Wednesday, April 15, 2009

Here it is...


OK - here are some buy/rent comparisons. The results may surprise you. My conclusions at the end will surprise you even more.

They are just random cases I found on the net, and I have applied my less than perfect analysis to them.

I read some posters state that a house should sell for 200X it's rent or some such simplistic formula.

In fact the relationship between renting and buying is very complex, and there is no 'right formula', it all depends on what is happening to housing and the economy. I will explain this all at the bottom.

Assumptions:

I have used the ING 5 year fixed @ 3.9%.

Some folks will compare mortgage payments with rent. However some of the mortgage payment is used to pay down the debt. This is a way of 'forced saving'. Over time the debt will diminish, however over time, rents generally go up. So I have put down the amount the debt is reduced for the first year of the mortgage as an indication. I think this gives you a fairer comparison. (I am a fair bear after all)

I have assumed a 20% down-payment +/- for rounding.

I may have played down the costs of owning. A new roof would set you back many thousands, as would any significant repairs.

Lets look at a few examples:


1) Small Condo in Coal Harbour:

# 807 555 JERVIS ST, Coal Harbour, Vancouver West, $358,000.00
HARBOUR SIDE PARK. Located in prestigious Coal Harbour just steps from Stanley Park, Marina and best downtown living. Updated kitchen/bathroom w/granite countertop. Hdwd flr. 1 parking/2 storage. Rent $1300/mth.

Rental cost: $15,600 a year

To buy:

Assume 20% down ($70,000)

Lost opportunity @ 1% = 700 a year
Mortgage on $288,000 = $18,000 a year
Strata fees = $2444
Repairs = $500
Taxes = $1200

Total = $22,844

In the above example nearly $7000 would be applied to reduce the loan. So there is no significant difference between the two.

2) Port Coquitlam home:


2100sf. house on an 8100sf. lot with 4 bedroom and 2.5 bath. House is like new with hardwood floors, granite counter top, island kitchen, vaulted formal living room, two gas fireplaces, master bedroom with ensuite bathroom, attached garage, and alarm system. Fenced back yard with large inground saltwater pool, sunken deluxe hot tub, garden shed/pool house, garden area, nicely landscaped with stamped concrete patio. To keep the yard beautiful the property has inground irrigation system. House is on a no thru road 1 min. walk to bus stop, close to park and school. 5 min. from Home Depot. Available June1, but flexible. No smoking and no pets please. Reference a must. $2100 +util

For Sale Comparison few doors down: V757487 $532,000

Rental cost: $25,200 a year

Owning with $100,000 down.
Lost opportunity on D/P = $1000
Maintenance etc= $2000
Mortgage on $432,000 = $27,120
Taxes (estimated) = $2200
Total = $32,300
However $10,000 of that will reduce the debt.

3) Large Luxury House in West Vancouver:


$41,880 a year.

To buy something equivalent look at 1265 INGLEWOOD AV, Ambleside, West Vancouver, (V724242) $1,288,000. Same area, though the rental property has a view. The property for sale is assessed at $1,127,000 and last year's taxes were $4241. (source: https://ecom.westvancouver.net/tempestlive/WebInquiry/frames.cfm)

So:

Lost opportunity on D/P $200,000 x 1% = $2000
Mortgage on $1088,000 = $68,300 a year
Maintenance. Roof/yard work/painting etc = $2000 a year

Total = $72,300 a year.

However $26,000 of this is applied to the reduce the loan. So the difference is not that much.
.....................................................................

Ok now for the chat:

As you can see, once we account for the amount which is used to pay down the debt, the cost of renting and buying are remarkably close. This has not been the usual case in Vancouver. There has been a premium to buying due to several reasons:

1) Due to limited land, population growth and inflation, property has trended up, leading to capital appreciation.

2) This capital appreciation is a tax-free gain and as such was regarded by financial planners as one of the best ways of accumulating wealth tax free.

3) When you rent -there are many tangible costs such as moving expenses and intangible ones such as being at the whim of your landlord for lease renewals and the anxiety of frequent moves, stability for schooling, neighbours etc.

Because of these, renting has been cheaper than buying for as long as I can remember. However as the lunatic boom of the last few years got going and everyone wanted to get on the capital appreciation band-wagon this difference expanded to 100% or more is some cases.

