Renting Is NOT Throwing Money Away

And, now that every single real estate salesperson is mad at me, let me explain.

There’s a common perception that renting is “throwing money down the drain,” but it is, and it isn’t.

Let me play devil’s advocate for a moment and show you a case where renting makes financial sense…

ThrowingMoney

Every mortgage broker, Realtor, or person with a vested interest in real estate will tell you that it makes more sense to buy than to rent.

And if you’ve ever read, “Rich Dad, Poor Dad,” they tell you that only the most brilliant financial minds rent, and suckers buy houses and condos.

Somewhere in between, there has to be a happy medium.

I do believe that more often than not, it’s better to buy than to rent.  I’m not just saying this as a real estate salesperson, but rather because I believe it.

But I figured just for fun, and to show that I’m not biased, I’ll show you a case where it makes far more sense for my clients to rent…

I sold Alice & Chris an entry level condo in mid-2010, which was about 600 square feet, with no balcony, no parking space, but overall, pretty nice.

It was the perfect spot for them at the time, as they were about 24-25 years old, just starting their careers, and soon they would be engaged and wed.

Coming from their two parents’ houses, via university dorms, a 600 square foot condo downtown was like living a dream.

That was then, and this story takes place now.

After three years, they’ve outgrown the condo.  They’re now in their late 20’s, eyeing a family, and their priorities, tastes, and preferences have changed.  They’re suffocating in that tiny condo that was once a palace, and their need for more space is bolstered by the want for “something different.”

Alice called me two weeks ago and said, “We want out of our condo, but we don’t know where to go.”

This wasn’t an unusual problem; most buyers need to be introduced to several different neighbourhoods throughout the city before they can really hone in on one to plant roots in.

But Alice added, “Although we want out of our condo because we’ve outgrown it, we’re really not ready for ‘the next step.’  We don’t feel like we’re ready to buy a house, and we also don’t feel like we know enough about Toronto to determine where we want to live for the next ten years.”

She had a point.

Alice feared that she and Chris had to “pick” a neighbourhood, and be comfortable living there for at least five years.  Transaction costs in real estate are high; we all know this.  And if they didn’t like the area they picked, they couldn’t exactly up-and-move in six months.

So Alice suggested something novel: that she and Chris would rent.

Perhaps you don’t think it’s novel, but I’ll tell ya – it’s not that commonly done.

Home-owners don’t usually sell to rent, but in this case, it was the perfect solution.

Alice and Chris wanted more space; scratch that – they needed more space.  They were living on top of one-another, and it was beyond time to move.  But they felt they were too young to move to babyville, they still had a ton of friends living in the downtown core, and they sure as hell didn’t know where they wanted to buy a house – when that time was right.

So Alice figured they’d rent a condo for one year, which would act as a “bridge” of sorts.

They’d move from a 600 square foot 1-bedroom with no parking and no balcony to a 2-bed, 2-bath with a nice outdoor space and room for a car, if and when they bought one.

It made sense from a life-planning standpoint, but it made even more sense financially.

Don’t forget – proponents of buying over renting always say, “You have to buy so you can pay down principal!”  But let’s look at the numbers in this case.

Alice & Chris had a monthly mortgage on their condo of $1,500, of which about $330 was principal, after three years.

Their monthly maintenance fees rose to $450, and that didn’t include heat, or hydro, which ran about $80 per month.

Their property taxes were just under $2,000, or about $167 per month.

The total cost of the mortgage interest, maintenance fees, utilities, and taxes ran just under $1900 per month.

Sooo……what would it cost to rent?

The places that Alice & Chris are looking at now are priced anywhere from $2,300 per month to about $2,800.

So let’s assume, for the purpose of this example, that they end up in a condo for $2,600 per month.  That means they’re paying $700 per month more than what they were before.

And what do they get in return?

Instead of being crammed into a 600 square foot 1-bedroom, now they’re in a 1,100 square foot, 2-bed, 2-bath, with a wicked view of the lake, and space to FINALLY have six people over for dinner.  Alice gets an entire closet for her shoes, Chris is finally allowed to keep more than one suit in the condo because Alice had previously taken 90% of the closet space, and they have the breathing room that they so desperately desired.

