The Rent vs Buy Decision

October 10th, 2017 by Potato

Introduction

Housing is usually the largest expense in any family’s budget. Getting the decision right about how to pay for your shelter (and how much to pay) matters. Yet you don’t get to take a hundred cracks at it and learn by trial-and-error, all you get is time to do some analysis and make the best move you can with the information available to you.

Unfortunately, many people will spend more time comparing their cell phone options than comparing their housing options. This is partly because it’s also an incredibly emotional decision with lots of overly simplistic heuristics out there: many people look to buy once they are able to, without even considering renting for the long term. They’ll jump to comparisons of condo vs townhouse, or a mortgage affordability tool without even considering whether they should buy at all.

The key thing to know is that in some conditions renting can be the better way to go. There are many factors involved, and this is a long post that will touch on many of them, but if all you take away from this post is the knowledge that renting is not “throwing your money away” but can instead be the better way to pay for your shelter, and that you’ll have to analyze your own situation, that would be fine.

Step zero in your hunt for a place to live should be to evaluate whether you should be buying at all, or if renting may be a better move.

I’ve organized this post with headers and sections to help make digesting it easier, but be warned, it is long. This video covers most the ground I’m going to go over if you prefer video content:

The Core Financial Point

Imagine you had two houses/apartments side-by-side, identical in every respect. You could live in either one, the first being offered for rent, the second for sale. There are non-financial considerations in the choice, of course, but start with the financial ones so you know what to compare the intangibles against.

If the rental is being offered at $2,500/mo while you could buy the other for $250,000, you don’t have to get too far into the details of the math to figure that buying is going to work out better for you: you’d pay off the purchase price in a little over eight years with rent that high.

If the rental is being offered at $1,000/mo while you’d have to pay $1,000,000 for the purchase, it looks very different. If you have to pay 3% on your mortgage, then the interest alone would be almost three times the rent! Renting is superior here by a large margin.

These are two extremes, a price:rent of 100X in the first case, and 1000X in the second. Somewhere in-between those two extremes is a cross-over point, where it’s a break-even proposition to rent or buy.

Exactly where that point falls requires doing some more math, and will depend on a few key assumptions, but the first key point is that it exists: there is a point where prices get so high relative to renting that it makes sense to rent your shelter instead of buy it.

The second key point is that this is not some weird hypothetical situation: the price:rent in some of Canada’s largest cities is above the break-even and it is financially better to rent given many reasonable assumptions.

Comparing the Costs of Renting and Buying

You absolutely cannot just look at the mortgage payment and compare that to the cost of rent. There are many more components to the comparison: you have to look at the total cost of owning versus the total cost of renting.

As a renter, you may have to pay rent, tenant’s insurance… and that may be about it. Any savings you have over the ownership costs you can save and invest, as well as investing the downpayment.

As an owner you’ll have to pay for the property itself; if you don’t happen to have that much cash on hand, you’ll need to pay for a mortgage, which consists of interest (the cost of “renting your money”) and principal repayment. You’ll have to pay for upkeep (note that if you buy a condo that will be split into upkeep you’ll have to pay for directly and irregularly, like replacing the appliances, and the regular condo fees), insurance, property tax, and the transaction fees to buy and sell (and don’t forget that at some point you will be selling — often sooner than you may plan to).

These things are not going to stand still: rent will go up, as will the price of the house (unless it goes down), and money invested will earn some return. These are very uncertain values, so you will want to run the calculation a few times using different estimates to see how it works out. Find a few similar (or if possible, identical) units in your neighbourhood and do the math to see whether buying or renting makes sense on an apples-to-apples basis.

Here is the page for the rent-vs-buy calculator that offers that tool and goes into more detail on the factors. Preet Banerjee also has a rent-vs-buy calculator that includes a Monte Carlo simulation to run many different values of the different parameters. If you’re allergic to Excel, Get Smarter About Money has a flashy one, but note that it has a bug and does not properly compound the differences. The New York Times has one that lots of people link to, but firstly it’s made for Americans, so you have to do non-intuitive things like set your tax rate to 0, and secondly it just shows you the break-even rent, but not how meaningful that difference can be after compounding for some time.

