Buy vs Rent. Why we're okay with renting today.

Conventional Wisdom: "Renting is pouring money down the drain" 

We've rented a number of places, we've owned a few homes and we've speculated on a few property flips.  In two weeks from now we will be back to renting a home rather than owning one.  Now many people may assume that we rent because we don't have the money for the downpayment or that we can't afford the monthly payments that come with owning.  But with us thats not the case.  Since we don't view our home as an asset, we look at home ownership differently than most people.  We generally do not feel the need to own a house.  We do not buy a house believing it is an investment but rather a lifestyle choice.  Sometimes owning makes sense for us and other times it does not.  At present, we have chosen to rent because for our lifestyle, renting makes the most sense for us right now.  It also makes sense for us from an economic sense at this point in time, specifically around month to month costs.  In the future this may change and we fully expect that we will own a home again within the next few years.  But not now.

But what about all that money we're throwing away?  Well, I've done some number crunching on the specific house we are renting and I can tell you we are not coming out poorly by renting.  For other homes it may make sense to buy, but we would calculate these numbers on a case by case basis.  I'm only going to focus on the basic math around the rent/buy choice on a monthly cost basis and not around full life-cycle costs (which would include buying and/selling costs of a Real Estate transaction, capital appreciation, land transfer taxes etc) because many people have psychological reasons to either buy or rent and the metrics also change depending on how long you intend to live somewhere, whether prices go up or not, and how emotionally attached you  are to where yo live... so I will leave that up to you to decide whether those types of reasons and parameters affect you.

The House:
The house we will be renting is a 3 bedroom house in a very desirable neighbourhood within a half hour walk to the heart of downtown Kingston Ontario.  It is about a 5 minute walk to the nearest public school, and within a 20 minute walk to Kim's work.   We really like the area and we are prepared to pay a premium to live in this neighbourhood.  The property taxes on the house are $6750 a year.  Based on the property tax mill rate of about 1% of house value, and surrounding sales which are close to a million dollars, I would estimate the house has a market value of about $675,000 or more, which in Kingston is well above average.  We have agreed to rent this house for $2300 per month plus utilities.

So how much are we flushing down the drain each month by renting this house in this desirable neighbourhood?  Lets do a little comparison math:

To buy this house we would need to have a 5% downpayment which would be about $34000.  The remaining $641,000 would be mortgaged.  Since I would only have 5% equity in the house I would need to get CMHC mortgage insurance.  That would cost 3.15% of the mortgage price which would add an additional $20,000 to the mortgaged amount.  So the fully mortgaged amount would be $661,000.  If I had a larger downpayment set aside,  I could put the money into the house but I am not a fan of putting more money than needed into a downpayment... simply because I like my money to be in liquid form and bricks and mortar real estate is very illiquid.  If I get a 25 year amortized mortgage at the lowest 5 year mortgage rate today of 3%, I can pay a monthly mortgage payment of $3128 per month.   In the first year, about $1500 is going towards paying down the principle and the remaining $1628 is going towards interest payment.  As mentioned above the property taxes for the year are $6750 which translates to $562 per month.  If we bought the house, we'd need to have home insurance or we wouldn't be able to get the mortgage.  For a house of this size and value, I'd estimate it would be about $150 through our current insurance company although I may be able to get a lower rate elsewhere.. but I'll go with what my insurance company would pay.   A rule of thumb for general upkeep (painting, repairs, fix-ups, new shingles etc) of a house is usually around 1% of the value of the property... which in this case would be about $6000 per year or about $500 per month.  This number seems a bit high to me, but there are always things that a house needs that we forget to account for so I am going to leave it at $500 per month even though I think it may be more than what I'd likely pay.   This number is also dependent on the age of the house... older houses sometimes just need more upkeep... and this house is 70+ years old.  So to summarize, the total monthly cost to us after buying this house would be $4340:

During the first few years, about $1628 of the mortgage payment each month goes towards the interest cost, so one could make the argument that each month, the remaining $1500 is going back into your pocket in the form of home equity.  You would get that $1500 back if and when you sell the house assuming the house doesn't go down in value.  So if we subtract the $1500 from the Total cost, we get approximately $2840 that is NOT going to your/our bottom line but to either interest, insurance, property taxes or upkeep costs.  

Now of course there are other monthly costs such as utilities, but I have to pay them each month whether I own or rent so I didn't include those.   Don't forget that if we bought we also would have had to front a $34000 downpayment... so there's also that cost and time that we'd have to consider.  Thats $34000 that isn't in my pocket or investment account.  

