Ah, Christmas… That wonderful time where the earth turns white, turkeys pop into existence over red tablecloths, and houses get invaded by hoards of relatives. And, of course, well, this:
“Are you thinking about buying?”
Shards, this is up there with “do you have a S.O. yet?” and “don’t you want hatchlings?” as my least favourite questions of all time. This is because, inevitably, if I say “No”, I end up in the following scenario:
Them: “But you should be building equity!
Me: “I am building equity. In the stock market.”
Them: “You can’t live in the stock market!”
Me: “The dividends pay for my rent, so it’s the same thing.”
Them: “No, it isn’t!”
Not a very productive discussion, let me tell you. Also, let me get this straight before we start – I am not inherently against the idea of owning property. I lived in mortgaged houses for all of my hatchling years, and had a nestroom painted my favourite colour, the works. What I am against is this: Making bad financial decisions.
And, regardless of what every dragon elder says about residential property and how it’s “the best investment you’ll ever have!”, houses/condos/castles are not always a good investment. In fact, I sometimes wonder whether they should even be called an investment at all, for a few key reasons:
- The average person only stays in one place for 4.86 to 5 years. That is super short-term from an investment standpoint.
- Buildings aren’t built to last, with most components needing replacement within 10 years. This makes upkeep a lot of work for the owner, especially with an older building. On top of this,
- The only way to build equity in a house (or a condo or castle) is through the inherent enforced savings plan (other name – a mortgage) or through an appreciation in value, which is not guaranteed.
- And on top of that, any equity you do get is eaten into by all the costs of owning property: maintenance, transfer costs, property taxes, strata fees, mortgage insurance, interest…
If I was choosing an investment, the above four points would not be favourable. When I buy ETF stocks, for instance, I’m looking for long-term gains, which the stock market is very good at. I’m not expecting to have to do any work – I buy it, I hold it, when I retire, I sell it. Easy as breathing. And equity building is much more straightforward – I only buy ETFs that have a minimum 4% dividend payout ratio, that’s solid cash, every couple months, that doesn’t have the ability to vanish like house appreciation. And as for costs of ownership, the most we’re looking at is the fee from whatever broker you’re with and the commission on buying/selling, which are generally pretty reasonable if you’re a long-term, hold em’ investor.
Makes house ownership look less pretty, doesn’t it? And, unlike with purchasing a stock, to buy a house, you usually have to give up all of your hard-saved hoard as a down payment, resulting in zero diversification. In short, when you buy a property, you are betting everything on one horse. Which I think is a bad thing – I’ve never bet on horse racing, but that’s archaic English sayings for you.
In short – I do not really think of residential property as an investment. If it’s a rental property, okay, sure, that’s a business venture, I’ll give that one to you (go check out Afford Anything, because Paula Pant knows way more about that than me). But if you’re an average Jane/Joe buying a house to live in it, stop kidding yourself. You’re buying the house because you want a house, not because it’s an investment. If it happens to make you money, well, hey, lucky you, don’t go mentioning that to any of the three million Americans who foreclosed their homes during the 2008 crash.
So why am I writing this post if I don’t think houses are an investment? Well, what it comes down to is that I need to live somewhere, and my options for potential castles are pretty limited:
- Renting – What I do now
- Buying – What all my relatives keep asking me about over Christmas dinner
- Roommates – What my dwelling-sharing friends complain about endlessly
- Escaping to the Wilderness – What my dad desperately wants to do
Well, I’d survive approximately two days in the wild (some dragon I am), and as choosing a roommate is akin to playing Russian Roulette with a fully loaded gun, that really only leaves two options.
To buy or not to buy, that is the question.
There are plenty of blogs and people who have dragged out this discussion before, and the ultimate answer is pretty unfulfilling: It depends. Thus, I am not writing this as a definitive guide. My situation is not the same as your situation, and therefore cannot be compared. However, I can give you the tools and analysis needed to make an informed financial decision, and that’s what this post is about.
INGREDIENTS FOR AN INFORMED FINANCIAL DECISION
Yeah, we’re going at this recipe style, because who doesn’t like recipes. Lots of structure, delicious outcomes… So, for this epic financial dessert, you’ll need:
- Two COMPARABLE properties, one for rent, and one for sale: this is where Millennial Revolution went wrong (well, the analysis worked for them, but couldn’t really be applied to anyone else). They compared their rental apartment against a $500k house. If you’re living in a small apartment and are thinking of buying a house/bigger condo, the property you are considering buying should be compared to a rental property as similar to it as possible, not the rental property you’re currently living in. After all, there’s nothing wrong with upgrading into a larger rental if it’s truly better than buying a comparable property.