Why Apples-to-Apples

I suggest you start with similar (or identical) places because that will give you the best gauge of whether your market favours renting or buying. For example, in North York (part of Toronto), price:rent can be so extreme (over 400X as of 2017) that a renter would be ahead of an owner by hundreds of thousands of dollars after just ten years. Once you see how skewed the prices are, and how favourable renting is, you can then take the next part in your housing decision: where to actually live.

If you were going to buy, you might have been looking at a 3-bedroom detached house, figuring that you’d save on some future transaction fees and just stretch for that, even if your family might not need the space for a few years. If you’re choosing to rent though, you might rent a 2-bedroom apartment for a few years first. Now it doesn’t make much sense to compare renting a 2-bedroom apartment to buying a 3-bedroom house in a rent-vs-buy calculator — of course the apartment will be cheaper. But that doesn’t mean that once you see buying is no great deal that you can’t then take that move to save even more money.

Similar logic applies for renting out part of a house: if it’s better to rent the whole house, then buying a place and renting out the basement is not suddenly going to make owning make sense.

It’s fine if apples-to-apples is not necessarily the actual decision before you, it still makes sense to do it to see what the price:rent is in the neighbourhood.

The Numbers Can be Huge

Near my daughter’s school there are several houses for rent in the $3500/mo range. That’s expensive, but Toronto’s an expensive place. Buying those same houses would run you around $1.5M in today’s market — even more expensive.

Let’s quickly run through the math: say you were going to buy one of these places for $1.5M. To have 20% down would be $300,000. You’d also need about $54,000 on hand for the land transfer taxes, title insurance, and legal fees.

So on the renter’s side: $354,000 to invest. A monthly rent of $3500 ($42,000/yr), and yearly tenant’s insurance of $420. Total of $42,420.

On the owner’s side: nothing to invest, a $1.5M house, and a $1.2M mortgage at 3.2%, for an annual mortgage payment of $69,634. The owner also has to pay property tax, about $10,500/yr. Insurance of $2000/yr. And they have to set something aside for maintenance and repairs – 1% is a decent rule-of-thumb, though some argue when prices are as high as they are in Toronto that over-states things (on the other hand, with trends the way they are now in the neighbourhood, tar driveways that need updating get replaced with interlocking, kitchens get upgraded far sooner than they wear out, etc. etc., so 1% may still be pretty close). So call it a $15,000/yr maintenance reserve. Total of $97,134.

Both the renter and owner have the same utility bills, as the houses are otherwise identical, and their other lifestyle expenses (from food to vacations to retirement savings) are not a factor.

In the first year alone, the renter is ahead by almost $55,000 in terms of cash flow. Part of the mortgage payment the owner paid would go towards building equity in paying off the house, but then the renter would also have (at 7% returns) another $26,719 in investment returns — the opportunity cost of having the downpayment sitting as house equity instead of invested.

We can keep going year-by-year to see how the numbers add up, but it’s clear just from the first year that the renter is way ahead financially. You may have non-financial reasons for buying, but there’s no way most people would put a $55,000/yr price tag on “pride of ownership.”

And you may say that ok, buying a million-dollar house in Toronto is nuts, but I knew that at “million-dollar house in Toronto” so how does that affect me? If you’re also looking at price:rents of over 400X, you’ll also find that renting is a much better way to go, even if it’s $1000/mo vs $400,000 on a condo. Run the numbers for your own situation and don’t assume that buying will be the better way to go, or that it will be close enough that you can let non-tangible factors make the decision – the numbers can be huge.

Also note that if you were to naively just compare the mortgage payment alone to the rent, they are not that far off — the mortgage is $69,634 to $42,000 in rent — especially if you factor back in the nearly $32,000 in principal repaid. But the other factors can’t be ignored.

What About Appreciation and Leverage?