I think it’s win-win.

Proponents of buying over renting might say, “Well, they’re still throwing away $700 per month,” but there’s no merit to that argument.  They’re not throwing away $700 per month; they’re spending that money on living.

$700 per month, times twelve months, is $8,400 per year.  That’s one week-long vacation at an all-inclusive, plus eight meals at nice Toronto restaurants, and two pairs of shoes, and two suits.

There’s no reason that the average couple can’t make up that difference, or if they choose, just spend it on top of what they already spend.

You’re not throwing money away; you’re spending it on your lives.  You eat, sleep, and live in your home, and what’s $700 per month if you’re miserable living in a sardine can?

Now if you took that money and put it towards a purchase, would you get as much, or as big a place?  Maybe, maybe not.  It depends on the market, and the location.

But rather than purchasing an entire house, which is more than Alice and Chris need right now, they’re deciding to spend $700 more each month to bridge the gap between a condo that’s too small, and a house that they’re not ready for.  That $700 per month not only helps them avoid making a mistake in buying a home in a location they don’t like, but it also gives them the flexibility of looking for a home whenever they like.

After a year in the new condo, they’ll be on a month-to-month lease.  If they find a house, great.  If not, they can keep taking their sweet time.

Is it worth living in a rental for three years?  I don’t think so.  Then they’d really be throwing money away.  But for one year, to act as a bridge, and to really “live it up,” as Alice puts it, I see no issue.  In fact, I think it’s smart.

Consumers are free to spend disposable income how they see fit.  And whereas your friend might have no problem blowing $700 per night for bottle service at TIFF parties, because that’s just “how he rolls,” you might prefer to wake up, and go home to, a bigger, brighter, more exciting condo each night.

Now I’ll throw one more log onto the fire here: what if the real estate market goes UP?

Well that’s the risk you run by renting, of course.  You miss out on the possible gains on your existing condo, which you sell in order to rent, or you miss out on the possible gains of the house that you could have bought.

But I have to reiterate again: if you’re not ready to buy a house in Bloor West Village, East York, Leaside, and the like, and you want to continue living downtown but NOT in your teenie-tiny condo, then renting in the short-term is a fantastic option.

19 Comments

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  1. Homeowner says:

    Look at the house price now. People who rented must be kicking them selves in th balls

  2. Pete says:

    I’m surprised you missed the amount of interest paid on a mortgage. Sure when you buy you may make some money when you sell. But you need to sell for the price you paid + the mortgage interest you paid just to break even. Using some of the bank’s calculators, that’s 50% to 80% on top of what you paid over 20 years.

  3. Some Guy In Toronto says:

    After three years it’s throwing money away?

    How about the opportunity cost of their principal? $100K making 6% a year for three years earns $19K+… add in the reduced costs of renting versus owning (let’s say $400/mo maintenance + $220/mo taxes) and your $100k is now $130k, or almost $1000/mo of EARNINGS (not “property value growth” which is merely on paper).

    Owning a property is not for everyone, although everyone seems to think they’re entitled to own.

  4. JC says:

    In my opinion, it also depends at what stage of life you’re at, and not to forget the “opportunity cost” of equity in your home, if you’re an owner.

    To me, a mortgage is renting money from a bank.

    If you own say, a home “worth” 500,000 and have 250k in equity into the home. A bit of a stretch for many perhaps but lets just use that as an example. Thats 250k that really isn’t working for you. If you invested that money and got say, a 5% return, thats just over 1,000 a month your home is “costing” you, in addition to mortgage, taxes and maintenance.

    In some cases, you could probably rent a similar property for less than it would cost to own it, AND have more liquidity.

    I know several older people with homes that are paid for, so they are living “rent free” (save for taxes and maintenance) but worrying about medical bills and other financial worries when they could sell the house, realize substantial gains, rent, and have a better standard of living. (And no, I’m not advocating reverse mortgages 😉

    1. AndrewB says:

      Isn’t that the point in time we all strive to hit? The point of owning the property is to have the mortgage paid off, sell when you retire, make a nice sum of cash and either downsize and stay rent free, or rent.