- Information on the rental property:
- The monthly rent
- The annual rent increase percentage allowed in your province/state
- Cost of parking/laundry if any
- Cost of tenant insurance
- Information on the property for sale:
- The list price
- The annual property tax (I’ll show some calculators for this later if the number is not available in the listing)
- Strata fees
- Cost of parking/laundry if any
- Cost of home insurance
- Financial information:
- The dollar amount you have available for a down payment
- The mortgage calculator of the bank of your choice
DIRECTIONS FOR AN INFORMED FINANCIAL DECISION
- Calculate the average cost per month of renting over the next five years (since, like I said above, most people move every 5, though feel free to change it up if you’re positive you’re staying wherever you are shorter/longer)
- Calculate the average cost per month of owning over the next five years
- Compare financial factors
- Consider qualitative factors
Yeah, that was pretty skimpy on the details. This is because it is much easier to show you than it is to tell you.
A (HOPEFULLY) HELPFUL EXAMPLE
I currently live in a 480 square foot apartment. It’s awesome, less than a block from work, and I’m not too interested in anything larger (cleaning takes time, which I tend to have absolutely none of during tax season). So, for me, I’m going to compare my current rental situation to a similar apartment. In your case, you may need to find a different rental property that compares to the house/big condo you want to buy.
Luckily, there happens to be an apartment for sale of about the same size, built by the exact same developer, just across and down the street from where I currently live, which makes for a nice easy comparison:
|My Rental Apartment||(Furnished) Apartment for Sale|
|Size||480 square feet||442 square feet|
|Age||Built 2016||Built 2009|
|Location||Half a block to my work||Next door to my work|
|Type||Low-rise apartment building||Low-rise apartment building|
|Pets||No pets permitted||Two cats or one cat and one small dog|
|Appliances||Fridge, Stove, Dishwasher, Laundry Hookups||Fridge, Stove, Dishwasher, Laundry Machines Already in Suite|
|Heat/Cool||Two Gree In-Wall Units||One Gree In-Wall Unit|
|Parking||Heated Underground Parking||Covered Parking|
|Storage||Bike Storage, one 3-foot closet, one 5-foot closet||Bike Storage, one 3-foot closet, one 10-foot closet|
|Layout||Excellent, while a studio, has definitive living, dining, and bedroom spaces with a built-in divider, no balcony||Adequate, also a studio, less definitive spaces, no real “living room” as space is taken up by a balcony/40 less square feet|
|Other||Rentable garden boxes available||Rentals/investment properties allowed|
|Financials||Monthly Rent: $900.00
Parking Fee: $ 40.00
(Rent includes hot water)
|List Price: $223,700.00
Strata Fee: $ 117.00
(Strata fee includes hot water and parking)
Yes, I really did say $223,700, and before anyone tries to tell me that’s ridiculous (AKA – what all my relatives/coworkers said), and that I should look for something reasonable, I’ll have you know that the median (not average!) condo selling price in the Okanagan Valley was $262,500 in 2016.
So let’s get started.
STEP ONE: CALCULATE AVERAGE MONTHLY RENTAL COST
I’m going to go with the five years I mentioned above. In BC, landlords are allowed to raise rent by 3.7% in 2017. However, we have to remember that some of this is just inflation, and since I want comparable numbers, we will be removing inflation entirely. In Canada, the inflation rate in December 2016 was 1.5%, so:
Real Annual Rent Increase = 3.7% – 1.5% = 2.2%
If we assume that my landlord (which is a corporation) will increase rent at the absolute max every year (they probably will), then my rent is as follows:
2017: $900.00 | 2018: $919.80 | 2019: $940.04 | 2020: $960.72 | 2021: $981.85
Or, on average: $940.48
Now, I’m not going to bother increasing the $40 parking fee, or the $28.49 I pay for tenant insurance , as there are no real strict rules with which to calculate and it would likely be at most an inflation increase, so what this means is that over the next five years, my rent apartment would cost:
P.S. Before anyone asks me why I’m not including utilities: remember, we’re comparing two comparable properties. If they’re truly comparable, the utilities cost should be the same.
