March 2012

To rent or to buy?

To rent or to buy?When taking the leap and buying a first home, it’s quite legitimate to compare the respective financial benefits of the new purchase… and the old rental. In fact, both options have benefits and drawbacks. Fortunately, there are tools that can help you make a more informed decision.

For the majority of Canadians, the dream of owning their residence remains firmly rooted in the family culture. When it’s not nostalgia for the home you grew up in, it’s the ambition to some day have “a place of your own”.

New expenses...

But if being an owner remains the most enjoyable way of putting a roof over your head, the value as an investment often depends on the buyer’s specific situation. As a general rule, those who become owners will find that they have locked in a substantial sum – the down payment – that could otherwise have been invested in the markets, plus they are now on the hook for a string of annual expenses, as illustrated in the table below, that would have been shouldered by the landlord if they were still renting.

Annual cost of buying vs. renting

... but a new source of financial leverage, too

On the other hand, becoming an owner means that you would benefit from a return on the entire value of the home, given a favourable real estate market. When you sell, providing it’s your primary residence, this return takes the form of a non taxable capital gain. Thus, the purchase could be advantageous if this increase in value covers and exceeds all the additional expenses taken on.

To get an idea of this requires some relatively complex calculations. These can be done with the help of some very useful online calculators. One of the most comprehensive is provided by the the Investor Education Fund.

And the winner is?

What do we learn by doing these calculations with the help of such tools? Well, it depends! It depends on many factors, including the mortgage rate, amortization period, annual rent increase, return on money invested, and other items. In short, the specific circumstances of each person. As a rule, however, you will note that it could take a number of years before the appreciation of the property offsets the annual savings offered by renting, and that buying a house is sometimes a good way of hanging onto one’s savings without necessarily making them grow.

The heart of the matter

And that’s something that concerns economists in some financial institutions in light of the recent experience in the United States. There is a fear that with the continual increase in house prices – and the associated expenses –, many owners are concentrating the better part of their savings in their homes, to the detriment of both their financial flexibility and their RRSP contributions. Some specialists go so far as to attribute Canada’s historically low savings rate to this phenomenon.

The pendulum might be swinging back, however. A study published in 2011 by the Institute for Fiscal Studies reveals that in the United States, the proportion of owners in the younger generation has declined in the last 30 years, even with easier access to ownership. Increased economic uncertainty and fewer people living as couples can offer a partial explanation for this. Not including, perhaps, those who may well want to own a home, but not at the expense of everything else: travel, leisure activities, savings...

Conclusion: Why not have a good talk with your financial services professional to weigh the pros and cons of such an important decision?