The decision of whether to rent or to own is one almost everybody has to make at one time or another. The comparison is usually on the basis of rent for a type of house vs. what a mortgage on comparable housing costs on a monthly basis.
The comparison is tough to make because while rent is whatever sum a landlord asks, mortgage costs are flexible. You can shorten or lengthen the amortization, go for a floating rate, a fixed rate, make a big down payment or get a high-ratio loan. The rent-or-own decision should include some estimate of what money not used for a down payment may earn if invested in bonds that have a term (length of time to maturity) equal to the mortgage amortization period.
There is a lot of pencil work here. There is another way to do the rent or own comparison that has nothing to do with bond interest and variable amortization.
One of the biggest drivers of asset value is inflation. It pushes up rents over time. Ownership costs also rise over time. Shelter cost is the largest single component of Canada’s Consumer Price Index. A roof over our head accounts for 26.6 per cent of the total CPI living expense.
If housing costs rise by 10%, they will push up the CPI by about 2.7%. It does not matter what the driver of costs may be: construction expense, interest charges, property taxes, etc.
Homeowners may pay more to own as the CPI rises, but they also receive a boost in the value of their home. Ownership means participation in asset inflation. Renters, on the other hand, pay more rent but receive no gain in their asset value. But they may be compensated. The money they did not spend on housing may have grown through investment in things other than housing.
Recent house-price data is a mess. The house-price bust in the U.S. was the result of market manipulation by the financial industry, artificial price support by the ability of U.S. taxpayers to deduct mortgage
Andrew Allentuck
interest from taxable income (enabling them to buy more home at any level of income) and by rent controls in many areas.
We need a longer view. In a survey of major markets in North America and Europe, a British journal, The Economist, found that house prices appreciated at a rate of just two per cent per year in the 20th century. That’s nothing to sneeze at. It means that a house will double in price every 36 years.
. . . compared to the zero capital gain renters get, the homeowner wins
Financial assets have done a lot better. Using American data, which is much richer and covers a longer period than Canadian data, it is clear that stocks provided an average annual return after inflation of 6.9 per cent per year in the period from 1871 to 2006. Bonds provided an average annual return after inflation of 2.9 per cent. U.S.-listed stocks fluctuated wildly in that period - think of the crashes of 1929, 1987, the dot com bust in 2000 and the present market collapse that appears to be ending. Bonds traded in the U.S. were much more stable except in the roaring inflation period
beginning in the early ‘70s that saw the CPI move into double digit territory, ending in a bond bust in 1982. For all that, bonds are the better comparison. Using that data, it becomes clear that bonds can beat house prices, but with a major difference. Housing, even with some maintenance expense, provides a place to live, something that bonds cannot do. Add just a small value for shelter to the house price average annual gain and you find that a home of your own is a good asset with less volatility than stocks and a better return than bonds.
If money not paid to a landlord is invested in bonds or perhaps guaranteed investment certificates that are rolled over into new GICs as they mature, then the renter may be ahead on a cash basis. But when the capital appreciation of the owned home is compared to the zero capital gain that renters get, the homeowner wins.
The homeowner can sell, reap his modest 2-per-cent average annual return (we are ignoring buying and selling costs here, though they can make a big difference) and find that his cash position is restored.
Finally, there is the matter of taxation. Stock and bond gains and GIC interest are taxable. But Canada exempts capital gains made on a principal residence. The U.S. procedure is more complex, but on a generation over generation basis, American taxpayers have to deal with succession duties, which can take as much as half of the value of large estates. There are ways to cope, of course, but they usually involve lawyer bills. But the Canadian taxpayer who owns a home has no tax worries in terms of generational succession. In this contest of renting vs. owning, the owner wins.
Andrew Allentuck's latest When Can I Retire? Planning Your Financial Life After Work, was published earlier this year by Penguin.
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