How do you choose housing that will make you rich? In his book Alex Avery, managing director of institutional equities at CIBC world markets, outlines the pros of renting instead of buying a place, specifically in Canada. Avery makes a compelling argument that renting is a much more cost efficient approach to living, especially with Canada’s overheated housing market. He states that as opposed to putting all of your equity in to a single investment, you’re better off putting that money into a Canadian Dividends Aristocrats fund where your money is diversified among roughly 75 holdings. When deciding whether you should rent or buy, primarily for living and not for renting out, look at the numbers associated with renting or buying as there seems to be a lot of hype around the notion that buying will make you rich. Look at all of the numbers associated with buying and look at all off the numbers associated with other available investments first. From there, you’ll be able to make a better informed decision as to whether renting or buying is the better option. Here are some of the points to the book:
1. For most people, housing will probably be the largest monthly expense whether you’re renting or buying. Having said that, why wouldn’t you want to learn more about how you’re spending your money on it. Using Pareto’s principle of the 80-20 rule, focus on the 20% of your expenses that’s 80% of your total expenses and better understand them. “So I’ve lived in many types of housing and I’ve rented and owned. I’ve also talked to family and friends about their homes. Having spent the last fifteen years analyzing real estate investments for everyone from pension funds, to the wealthiest Canadian families, to roommates, friends, and family members, I’ve helped hundreds of people make decisions about their housing. What I’ve come to learn is that, for most people, although the housing decisions our parents have made and we have made form the settings for our lives, we seldom think about the many different ways housing affects our lives. In fact, our housing decisions have much more of an effect on our lives than most people think. Where we live defines how we live our lives. Our housing choices determine how long it takes to get to work. How much time we spend with our friends and family. If you have kids, it determines where your kids will go to school, where they play, and who they play with. It can affect how well we do our jobs. It can determine how much money we have for other things, like travel and the nicer things in life, such as cars, clothes, jewellery, electronics, and collectibles. It’s probably the biggest factor that determines when we can retire and how we retire. Housing is the largest single expense in life for the vast majority of Canadians. For those who choose to own, buying a home is the biggest purchase of their lives. For renters, the rent cheque is usually the largest monthly expense and over a lifetime is almost certainly the largest expense. As the biggest expense of our lives, how well we manage the cost of our housing has a greater impact on our cost of living than any other factor.“
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2. Renting gives you significantly much more flexibility; you never have to be tied down to a situation you don’t like. I personally think that in this day of age as society is moving at such a rapid pace due to technology, being nimble and adaptable is a must. It’s much more difficult to just up and leave when you’ve got an asset that isn’t very liquid (can’t be easily sold), and not to mention the fees associated with selling a place. With renting, the fees of moving aren’t very significant to deter you from doing so. Don’t like your job? You can easily move to find another one. Having kids and need more space? You can easily find a new place. See a great investment opportunity? No worries, you don’t have your cash all locked up in a single nonliquid asset. “Maybe you need more space or less space. You might find the rent is too much or that you can afford a nicer place and the higher rent that goes along with that. Maybe you’ve decided to move in with a girlfriend or boyfriend. Or maybe you’ve decided to stop living with a girlfriend or boyfriend, in which case the ability to move quickly is particularly important. Having a kid? Or another kid? New place! As life changes, so do your needs, and you’ll often find yourself looking for something bigger, nicer, smaller, or cheaper. Whatever the reason you might have for moving, sometimes you can’t wait to make a move. Renting allows you to move quickly and without a lot of costs. If you’re renting and you decide you’d like to move, there are no fees or commissions payable to move into a rental, and there are no fees when you leave. If you were to try the same thing as a homeowner, the transaction costs of buying and selling could be 5 percent or more for each transaction. If you buy a home worth two and a half times your gross annual income (a guideline that seems quaint and outdated, given Canada’s house prices — do the math!), you could easily spend three months of gross income selling one home and buying another. If you bought and sold the average house in Canada, at just over $500,000, that cost could be $50,000 or more.“