So how did we end up near even now?

1) Prices have dropped

2) Mortgage rates are at remarkably low rates.

3) The 'lost opportunity' on the down-payment is very low (unless you can time the stock-market)

So is this the time to buy?

There is no magic formula for when to buy. The most important factors are the mortgage interest rates and the state of the economy.

The fact that rent/buy costs are so close, is a sign of how unusual (and potentially bad) our current situation is. If things weren't bad- interest rates would not be so low, and yet house prices are dropping even though it costs as much or less to buy than rent.

If you expect rents to drop, prices to drop, no bonus or worse no job-do you buy- whatever the comparisons?? No!

It is the current uncertainty that is causing the rent/buy parameters to get so close. While it has stimulated some demand, I would expect the uncertainty to trump it very soon...perhaps this summer.

I expect that by the time this is all over we will see rents and prices fall further and just as a pendulum swung too far to one side, it will then swing too far to the other side and there will be a period when it will be CHEAPER to buy than rent! A complete repudiation of the bubble we just had.

However this is just may opinion, and worth as much or as little as anyone's. Opinions welcome..



57 comments:

  1. all the pictures are from freefoto.

    ReplyDelete
  2. Given just numbers now probably isnt a terrible time to buy, mostly due to the incredibly low mortgage rates. But those rates won't be around forever, so in 5 years when you are up for renewal you could end up getting screwed if you havent made much of a wage increase.

    You mentioned the advantages of owning, but i think i would prefer renting at this time in my life (early 20s). When renting it is much easier to make a change if your needs change. If you lose your job or get married/ have kids or just want to live in a different area it is as simple as packing up and going. Moving when you own entails selling you home and buying a new one which takes a minimum of 3-4 months. (far more in this market). Not to mention most people dont have 50k-100k lying around.

    The only people who should be considering buying now are people who are almost positive they wont want to move for a long time. It doesnt make sense to buy now when the economy is unstable and your home could easily take another 15% dive in value next year.

    that said it was a pretty fair analysis and i was actually quite surprised that the rent vs buy was that close right now.

    ReplyDelete
  3. I second david's opinion.

    Also, where is the 1% lost opportunity from? IMHO, it should be much bigger, at least more than inflation rate.

    ReplyDelete
  4. Cz- 1% is the rate of interest you would get in the bank.

    ReplyDelete
  5. I enjoyed your analysis Fish.

    What makes the numbers work for buying is artificially low interest rates. The rates are artificially low since the US government has been using every trick in its arsenal to lower mortgage rates, and that lowers them here too. I think a 6% rate should be used since you will probably be lucky to get that in 5 years from now. (Note Seymour Schulich writes in his book that 6% for a long term mortgage is time to lock in)

    In any case, I've noticed that if you use 3.52% (an advertised 5 year rate) all sorts of housing product comes in much cheaper than renting. But a more realistic 6% long term rate leads one to conclude that it is cheaper to rent.

    ReplyDelete
  6. Panda- 5 years is a long time. I have trouble forecasting what I will have for dinner.

    However here are two important points that I may not have got across in the main post:

    1) Even though some of the mortgage payment reduce the debt, if the price of the asset is dropping, then you are no further ahead.

    2) Also if wages stay low or even drop (which they will soon) then people will have difficulty making rental payments, never mind the much larger payments to own (regardless of the amount 'saved' which reduces the debt).

    So just looking at rent/buy comparisons is just one factor. What I was tying to state is that the equation is getting closer (and will cross I think). They are getting closer because things are bad.

    in a thriving ecomony people would rather own. In a faltering economy they have to rent.

    A long answer to your comment!

    ReplyDelete
  7. OK. The "ingangibles" of owning and renting, including tax treatment, mobility, ability to renovate, whatever, they won't matter. Don't believe me? Just look at it from an investor's point of view. He is competing head on with owner-occupiers to buy this property. If the owner-occupier is willing and able to pay a higher price, the investor would have to accept a substandard return.

    It's so simple: while you may be willing to pay a premium to own, you don't have to. All that matters in the end is what an investor would pay and you know where prices are heading.

