Aug 172014
 

Some experts say the North American real estate market is starting to become overvalued again. In today’s post we’ll compare property prices to rents and explore whether or not overheated markets like Vancouver are headed for a hard landing. 🙂

Rent vs Buy

Let’s take two fictitious singles, Alice and Barry, who are both from Vancouver and work for B.C. Hydro, a utility company. They each have $20,000 in savings and they both want to move closer to work. Alice plans to rent while Barry plans to buy.

Alice manages to find a suitable apartment that’s located very close to her job. It only takes her 5 minute to walk to work. 😀 She decides to invest her $20,000 of savings into the stock market.

  • Alice’s Apartment:
  • Location: 7418 Byrnepark Walk, Burnaby B.C.
  • Size: 800 sq ft.
  • 2 beds, 2 baths.
  • Rent: $1,600 a month.

Here is the actual listing on Craigslist I found. The move-in date is not until Sept 1st, 2014. So this is a real life housing situation that could happen to someone in Vancouver right now. Click on image to biggify.

14-08-rental-unit Rent vs Buy

 

Meanwhile, Barry also finds a place to buy, coincidentally in the exact same building as Alice, and also has the same number of bedrooms and bathrooms.

  • Barry’s Apartment:
  • Listed Price: $369,000
  • Location: 7418 Byrnepark Walk, Burnaby B.C.
  • Size: 792 sq ft.
  • 2 beds, 2 baths.

Here is the direct link to the actual listing on realtor.ca.I’ve taken a screenshot as well in case the listing is removed in the future.

 

14-08-purchase-unit Rent vs Buy

Barry decides to spend his savings on the down payment and get a mortgage for the remaining $350,000 balance. I’m currently paying 2.6% on my mortgage so let’s keep it simple and give Barry the same rate. Using a mortgage calculator we find that Barry’s mortgage payment amortized over 25 years is $1,585 per month. That’s almost the same as what Alice is paying for rent. 🙂

This is why a typical condo in Greater Vancouver costs $369,000. It HAS to cost this much in order to stay competitive with rental rates. Condo prices aren’t falling because lower prices would lead to lower mortgage payments, and it’s simply not rational for people to rent a place when it costs a lot less to easily own another (almost identical) unit in the same building.

The decision to rent vs buy is personal. Some people want to rent for $1,600 a month like Alice, while others like Barry prefer to buy and pay $1,585 a month for virtually the same home. The idea that young individuals are forced to rent because they’re priced out of the real estate market is a myth. If we can afford to rent a condo, then we can clearly buy a condo just as easily, using today’s real life examples as proof. The high property values in Canada are the results of logical human behavior based on fundamental supply and demand, and not speculative in nature. Property prices will only fall if interest rates increase or the cost to rent decreases. But given the low vacancy rates between 1% and 2% in most neighborhoods around Metro Vancouver it’s very unlikely that rents will drop any time soon. 😕

But not so fast. Doesn’t Barry have to pay for maintenance and tax as well?

Yes. 🙂 If strata fees (HOA) costs $229 a month, and property tax is $126, then Barry’s total expenditure for housing is $1,940 a month, which of course is $340 more than what Alice pays for her $1,600 rent.

So this means it’s actually cheaper to rent like Alice right? Because she saves $340 more than Barry every month.

Well yes and no. Many experts argue that paying down a mortgage counts as forced savings. By this measurement Barry pays down his mortgage principle by $840 a month. This means his real cost of owning the apartment is actually $500 a month less than the cost of renting for Alice.

So it’s better to purchase a home then?

Well, it depends on if you think the extra $500 monthly gain to net worth is better than having an extra $340 in monthly cash flow. Some people like Barry believe building up $6,000 a year in equity is important so they become a home owner. Others like to have the $4,000 a year of tangible cash in their hands to spend or invest, like Alice, so they become renters. Both are fair choices, but keep in mind that the wealthy tend to focus on their net worth, while the middle class is more concerned with their income.

But what about the long term? 

Let’s look at their situation 25 years from now. We’ll assume 8% for annual stock market returns, and 2% for inflation.

Alice:

  • Housing Expense: $2,600 per month (inflation on $1,600 rent over 25 years.)
  • Assets: $404,000 more stocks than Barry ($20,000 head start, plus $4,000 a year of new investments from annual cash savings for 25 years.)

Barry:

  • Housing Expense: $570 per month (inflation on Strata Fees and Tax over 25 years.)
  • Assets: $605,000 more property than Alice (inflation on purchase price of his apartment over 25 years)

After 25 years Barry is mortgage free and he spends less on housing expenses than Alice. His net worth is also higher by about $200K. But Alice has a lot more liquidity.

So overall which has more advantages, renting or buying? 

Well, it depends on where you think interest rates and home prices are going in the long run. We can make different assumptions about mortgage rates, repair costs, and future property values until the cows come home, but that won’t get us any closer or farther to being right. Personally I don’t bother trying to predict the future. Fighting the market can have negative consequences. I simply make my financial decisions today based on the best option right now assuming interest rates and prices stay the same for the foreseeable future. Rent vs buy. In the end we all have to decide what’s best for ourselves. 😀

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Random Useless Fact:

14-08-beliefs-and-actions Rent vs Buy

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56 Comments on "Rent vs Buy"

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The Asian Pear
Guest

Both renting and buying have equal pros and cons. Renting gives a more flexibility. You are able to easily move out (within a period of time with notice) and you are not financially anchored by anything. Likelihood of return is better if you buy and hold onto the property longer (unless you plan to do a riskier quick buy-flip-sell technique for shorter gains.)

Personally, I think buying is always better than renting if you can afford it and if you forsee that you are able to live there for a long-time.