STEP TWO: CALCULATE AVERAGE MONTHLY OWNERSHIP COST
- Probable Closing Costs: The Pihl Law Corporation Okanagan Home Purchase Cost Estimator tells me that I should expect about $1,200 in legal fees and $757.50 in third-party transaction costs, but nothing for property transfer tax, because the First Time Home Buyer’s Program eliminates property tax for me.
- My Down Payment: Before closing costs, I have about $18k available, so after them, I could afford a down payment of about $16,000. But the BC Home Owner & Equity Program will match my down payment up to 5% of the purchase price, with no interest or principal payments for 5 years. Which is basically free money, since we’re only looking at a 5-year timeline.
- Interest Rate: Scotiabank offers the lowest 5-year rate I can find @ 2.90%.
Now that we have the raw data out of the way, let’s talk about the logistics. First of all, the list price doesn’t necessarily mean that the price in the listing is the price you’re going to pay. Realtors generally recommend making an initial offer 10% below asking price (if the property has been at the same price for a while) and being willing to take a counter-offer of 5% less. For arguments sake, we’ll assume that I could buy the apartment across the street for $212k, which is about 5% below the list price.
So what’s the damage?! Mortgage-wise, that is.
Well, first, we have to consider mortgage insurance. At $16k down, plus another $10,600 (5% of purchase price) from the BC HOE Program (hehehe, good job, naming people), I’ve got a 13% down payment, which means 87% leverage. According to the Canadian Mortgage & Housing Corporation, that means a 2.40% insurance premium.
($212k – $16k – $10.6k)*(1+2.40%) = $189,850 (rounded)
Ah, the sweet sound of a mortgage nearly five times my salary. Lovely, isn’t it?
Now, with Scotiabank’s low low low interest rate, and their handy online calculator, this gives me…. drum roll please!
Monthly Mortgage Payment = $888.74
Well! That sure looks nicer than the $1,000 my apartment will cost me. But hold your horses (wow, English has a lot of horse-related sayings, I never realized), the mortgage is not the only cost of owning property. We also have to consider:
- Property Tax,
- Strata Fees (if applicable),
- Home Insurance, and
Now, same as I did with the tenant insurance and parking fees for my rental apartment, I’m not going to increase these costs year over year. The assumption is that they will rise at the rate of inflation, and therefore will be the same cost next year as this year, in today’s dollars.
Calculating property tax can be tricky, since not all property listings will include them. However, if you’re lucky, your province/state will have an online assessment database, like E-Value BC, where I was able to find out that the apartment I’m looking at was assessed at a $168,600 value in July 2016. Punching this value into the City of Kelowna Property Tax Estimator leads to a $1,082.44 property tax levy for 2017, or $90.20 a month.
Home insurance was easier, as finding an online calculator is pretty straightforward. This particular calculator tells me I’ll spend $36 a month on insurance.
Maintenance tends to be a subjective topic when it comes to home ownership. The cost can vary depending on the age of the building, how well it was built, how good its previous owner treated it, how big it is, etcetera, etcetera. However, most experts (AKA people like Paula Pant – I have a crush, you can tell) suggest budgeting 1% of purchase price for maintenance, or budgeting $1 per square foot. This creates interesting results for the apartment I’m looking at:
- 1% of purchase price = $2,120 per year
- $1 per square foot = $442 per year
That’s a bit of a range, so we’ll compromise and average it to $1,281, or $106.75 per month. If you’ve got more knowledge about maintenance costs, go with your expertise and not a random rule, because, as you can see, math really only goes so far (And here I thought math was the ruler of universe… So much for Mr. P’s 9th grade arithmetic mantra).
And we put it all together and what have we got? (That’s a song, isn’t it… I can hear it, the music, tickling at my brain. Disney, you brain washer). Bibbidi bobbidi boo!
Strata Fee (see the big table above)
Okay, that’s a little bit less magical than Cinderella’s glass slippers. And that brings us to the next step in this fancy little recipe…
STEP THREE: COMPARE FINANCIAL FACTORS
The first part of this step is pretty straightforward:
BUYING WOULD COST ME $229.72 MORE A MONTH THAN RENTING.
Notice the “me” in there. Because before anyone gets riled up, this is entirely specific to my situation and you need to go do the math yourself. If anyone sends me some kind of “But I’m special! My situation is ________.”, I swear to high dragon heaven I will screenshot it, print it, and set it on fire.
Now, the interesting part (at least to me), is that I could actually afford this. I have a $300 surplus (yeah, it’s low, yay entry-level salaries in accounting) in my monthly budget that I deposit directly into my marketable securities account. It would be difficult, and I would have barely any wiggle room for emergency savings, but I could technically afford that apartment across the street.
