In my last video, I told you that renting is not throwing your money away, and home ownership may
not be all that it’s cracked up to be. Renters take less risk, have more predictable costs,
and have no illusion that their housing is an investment. The cost of home ownership is high,
and long-term real estate returns have not been as good as many people think.
Let’s crunch some numbers to further the case that renting a place to
live is a sensible alternative to home ownership for building long-term wealth.
I’m Ben Felix, Associate Portfolio Manager at PWL Capital. In this episode
of Common Sense Investing, I’m going to show you how a renter can get rich.
Let’s look at an example. Imagine someone who decides to purchase a $500,000 home with
a $100,000 down payment. Between legal fees, land transfer tax, and other purchase costs
they might have to come up with another $6,000, for a total cash cost at purchase of $106,000.
We can assume that the rest of the purchase is financed with a 25 year mortgage at a 3%
interest rate, resulting in a monthly mortgage payment of $1,893. The buyer
will also budget for property taxes at 0.75% of the value of the home per year,
maintenance costs at an annual average of 1.5%, and home insurance at $200 per
month. All things considered, the annual cash cost of owning this $500,000 home
is around $37,000. We can assume that real estate grows at 3%, beating inflation by 1%.
Alternatively, this person could take the $106,000 cash cost of buying a home
and invest it in an aggressive portfolio of index funds. They could rent a comparable
home for $1,875 per month, and pay a less expensive $100 per month for
renter’s insurance. Their total annual cost of housing would be about 24,000.
The renter could take that $13,000 annual cost difference between renting and owning and add
it to their portfolio of index funds each year. We can assume that the portfolio is held in a taxable
investment account, and consists of 90% stocks and 10% bonds with an expected annual pre-tax
return of 6.6%. After fees on the index funds and taxes, the annual return might be closer
to 5.3% assuming fees at 0.20% and tax at the rate for income between $75,000 and $85,000.
Fast forward 25 years. Owning the home would result in a real estate asset worth $1,046,889,
which would be reduced to $994,545 after 5% selling costs. Selling the
principal residence would not result in any taxes owing. Renting and maintaining
a disciplined investment schedule would result in an investment portfolio worth $1,016,977,
but selling the portfolio would trigger some taxable capital gains. After-tax, the portfolio
would be worth $987,579. The difference in ending wealth between the renter and owner
is a negligible $6,966 in favour of the owner. If instead of investing in a taxable investment
account the renter invested in the RRSP and TFSA, the scale tilts heavily in favour of the renter.
We used reasonable assumptions to show that renting and owning can both result in substantial
wealth accumulation over time. It is possible that reality will differ from our assumptions,
tilting the advantage toward either renting or owning over some time periods. Many of
the variables we cannot control: asset returns, inflation, and interest rates will be what they
will be. Other variables are within our control. If a renter keeps their investment fees low,
invests in an aggressive portfolio, and maintains strict discipline, they are putting themselves in
the best possible position to build wealth that meets or exceeds the wealth of a homeowner.
I just showed you quantitatively that there is nothing wrong with renting from
a financial perspective. I have nothing against home ownership, but I do believe
that renting a place to live deserves equal consideration as a sensible financial decision.
What do you think would be a sensible reason to buy a
home instead of renting? I’d love to hear about it in the comments.
Thanks for watching. My name is Ben Felix of PWL Capital and this is Common Sense
Investing. I’ll be talking about a lot more common sense investing topics in this series,
so subscribe, and click the bell for updates.