Home shopping: to rent or to buy

[steve_toronto]

A question closely related to the very existence of a real estate bubble is to rent or to buy. I have believed it
for awhile that Toronto is facing a real estate bubble or a correction to say least. Therefore, I was
surprised to find out that even in today's market, one would be better off to buy a home than to rent one in
today's Toronto, according to the calculation of the following site from CNN;
http://money.cnn.com/2010/10/08/real_estate/rent_vs_buy/index.htm.

The following numbers, based on a one-plus-one condo in the downtown core, are used in the calculation, and they are very realistic.

Rent:
1950 including one parking and one locker
0 for no extra costs, (rental covers all utilities)
20 for renter's insurance premium
2% annual rental increase
Purchase:
420K purchase price
25% Down payment
3.7% mortgage rate
25 mortgage term (years)
2500 property tax
2% annual appreciation

The comparison, based on 5 years and 1.5% annual inflation rate, shows that the renter will pay $46,000 more than the purchaser.

Do you really believe it is better to buy than to rent in Toronto today?

Appendix the result from the calculation

Buying a home would save you approximately $45,937 (in today's dollars) over 5 years, compared to renting, based on the assumptions you provided.
Cost comparison
[1] Rent $123,024
[2] Buy $74,957
Mortgage payments $94,356
Property insurance $0
Property taxes $13,010
Maintenance $24,000
Opportunity cost $10,558
Tax savings (interest/taxes) $23,253
Home Appreciation $43,714
That is, the difference is $45,937.

 

[lafard]

It's better to rent right now.

You'll notice that in your scenario that the rent-vs-own scenario the cost difference provided depends almost entirely on capital appreciation of the condo unit. Factor out appreciation the difference is 2500 dollars or so - negligible, really, considering unpredictable costs like replacing a broken appliance can affect that number by 30% or more.

As we know, the capital appreciation is not a given. We don't know what condo prices will be like in late 2015. No clue whatsoever. You could be +80k or -100k. Again, with this calculator the rent-own calculation depends entirely on appreciation, so that's somewhere between 80k in your pocket and losing your downpayment, with a small risk of ending up somewhat "under water" at the end of the term.

I'm a real estate bear right now, I think a substantial correction is in the offing particularly for condos. If it happens, then 2015 will be too early for prices to climb back up to current levels.

It also fails to account for "opportunity cost" for the downpayment. IF you buy you spend 100k on the downpayment (25% is way bigger than most spend). If you rent what are you doing with that money? It's not just sitting there. Buy a bunch of dividend stocks with it and you're talking 5% return without even thinking about it, and there's a decent chance of 25% or more increase in the capital value of the stock market over 5 years - your 100k could very well yield you 50k in investment income. Even GICs - famous for really crappy returns right now - yield 15% over 5 years or 15k

There is significant downside risk in that too. The stock market may drop again, losing capital, and if falling real estate hurts the economy (which seems to be happening already) then the markets will hurt. Canadian ones, anyways. There's a very good reason why safe investments have a crappy yield these days, it's where all the money is parked.

In your situation, let's simplify to three major possibilities
a) Buy your condo.
b) Rent, but buy stocks with the downpayment
c) rent, buy GICs.

In each of those three conditions, consider a bull market:
a) Your condo appreciates 4% a year. Net gain around 80k.
b) Your stocks gain 8% a year (div + appreciation). Net gain around 35k.
c) GICs produce the same yields no matter what. Net gain around 15k

In a neutral economic time,
a) Your condo's value is not forcastable. Historically they drop and regain some, but not all of the ground they lose. Net gain somewhere between +/- 20K
b) Your stocks have no capital appreciation, but continue to pay 4% dividends. Yield 16k.
c) GICs produce the same yields no matter what. Net gain around 15k.

In a prolonged bear market:
a) Your condo drops from 420 to 320k, losing 100k
b) your stocks drop from 100 to 75k, losing 25k (but dividend stocks usually keep producing dividends, so the actual loss is much less and you might come out even).
c) GICs produce the same yields no matter what. Net gain around 15k.

We can't tell in advance which situation will come to pass. I'm bearish on real estate and neutral to bullish on stocks. Real estate's had a long bull run, but it's just about played out at this point. The stock market? It really depends on how the next two years plays out. We're definitely in a bull run right now but that can turn around at the drop of a hat, and given that the recent economic reports are not all sunshine and rainbows particularly in Ontario that bull run may end very soon. Even if it does go down again, in a 5 year time frame they will probably regain their value. Given the length of real estate cycles your condo won't regain value for a decade or more.

In the longer term, 20+ years, which is better really depends on how aggressively you invest your money. In the longer term real estate will track incomes so the only real gain comes from having a "free" place to live once it's paid off. (even then it's not really free - you're still paying 600 or so a month in condo fees and taxes). Meanwhile a 500k investment portfolio will throw off enough investment income to pay your rent 100%.

Ignoring inflation for simplicity's sake
a) Own: assets 420k (condo value). Investment income 0 (long term appreciation is not feasible as affordability is stretched now and prices can't increase much, though you might make a one-time profit off shorter cyclic variations). Costs = 600/month (tax/fees/hydro). Net -600/month.
b) Rent: Assets 430k investments (100k * 6% return [8% - 2% ignored inflation] * 25 years). Investment income $25,800 pa (2150month). Costs (rent) 1900/month [2% increases track inflation, more or less, so we can ignore them if we ignore inflation). Net +150/month.