Note though that in this comparison I do not need to add leverage to the renting side — while real estate gives you access to far more leverage than you could get as a renter buying ETFs, leverage adds risk and you don’t need it.

When you run the calculation for a longer period of time, your assumptions about the future appreciation of the house price matters a lot to the comparison, especially with leverage involved.

If we’re in a bubble and prices decline, then of course renting is going to win, but that may not be the way that this irregularity in the market gets corrected.

Toronto house prices were up double-digit percentages last year; if you believe that kind of insane growth will continue, then the comparison is very one-sided: a leveraged investment with an incredible rate of return is going to be a good thing. If you truly believe prices will continue to go up double digits then go out and buy five houses with as much leverage as you can scrounge. However, trees don’t grow to the sky: even if there isn’t a full-on housing crash, it’s highly unlikely that these rates of price increases will continue — and there’s no way to be sure in advance. A more conservative guess might be closer to the rate of inflation, which is about what housing has done over the very long term. You can even play with the spreadsheet to find what rate of appreciation is “baked in” to current prices, see where that puts prices a decade hence, and ask yourself if that makes sense.

To try to justify the price movement as something other than the madness of crowds, some people have tried to compare Toronto or Vancouver to pricier markets like New York or London. We may think of New York as a kind of archetype for cities: Toronto is like New York in that it has transit and a dense urban centre with financial and research and technology jobs with some kind of arts scene — maybe it is the next global cities and prices will keep going to the stratosphere. A helpful framework is to invert the comparison: if Toronto is like New York in some ways, and therefore should have prices closer to New York’s, how is New York similar to Toronto? Put that way, you may say, “Should New York have prices similar to Toronto’s?” and your mind goes “Whoa, it’s New York, it’s nothing like little Toronto!”

Invest the Difference

Another big point in the rent-vs-buy comparison is that the renter gets to invest the downpayment and any difference in annual costs. Earning a decent return (the default in the calculator is a 7% nominal or 5% real return) is another factor that makes renting a good move. However, if you don’t know how to invest, and your only alternative to buying is sticking your money in a savings account, then it’s harder to see how renting will work out. People often ask “How do I invest my money to get a decent return like that?”

I’ve written a book and created a course specifically to help guide people through how to do that.

Just like with the point on making apples-to-apples comparisons, you don’t have to invest the difference if there are non-financial considerations. For instance, you could have a more fulfilling and balanced life by investing most of the difference, and using the rest to take an extra vacation or eat out more, or buy a car, or rent a place that’s even nicer than what you could afford to buy — whatever fits your life.

Non-Financial Factors

The financial comparison has a lot of factors and is important, but really it’s just the start to frame the decision. There are lot of non-financial factors and pros and cons to buying and renting, and you can always spend more for something — money is there, in part, to spend — just make sure that the intangible benefit you get is worth the cost paid (and for that, you have to start with the financial comparison to set the stage).

Owning Pros:

  • Pride of ownership
  • Security of tenancy
  • Easier to renovate/control of property
  • Leverage

Renting Pros:

  • Flexibility
  • Lower financial risk (no maintenance risk, no liquidity risk, diversified portfolio)
  • Lower cash flow (don’t have to invest the difference)
  • Can look to only meet current needs (non apples-to-apples comparisons)

(And the cons are mostly inverses of the pros: renting has less security of tenancy, no pride of ownership, and having to work with a landlord and their whims; owning has cons of a lack of liquidity and financial risks)

Risk and Life Trajectory

Imagine the path or the trajectory your life is to take: you’ll live in this starter house, then sell it and move to this forever house; you’ll get this job then move to this city to take this promotion; you’ll have these kids at this time.

Housing can play a big role in that life trajectory, and a crash in the housing market (or even a “soft landing”) can have big effects on that trajectory. If you own your house and need to move for a new job, or to get more space for kids, there are huge transaction costs. If you haven’t built up enough equity, you could be stuck. You could be forced to sell at the worst time by a job loss or transfer, or a divorce; your plan to upgrade the starter house may not work if the market declines and the equity ladder you thought you were climbing turns into a snake.