      The reality is that while yes you can make money not owning property and see better returns, the majority of society is not disciplined enough to invest the difference in cost of living. A mortgage for many is forced savings. This doesn’t work however, for those who decide to change properties every 5 years and never actually pay off their mortgage by retirement age. For those people, the mortgage IS renting from the bank.

      Some of the best perks of owning something are the intangibles that don’t have a monetary value. Pride of ownership, ability to make significant changes to your space (if you own a house), etc.

      1. Philip Varmuza says:

        I agree with you regarding people, in general, not being disciplined enough to diligently save the spread between renting and owning. However, it’s not like ownership makes people more fiscally responsible. How many people use the equity built up from “forced savings” to take out HELOCs and spend it. In this situation, since your equity is tied up in an illiquid asset, in order to have the “privilege” of tapping into that hard earned equity, the bank will charge you more interest. Hoorah!

  5. Potato says:

    What’s the rest of the story? What did they pay in 2010, what did they get now (if it’s already sold)? What maintenance/renovation costs did they have beyond the condo fees?

  6. George says:

    I recommend a breakeven analysis with the goal of determining how long you need to live in a purchased property in order to make buying (and selling) it more financially sensible than renting it. All transaction costs, taxes, fees, etc. have to be included, and the buy/rent prices must be relevant to the property. For my condo, my analysis said it would take 3 years of living in my purchased place (with a 1% home value appreciation rate) to come out ahead of renting.

    By far, the most important variable in this type of analysis is the anticipated home value appreciation rate. Of course, it’s also the most difficult to predict. Projecting an increase of 2-3% per year makes buying especially attractive. Projecting a flat appreciation rate or even a negative one makes renting much more effective.

  7. Kyle says:

    One issue i see with this scenario, is that their equity will likely not appreciate as fast as the price of a house. Meaning they’ll need to borrow more to eventually buy that house. I think this is the situation many bears have found themselves in by waiting for the crash that never was.

    Example:
    Let’s say an average house is $500K, and it appreciates at 2% each year (i.e. just the inflation rate to be conservative) or roughly $10K per year.

    Let’s say they currently have the equivalent of a 25% downpayment or $125K, built up as equity in their condo. They need to earn at least 8% on that 125K (or approximately $10K per year), otherwise the amount they’ll need to borrow later will be much larger than the amount they would be borrowing today.

    Now imagine if the average house appreciates by more than inflation, say 5.5% (like they did in August), then their equity would need to return 22% in order to not need to borrow more later on. Not many investments offering 22% return these days and to make matters worse they are spending $700 more per month to rent, so likely they will be saving less. So while they may not be throwing money away, they are making a lifestyle choice that comes with the risk of having to borrow much more when they do decide to buy that house.

  8. Suburban says:

    This is what we did. We were tired of the suburbs (we have no kids) but downtown prices were scaring us. So we rented downtown for a while. We wanted to see whether living downtown would be worth the extra expense, at least for us.

    We loved being downtown a lot, but the prices are still out of our reach right now. Still, renting was the perfect idea at the time, before we made that huge commitment.

  9. Adrian says:

    I prefer to think of paying rent as buying time. Time I won’t have to spend worrying about things that otherwise bore me to tears, such as real estate prices and interest rates and insurance premiums and maintenance fees and the like. Or about what my neighbours are doing that could affect the value of my property. Or about painting and landscaping and plumbing and everything else that falls under the “maintenance and upkeep” label. Or about what to do when I have a new job opportunity with higher pay but can’t move without losing money. Or, frankly, any one of a million other worries that come with plonking a very large amount of borrowed money into one single high-maintenance asset.

    That’s a *lot* of time I can spend doing far more enjoyable things than worrying about all of the above, just by paying rent. And as time is the ultimate scarce resource, I believe getting so much more of it back in exchange for a mere 15% or so of my annual income is a *very* good deal.

  10. Huuk says:

    You missed one important mathematical scenario:
    How much is the mortgage and expenses on this 1,100 two bedroom with views of the water to own? Is it greater than, or less than the $2,600 to rent?
    Comparing a 600ft own to a 1,100ft rent is like apples and potato chips.

