The Case For Renting A Home Part 1 | Common Sense Investing

Canadians really like real estate. It’s hard not to be excited when prices
in hot markets like Toronto and Vancouver have been making global headlines. Around two-thirds of Canadians own their home,
and the perception is generally held that owning your home is a smart investment. Many Canadians feel that they need to buy
a home as soon as possible because they are throwing money away by renting. I’m sure that you have heard the line that renting
is “paying someone else’s mortgage.” On the surface this seems to make sense, but
there are some important factors that need to be considered. I’m Ben Felix, Associate
Portfolio Manager at PWL Capital. In this episode of Common Sense Investing,
I’m going to tell you why renting a place to live is not a waste of money. Let’s think about the benefits that renting
has over owning. If there is a possibility that you could move
within ten years of purchasing a home, you are taking on enormous risk. It is true that over the long-term real estate
tends to go up in value, but in the short-term, its value can go up or down unexpectedly. Combine this price risk with the fact that
most people borrow a significant portion of the money needed to buy their home, and ownership
gets pretty risky for anyone with a short or uncertain time horizon. A renter is paying a set cost in exchange for a place to live. Explicitly knowing the cost of your housing
has its advantages, and the predictable monthly expense is useful in planning your finances. A homeowner can easily plan for their mortgage
payment and property tax, but they may also have expensive maintenance costs that appear
unexpectedly. These unexpected costs may result in the need
to borrow money, or the need to carry a large cash reserve – both inefficient uses of capital. Owners get sucked into the idea that
their home is an investment. Based on this thinking, they will often spend
heavily on renovation or maintenance projects on the premise that they are increasing the
value of their home. Unfortunately, there is no guarantee that
expensive home improvement projects will actually pay off. In his book The Wealthy Renter, real estate
analyst Alex Avery explains that his “Golden Rule of Investing in Real Estate is that
buildings never go up in value. Ever. Period. Only land can go up in value”. Those were three benefits of renting that
are important to keep in mind: Less risk, predictable cost, and no investment illusion. Of course you’re still wondering, isn’t
renting throwing money away? When you’re renting you’re just exchanging
money for the use of something without any expectation of a residual value. Paying rent for a place to live is obvious. You give money to the landlord. They give you the keys. You get nothing back in the end. What many people fail to consider is that
homeowners are also paying forms of rent. They are renting services from the city in
the form of property taxes, they are paying unrecoverable maintenance costs just to keep
their house inhabitable, and they are renting money from the bank while they have a mortgage. But surely when the mortgage is paid off a
homeowner’s cost of living is much lower than a renter’s. Not so fast. Let’s think about someone with a paid off
house worth $500,000. They could sell that house, keep around $475,000
after costs, and invest that money. Let’s say that they could expect to earn a 6% annual average long-term return on their investments, while the long-term expected
return on real estate is closer to 3%. That 3% difference in expected returns
is called an opportunity cost. The opportunity cost of owning this home is
around $14,000 per year. You don’t actually see the opportunity cost
in any of your bank accounts, but it’s there. Add that to property tax and maintenance costs,
and we can easily arrive at a total monthly cost of ownership of over $2,000. That’s $2,000 of unrecoverable costs with
no residual value. Renting doesn’t look so bad anymore. So far we have established that renting has
some advantages, and owners also have substantial expenses with no residual value, so why does
home ownership have such a good reputation? The real estate and home improvement industries
have obvious self-serving motivations to make home ownership look good. The Canadian government has programs in place
to encourage home ownership, making it seem like a good idea. Most importantly, there are a lot of people
in Canada who genuinely believe that their home has been their best investment. It is very common for well-meaning friends or relatives
to encourage home ownership based on their own perception of their own experience. It’s really no wonder why many people think that
their home has been a great investment. The numbers are big, and investment returns
are not always easy to understand. The average Canadian home purchased in 1980
for $62,000 would be worth $496.500 in 2017. That seems like a great return. Over 38 years it works out to 5.63% per year
on average before costs and inflation. When a homeowner is standing back after 38
years and admiring the appreciation in the value of their home, they aren’t usually
accounting for the costs incurred along the way, but the costs were definitely there. Property taxes and maintenance could be reasonably
estimated at a combined 2% per year reducing the annual return to 3.63% after
costs and before inflation. Canadian inflation over this time period was 3%. So that seemingly massive gain from $62,000
to $496,500 was really only equivalent to a 0.63% average annual return after costs and inflation. For context, the S&P/TSX composite index returned
an annual average of around 5.9% after inflation over the same time period. The long-term after-inflation returns to US
and UK real estate are similarly low, barely beating inflation over the past 115 years,
while stocks in those countries have far exceeded inflation. Hmmm. So real estate returns aren’t actually
so great. Home ownership does have one big benefit that
really does build wealth. A mortgage forces discipline. It is much easier to stop the monthly contribution
into your RRSP than it is to miss a mortgage payment. That discipline does pay off over the long-term,
but it does not actually make home ownership an inherently great investment. People can be disciplined renters and investors, too. I have started to make the case that renting
a place to live is a sensible alternative to home ownership for building long-term wealth. In my next video, I will lay out
the numbers that prove my case. Would you consider being a forever renter? Tell me about it in the comments. Thanks for watching. My name is Ben Felix of PWL Capital and this
is Common Sense Investing. I’ll be talking about a lot more common
sense investing topics in this series, so subscribe, and click the bell for updates.

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