Renting gives you a lot of flexibility: you can move to follow a job, split up, or upgrade with very little in the way of notice or transaction fees. If renting costs less, and you’re saving up the difference for larger financial cushion, it also gives you flexibility and resiliency to accept lower income (for illness, job loss, mat leave, or to go back to school). It will let you take more risks at work, which might help you get out of a bad or shady situation, or more aggressively chase a promotion or new opportunity, even start your own business.

The flexibility does have a downside: there’s less security of tenancy. Your landlord might sell the house out from under you, forcing you to move. Many people want security, and that’s fair — but at what price? Security of tenancy is often over-valued, and while flipping and reno-victions do happen, they’re often after tenants have had several years with a place.

Moreover, the risks of security of tenancy are risks of inconvenience, whereas the risks of getting stuck in an underwater house may be rarer but have much larger severity: they can completely derail your life trajectory.

Renting Mindset

Some people don’t see their rental home as truly theirs, and that’s a bad mindset to be in. Owners move every few years on average, but while they’re in that transient house or condo, it’s theirs. Treat your rental the same way. Find a rental you want to live in, don’t just get the cheapest place you can find and count the hours until housing Armageddon finally arrives. Hang your pictures and paint the walls. Remember: renting is still better even if house prices don’t crash — at these price:rents, all that’s required is that they not go up at insane rates. It will take years for a correction to come, if it does at all.

And don’t let choosing to rent your housing derail your life trajectory: kids can be born into rental household (I do have one myself) just fine.

Myths

Many myths and mantras have developed over the years with regards to housing, and they can be tough to shake. Here are a few dispelled:

Throwing Your Money Away

Versions include: “renting is throwing your money away” “pay your own mortgage instead of your landlord’s.” “rent will include all those costs like maintenance and property tax and interest because landlords make money.”

Working through the rent-vs-buy math above should put this to rest — there are many costs involved in owning that are “throwing your money away”. Yes, landlords aim to make a profit renting their units out, but it doesn’t mean that this is a guarantee, a natural law that man cannot break. It is possible to mis-price a rental (or to be primarily a speculator).

A clever way I’ve heard it put: You can rent your house, or you can rent the money from the bank to buy it. Either way you’re paying rent.

Or if you prefer more clever sayings to combat a meme, consider this: buying food is just throwing your money away. Why don’t we all grow our own food?

Forced Savings and Building Equity

A very common point in favour of buying is to say that you build equity by buying, that it’s forced savings. This is true, but can be myopic because it’s not like renters can’t build equity in other ways.

You have to look at the whole picture. Consider chips. At one store you give me $10 for a bag of chips and I give you $2 back in the form of loyalty points that you can later redeem for cash. You get to eat a delicious bag of chips that’s all yours and you got $2 worth of points back, that’s good, right? Forced savings! Building equity! Not all of the money is “thrown away”! But if you can just buy the bag of chips for $5 from another store you’re better off — you can hold on to $5 out of your $10 separate from the purchase of the chips, rather than just $2. There’s no “return” or “forced savings” in the second case, and the full amount paid for the chips is “thrown away”, but you put out less to begin with. In both cases you get delicious chips. In one case you paid a higher total cost, but got something back.

If you need to be threatened with homelessness to save — which is what “forced savings” really means — then you need to call a money coach, not a realtor. After all, homeowners need to save, too: for repairs to the house if not retirement, so you can’t rely just on forced savings. And having the flexibility of lower cash flow can be important in emergencies.

For those who say that “real” people don’t save the difference: yes, people often have trouble saving and investing intelligently. But we’re not talking about the general population, we’re talking about you and your choices: the fact that you’re here means you’ve self-selected to be more likely to have your financial house in order.

