Blessed by the Potato

David Fleming says that (gasp!) renting is not throwing your money away in a recent blog post. I’m always amazed at how close he can come in his arguments to seeing the bearish light and yet not quite cross over. As usual he has his realtor I-work-in-today’s-market blinders on: “That was then, and this story takes place now.”

Though renting may not be throwing money away, he concludes near the end: “Is it worth living in a rental for three years? I don’t think so.” Now conveniently, he provides a backwards-looking example of a couple that bought for just about three years rather than rent. These past three years — two of which represented some of the strongest, hottest Toronto real estate markets they could ever wish for. This was as close to the best case scenario as you can come as a condo owner for three years. Let’s even go back and revisit that choice — was it worth buying for those three years?

One criticism people like to make of bears like myself is that the analysis for rent-vs-buy says how distorted the market is, yet it irrationally keeps going up anyway. The timing is hard — irrational prices are irrational — so it’s all too easy to say “if you had listened to Potato back in 2010 you would have missed out on an incredible market!” My thinking is that you have to make the best decision with the information you have available at the time. Taking a bad bet and having it pay off does not mean it was a wise, justified move, it just means you got lucky despite the math. Considering and accounting for risk moving forward is how I have to live my life, and when I take extra steps to avoid a calamity that does not occur I don’t consider the steps “wrong” any more than I consider paying for car insurance wrong even though I’ve never been in an accident. But let’s say that you are swayed by backwards-looking logic, and run the numbers for David’s clients and see just how worth it it was to buy a condo for just 3 years in one of the best possible appreciation scenarios.

So far he hasn’t provided the full details so we’ll have to make a few extrapolations/work from an average couple over the same timeframe.

Buying scenario: The couple bought in mid-2010. The average 416 condo price was $340k in May 2010. David says that their mortgage is $1500/mo. Most likely they took a discounted 5-year rate, which at the time would have been 4.1%, suggesting a 30-year $310k mortgage. On purchasing they would have had to pay $6700 in land transfer tax (or burned their first time buyer credits), and with just $30k down would have had to pay $6820 to CMHC/Genworth. Pretty typical scenario for a young couple. Assume they also paid about $1000 for legal and inspection, and another $3k either up front or over the course of their time there in maintenance/remodelling. So their starting capital would have been $47.5k — money they could have invested as renters.

Their annual cash flow would break down as: $18k for mortgage, $5.4k condo fees, $2k property tax; total of $76.2k paid out over the three years (some of which went to principal which will come out below). They would have some additional costs over renting as well in terms of insurance, but we’ll let that slide.

Upon selling they are delighted to see that the “bears were wrong” and they can now sell their condo for $357.5k in August of 2013. They pay Dave his 5% commission ($17.9k), the bank it’s mortgage break fee (IRD of $7.5k), and they are free and clear, ready to move up to something bigger. At the end, they have had a condo to live in for 3 years and, after paying the remaining $293k on the mortgage, are walking away with $39.1k in their pocket.

Renting scenario: The couple, after reading my blog and doing the math themselves (this is back in 2010 before the spreadsheet calculator was out), find that the Toronto condo market is kinda, well, insane. So they take their $47.5k and stick it in an ING Direct Streetwise account and decide to rent the very same condo and get on with their lives. A comparable unit runs them about $1525 in 2010 (a price-to-rent multiple of 222X). The landlord hits them with a 3% rent increase in 2011, and in 2012 after reading a ridiculous Condonation report summary in the Star, hits them with a shocking 10% increase. Over three years, the renters pay $57.9k in rent.

After the end of the three years, their initial capital has grown at 7.83% per year net of fees in the ING Streetwise growth account, giving them a nest egg of $59.5k. They saved an additional $18.3k, which let’s face it, I don’t even have to pull out the spreadsheet to trickle into an investment account because renting knocked it out of the park. Their total capital is north of $77.8k.

The renters are $39k further ahead — after just three years, in what has been a relatively good real estate market (keeping pace with inflation, no signs of a crash anywhere, naysayers defied… at least according to the news). Even if you’re more generous to the owning case (or as I would call it, less realistic) and ascribed no value to burning up the first-time exemption to the land transfer taxes, started with more capital to avoid mortgage insurance, assumed that the buyers were prescient enough to go with a variable-rate or 3-year mortgage, or that the investments wouldn’t have done quite as well: it’s not a good outcome. And it could have been so much worse if a correction did occur in those years and they ended up underwater — as could still yet happen.

At these price-to-rent multiples it really doesn’t make sense to buy. Even at more normal price-to-rent multiples it wouldn’t make sense to buy for only three years: the transaction fees are killer. When you’re 24 and just slogged through a two-year MSc, or are barely into your career after a four-year undergrad, three years seems like forever; how are you to supposed to be able to plan what your space needs will be that far out? It really makes more sense for people in that situation to rent: both projecting forward as well as looking at the past few years. Add in the current extreme prices and there is basically no scenario where it makes more sense to buy — this is the era of the renter.

Note some important real estate mantras shattered by the short timescale:

1. Renting was not throwing money away, it was the wiser move here. Even if they were poor budgeters with little savings discipline — people who “should” buy for “forced savings” — and spent the ongoing savings from renting on enjoying life more, just the growth in their nest egg and not blowing tens of thousands of dollars on transaction fees still put them ahead (though just barely in that case). And though I would not recommend that scenario, such a couple would have been able to go on more trips or eat out more or whatever it was that they spent the money on not being house poor.
2. Buying did not build equity. With such a short holding time and such steep transaction costs, they walked away with less capital than they started with. And that’s with decent growth in average prices over those three years and low mortgage rates.
3. There is no such thing as a “property ladder” and if there is, they were not climbing it. With the reduction in their capital base they ended up further away from being able to afford a detached house in 2013 than if they had rented and built up a downpayment through savings and investing. This was exacerbated by the different growth rates in the property types: while Toronto condos were up about 5% over the time period, the average detached house was up more than 13%.

2010-2013 were a couple of pretty decent years for the economy and real estate, and yet for this pair renting was still the better move.