The incredible benefits of house ownership

The financial media, as always, are exuberant over the prospects of higher housing prices—an attitude I've never quite understood.

Housing is a basic human need. If the cost of bread were to rise 8.9% year-over-year, would the media proclaim a "bread boom" and paint a glowing picture of the strong bread market? If people viewed the cost of housing as they view the cost of gas, we'd all be talking about how we're being ripped off, and there would be calls for the government to intervene to keep prices lower. I've always found it rather puzzling that houses are given this special treatment.

Thankfully, a pamphlet from the National Association of Realtors arrived in my mailbox to explain the pro-side of house ownership. This is a document I must share with you. I found it very entertaining, and even enlightening (though probably not in the way the authors intended).

The first thing I learn from this pamphlet is that homeownership provides 5, count 'em 5, "substantial social benefits for families, communities, and the country as a whole":

1. Higher Academic Achievement
2. More Cohesive Communities
3. Better Connected Families
4. Improved Health and Safety
5. Stronger Economy

Under section 1, Higher Academic Achievement, they reference a number of rather esoteric statistical studies that I'm not capable of criticizing, though if I trust their motives and methods, their conclusions do seem to support a causal relationship between owning one's home and higher academic achievement for children. All I can say here is that in my own community of rented townhouses, we have about 30 school-aged children. In that population, one would expect to find 0.6 children in the 98th percentile, yet there are actually three children in the gifted program. It's hard to draw a conclusion from this one data point, but it's safe to say not all communities of renters are populated by academic underachievers.

However, my favourite part of section is the following chart:


As you can see by the axis labels, this chart clearly shows that the more Renter you are, the more Homeowner you are too!

Sections 2 and 3 describe More Cohesive Communities and Better Connected Families, using statistics from Cincinnati telling us that homeowners are "9% more likely to know who their school board representatives are" or "are less likely to have alcohol and substance abuse problems". These are clearly confusing correlation for causation, and so they'd bear no more thought if they weren't so entertainingly ironic or irrelevant in my particular situation.

For example, apparently homeowners are "28% more likely to repair or improve their home". I can tell you my odds of repairing my home are zero, because all I do is walk to the management office and fill out a work order, and the repair is done for me, for free. Likewise, they are "1.3 times more likely to read newspapers". I guess rentership explains why I never read newspapers. I suppose if I bought a house, I'd be more likely to stop getting my news online and order a subscription for a daily dead tree.

Homeowners are also "16% more likely to belong to parent-teacher organizations, book clubs, etc." My wife belonged to a book club at one time; I guess renting made her quit? And both my wife and I have belonged to our school council (which I currently co-chair) since the first year our older son started kindergarten, which doesn't particularly prove anything except that participation in such things is an individual choice.

The sizable Muslim population in our area may be alarmed to find that homeowners are "10% more likely to attend church". There's a rather narrow-minded implication there that we're all Christians, but homeowners are better Christians than renters.

My personal favourite is that homeowners are "59% more likely to own a home within 10 years of moving from parents [sic] household". Beyond the obvious reversal of causality in this statement, there's also an insidious circular argument that homeowners are better because they're homeowners. I've heard this a number of times in arguments such as "I don't want my kids growing up around renters", and I just don't know how to respond to that kind of statement.

Section 4, Improved Health and Safety describes how renters who buy a house suddenly experience higher self-esteem and perceived control over their lives. I'm sure taking up cigarette smoking would have a similar effect, but surely that doesn't make for a strong argument.

The pamphlet saves the best for last:


It's nice to think that the economy benefits from $60k out of my pocket when I buy a house, but it does tend to contradict the statistic in that green bubble that "a home owner's net worth is 45.9 times that of a renter's [sic]". Apparently, buying a house will reduce my net worth by $60k initially, and it will do very little (aside from forced saving) to help me recover that amount.

All in all, if I were a member of the National Association of Realtors, I'd be pretty embarrassed that this document is being used to represent the argument in favour of house ownership.

Financial independence without home ownership?

As Jonathan Chevreau says in his recent column: "a paid-for home is the foundation of financial independence". Or is it? Happily, this serves as the perfect lead-in to what is becoming a tradition for me: my annual rant on the topic of renting versus buying your home.

I rent. I always have, and unless something changes dramatically in the world of real estate, I always will. When it comes to the purely financial side of home ownership, the numbers just don't add up in Toronto, nor in most of the major Canadian cities. I rent because it saves me money.

It all comes down to the fair value of a house. If actual houses cost less, buying makes financial sense; otherwise, you'll save money by renting.