Landlords and Yield-on-Cost

Part of why people rent houses for ridiculous price:rents is because while you have to choose between buying at today’s price or renting at today’s price, many landlords paid a much lower price many years ago. They don’t consider the current yield, they think in terms of yield-on-cost, which might be quite good (and I’d be totally open to buying my place at the 2003 price).

You Have to Buy to be an Adult

You may “need to buy before having kids” or “to really be a grown-up”, but these are just social norms from a past generation. Babies don’t care whether the roof over their heads is owned or rented, all they care about is their parents’ love (and the cold glow of the tablet computer). If you want or “need” a detached house with a yard for your kids or fur-babies, you can still have that as a renter. They’re rarer than studio apartments, but still an option.

Make Renting Work for You: Everything is Negotiable

There are definitely some cons to renting. On balance renting is quite possibly the better move for you, so consider some ways to try to mitigate those cons.

Remember that rules and tenant protections vary by province. I’m most familiar with Ontario’s (I live there) and to some extent Alberta’s (where tenant protections appear to consist of a bar napkin with “screw you, renter scum” scrawled across it). Moreover, remember that everything is negotiable, and landlords are (mostly) people too.

Long Leases

A big concern people have when deciding to rent is the security of tenancy and potential rent hikes. Moving isn’t fun at the best of times, and it’s especially exhausting if you’ve just had a kid.

Long leases are a potential solution that hardly ever gets talked about. In Ontario, tenants automatically get to stay and become month-to-month tenants after their lease (typically 1 year) expires. You may get to stay for as many years as you want, with rent increasing by provincially controlled inflation, but the concern is what if the landlord wants you out? What if they want to sell, or push you out in some other way (say the unit is being renovated, or that their close relative needs it, or they sell the building)?

As a month-to-month tenant, you could be forced out with relatively short notice for these reasons.

To mitigate this, you can sign a longer-term lease: 2, 3, even 5 years — longer than many homeowners end up sticking around. In Ontario, as long as you have a lease in place you have the place, even if the landlord wants it for personal use; even if they sell, the new owner has to take you on at least to the end of your lease. If you sign a long-term lease and you end up wanting to leave early, you may have to pay the lease out (depends on how fast the landlord can find new tenants and what rent they will pay), the cost of moving would likely still be less than an owner would have to pay in land transfer taxes and realtor commissions.

Many landlords want long-term tenants, and would likely be thrilled at the prospect of a longer lease, but hardly anyone I know actually asks for one.

Renovations and Improvements

You can hang pictures and paint the walls in a rental. You may have to paint them back when you move out, but you absolutely can personalize your rental within reason to make it your home. Now owners will sometimes personalize to the next level with renovations. As a renter you can avoid all the construction dust and just find a place renovated the way you want in the first place, and move easily when it no longer suits you.

However, if you have specific needs or desires, remember that everything is negotiable. You can renovate a rental, you just have to work it out with the landlord. I myself have split the costs of adding a dishwasher with a landlord when a house we wanted didn’t have one in the kitchen. More substantial renovations are possible — around the corner from me a fixer-upper went for way below market rent in exchange for the tenants putting in the sweat equity of renovating it (the landlord paid for materials). In The Wealthy Renter, Alex Avery describes a case where someone worked with the landlord to renovate the kitchen, coming up with a unique long-term lease that had provisions for paying the tenant back for the work if the tenancy was ended early.

It’s important to remember that renovations are usually a lifestyle expense. We like to tell ourselves that they’re “investments” and that when a place is sold a new buyer will pay more because of the renovations, but in 15 years a buyer will look at the kitchen you upgraded and decide it’s dated and has to be redone just as much as they would have for the previous one you replaced. So it’s ok then to spend money renovating a rental to make it more enjoyable for you even if it’s not “yours” – you can’t fool yourself about the investment value up front, but that doesn’t mean it isn’t worthwhile in some cases to put the time, effort, and funds into renovating your rental home to make it fit your life.