But why would I willingly spend $230 a month more on the exact same living space?!
And that’s where the usual rebuttal comes in: “Because you’ll be building equity!”
And that’s the kicker, isn’t it. The true decision here isn’t “Should I rent or should I buy – which is cheaper?”, it’s really “Will renting or buying improve my net worth more?” So let’s do the math.
Scenario 1: I continue renting and invest that $229.72 a month in my stock portfolio.
Scenario 2: I buy, and I don’t get to invest that $229.72, but I pay off my mortgage and build equity that way.
We also need to remember that if I continue renting, I don’t have to cash out the beginning balance in my marketable securities portfolio for the closing costs and downpayment, so that’s $18,000 that will continue earning money. We plug that, plus a $2,756.64 ($229.72*12 months) annual contribution into this handy calculator with a 7% return (my average, and also the stock market’s), a 5 year timeline, and 100% reinvestment, and we get:
Net Worth After Renting for 5 Years = $41,099
Note that I will probably be investing more than $230 per month, but anything I’d invest above that is the same I’d be investing if I bought, so there’s no point in including it in the calculation.
But what about net worth when owning property? Well, if we assume that the apartment will retain its value (not going up or down, for the record, I’ll talk about housing appreciation in a bit), then the equity is simply the original downpayment of $16,000 (after closing costs) plus the amount of principal I managed to pay off over five years. For the less math-savvy, this is because if, in five years, I sell the apartment, my “earnings” is simply the difference between the list price and the remaining loan I have to pay back to the bank.
So let’s take a look, and head back to the mortgage calculator I used back in Step 2 to punch in the same data. If we toggle the little “chart” button on the right side of the screen, it tells us how much principal we pay off each year:
Year 1: $5,261.36 | Year 2: $5,415.03 | Year 3: $5,573.20 |
Year 4: $5,736.02 | Year 5: $5,903.56 | Total: $27,889.17
Add all of that to the original $16,000 down payment, and we get:
Net Worth After Owning for 5 Years = $43,889
Wowza! If I buy now and sell in five years, I can make a whole… $2,790 more. No offense, dragon elders, but this is really not the mad equity I was expecting to make with all that talk about how “castles are the best investment you’ll ever have”. And the thing is, that equity isn’t even guaranteed.
See, the reason (Canadian) people believe that housing is an excellent investment is that, in the past 10-15 years, Canadian housing has shown absolutely insane appreciation, and even more so in the last couple years. Instead of just making equity through paying off the mortgage and selling for about the same price, inflation-wise, as they bought it for, people have been able to hold on to a house and sell it, 7 months later, for a price 25% higher in some cases.
If prices go up higher than inflation, suddenly, residential property starts looking like an amazing investment. However, just because the housing market has been skyrocketing like crazy for the last 15 years doesn’t mean it will in the future. This is actually something called a “gambler’s fallacy“. It’s also the reason I sometimes wonder why accounting is a profession, because what we do is create reports based on past data, and just because OpCo made $1 million last year doesn’t mean they’re going to next year (but hey, I like my job, so I try not to shout about it).
Economists all over the world have been eyeing the Canadian housing market with critical suspicion since the appreciation kept going, even when the USA’s bubble burst way back in 2008. Robert Shiller, who predicted the American crash, has been blaring red alerts for years. Garth Turner, one of the financial bloggers who actually got me interested in F.I.R.E., actually thinks the bubble started popping back in October 2016. Even the CMHC itself has called the Canadian housing markets overvalued.
So what does this mean for me, if I went and bought that apartment? Well, if housing is overvalued now, that gives me the distinct impression that in 5 years, I probably won’t be able to sell that suite for the $212k I bought it for, and the thing is, even if the value only drops 1.5% ($3,180) , I’ll actually make less than I would in the stock market, not considering closing costs and so on.
However, a 1.5% drop would be a mere blip on the radar, from an economic perspective. CMHC stress testing in Fall 2016 showed that if interest rates increased, housing prices could actually drop as much as 30%. Given it would only take a 21% drop to bring my net worth below $0 at the end of five years, that’s not exactly a point in favour of home ownership.
My point is – While, yes, you can build equity in the housing market, if you’re lucky enough to live in an area where housing appreciation is at least above inflation, this is not a guarantee, and believing in the idea that “housing always goes up!” is part of what caused the American housing crash. Does the phrase “we must learn from history” ring a bell? It certainly does for me, because my Grade 8 social studies teacher must’ve repeated it a dozen times, and Grade 8 me didn’t give a damn when I probably should have. Better late than never, eh?