Real estate as an investment

Historically, real estate values just keep pace with inflation, making it equivalent to real return bonds, but with lower liquidity. This makes real estate one of the worst possible investments if you're looking for capital appreciation.

So why do people invest in real estate? There are two reasons.

First, just as bonds have their interest payments, real estate can generate cash flow. In the case of your own home, you do not actually see any positive cash flow, but you do get to avoid a negative cash flow in that you're not paying rent.

Second, real estate makes good collateral for a bank loan. Residential mortgages have among the lowest interest rates available to individual investors. That interest is not tax-deductible in Canada, and the idea of losing your home for defaulting on a loan is not a pleasant thought. Nonetheless, a mortgage is still a relatively attractive borrowing proposition.

Cash flow

Consider the 4% rule. It states that if you were to invest an amount equal to 25 years' rent in stocks and bonds, you could safely withdraw enough per year to pay your rent. Thus, no house is worth more than 25 years' rent. If your house can fetch a price worth more than 25 years' rent, you should sell your house, rent it back from the buyer, and pocket the difference!

The cash flows for owning one's home take three forms:

1. one large negative cash flow for buying the house;
2. recurring negative cash flows for mortgage interest, property taxes, and maintenance; and
3. one large positive cash flow for selling the house.

Because real estate values can be expected to track inflation, the net present value of cash flows #1 and #3 cancel, leaving #2. (For simplicity, I'll ignore transaction costs and moving costs.)

The recurring cash flows for home ownership are entirely negative, as they are for renting. In any given month, if renting saves money, we should be renting, since it would be more efficient to wait a month and use the money saved to increase the downpayment on an eventual house purchase.

Let's compute the break-even point between renting and buying.

For buying, most annual expenses depend on the value of the property. There are other expenses that depend on the house size, but to keep things simple, I'll express these too as a percentage of the property value.

Roughly speaking, house owners must pay the following costs that renters don't (mostly because they already included in rent):

• 2% mortgage interest. (We don't include the equity portion of the mortgage payment because that money has no impact on net worth.)
• 0.5% building insurance. (We don't include insurance on contents because renters must pay that too.)
• 1% property tax.
• 1% repairs and maintenance.
• 0.5% additional utilities.

TOTAL: 5%

At 5%, the house is costing you an amount equal to its value every 20 years.  This means if you buy a house with a mortgage worth more than 20 years' rent, you will waste money every month relative to renting. 20 years' rent in my current apartment is about $310,000. In my Toronto suburb, that means if I don't mind settling for a semidetached fixer-upper, and I have a decent downpayment, and I don't anticipate any increases in mortgage interest rates any time soon, I would save money each month by buying a house.

So why not buy a house then?

Because interest rates will not be this low forever. If you have a variable-rate mortgage, and rates increase, suddenly renting starts to look pretty good again.

Suppose rates increase by 3% to a more normal (yet still historically very low) 5%.  This brings the break-even mortgage to 12.5 years' rent, or under $200k in my case, which would price me out of the housing market in my area.

Ok, suppose instead we lock in at the current low rates by getting a fixed-rate mortgage. Guess what? The banks have thought of this. 5-year fixed-rate mortgages are going for right around 5% right now. This represents the same 3% increase we just considered a moment ago. No luck there.

All right, perhaps we can get a smaller condo instead of a house. Sorry, no luck there either: typical condo fees are also about 3% of the condo's value.

Any way you look at it, a realistic break-even mortgage is closer to 12 years' rent than 20.

But hey, you don't rent a house! You're comparing apples to oranges!

True. I rent a two-bedroom townhouse. Isn't it unfair to compare the rent on my apartment with the cost of a house, when the latter is much larger? Shouldn't I be using the rent on an equivalent house in my calculations?

No. Here's why.

Consider this: suppose you were evaluating the cost of a car. If you don't own a car, you still need to get around, so to be fair you will have to calculate the cost of public transit, taxi rides, and the occasional car rental. But you do not need to calculate the cost of permanently renting an equivalent car. That option is not relevant unless you are seriously considering doing it! Most people without a car are content to take public transit and taxis.

Likewise, I'm content in the apartment I have. It's not my fault nobody will sell me a house this small anymore (though such houses were commonplace just a few decades ago). If they did, I could do a direct comparison, but they won't, so I must compare the options available to me. Apples-to-oranges is the way toward a rational decision.

Among the options available to me, renting is financially the winner, hands down. If someone gave me a house for free, I'd sell it and move back here.

Still renting?

A year ago, I posted my most popular article yet: Save money by renting your home. A lot has changed in the last year, but one thing that's the same as ever is that I'm perfectly content renting for the foreseeable future.