Conclusion

We can talk about large systematic issues, speculation, household debt, regulations, and all that jazz, but this is the main point I want you to walk away with: you have options in how to go about arranging for your shelter and largest expense. You have to live somewhere, and the rent-vs-buy decision for your neighbourhood is the only one that matters for your life. For many Canadians, especially in Toronto and Vancouver, renting may be a much smarter choice.

For more, check out this discussion from Because Money, and of course the rent-vs-buy spreadsheet.

Meta

I’ve written a lot over the years on the housing market and the rent-vs-buy decision. I wanted to try to summarize it down to one post that I could point people to when the matter of “step zero” came up. To try to keep this post as “the one”, I will likely edit it several times after publishing as I realize I forgot some things, could organize it better, or explain parts better.

I also believe that Toronto (and Vancouver) is in a massive real estate bubble, and that the current price: rent imbalance will be solved by prices going down… one day. But it’s not going to be fast. Note that coming out better as a renter does not depend on prices going down — just on the cashflow differences and alternative investments out-performing house appreciation in the long term. I don’t talk about the macro picture here, or issues of foreign investment (which may be another source of why someone might rent a place out for less than it costs to own) or interest rates increasing or how or when things might correct. Because all that stuff is too high-level. When you’re looking to put a roof over your head and are at step zero of the house-buying process (should I buy at all?), you can’t make your decision dependent on a housing crash that may or may not come, or may be half a decade in the future if it does. It may be folly to compete in a bidding war for a house with price-insensitive capital, and it may be easy to talk in broad strokes about the doom (or future global primacy) over the horizon… but you have to live somewhere, today, which means seriously considering renting and looking at the options available to you today.

Burn Your Mortgage

August 12th, 2017 by Potato

So this is going to be a review of Burn Your Mortgage, and TLDR, it’s mostly going to be me ranting and nitpicking so if you don’t want to get into that, just know that most of it is fine but there are some particular issues. This image sums it up:

Figure from page 9 of Burn Your Mortgage. The caption reads: Canadian real estate prices have been trending upward over the past 25 years. That’s more than we can say about the stock market over this same time. A commentary is superimposed showing that the stock market return goes off the scale of the real estate one before the halfway point in the data displayed, proving the caption wrong.

Before getting to the book itself, some quick background on the tale. Sean is famous for buying a place, living in the basement, renting out the rest, and working super-hard to pay off the mortgage before he turned 31. The Sean Cooper Story boils down to: guy makes $150-200k/yr, lives cheaply in a basement apartment, saves up $500k over 7 years. Yawn. Oh wait, he didn’t just save and invest that money: he bought a house and then burned the mortgage. Now that’s a marketable story!

The biggest problem with Cooper’s story is that it happened at all. In the book and several articles, Sean has said that the reason he was so motivated to burn his mortgage was because of his mother and how she struggled to pay off the mortgage. He had a nearly irrational fear and distaste for debt.

So what should a debt-averse single person who is frugal and content living in a basement apartment do? Rent, of course! No, wait, I meant buy a house you don’t need! Then you can rent out the top floor while you live in the basement apartment, adding risk, losing your principal residence exemption, stressing about the mortgage and pouring everything into paying it off. I have referred to this as Cooper’s Folly.

Indeed, back when Sean first set off on the journey I pointed out that renting out the top floor of his house wasn’t as good a deal as he made it out to be — he was effectively paying something in the neighbourhood of $800-900/mo to live in a basement apartment based on the numbers he was publishing, which is what basement apartments cost anyway. In hindsight, the Toronto real estate market has been on fire, but because he didn’t stay crazy levered, he actually would have been wealthier if he had just rented a basement apartment, saved himself some stress and worry over debt and space heaters, and invested in a diversified portfolio (thanks to the markets also having a great 5-year run — over 12% annualized for an aggressive e-series portfolio vs ~9%/yr for Toronto real estate).

Anyway, this is just the background to the book: Sean bought a house, rented most of it out, lived frugally, worked an insane amount, and paid off the mortgage in 3 years (or, because the downpayment was also significant, the alternative title might be “local man works three jobs, lives in basement, saves $500k over 7 years.”).

