ‘cost of renting’ that can be compared across property types and locations.
The opportunity cost quantified
To understand the opportunity cost for renters, it is important to look at the typical profile of first-time buyers saving up for a home. Often first-time buyers are renting 2 or 3 bedroom properties where the rental yield is in excess of 5%. StrideUp’s analysis highlights the North West, North East and Yorkshire as some of the most expensive areas to rent in England.
Average rents for 2- and 3-bedroom properties in these cities and regions as of May 2022. Source: Zoopla listings. StrideUp
Younger people based in cities are being pinched especially hard with rental costs averaging 4.50% - 6.00% across major UK cities. This difficulty in getting on the housing ladder in cities is reflected by record numbers of current London residents moving out of London to secure their first home. A decade ago only 13% of Londoners buying outside the capital were first time buyers. This figure has more than doubled to 28% for the first half of 2022.
Many renters would view rental yields of approximately 5% as high but ultimately a price worth paying while saving to secure a mortgage at a lower rate. Until the recent Bank of England rate hikes, most mortgage products sat comfortably below this amount. The complication is that this trade off doesn’t include the increase in property prices during the period of renting. When the opportunity cost is factored into the equation the reality for renters becomes significantly worse.
Average house price growth over the last 3 years. Where city level data was not available UK average of 4.9% has been used. Source: Zoopla. Hometrack, StrideUp
As house price growth has greatly outpaced average salary increases, the length of time it takes to save for a deposit has also grown. This extended saving period greatly increases the importance of changes in the housing market. The data above shows that house price increases, far from being a secondary concern, amount to the biggest cost of renting in many UK cities including Sheffield, Nottingham, Liverpool and Leeds. Only by adding rental yield and house price increases can renters fully understand the opportunity cost of renting
Would be house-buyers are often paying in excess of 10% by waiting to finance their home with a traditional mortgage. Liverpool, Cardiff, Nottingham and Glasgow renters are worst affected by the opportunity cost by effectively paying rates of 12%+ to rent. For many, the opportunity cost makes saving for a sufficient deposit impossible.
First-time buyers have traditionally compared the cost of renting to the cost of a mortgage when deciding on the best time to buy. The standard calculations assume a deposit of 15% and a mortgage set at about 4.5 times salary, the criteria required by most banks. But this one-size-fits all approach can blind first-time buyers to the real cost of renting as well as alternative ways to finance a home.
By not adapting to consistent and often dramatic property price increases, prospective first-time buyers become locked into a never-ending cycle of renting and saving. Often the only way to afford a deposit for a traditional mortgage is when their financial circumstances change dramatically, such as coming into an inheritance.
When the true cost of renting is quantified, it shows many buyers would be better served by buying earlier with a shared ownership mortgage, potentially saving them money as well as providing the comfort of home ownership. Home purchase plans like those provided by StrideUp often offer finance at higher rates than high street banks. But as the data shows, this must be weighed against the money saved be getting renters on the property ladder potentially years before they otherwise would have.
Our data exposes the double bind of the renter’s predicament –the longer they rent, the more house prices increase, but as rents rise at a similar rate, it’s even harder to save for a deposit. StrideUp offers a third option that could be the solution first-time buyers are looking for.
Have you experienced the opportunity cost of renting vs buying? Or have you opted to rent until the market settles? Share your thoughts and comments on StrideUp’s social channels.