    What the rent vs buy calculation really shows you is whether an investor who is not relying on selling to a greater fool (i.e. speculating) is going to make a decent return.

    Also note that when you're doing a straight buy vs rent calculation using approximate numbers, it better be darn well WAY BETTER to buy than rent. The reason is there are always hidden costs to owning, including special assessments/major repairs and other risks. To compensate for all these, a straight equivalence calculation will need to have risk added in. I think a better way is to look at cap rates that are closer to historical levels.

    A bit of a quibble. You should discount your opportunity cost at the same rate as your cost of capital. 1% savings account is not apples to apples unless you explicitly account for risk in the other incomes and expenses.

    ReplyDelete
  8. The logical fallacy I often see is applying your personal situation to justify why making a financially inopportune decision is justified. Don't. Just accept that due to other non-financial reasons you are going to pay a premium to own. And that's fine. Just don't use it to obfuscate that your straight financial ROR is going to suck.

    The reason renting has been cheaper is because there is speculation. It's as simple as determining what a reasonable ROR is for a property investment from cash flows. In the case of detached properties yes, renting will be cheaper than owning because the purchase price factors in future redevelopment that will increase the land's productivity. This is nothing new. With condos there is no such premium and worse the building depreciates and the rent one can charge also decreases over time as the building ages. Be sure to factor that in to any ROI calculation.

    ReplyDelete
  9. if you are using ING for the mortgage, then why not for the savings?

    @ present 1.85 % not much, but more than 1%

    ReplyDelete
  10. Jesse- not sure I followed too much of that. Maybe point form would help getting your ideas to the obtuse like me easier.

    deedavid- fair enough. Add a few hundred $ to the buy side in each example.

    This is how I see rent/buy compraison as it stands now.

    Am I running out to buy? Nope. I am keeping my powder dry for the next 15% down. BTW I think rents and prices will come down together.

    ReplyDelete
  11. Ok real simple. A buy vs rent calculation should be way in favour of buying if we are at fundamental value. A straight buy vs rent comparison ignores risk.

    ReplyDelete
  12. Interesting analysis Fish. I think the key is the 20% down as I am not sure how many people actually have that much $ to put 20% down. $70K is a lot of money for a first time home buyer unless they are receiving money from external sources. Also for me at least I believe that I would have more anxiety about buying in that it makes it more complicated to move if I lost my job. I moved here from the states and it took me 11 months to sell my house at a loss and I can tell you that I had many anxious moments..

    ReplyDelete
  13. As already noted, your cost analysis is based on 20 percent down, as should be the case for a traditional mortgage. However, as we now know, few, especially first timers, are able to raise that much capital.

    Using your numbers with 5 percent down, skews things much more in the favor of renting.

    I will renting for a bit longer yet.

    ReplyDelete
  14. This comment has been removed by the author.

    ReplyDelete
  15. dbooy. I think FTB have had difficulty getting on the first rung for several years now. Help from family has usually been the way they have managed it.

    IMVHO 20% is the minimum one should have to get into a property. Less than that and you own nothing.

    BTW the lenders that have been lending at lower % eg 5-10% down are just plain stupid. The buyer has No skin in the game.

    I think CHMC has just helped this stupidity along

    ReplyDelete
  16. Yes, i agree. I feel that 20 percent should be the min down, not 5. But that would do little to drive the local economy.

    Even though there has been and up-tick in sales, it would be illustrative to see what sort of people are buying and what they are buying. My feeling is that more expensive properties, say over the 550,000 mark are still not moving, for the most part.

    ReplyDelete
  17. How much should I worry about higher rates of inflation? If we're almost in balanced territory now, I think inflation might be a bigger consideration than the advantages mentioned re: renting, in deciding whether now is a good time to buy.

    ReplyDelete
  18. You could also take the point of view that if housing prices are decline at a rate of 10% per year, effectively your opportunity cost on down payment is 11% (more because you are leveraged).

    If you go and use one of these rent versus buy calculators, they always allow a field to input estimated rate of increase of property value. If you use the calculator for a short term analysis, it would be inconsistent to plug in a large double digit increase rate during a bubble, but not plug in a double digit rate decrease during the downturn. Of course, the market will do what it wants and doesn't worry about inconsistency though it usually manages eventually one way or another.

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