So what’s the conclusion here?
- Per month, owning would cost me $229.72 more than renting,
- Over five years, if housing prices stay stable, I have the potential to make about the same money owning as I would renting, net worth-wise.
- House ownership is a hell of a lot more risky than stock ownership, especially in my region (the Okanagan, which has not escaped the effects seen in Vancouver).
And that brings us to step four.
STEP FOUR: CONSIDER QUALITATIVE FACTORS
So, you’ve done the math, you’ve seen the costs, you know the risks. If you’re lucky, you live somewhere that is not Canada or some super-expensive city, and don’t have to stare at micro-suite listings that exceed $200k. Maybe the cost actually is less than renting, in which case I am massively jealous and also happy for you. But once you’ve done all that, you also need to take a step back, and remember that money isn’t everything.
Other things to consider:
- Financial risk tolerance – maybe you think housing is still going to go up, and you’re good with buying and taking that risk. Maybe you’d rather take the safer route that is a healthily diversified portfolio. Maybe you found a foreclosed fixer-upper that is half as expensive as everything else and you’re going with it. Your risk tolerance is your own; make sure you listen to it.
- Liquidity – one of the problems with housing as an investment is that you have no access to your equity unless you sell or take out a home equity loan (dangerous). A marketable securities portfolio, on the other hand, is easy to sell – I can cash mine out in 3 business days. If you know you’re going to need cash (for school, your new hatchling, tires on your car…), investing in something that is not a house might be a better play.
- Your own self-control – are you actually going to put that $229.72 into savings each month, or are you going to spend it on beer? Buying a house can often be an easier way for people to save because you don’t get to tell the bank “No, I ain’t payin’ you this month”, whereas I have to physically go click buttons to make sure money ends up in my Questrade account. However, there are ways around this, like employer savings plans that deduct directly from your paycheck, or setting up a bank-automated system that siphons away your money to savings without you even noticing.
- Effort expenditure – owning a house takes work. Repairs and maintenance become your own prerogative; there’s no landlord to call up and inform about a problem. If you like housing maintenance and weekend projects, this might not be a problem for you, and as a hopeless white girl who has accidentally cut herself with a tape measure, I applaud you.
- Flexibility – the beauty of being a tenant is that it is really easy to get up and leave. My first year at my new place is a one-year lease (municipal government has rules about new buildings), but after that, it’ll transfer to month to month. If I got offered a better job, wanted to move in with an S.O., or suddenly got tired of my downstairs neighbours, moving would be comparatively painless. In contrast, with home ownership, the property needs to be either sold or rented out, which can take months to go through, a period of time where you may be paying two mortgages, or a mortgage and monthly rent.
- Benefits – Home ownership isn’t coveted for nothing. You get to paint your walls whatever colour you’d like, pet ownership becomes acceptable, you can rip out the ugly vertical blinds and replace them, etc. If you really want to own six dogs or a pet pig (my sister loves those things), or have an itch to constantly renovate, then ownership is probably a better option.
- Social pressure – Maybe your S.O. is convinced renting is synonymous with being poor. Maybe your co-workers look down on you because they think you’re bad with money because you don’t own a house. Maybe your soon-to-be father-in-law is horrified that you didn’t have a place already bought in which to house his precious daughter. Social pressure is a definite factor in a lot of housing decisions, and shouldn’t be underestimated.
And there we have it – seven things to consider, which brings us, finally, to:
STEP FIVE: DECIDE
In the end, it is ultimately your decision. Like I said, the answer to the question “Should I rent or should I buy?” is: “It depends.” But if you’ve mathed the math, researched the research, and considered the consequences, then I can honestly say that yes, you’ve done your homework. If you choose to then ignore that homework and do whatever the hell you want, then sure, okay, that’s also your decision.
You do you, mate, you do you. But don’t come crying to me in five years if you bought in Vancouver and have lost the scales off your back. I genuinely will not give an egg shard about your problems.
Me, I’m renting. The building managers are great, the commute is under 10 minutes, the dishwasher is my best friend. My stock portfolio continues to show me nice shiny dollar signs. What more could I want?
In conclusion, do the math, make your decisions. But, for the love of Smaug, make sure its a good one.
You’re a dragon, not a brain-dead sheep. Don’t follow the herd. Eat them.
…. metaphorically, of course.