Ed
Guest
Ed

Always better to buy like the example above when no closing costs, CMHC premiums, lawyer fees, land transfer taxes, etc or utility costs are included;considering his property value went up over time, we are in an inflationary period do having no increases in interest rates, utilities and taxes or insurance premiums is also a huge bonus! Lucky guy that Barry!

Investing Pursuits
Guest

I prices of real estate in Canada’s major cities is crazy. Vancouver, Calgary, Edmonton, Toronto, and even Halifax the prices are out of this world. The problem is that the personal residence is the only “investment” these people buy only. If you lose your source of income, usually the job, you are in big trouble

PC
Guest
PC

Ppl shouldn’t pay $1600/mo for rent based on single income. Thats way too much going into shelter each month. No offense or anything, I find most renters can’t afford a down payment to buy thus they rent. Who doesnt want they own place? Ppl who are generally good with money would want to build their own equity rather than paying someone else’s equity. Renters would generally argue they save a lot of their disposal income to invest and grow over time. That comes with risk too. Nothing is for sure. But if you keep paying your mortgage you’ll eventually pay it off and don’t have to worry abt it anymore vs a renter who can be left in a dire situation if their landlord wants to sell or increase rent. Do u really want to be 65 and still have to rent or own a home mortgage free. End game ppl. Think of future. Landlords get rich.. renters get by. Owning is better always even with the extra costs.

JR
Guest
JR

Liquid,

I agree 100% with your analysis above.

I paid off my mortgage in 6 years. Something about forced savings really shakes things up, and forces you to focus on cost reduction. Never regretted buying right before the crash of 2008.

I had a renter who was in the same career situation as myself always told me how he was going to buy my place from me for half-off once real estate corrected. The fact is, without forced savings he never could scrape much of a down-payment; poor guy is still waiting.

JR

Asset-Grinder
Guest

Tough call on renting or buying right now especially in Vancouver. With Vancouver real estate so pricey its a safer bet to rent is my guess. A market correction of 10-20% is badly needed

Kapitalust
Guest

Hehe I’m currently working on a rent and buy post to follow up from mine from last year. You’ll have to come critique my calculations because mine ended up being superior for renting in a 5 year scenario (dependent on controlled factors, that are up for critique!) 😀 😛

Rates
Guest
Rates

Way to assume 2.6% interest rates will last for 25 years, let alone one.

Not strictly impossible, but with the end (???) of US easing imminent…

Dan @ Our Big Fat Wallet
Guest

Im always surprised at the number of people who refuse to rent. In some cases it makes perfect sense to rent especially if your employment situation isn’t stable or you know you will be moving long term

AAFS Insurance
Guest

Interesting analysis. I’m thinking about this myself and have to look into it in more detail. Always had the mindset that buying should win out over the long term, but with the inflated prices, I’m starting to look at renting as a viable alternative.

Adam112
Guest
Adam112

He wouldn’t have been able to buy that condo with 20K cash in hand. Closing costs would have consumed that 20K and he wouldn’t have been able to make the minimum 5% down required by law.

Anne @ Money Propeller
Guest

Thank you for using a real life example.
It’s all about what you need to value. Liquidity is valuable in and of itself, for a lot of folks, especially when you are young and don’t know what’s going to happen.
I’m actually surprised that the buy/rent numbers were so close in Burnaby. Good to know. They are horrible in my town, it doesn’t make a ton of sense to rent, until you figure that you are completely losing 15K or so to liquidity and whatnot. Then, it starts to make more sense, but not from a strict $1200 vs $1500 perspective.

Tawcan
Guest

Interesting analysis. When it comes to buy or rent there are so many parameters that would affect the decision. Some people just don’t feel comfortable renting while some people don’t want to own and only want to rent.

DivHut
Guest

Thanks for sharing one of the classic financial questions of our time. You broke it down pretty nicely with those two examples and I guess the bottom line is it’s a personal choice and depends on where you live. For now, I am very happy to rent. The rate is very reasonable since I have been living in the same place for many, many years and love to not have to worry about insurance, tax and maintenance costs. I’m not against home ownership, just don’t feel the need for it just yet.

Phil
Guest

Rent or buy depends on you personal situation. You could break it down financially to an equation of sorts to find out which would cost benefit you better, but ultimately life’s inconveniences would most likely make those calculations irrelevant the following day as life situations constantly evolve. There are times in anyone’s lives where renting makes most sense, but once stability presents itself to ones life, purchasing becomes an option. – Cheers. … AVO still on a tumble, sorry you thought I was wise on this one. For the record, I continue to hold, as I still believe the company has a reasonably solid foundation for continues growth.

save. spend. splurge.
Guest

Once you have decided where you want to live for life, buying a place MAY make sense especially if the real estate market goes down and is depressed.

We had no idea where we wanted to retire, and now that we’re set on a city, it makes sense for us to look at something to buy but only if the price is right.

andy
Guest
andy
Masters
Guest
Masters

That is a really ignorant message. It may be “higher later on down the road” but HOW much and When? If your house is worth 30% more 30 years down the road (not factoring inflation) then you have lost BIG time.

Zippy
Guest
Zippy

You’re not really comparing apples with apples here. Barry is leveraging like crazy on his apartment but Alice is debt free. I think you should try running the numbers again, but instead, Alice borrows $350,000 just like Barry does, and pays it off just like Barry does, but she invests it.

Ian
Guest
Ian

An interesting thing you can do to reduce your monthly payments on your mortgage is to pay it weekly. Run the numbers through a mortgage calculator. If your monthly payments are $900 now you could probably pay about $820 monthly if you paid weekly, if you are saving $960/year that can add up to a lot over time

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