Blessed by the Potato

It was 10 years ago that I finished my PhD and started looking for a new place to live. I went deep, deep down the analysis rabbit hole, eventually emerging with my rent-vs-buy spreadsheet. At the time, we decided to rent: the housing market in Toronto was already at a price-to-rent ratio of over 300X, and using a bunch of very reasonable assumptions, renting looked like the much smarter move.

Well, now it’s 10 years later. How’d that all work out?

The housing market (esp. in Toronto) performed very well over the last decade. That was unexpected: the market was already expensive on a price:rent and price:income basis in 2011, and it just simply got more expensive — incomes have not surged ahead in the city, nor have rents. Yet prices have been on an absolute tear, roughly doubling in that decade.

Back then interest rates were at “emergency” lows, and nearly everyone was warning buyers that they would have to be prepared to renew at higher rates. Reality is stranger than we can imagine though, and instead we find ourselves a decade later with rates even lower. If you predicted that, congratulations, you already have your prize. If you used the best information available at the time and decided to rent instead, then you likely have a constant stream of people looking to dunk on you. “How’d that renting thing work out for you anyway?”

While housing is the national obsession, investments had a hell of a decade, too. Remember in the rent-vs-buy analysis we assumed a 7% rate of return for investments? Well in actuality an aggressive diversified portfolio got over 9% because the stock market also blew the lights out.

So how did those two choices shake out with all things considered then? The answer comes down to leverage: if you had a big pile of money and were looking to buy a place outright, you were better off investing it. A $775k (the price of an average detached house back then) investment in a TD e-series portfolio would grow to become $1.9M, while a house of the same value grew to $1.7M. Without leverage, renting and investing was a toss-up versus buying.

If you use the more realistic scenario of starting with a smaller amount to invest and using that as a downpayment (and getting a mortgage for the rest), then buying a house came out better — thanks, leverage!

To look back we can use the same rent-vs-buy calculator and just adjust a few numbers based on how things played out — higher realized returns for both investing and house price appreciation, lower mortgage rates, lower property taxes, as well as lower rent inflation [1].

Saving the extra cashflow from renting plus investing the downpayment would leave the renter with a portfolio of $820k (remember how expensive housing was compared to rents — it took a lot of cashflow to buy!). But that house appreciation (to $1.7M!) leaves the owner with even more equity. Once you sell both (hit the renter’s portfolio with some capital gains taxes, the owner with some sales commission), the owner is better off by $367k.

That’s… not a small difference.

Findependence Proximity

Here’s the strange thing: in reality I chose to rent, so I can see how much more houses in my neighbourhood are than my portfolio. Yet I don’t feel bad about missing the boat. Part of it is not wanting to engage in resulting. I knew what information I had at the time, I know that I put a tonne of effort into my decision-making and analysis, and made the best decision I could with it at the time. Some people were indeed calling for those high growth rates to continue, and we would do the math and laugh.

“You can’t be serious. At that rate, in a decade an already-expensive bog-standard 3-bedroom detached house would be $1.7M! Who would possibly be able to buy that!” Well, here we are, the Darkest Timeline.

With the incredible stock market returns, the renters now have enough to be able to buy in cash — mortgage-free — the house they were previously renting… if it had only appreciated in-line with inflation. But it didn’t, and instead they’re priced out forever (…ever-ever-ever…).

Yet in a way, they’re better off.

I tend to try to put big numbers into context by thinking about FIRE — how much closer to retirement would $367k [2] put me? On the surface, that much money should be a very meaningful difference in outcomes — years knocked off the time in the science mines. But it’s all locked up in real estate equity in the counterfactual. That’s the funny thing: though they can’t buy a house, that stock market performance means that the renter’s investment portfolio is now roughly large enough to pay their rent indefinitely. A few more years of saving and investing to cover their other needs and they’re on track to retire in their 50’s.

The owner still has 15 years of mortgage payments to make, and then still has to save up enough to be able to pay the other costs of the property (tax, insurance, maintenance) and then find a way to pay for food and all the other necessities of life. Their net wealth is significantly higher, and yet their life goals are much further away.

Unless, of course, they’re willing to sell and realize those gains. But at what point do you do that? If you looked at the market in 2011 and decided to buy anyway, when do you switch tracks and get out? What do you do with all that housing wealth if you don’t sell?

The market has seriously warped the notion of wealth. Ten years ago I was aiming for an early retirement (not extreme FIRE, something like early-to-mid 50’s). Round numbers, $1.5M invested would have been in the ballpark for me to comfortably quit my job and either fully retire or go freelance part-time. Yet these days, that doesn’t even buy a house here.

Resulting and the Next Timestep of the Simulation

Was it a “bad decision” to rent 10 years ago? I don’t think so — based on the information available at the time, it was the right move under most expected future scenarios. The future as it turned out happened to be the darkest timeline: rather than correcting the 300X price:rent, it simply went to an even crazier 470X through massive appreciation. If in 2011 you told me the high rate of growth would continue for another decade, I’d say that seemed laughable, and do the math for you — wouldn’t the average house becoming $1.7M in 2021 seem like a ridiculous outcome? …yet here we are. So no, I don’t think it was a bad decision, just a bad outcome.

Likewise, continuing to rent from here: there is nothing in the short-term data that suggests this market is about to crash. The bulls are firmly in control and the government has explicitly said it’s not going to do anything that might bring prices down. But it doesn’t have to crash for renting to come out ahead — it just has to stop growing at such a ridiculous rate. The price:rent is even more insane, so even with lowered expectations about future stock returns, renting looks like it should come out ahead if the housing market also settles down to inflation-plus-a-bit returns. And maybe in 10 years we’ll laugh at how people thought a two-and-a-half decade bull market would continue into a third and fourth decade, and that an average house would somehow be trading at $4M by 2031. Or maybe we’ll see that become the price and the class divide will be complete.

Now, if you gave me a time machine and said what would be the best move to make in 2011, then sure, buying might be the way to go… but that would be a terrible waste of a time machine. As Ben Felix said it would be even better to use that time machine to go back and rent and then invest the difference + downpayment into Bitcoin.

1. There’s a big suburbia/downtown split here — AirBNB really threw a wrench in the rental market. If your condo approximately resembled a hotel room, the rent went up by more than the 2% assumed inflation, then crashed in 2020, while rents out here in commuterville have gone up less than 2%/yr yet held up through the pandemic.
2. Or whatever scaled but not so very different amount for my actual situation vs. the average house retrospective/counterfactual numbers here.