Of course, ownership typically has a cost premium associated with it. The reality is you actually typically save an additional 300 or so per month by renting. Aggressive investment of the difference yields around 700k in net worth for situation b).

c) rent with discount: Assets 700k. Investment income $42000pa/3500 pm. Rent = 1600/month, net = +1900/month.

Your own mileage may vary, though the assumptions behind this scenario are fairly realistic. Investment income is probably not going to be that high but even a 4% yield in situation C yields 450k at the 25 year mark, which throws off 1500/month in income and leaves you with a net cost of -100/month vs the 600 or so in condo/taxes for ownership.

It's not as simple as what some online calculator says. Let alone what happens if you meet it halfway and buy a cheaper unit and invest the rest (diversification is safest). The reality is we're living in unpredictable times and you pretty much have to make a leap of faith and hope it works out. The only thing to remember is that leverage is very, very dangerous in unpredictable times.

 

[cdr108]

several MAJOR assumptions not valid:

- mortgage payments i calculated is $96,368 not $94,356 over the first 5 years.

- your amortization may be 25 years; however, you WON'T find a 3.7% rate for 25-year term in Canada
(AFAII the longest term available so far is 10 years at 5.25% with ING).
Every mortgage in Canada is like the teaser mortgages with low rates in the US.
I can guarantee you that in 5 years when it comes for renewal the rate will be at least 5% and one will be paying more each month even though the principal is lower.

- where is the property insurance ???
the bank will require that you have that since it is the only asset available as collateral for your mortgage.
that might run you $600+ per year and rising as insurance seems to go up exponentially ... that's at least $3000 for the 5 yrs.

 

[greenleaf]

Rent or buy? I use the calculator on the NY Times site:

http://www.nytimes.com/interactive/business/buy-rent-calculator.html

You can really fine tune it with the advanced settings to look at various scenarios to see what's best for you. It's not perfect, but it's helpful.

 

[cdr108]

one really should not be using those calculators which are US based b/c they will sometimes include the tax deductability for mortgages into their calculations which can significantly skew figures.

i believe that was the same one used by a realtor from Kelly something RE(???) on here to justify buying, but when presented with Canadian figures, we never heard a rebuttal.

 

[CN Tower]

A question closely related to the very existence of a real estate bubble is to rent or to buy. I have believed it
for awhile that Toronto is facing a real estate bubble or a correction to say least. Therefore, I was
surprised to find out that even in today's market, one would be better off to buy a home than to rent one in
today's Toronto, according to the calculation of the following site from CNN;
http://money.cnn.com/2010/10/08/real_estate/rent_vs_buy/index.htm.

The following numbers, based on a one-plus-one condo in the downtown core, are used in the calculation, and they are very realistic.

Rent:
1950 including one parking and one locker
0 for no extra costs, (rental covers all utilities)
20 for renter's insurance premium
2% annual rental increase
Purchase:
420K purchase price
25% Down payment
3.7% mortgage rate
25 mortgage term (years)
2500 property tax
2% annual appreciation

The comparison, based on 5 years and 1.5% annual inflation rate, shows that the renter will pay $46,000 more than the purchaser.

Do you really believe it is better to buy than to rent in Toronto today?

Appendix the result from the calculation

Buying a home would save you approximately $45,937 (in today's dollars) over 5 years, compared to renting, based on the assumptions you provided.
Cost comparison
[1] Rent $123,024
[2] Buy $74,957
Mortgage payments $94,356
Property insurance $0
Property taxes $13,010
Maintenance $24,000
Opportunity cost $10,558
Tax savings (interest/taxes) $23,253
Home Appreciation $43,714
That is, the difference is $45,937.

Let's see-

Fixed operating costs and taxes, rising rents, guaranteed appreciation. Where did you get your data from? Brad J. Bullsh*t Artist?

 

[steve_toronto]

several MAJOR assumptions not valid:

- mortgage payments i calculated is $96,368 not $94,356 over the first 5 years.

- your amortization may be 25 years; however, you WON'T find a 3.7% rate for 25-year term in Canada
(AFAII the longest term available so far is 10 years at 5.25% with ING).
Every mortgage in Canada is like the teaser mortgages with low rates in the US.
I can guarantee you that in 5 years when it comes for renewal the rate will be at least 5% and one will be paying more each month even though the principal is lower.

- where is the property insurance ???
the bank will require that you have that since it is the only asset available as collateral for your mortgage.
that might run you $600+ per year and rising as insurance seems to go up exponentially ... that's at least $3000 for the 5 yrs.

Oops, I got a number from an alternative scenario. Yes, the mortgage payment should be $96,368 not $94,356.
The property insurance is contained in the maitainess fee of $400 per month.

 

[steve_toronto]

Let's see-

Fixed operating costs and taxes, rising rents, guaranteed appreciation. Where did you get your data from? Brad J. Bullsh*t Artist?

The cost and tax are supposed to be adjusted according to inflation rate by the calculator. 2% appreciation is way lower than
the average from data collected in last thirty years or so.

 

[Kenny]

The cost and tax are supposed to be adjusted according to inflation rate by the calculator. 2% appreciation is way lower than
the average from data collected in last thirty years or so.

Where are the agent fees? The opportunity cost seems very low. Are the tax savings mitigated by the fact that the renter will have more funds available for RRSP/TFSA savings? Maintenance costs will likely go up as the building ages. Also, condos tend not to have the same rate of appreciation over a 25 year period as homes.