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January 29, 2018 | The leap

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

“Wife and I have a little diaper filler coming up on one year old,” says Peter, 30, who didn’t get the memo about objectifying his spouse, “and it’s getting tight in our one bed apartment here in Vancouver and we need more space.”

You know what’s coming next. Mars vs Venus in YVR.

“We love the neighbourhood we’re in, it allows us to walk to everything, it’s safe for the kid yet close to downtown, my commute is minutes by bike so I spend more time with the family. It’s where we want to be. Problem is the $1500/month we pay needs to double to get us a two-bedroom place.

“To her, $3000 seems like such a huge amount of money to “throw away” on rent so she’s talking about buying. It won’t be around here, as that $3,000 rental went for $1.2M last time I saw a nearby unit up for sale. I’m happy to live a million dollar lifestyle by renting and with our $12,000/month take home we can afford it. However I see what she means by spending such a large chunk of change on rent. Am I kidding myself?

“Is there an amount when renting is too much and we need to either cram into a cheap place or admit we can’t afford our area, suck it up and move to the burbs? Have you ever had to tell a client to not spend so much on a rental that builds no equity?”

Now that it’s likely real estate values could stagnate, if not decline, the rent/buy analysis gets more interesting. After all, if housing’s not appreciating and no longer a slam-dunk investment vehicle, it’s just shelter. There has to be a reason to buy. Especially in a city where prices are insane.

To purchase the average detached ($1.6 million) for 25% down requires $400,000 in cash upon closing with monthly mortgage payments of $5,900. Add in property tax and insurance, plus a wee bit for maintenance, and you get almost $7,000 in overhead. Meanwhile the lost opportunity cost of the downpayment (what that cash could earn if invested at 7%) is $2,300. This brings the true cost of owning the house to $9,300 a month, or $111,600 per year.

For a property like this one:

So, seven grand a month equals almost 60% of your take-home income, Petey. You’d not even qualify for this amount of financing at conventional rates, let alone with the stress test in place. You could increase the deposit to five or six hundred grand, but that would simply be subsidizing the monthly outflow by gobbling up liquid net worth. If the Dippers in power manage to destroy the market, as they clearly wish to do, buying could amount to the worst decision in your lives.

So why would you? To this point you’ve been spending only $1,500 a month, or a paltry 12% of your take-home on shelter. If you double that to three grand, the proportion rises to 25% – which is still a helluva lot better than 60% for an asset that could lose value faster than it gains. In terms of ‘throwing away’ the rent, what does Wife think mortgage interest, property taxes and foregone investment returns are?

It’s useful to remember what the price-to-rent ratio tells us about the cost of shelter, and in what markets tenants are wise to become owners. It’s simple. Divide the market price of a property by the annual rent it commands to determine the ratio. As I have detailed previously on this pathetic, yet gender-sensitive blog, here is the scale:

  • Price-to-rent ratio of 15 or less – buy the sucker. You’ll save money.
  • Price-to-rent ratio of 16 to 20 – you’ll be money ahead renting.
  • Price-to-rent ratio above 21 – your landlord is a benevolent deity. Or an idiot. Or a realtor.

In your hood, Peter, that $1.2 million place which rents for $3,000 has a P/R ratio of 33. So your landlord is subsidizing you each and every month. Given the hefty take-home income, you’d be far wiser to continue renting and shovel your cash into a nice balanced portfolio, ensuring your TFSAs are filled to the gills.

Tell Wife this: the $4,000 a month you will save by renting, invested in a balanced and diversified portfolio, plus the $400,000 not shovelled into a downpayment, will become $1.496 million in ten years. In twenty years – when are just 50 – it becomes $3.7 million. At that point you can retire with an annual, lifetime, tax-efficient investment income of $260,000 and still retain the principal.

Or, you can have the house.

Tough choice. Let us know.

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January 29th, 2018

Posted In: The Greater Fool

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