Should you rent or buy a home? Why that calculation might be changing
A home for sale in Guelph, Ont., went viral on TikTok this month when a user walked their audience through the property. It had a massive hole in the ceiling, was coated in filth and had burn marks on the front door.
It was listed for more than $640,000 — and sold for $117,000 over asking.
Stories like these aren’t uncommon in Canadian real estate, where the average selling price of a home has surged more than 50 per cent in the last two years, according to Reuters.
But the headlines have led some Canadians to question whether they can — or should — take the plunge from renting a home to owning one.
Here’s what you need to know.
The case for buying
In many ways, buying a home is seen as a marker of adulthood.
Canadians have a “deeply ingrained view” of housing as a “good, stable investment” and as something that everyone is “striving to buy,” said Paul Kershaw, founder of Generation Squeeze.
That view doesn’t come from thin air. Housing prices have been growing and growing across the country in the last 20 years, with the national average home price in February 2022 jumping to more than $800,000 — a 20-per cent increase from the same month last year, according to the Canadian Real Estate Association.
Because of this price increase, many view housing as a wise investment. Instead of “throwing away your money” by giving it to a landlord, you’re building equity and — depending on the market — will likely see the money you spent on a house grow, if recent trends are any indicator.
Another upside is the fact that there’s no capital gains tax on your primary residence. While 50 per cent of the income Canadians make from investments is taxable, they don’t have to pay this on the accumulated value of their home.
“The challenge with renting over owning is there’s a significant tax advantage to accumulating capital gains in your principal residence versus accumulating those in various types of investment vehicles that would you use if you’re not investing in your house,” explained Jean-François Perrault, chief economist at Scotiabank.
On top of that, if you’re staying in a house long-term, you don’t have to worry about the impact of fluctuations in the housing market to the same extent as you would while renting. While renting, these fluctuations could lead to rent increases or even renovictions, which means you’re evicted so the landlord can renovate the apartment.
Owning a home gives you a “really nice hedge” for your future housing consumption, said Ben Felix, who is a portfolio manager and head of research at BWL Capital in Ottawa.
“I think owning a home is less risky than renting from the perspective of housing consumption. But I also don’t think most people end up living in a home for 30 years,” Felix explained.
Which brings us to the second option: renting.
The case for renting
In Canada, about 30 per cent of residents rent their homes — but not necessarily by choice.
With the average price of a home hitting $800,000 in Canada in February, the average resident would need to have $40,000 to make a five-per cent down payment — and that doesn’t even include the costs of the transaction itself, nor the CMHC insurance you’d have to pay on your mortgage in order to qualify for such a small down payment.
“We have gotten to a point where housing affordability is a significant block on people being able to buy a house,” said Perrault.
“So like it or not, you need shelter. If you can’t afford to buy a place, you’re going to rent. So for a lot of folks, it’s not even an option.”
However, renting doesn’t have to be the reluctant, financially-irresponsible second choice it has historically been framed as. According to Felix, in many cases, renting might actually be a smarter move.
“From a wealth accumulation perspective, renting and owning can be comparable. I think that’s something that often gets missed: rent is viewed as throwing money away,” he said.
When people look at the money gained from buying a home, they often look at the initial purchase price and then the ultimate selling price. The difference between the two, you might think, is pure profit.
But that’s not necessarily true. When you own a home, there are all kinds of recurring costs you have to “throw away” money in paying for: property taxes, maintenance costs and interest payments on your mortgage, to name a few.
“When you add up the unrecoverable cost of owning and compare it to renting, they can actually be very similar,” Felix explained.
Owning a home does force you to save, though. In making your monthly mortgage payments, you’re increasing the money you’ll get back when you ultimately sell your home — plus any profit.
The Credit Suisse Global Investment Returns Yearbook has tracked global investment returns for over 100 years. Between 1900 and 2017, the average global return from real estate investment — like owning a home — was roughly 1.3 per cent, it found.
For investment in the stock market, the average return was just over five per cent.
If you can be disciplined about saving money and investing it, then you theoretically could make as much money — if not more — while renting, Felix said.
“Investors can increase the weight in their portfolio of riskier stocks, small cap and value stocks to be specific, which increases expected returns,” he explained.
“If you make the comparison on that basis, I think renters can actually have an even bigger advantage. You can’t do the same kind of thing with owning real estate.”
How to choose
While there are strong arguments on both sides of the debate, only you can decide what’s best for your finances based on your unique situation, Felix said.
In his case, he wanted to live in an area where there are very few rentals — a reality that forced Felix to buy, despite his preference for renting. You might also need the constraints of an enforced savings plan, like a mortgage, otherwise you’ll blow all your extra cash on frivolous purchases.
At the end of the day, the choice is deeply personal — but there are some general rules that can help guide your decision.
This is where the five per cent rule comes in. Felix explains the concept on PWL Capital’s website, where it lays out the tools you need to do the math that can help you decide between renting or owning.
Home owners can expect to pay about five per cent of the value of their home in unrecoverable costs, Felix says. So if you take the value of the home you’re considering, multiply it by 5 per cent, and then divide it for 12 months, you get the maximum figure you should be paying in rent.
If you can rent for less than that figure, then “renting may be a sensible financial decision,” he wrote.
If math isn’t your strong suit, this Global News real estate calculator from 2016 can help, too.
(Real-estate calculator methodology)
To calculate your monthly rent, we assume your rent will increase with inflation (2 per cent per year) and that you purchase renter’s insurance (at 1.32 per cent your monthly rent).
To calculate the monthly costs of owning a home, we determine your monthly mortgage payment at the interest rate you specify, assuming you will pay the mortgage off fully in 25 years. We then add costs for property tax (1.2 per cent the value of your home each year), homeowner’s insurance (0.46 per cent the value of your home each year), maintenance costs (1 per cent the value of your home each year) and utility costs ($300 a month). These costs are assumed to rise either with inflation (2 per cent per year) or the value of your home (4 per cent per year). If your down payment is below 20 per cent a mortgage insurance premium is added to your mortgage at CMHC proscribed rates. We also add a one-time fixed cost of your down payment, as well as the closing costs associated with buying and selling the home (at 4 per cent and 8 per cent the value of your home respectively). The net gain from selling your home is subtracted from the total costs.
We apply a net present value calculation to each of these values to get the cost in today’s dollars. Put simply, money earned today is worth more than money earned in the future because of its earning potential. This acts to decrease rental costs, as those are spread out over many years. Buying a house, on the other hand, involves large upfront costs, while the proceeds are put off years into the future, and are thus worth less in today’s dollar. This acts to increase home ownership costs relative to renting.
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