The the article hinged on a calculation of the largest mortgage I could carry and still save money every month:

I pay $1200 per month in rent, including my parking space. That rent includes a number of items that would come out of my own pocket if I owned a home, such as property tax, repairs, maintenance, and some utilities. All told, I get about $500 in value every month included in my rent. That leaves $700 that is truly "thrown away" just like mortgage interest.

How large a mortgage would cost $700 per month in interest? Today's variable-rate mortgages are going for about 4.6% per year. At that rate, a mortgage of $182k would have interest charges of $700 per month. That means if I could stop renting and move into a house with a mortgage of $182k or less, I would save money every month.

Here's what has changed:

• My rent has increased by $50/mth. That brings my "thrown away" money up to $750/mth.
• Variable-rate mortgages can now be had for 3.05% interest.

With these new figures, we find that the magic mortgage number is now about $295k. If I can find a buy a home with a mortgage of $295k or less, I would save money every month.

Here's what hasn't changed:

• Homes in my area still don't go for $295k. They're still up around $480k.
• Condos can be had for $295k, but the condo fees move the break-even point below $295k, so they're still not better financially.
• I still don't particularly want to own a home.

I'd like to leave you with one final thought. It is being claimed that now is the time to buy a home because of increasingly favourable interest rates and home prices. To my mind, the best time to make any investment is when the price is low and increasing. Right now, real estate prices are high and decreasing. As far as price is concerned, you could hardly choose a worse time to buy a home than right now (except perhaps six months ago).

The worst has happened. The sky has fallen. I've lost a gut-wrenching amount of money on paper in the stock market since September. But I'm as satisfied as I ever was in my asset allocation, my risk tolerance, and my decision to rent rather than buy.

Update, Apr 21: As of this week, you can get mortgage rates as low as 3.05%, so I have adjusted my calculations above to use this number instead of 3.3%.

Update, July 15: Looking at the same link given above, we see now that variable mortgage rates are as low 2.85%, so the break-even mortgage is up to $315k. This means I probably could buy a house in my neighborhood and, ignoring the buying and moving costs, I might save a few bucks every month starting on day one. But I still have no interest in buying a house just yet. For one thing, the moment the mortgages return to more historically normal rates, the mortgage's advantage over renting disappears, and I would be back to losing money every month relative to renting. I consider it unwise to bet against this happening in, say, the next five years. There are also non-financial considerations, like the freedom to change homes with just 60 days' notice at no cost, or my nearly complete protection from risk in the real estate market. A house would need to cost substantially less than my rent for me to take on the extra risk and responsibility of house ownership.

Update, November 3: Now rates are down to 2.25%, so the break-even mortgage is up to $400k. If I were convinced mortgage rates would stay this low indefinitely, and I liked the idea of skewing my asset allocation heavily toward residential real estate, and I didn't mind mowing my own lawn and fixing my own roof/furnace/toilet/whatever, and I was ok with losing the freedom to move with 60 days' notice, I'd buy a house right away!

Update, November 24: The neighbors just sold their house for $650k. It was a decent-sized 5-bedroom house, but it just goes to show that I wasn't being overly pessimistic by estimating $480k.

Save money by renting your home

If you're renting, you're throwing your money away, right? Well, if you're paying mortgage interest to the bank, that's throwing money away too. Which costs less over the long term?

I pay $1200 per month in rent, including my parking space. That rent includes a number of items that would come out of my own pocket if I owned a home, such as property tax, repairs, maintenance, and some utilities. All told, I get about $500 in value every month included in my rent. That leaves $700 that is truly "thrown away" just like mortgage interest.

How large a mortgage would cost $700 per month in interest? Today's variable-rate mortgages are going for about 4.6% per year. At that rate, a mortgage of $182k would have interest charges of $700 per month. That means if I could stop renting and move into a house with a mortgage of $182k or less, I would save money every month.

Houses in my area don't sell for $182k. They sell for more like $482k, meaning I would need a $300k downpayment. With that large a downpayment, I'd need to look carefully at the opportunity cost of moving $300k worth of assets into a single piece of real estate. $300k in the stock market would earn about half the Canadian median household income every year, so that's a pretty high opportunity cost.

What if I get a larger mortgage instead? If I get a $300k mortgage instead of $182k, that would cost an extra $452 per month. I'd have to justify that extra cost either using the appreciation in the value of the property I buy, or else using non-financial arguments (e.g. I just really want to own a house). Since I don't particularly want to own a house, that leaves me with the appreciation argument.

So the question I ask myself is: do I want to borrow several times my gross salary to bet my entire net worth on a single real-estate investment? Given the current climate of the real estate market, I'm pretty happy with my current diversified portfolio, thank you very much.