So contrast the $4340 (or $2840 if you prefer) with the monthly $2300 rental cost of the exact same home, without having to come up with $34000 downpayment up front and I think we're doing well to rent.  As an aside, if I had a potential $34000 downpayment and wanted rather to invest in Real Estate, I could put it into Killam Properties (KMP on the TSX).  They own and operate apartment buildings and manufactured home communities and the stock currently pays a handsome dividend of about 5.75% per year.  The stock is very liquid and I could sell it at virtually any time which is very different than owning a physical building.  If I bought $34000 in KMP stock, I would collect $1955 annually in dividends or about $162 a month that I could apply to my rent cost if I chose to do so.  If I did apply the $162 monthly dividend to the rent cost, it would lower my rent cost to $2138.

So on a month to month basis, the rent of $2300 comes out better than the $4340 (or $2840) monthly costs involved in buying/owning by about $2040 (or $540) per month.  The winning option, with respect to monthly costs in this comparison is renting, yet it is not so cut and dried in there grander scheme of things.   For our current needs we think we're coming out ahead by keeping the deposit in our pocket and renting this attractive house in this sought after neighbourhood.

Rule #8 Your Home is not an Asset.

This is one of the topics where people tend to get a little bent out of shape with respect to our perspective on what makes something an asset or a liability.

If you buy something that pays YOU to own it, it is an asset. If you buy something that YOU PAY (net) to maintain or own, its a liability. Those are two definitions that WE use to describe almost everything we own or think about buying.  By these definitions a bought home is not an asset, it is a liability.  A lot of people have bought in to what they've been told by Realtors, Banks, Big Box Home Centres and HGTV - that their home is the biggest asset they own...  It certainly is one of the biggest purchases that people make, but is in an asset?  A home, whether it be a condo or a stand-alone house, does have intrinsic value, but the bricks, wood, fencing, and countertops if neglected or without maintenance, are most likely depreciating in value over time.  The only thing that is truly increasing in value is the land value.... because God's not making any more land.  It is a scarce and limited resource.

Then there are the monthly costs.  Lets have a look at a $300000 house that someone might purchase... What kind of expenses does a house of that size have? That home owner would now have to pay the following things... these things are pretty much non-negotiable... they must be paid: Mortgage, Property Taxes, Insurance on the home, Utilities, and General Upkeep.  If you buy a house or condo with monthly fees, you can add those in as well, but lets assume there are no monthly condo fees. We'll also ignore Land Transfer fees and all the other costs that it takes to make a Real Estate Transaction.

If you add all those costs up, the house costs about $2150 per month to keep it in your name. Of that $2150, only about $400 of the monthly mortgage payment will go on the principle in the first few years or so.  Lets also not forget the 25% downpayment or $75000 that needs to be put down in order to keep the CMHC fees low... I hate extra fees.  After the $400 is deducted from the $2150, that adds up to about $1750 of monthly costs.  So for the initial $75000 that you put up, you now will pay $1750 a month in costs that will fill other peoples pockets.  Its actually quite an expensive liability that you've purchased.  This is not to say that you shouldn't buy a house, because we all have to pay to live somewhere, but if you think of it as a liability and a lifestyle choice as opposed to an asset, you begin to view it quite differently.

Another path you could take with that $75000 would be to invest it in something that has a higher growth rate than a house, and pays you either a rental cheque, distribution or a dividend as a shareholder.  It should be reasonable to rent a house for the same amount... lets say $1750 all in and then save the $400 per month that would have gone on the house principle and invest it somewhere instead.  It certainly adds more flexibility if you wish to move within a few years and don't want a significant amount of your equity tied up in a house.

What about appreciation of my home/property?  Well, the average appreciation of real estate has been about 3.5-4.5% per year in Canada for the last few decades.  This is in contrast to the 2-3% typical inflation we have in Canada.  What this says is that either housing has been very undervalued in Canada and the market values are steadily catching up, or housing prices are, or will be, overpriced and due for a correction.... I tend to believe in the latter case.  Much of this market appreciation has occurred due to historically low interest and bond rates, which control mortgage rates, and the sustainability of low rates is always in question.  There are hotspots like Toronto, Vancouver, and Calgary that may be due for a correction, and local markets will vary, but lets not fall into the trap that real estate values always go up... because as we've seen with our neighbours to the South, house appreciation is not a given.  If you are banking on the house appreciation game, then you are also playing the timing game, and timing can be a difficult game to play....

There are lots of reasons people might want to own a house: pride of ownership, control over where they live and for how long, the ability to modify a home to make it their own.  These are all good reasons to buy a home for your own living... But by my definition, it is not an asset.

from tinyhouseblog.com