We’ve all heard the argument some use to “prove” owning is better than renting—the one that says paying rent is simply throwing your money away. But if you can’t afford a home, then it makes perfect sense to rent. “The fear of missing out is what’s driving a lot of people to buy real estate when they’re not ready and that means they’re making bad financial decisions,” says Julia Chung, a certified financial planner in Vancouver.
So how do you decide between owning and renting? For starters, when you run the numbers, you can’t just compare the mortgage payment and the rent.
Alex Avery, author of The Wealthy Renter, explains that’s an over-simplification that ignores the fact that the owner of a home has put down a substantial amount of money to own it—money she will not be able to invest in a faster-growing investment like stocks.
After all, the homeowner still has a form of “rent” to pay in the form of money paid annually on the mortgage, taxes, utilities, maintenance, and other expenses. Avery calls this a “negative dividend” and it averages 1% to 2% of the value of your house per year.
Room for improvement
All of this leads to the conclusions that renting is often the best option for building wealth as long as you are doing one key thing—saving aggressively in other investments on the side.
That’s because while houses in Canada have been okay investments, with prices rising at a compound annual return of 4.7 per cent over the twenty-five years to Dec. 31, 2015, the S&P/TSX Composite Index has seen its price rise at a compound annual return of 8.2 per cent over that same period.
That means that $100 invested in a house 25 years ago has grown to $318, the $100 stock market investment (including dividends) would have grown to an impressive $728—more than double.
Navigating the rental market
Still, renting isn’t necessarily cheap. In fact, rent in large Canadian cities such as Vancouver and Toronto charge average rent of $2,000 or more monthly in the downtown core. But you can bring down the cost by sharing a place with a friend or renting a place outside the main city centre. And remember, one of the key benefits of renting is that if you have to get out of your rental for a job move or some extended travel, you can do it quickly and cheaply.
Bringing it home
The bottom line? If you’re paying less than 32 per cent of your income on rent and investing the rest with decent returns and a long term strategy such as a low-fee, well-balanced portfolio made up of 60 per cent equities and 40 per cent bonds, you’ll likely come out ahead of homeowners. Having a forced savings program such as this will insure you build wealth over time and have a secure financial future.
Of course, if you have kids and need the extra space that a single-family home provides, then realize this is a lifestyle choice. What you lose out on long-term investment gains, you will surely make up for with fond family memories that last a lifetime.