by Larry MacDonald, Canadian Business Online
Tuesday, January 26, 2010
"I'm perfectly content renting for the foreseeable future," says Patrick Doyle. That’s because he can rent for considerably less than the cost of owning a house in his neighbourhood. The savings, in turn, can be used to build up a portfolio of financial assets much quicker than otherwise.
"I pay $1,250 per month in rent, including my parking space," continues Doyle, who authors the blog A Loonie Saved. "The monthly mortgage payment on a detached house in my area would be about $2,200. After you add in property tax, repairs, maintenance and utilities, the total monthly payment is at least $2,700. By renting, I can save and invest at least $1,450 per month."
Mike Ronquillo, one of the persons behind the Colourful Money blog, has crunched the numbers to show how it’s possible to end up with a higher net worth by renting. "The rationale is that over the long term, stock returns are better than gains in housing prices. Especially in current times, where stocks have crashed and houses are still near record highs in most places in Canada, this could be a very beneficial strategy for young people to consider," he notes.
In his example, Option No. 1 is buying a $300,000 house for zero down with a 5% mortgage amortized over 15 years. With property taxes, insurance and other costs, the total monthly payment is $2,854. After 15 years, the property "is owned outright, and assuming the home’s value grows at a long-term average rate of 2.5%, the property would then be worth $435,000 at that time."
Option No. 2 is renting an "equivalent house now for $1,200 and investing the difference." Assuming rent goes up 2.5% every year and an average annual return on your stock portfolio of 8%, "you would then have $517,000 at the end of 15 years." That’s $82,000 more than owning a house.
As Ronquillo states, this is not a guaranteed result. It depends on a number of assumptions. In particular, a lower after-tax rate earned on stocks could leave net worth lower than if homeownership was chosen.
But for many renters, that risk is acceptable — especially considering the other benefits they derive from renting.
See below for the top 11 reasons why some people would rather rent than own:
1. Your net worth may end up higher as a renter, depending on the gap between rents and homeownership costs, investment returns, and other factors as mentioned above and elsewhere.
2. Renting avoids the risk of having most of your wealth in one basket. As York University professor Moshe Milevsky writes in his new book Your Money Milestones: "Buying a house for an investment has strong similarities to someone being convinced stocks are a good investment for the long run but they decide to buy only one stock for their portfolio. I don’t care how reliable that one stock is, or how large are the dividends, that stock portfolio is not diversified. The same goes for housing."
3. Housing is not only a "completely undiversified" investment, in the words of Milevsky: it’s also a highly leveraged one, say other observers. While this aspect magnifies gains in house prices it also magnifies losses, so that relatively small fluctuations can wipe out all of the owner’s equity. Indeed, the value of the house could even fall below the value of the mortgage — as millions of U.S. citizens have discovered since 2007. Renting reduces exposure to this scenario.
4. The lack of diversification from home ownership may be even worse if your job is affected by the housing market. This means, oddly enough, that a real-estate agent may enjoy a better risk-adjusted return from renting instead of buying. Another example is a worker in a "one-industry town."
5. You may have a job or career that requires moving around a lot. The costs of moving frequently could eat up the investment gains from housing. Noteworthy costs are the 5% to 6% brokerage fees to buy and sell.
6. The economy is always is a state of flux and we cannot rule out getting laid off from work now and then. The transaction costs of buying and selling several houses could erode gains for workers in cyclical industries, or those in jobs with variable/uncertain income. They are also exposed to the risk of being forced to sell a house at a loss during a downturn.
7. Many persons don’t want to be bothered with mowing the lawn, fixing leaky taps, and other household chores. They would rather spend their time golfing or making more money (another monetary gain that could be added to into rent-versus-buy calculations).
8. House prices in Canada are now overvalued by most measures. Gluskin Sheff economist David Rosenberg wrote in a recent report: "When the price-to-rent and price-to-income ratios are between 15% and 35% overvalued, you know that something isn’t quite normal. Not to mention the fact that mortgage debt relative to after-tax income and homeownership rates have hit all-time highs."
9. Buying now, after the recent sharp run-up in house prices, may not generate much of a return for the foreseeable future. Those recent gains were triggered by abnormally low interest rates, engineered to fight the recession. When the economy recovers, rates should climb back up and could cause house prices to level off, or even slip back.
10. Home ownership carries greater policy risk. To encourage home ownership and boost the economy during downturns, the government has progressively relaxed the conditions for buying a house. For example, the government supports the housing market through the RRSP Home Buyer’s Program and various measures under the Canada Mortgage and Housing Corp. These polices could be amended in the future in a way that undermines prices.
11. They don’t need the forced-savings aspect of homeownership; they are confident in their own saving and investing discipline. Moreover, they are not overly bothered by having to deal with a landlord (e.g. delays in repairs).
*I posted this for my future reference just in case we decided into home ownership. So far I like investing my money on stock market because the return of my investment went double just for a year. *
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