It used to be the other way around, did it not?
Which question is currently the rhetorical one?
With a red-hot real estate market, and a luke-warm rental market, it has economists and personal finance experts asking WHY so few people refuse to rent, when it’s actually cheaper compared to owning.
Let me first outline the costs associated with each option, and then the reasons why I think more people are buying instead of renting…
Let’s look at a unit currently available for sale in Liberty Village on East Liberty Street: a 1-bed, 1-bath unit with parking and locker, in a 3-year-old building, reasonably well-maintained, with decent upgrades including engineered hardwood floors, stainless steel appliances, granite counters, etc.
The unit is $1,750/month to rent, and $327,000 to purchase.
To rent, your expenses are pretty simple: $1,750 per month, plus hydro, so call it $1,800.
To buy, it opens a whole other subset of calculations.
Let’s say that you’re buying with a 10% down payment, or $32,700.
The $294,300 balance is going to carry for $1,331.59 per month.
But with a 10% down payment, you’re going to have to pay $7,063.20 in CMHC insurance, or $23.54 per month over 25 years. This fee is not refundable, so if you decide to sell the unit after a month, or a year, you still have to pay the entire $7,063.20.
But let’s just add the $23.54 for now, and call the monthly payment $1,355.14.
Your maintenance fees are $316.41 per month, plus that $50 estimate for hydro.
Your taxes are $1,822.04 per year, or $151.84 per month.
So with the mortgage, maintenance, hydro, and taxes, you’re paying $1,873.39.
That’s it, eh?
Just $73.39 per month MORE to own, than to rent?
Well of course, it’s not that simple.
You’re going to pay $1,380 in Land Transfer Tax to acquire that property as a first time home buyer, or $6,375 if you’re not a first-time buyer.
You’ll also pay about $2,000 in legal fees upon the purchase.
So with CMHC fees, land transfer tax, and legal fees, you’re over $10,000 in sunk costs as a first-time buyer, and you need to have $32,700 in savings to even buy the condo in the first place.
Why not rent instead?
Why not pay less each month?
Well let’s not forget that out of that $1,355.14 monthly mortgage payment, over $700 is coming back to you in the form of principal repayment, and whether it’s cash in your pocket or a lower mortgage – it’s still equity.
Perhaps this is what many personal finance experts and newspaper columnists choose to ignore?
Allow me to outline the five major reasons why I think people are buying, rather than renting:
1) Low Interest Rates
I think this goes without saying, but it’s worth working through an example just to demonstrate how low interest rates have affected affordability, and thus why so many more people are choosing to buy rather than rent.
In the example above – the $327,000 condo, being purchased with a 10% down payment, and financing the balance at 2.59%, the monthly mortgage payment comes to $1,331.59 (before CMHC fees).
In the first year, the average principal portion of that mortgage is $708, and the average interest portion of that mortgage is $623.
I think people have become so accustomed to low interest rates, that perhaps they don’t recall a time when interest was actually MORE than principal!
Now what if rates were at 5.99% like they were in 2007 at one point? How would these numbers look?
@2.59% – $1,331.59 mortgage, $708 principal, $623 interest
@5.99% – $1,881.20 mortgage, $432 principal, $1,439 interest
Have you ever worked through these numbers?
Well, I know you have; you being my regular blog reader who is informed and astute. But what about today’s young 20-something? They’ve tuned out the stories from Mom & Dad about “……when rates were at 21% in 1980….” but will they tune out a 30-something talking about only seven years ago?
So at 5.99% interest, not only does it cost $550/month more for the mortgage, but you’re paying down $276 less per month in mortgage principal!
If rates were higher, would more people choose to rent? I think so.
Then it seems to follow that low interest rates, via increased affordability, are likely the number-one reason why people today are choosing to buy, rather than rent.
2) Bank of Mom & Dad
There is a LOT of money floating around out there these days, and much of it is old money.
I don’t mean “old money” in the contemporary term to describe “generational wealth,” ie. a family living in a large house, who is wealthy because of their family before them, and that family was wealthy because of the family before them, and so on.
I mean old money as in the older part of today’s population is sitting on accumulated wealth, and it’s being redistributed through today’s younger population.
I remember the very first time a client of mine told me that his parents were helping him with the down payment on his condo purchase. I thought, “Wow, that’s awesome! What a novel concept! And what a great set of parents!”
Now, it’s simply expected.
While I do get a young client from time to time who prides him or herself on having built up savings, and wants me to know, “I’m not getting any handouts; this is my money,” I would say that the norm is money from Mom & Dad.
There’s nothing wrong, or right, about this. It’s just the way that it is.
I try to put myself in the mindset of a 59-year-old who has a 21-year-old daughter, but perhaps my style of parenting (I don’t have kids, but I like to think I’ll know how I’m going to handle them), is a bit different.
I would have thought many parents would want their kids to “learn the value of a dollar,” and “make it or break it on their own.”
Apparently, this isn’t the case anymore.