    1. Jason H says:

      I’m in agreement.

      You have to compare purchasing of the same house vs renting (and include the downpayment). that will tell the tale on how you’ll have to “adjust” your life to fit the new lifestyle.

  11. Paully says:

    Unless you are made of money or have a multi-million dollar trust fund, the classic pro-buying statement is “you are going to be paying a mortgage…yours or your landlord’s.”

    However, this statement is equally accurate: “You are going to be renting…either you’ll rent the money from the bank for a mortgage, or you can just rent your home directly.”

    1. Joe Q. says:

      Great post.

  12. Vincent Cheung says:

    I have to disagree on the 3 year renting is throwing money away. What hasn’t been calculated is if you choose to buy and sell in three years: the cost of buying/selling. Approx 5-7% of the value of the home is “lost” due to land transfer tax, lawyers and agent fees. So in order to balance that out the condo has to increase in value by more than the 5-7%. I know in the past 2 years, my condo I am renting hasn’t increased in value, it’s lost value.

    1. Jason H says:

      What’s also not factored is lost opportunity costs, down payment (or investment) to compare against.

      I was an owner of a home for over 7 years and am now renting. Not waiting for the sky to fall either but I’m recognizing quickly I have more money renting than I did with owning.

      So you ask how is that possible? I built a brand new house no landscaping, no completed basement but all top of the line. I had a 65% down payment on this house, so my mortgage was nominal in comparison to my current rent – My rent is more than my mortgage payments were.

      Whats the difference? Well.. If you purchase a home (not a condo) there are many things to also factor in you don’t have to deal with when renting. Maintenance, house purchases, “prettying it up” you name it (on top of what you’ve suggested, Vincent).

      When I owned and had a free 500 bucks.. What was my first thought to do with it? Hmm maybe I can add additional things to the landscape? Maybe a picture? Maybe some new feature to go with our new flooring? Oh.. snap we need to replace this faucet… These are small in comparison to purchasing new.. Now it was.. Well what about filling in my 1/2 acre property to get it leveled (Spent over 5k in fill and still wasn’t leveled)? How about that new deck I built? What about me finishing the basement?

      Now when I have that 500 bucks what do I do? Hey kids (and dear) what do you want to do this weekend? Or… Maybe I’ll throw this extra cash into my RRSP and/or RESP.

      I sold my property after 7 years and it increased in value by almost 35% but after EVERYTHING was completed what did I really gain from the purchase? Wow I got my money back, paid a wack load of interest, paid real estate fees, paid first/last months rent and this ate up most of that 35% of value I gained on the property.

      Even at that 35% over 7 years.. It was a poor investment (i don’t consider a house much of an investment) over my actual INVESTMENTS. So I gained 5% a year! Wow.. but how much money did I have to spend for that 5% gain.

      It’s not as simple as his blog would suggest but at least he’s on the right track to understanding.

  13. Chris says:

    I’ve rented throughout my 20s and just turned 30. I live in a huge 2 bedroom (around 900 sq ft) at a very reasonable price (under 1400/month) with underground parking, tons of storage, no balcony, and a great view in midtown just off Yonge. I share it with a friend, and at the end of the day, I’m probably spending near the same on my portion of the rent (which is under 700) than I would spend on taxes + condo fees in some condo buildings, let alone mortgage payments. I’m saving a lot of money each month, though it does pain me to hear of friends selling their condos and making tens of thousands of dollars like Alice and Chris above surely are (I’m not that Chris, by the way).

    1. jeff316 says:

      Well said.

      I’ve never understood that rationale of buying a condo *if* you’re not planning to live there long-term. Renting is almost always a better deal.

      There are a lot of older 1 and 2 bedroom apartments that provide tonnes of space, balconies often inclusive of utilities and sometimes even a/c at a really decent rental rate, particularly if you’re willing to live north of Dupont.

      It’s when you go to three-bedrooms that the cost-comparison between renting and buying starts to flounder.

      I loved our old apartment.

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