3. Whether you’re renting or buying, you’re still “renting” in some form. If you’re renting, your rent money is going to the home owner. If you’re buying then you’re “renting” money from the bank (assuming you’ve taken out a mortgage). There’s a notion that renting is just “throwing away” money which isn’t exactly the case. “The backbone of the argument most people use to ‘prove’ owning is better than renting is that to pay rent is to throw your money away. That a renter is simply paying the mortgage of the owner of the property. While this argument seems logical and is intuitively appealing, it’s an over-simplification that ignores two important factors: 1) the owner of the property has invested money into owning the property and is taking on the risk of the property going up or down in value; and 2) everyone who lives in a house (or mobile home or recreational vehicle or tent) is paying rent. Always. That second point might seem like a ridiculous statement, so let me clarify what I mean. The word rent is defined as money paid for the use of something. For housing, rent is what is paid for accommodation — which can be an apartment, a house, or any other form of accommodation. However, any payment should be considered a rent payment if there is 1) a use or service provided in exchange for the payment; and 2) there is no remaining value after the rental period expires.“
4. Properties don’t go up in value, only the land does. Properties don’t go up in value because everything in a place gets old; things will rust, rot or depreciate. The reason why properties go up in value is because of the scarcity of the land. In Canada specifically, land isn’t scarce at all which is why housing in Canada is overheated; Canada has one of the lowest population densities by country. In other places where land really is scarce such as New York, Hong Kong, Singapore, housing prices are better justified. “Only land can go up in value. Some land goes up a little, and some goes up a lot. Sometimes the land goes down in value. But the house always goes down in value. Both parts of this rule are important to keep in mind when considering ‘investing’ in a home and when comparing the potential financial benefits of doing so compared to the cost of renting. This rule I’ve created helps me to gain perspective when I’m trying to value real estate. I created the rule based on a few things I kept noticing as I was making my way into the real estate industry: All properties have maintenance costs. For tax purposes, properties are depreciated — a fixed percentage of a property’s purchase price can be expensed each year against income the property generates. Properties in large cities tend to perform better than rural properties over time. What the first two observations told me was that buildings go down in value, while the third observation told me that, where land is scarce, property values can go up. And, conversely, where land isn’t scarce, its value doesn’t tend to go up.“
5. When you’re looking for a place to buy, you’ll automatically get sucked into various cognitive biases that will affect your purchasing decision. This is called “investment creep.” This essentially means that you’re going to overlook the price of the place or you’ll stretch your budget because of some feature of the place. You’ll start overlooking your budget because of how much you like something the place has to offer; it’s difficult to separate emotions from logical decisions. “The point is that we live in a world saturated with marketing and materialism, and it’s almost impossible to remain immune to the psychology of materialism and the idea of ‘keeping up with the Joneses.’ Now apply that thinking to the most expensive thing you could ever buy (or rent!). The thing that forms the stage on which we all live out our daily lives. The most personal and private space we have and, at the same time, for many people the most prominent manifestation of who we want the world to see us as. And that leads to all sorts of strange decisions that people might not otherwise make, particularly when you contrast modern housing features with the necessities we require from housing, like a six-burner Wolf range costing 20 times the most basic electric stove available. Thick black line separating the needs from the wants, just a grey continuum of blurring between what is necessary and what is desirable. This is where investment creep comes in. Investment creep will sneak up on you in the kitchen. There you are, in the kitchen of a home for sale. You might be with your spouse or boyfriend, a best friend or parent, or you might be alone with your real estate agent. You’ve got your budget and your wish list of must-have ’s and ideally’s, and you’re looking to buy. Inside of your head, or out loud with your partner or advisor, the conversation will bounce back and forth from the first place you saw the day before to the one you saw that morning to the one you’re standing in, and how each stack up against your list. House A had a great kitchen but a terrible view. House B fit your budget perfectly, but the kitchen and bathrooms needed updating. The kitchen you’re standing in has it all, but it’s just out of reach from a budget perspective.“
By Ryan Timothy Lee
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