I asked a client of mine the other day, who is buying a condo for his 21-year-old daughter to live in while finishing her Masters, “Don’t you want her to rent a basement apartment for $900/month, eat Kraft Dinner on a hot plate, and see what the world is really like?”
His one-word response: “No.”
I asked, “Don’t you think that’s the best way for a young person to learn the true value of each dollar they earn from work, and see how far it goes in today’s world? Don’t you think propping them up is a mistake?”
He responded, “Don’t know, don’t care. But I don’t want my daughter living in a basement apartment, eating Kraft Dinner. I want here in a nice, comfortable, safe apartment, and that’s the starting point, so whatever happens after that, happens.”
I feel like my Dad would have actually wanted me to live in a basement apartment, eating Kraft Dinner, as he’d have thought it would harden me as a man, and teach me to value things differently.
But today’s generation is different.
Those in their 50’s and 60’s have so much money, sometimes they feel as though they have no choice but to spend it on their kids.
One of my clients owns four properties – a primary residence, an multiplex, a cottage, and a vacation property. He told me, “For me to sit on $6 Million in real estate and not give my son $30,000 for a down payment on a condo is absolutely cruel. It’s unnecessary.”
The wealth that the baby-boomers, and those slightly younger, have accumulated over the course of their lives is more than they need at this point, so I see most of them giving it to their kids to buy real estate.
Of course, much of their collective wealth came through owning real estate, and thus they want their kids to get started early as well.
3) Societal Changes
One of the very first things we learned in Economics: wants versus needs.
I don’t know if much of today’s society can differentiate.
I don’t have stats to back it up, but I would assume that impulse purchases are at an all-time high. Whether it’s the magazine you read in the checkout line at Metro, that you decide to throw on the conveyor on a whim, or whether it’s the article of clothing you see on a mannequin in a store window that you end up purchasing, as you just happened to walk by – our impulses seem to be in far greater control of us then they ever used to be.
I like a nice meal out at a restaurant from time to time, but I’m amazed at how many people go to restaurants like it’s a hobby!
I played golf with two guys recently and in the car on the way back, all they talked about were restaurants in the downtown core. Each of them knew every single restaurant the other one mentioned, and it took a while to find a restaurant that the other hadn’t been to at least once. “I actually went there last night,” one of the guys told the other guy, at the mention of “One Pizza” on King Street East.
Since when do people eat at restaurants 50-60 times per year? This isn’t the way it used to be, and keep in mind that the prices people will pay for “a night out” are astronomical and in no way in line with inflation, comparing to what a young couple might have paid in the 70’s, 80’s, or 90’s.
Did young women buy the equivalent of a $2,000 purse in 2015 back in the 80’s? Did they even have such a thing?
I feel as though people in society today just want things, and those wants are in no way aligned with their needs.
When it comes to real estate, the same can be said.
Many people simply “want” to own real estate, whether it makes financial sense, or whether they’ve put a lot of thought into the process.
With prices having done nothing but increase for almost two decades, I suppose they’ve proven to be correct. But I feel that the reason for buying has less to do with price appreciation, and more to do with simply “wanting” to be a real estate owner.
4) The Next Generation
Along the same lines of what we just discussed in the section above, I see the “wants” of the younger generation pushing them toward real estate.
I’ve told this story before, but one of the kids I used to coach at Leaside Baseball reached out to me before he was even finished university, and asked about buying a downtown condo. He gave me several reasons, but the one that stuck out the most: “I want to be the first one in my group to own a condo.”
Is that a good thing?
Is it a great goal to have? Or is it irresponsible?
I told him to stay at home for 2-3 years, live off his parents for free, salt away his earnings, and reap the benefits of free meals, laundry, and all the “little things” like toothpaste, paper towel, and light bulbs.
But to him, owning real estate represents an accomplishment. It’s a goal to set, then achieve, and then continue to build from.
The kids finishing university at 21-years-old used to go back and live at home for 2-3 years, then rent for 2-3 years, then buy their first place at 26-27 years old.
I’m currently working with three condo-buyers aged 22 to 23 years old, which is something I never experienced a decade ago.
5) The Market Continues To Rise
This isn’t rocket science, so I won’t belabour it.
The market has risen every single year since 1994, and shows no signs of stopping.
Why would you rent a condo and only really “save” $100 on a 1-bed, or perhaps $400 on a 2-bed, when you stand to make 5-10% in appreciation each year that you hold the unit?
Well, the market will go down at some point.
And how many people decided to start renting in 2009, thinking the market would go down, only to miss out on a 30% tax-free capital gain on their property?
People are buying rather than renting as they are afraid of missing out on further appreciation.
And the way the market has gone the last two decades, I can’t say I blame them.
As the old saying goes, “You can make numbers say anything you want,” and I’m sure we could find another property where renting it versus owning it saves $700 per month or something to justify renting.
But as the five reasons outlined above go, I think much of the buyer pool still wouldn’t care.
As a result, the rental market is sluggish.
Sooooo………maybe it’s time to consider renting after all?