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Jun 30, 2015

Housing Rent Or Buy?

by Derek Foster

Derek FosterHouses have been pretty good investments for me (and most other people). My wife and I bought our first house back in 1999 and it soared in value! When our family grew, we cashed in our chips with our first house and bought a bigger house for our growing family. We sold that second house back in 2012 for sizeable gains. Housing has provided nice, tax-free gains for me over the years. But in truth, any idiot who bought a house almost anytime during the last couple decades did very well. The future is not so clear however.

We sold our house back in 2012 because we decided to buy a camper and travel around North America for a year. We also decided to sell because the market seemed good and it can be a hassle collecting rent while you’re “on the move”. When we returned in 2013, we decided to rent because we needed to get something quickly – and we’ve been renting ever since.

In a previous article, Housing Bubble??? – A Homeless Idiot’s Perspective..., I highlighted my thinking on housing and why I thought housing has become expensive. I used my first house as an example, writing:

In early 1999, my wife and I purchased a condo townhouse as we were starting out our family. These condos were renting out for $1,300/month and had expenses of approximately $400/month for condo fees, property taxes, and insurance. We could rent them for $1,300 a month or buy them and only pay the $400/month ownership costs. The savings from buying the house versus renting worked out to around:

$1,300 - $400 = $900/month (or $10,800 per year)

The negotiated price tag for this house was $130,000. In other words, by buying the house, we were saving $10,800 per year in housing costs. Stated another way, the house offered an effective ‘dividend yield’ of:

$10,800 divided by $130,000 = 8.3%

If I wanted to calculate the “P/E ratio” on the house, it would be:

$130,000 divided by $10,800 = 12 X

Then I showed how the valuations had crept up over time:

The original condo we bought would now sell for around $270,000. Rents have increased slightly to around $1400/month, but property taxes and condo fees have increased by around $200/month to $600/month. In other words the savings from buying the same house today would work out to around:

$1,400 - $600 = $800/month or $9,600 per year.

The dividend yield today would be:

$9,600 divided by $270,000 = 3.6%

If I wanted a rough “P/E ratio”, I would get:

$270,000 divided by $9,600 = 28 X

The basic idea was that valuations had risen significantly. With an original “yield” of 8.3% and an original P/E ratio of 12, the house price had risen to the point where the “yield” had fallen to 3.6% and the P/E ratio had risen to a much higher 28.

The point of filtering the number through this lens was to make it easy to compare housing prices to stock prices. My thinking was that I had no clue whether or not we were in a housing bubble, but these valuations encouraged me to rent once we returned from our year-long camping adventure.

So how does the landscape look today? A recent check of this style of house shows only one listing right now for around $250,000 – so pretty close to where prices had been when we left back in 2012 (a 7.5% price drop, but this could be house-dependent factoring such things as renovations, etc), so basically, we’ll say in this market (Ottawa), house prices have not really changed much in the way of prices over the last few years. The housing market still seems to be on the pricey side.

In the meantime, I invested the proceeds from the sale of our house (back in 2012) into stocks (mostly US stocks). During this time, stock markets have roared higher! With price gains and the added bonus of our declining Loonie, there would now be enough money to buy almost two houses. This move has proved lucrative—but how do things look now with the stock market pretty high?

I looked at the numbers with the house we now rent. Right now we pay around $1,650 per month to rent our house (or $19,800 per year). This house would cost roughly $325,000 to buy right now. The property taxes, maintenance, and extra insurance for homeowners would run about $6,800 per year. So by buying the house outright, we would save $13,000 per year. Is this a good return? Let’s see:

$ 13,000 dividend by $ 325,000 = 4%

If we were to buy the house we live in now (or something similar), we would earn around 4% (tax-free) on our money in saved rent. In addition, there could be tax-free capital gains if housing prices rise. With elevated stock prices, this might not be too bad a return (depending on whether house prices go up, down or remain the same over the next several years). The end result is that there is no clear “winner” in the rent or buy decision as things sit right now.

Overall, houses seem on the expensive side (in Ottawa), but not at nosebleed levels. However, all assets (real estate, stocks, bonds, etc) are on the pricey side right now—mostly because of low interest rates. I have no clue what will happen to house prices going forward, but I am happy with my stock portfolio and content to keep collecting the extra dividends our house sale has provided for us. For now, I think we’ll simply keep renting—if for no other reason than the simplicity of it.

 

Derek Foster (The Idiot Millionaire) – Six-Time National Bestselling Author. www.stopworking.ca