The first chapter relates that story, and talks generally about buying a house, while barely even analyzing whether anyone should be buying a house or if renting might be better in their situation. Where it does touch on the topic, it does an egregiously bad job of it, so if you happen to know something about how to compare the options it comes across as extremely biased towards buying. The figure above says volumes about the dismissive tone towards renting and investing. He takes a dig at bears (throwing shade at Garth Turner in particular), but then sets up a strawman version of the rent-and-invest thesis to then make a show of toppling. Sean ignores interest in the rent-vs-buy comparison (implying it’s insignificant), then on the same page says that mortgage interest is a compelling reason to pay down your mortgage (implying it’s an important factor). Within a few pages he talks about the power of leverage as a reason to buy over renting (indeed, 2 of his 8 pros to buying relate to leverage)… then excoriates the reader to not use leverage and burn the mortgage.

MegaMaid from Spaceballs. She’s gone from suck to blow!

After that, the rest of the first section is generic advice on frugality, with a lot of lists… Most of it is fine, but parts of it read weirdly. To take one particular example, he suggests that you could save $500/yr on gas by planning your trips better and driving more efficiently. I spent $400 total on gas last year. Yes, I don’t drive much and have a pretty efficient car, but even with a normal car getting 10 L/100 km, that would take about 4500 km/yr of “extra trips” to get that kind of savings — it really just isn’t realistic. Similarly, who spends $1000/yr on taxis (actually, more than that, if they can save $1000/yr by cutting back or splitting with friends)? A lot of what he talks about in the frugality tips are outside his expertise and it shows.

Weirdly enough, there’s only ~4 pages on work ethic and time management. This really could have been almost the whole book, as the side hustle thing is a huge part of how Sean did what he did and is within his circle of competence to talk about. In some of his better times, Sean made more in a month (on top of his regular job!) than I made in a year as a grad student.

Let’s not understate this: he’s a very hard-working guy. He worked 80+ hr weeks for years at a time — not just a few months holding the world together while his wife was sick or ahead of a major deadline. And he kept that grind up without burning out.

Part of why I didn’t like the book is because of the massive missed opportunity there — I kept expecting to hear how I could also burn my hypothetical mortgage by hustling to earn more than my day job income, and how to fit all those hours in a day and avoid burning out. But the formula for success remains a secret. There is a side hustle appendix at the end, but it’s almost an insult, full of vacuous tips like “Childcare: Look after other people’s kids.” Yes, that is seriously the entire tip. He also suggests donating plasma for money, but there are only two clinics in Canada that do that (Moncton and Saskatoon), and Canadian Blood Services does not and will not pay for donations (though Wayfare is only alive because of the work of ~200 blood/plasma donors, so please do that one anyway). The rest of the list serves similarly as a brainstorming session with no regard to practicality — and clearly isn’t the way that he did it.

Anyway, from the generic middle we come to the FOMO section:

“Although foreign buyers help prop up the economy, many locals are finding themselves being priced out of the market. It’s probably wise, if you’re in the financial position to do so, to buy now while you can still afford to.”

Yep. He also suggests turning to the bank of Mom & Dad, so they can tap a HELOC on their house to help you buy one. Or buy with a friend (“great way to build equity and get your foot in the door” — BTW there will not be a giveaway as I threw up on my copy).

Only late in the chapter, after fanning the FOMO, does he include a note of temperance: “Buying a home is a good long-term investment — most of the time. But it doesn’t always make good sense. (With a book title like Burn Your Mortgage, I bet you weren’t expecting me to say that.) In fact, you may jeopardize your financial freedom if you buy a home before you’re ready and end up selling it within a year, say.” I for one, could have done with a lot more temperance.

The book pays a fair bit of lip service to buying what you can afford and staying within your budget, so it seems like a huge gaping hole that it’s not until much later that he does actually provide a rule-of-thumb on what affordable means. Though that gets immediately undercut because after introducing the figure for affordable, he says to spend more in a pricey market (no justification on how that’s still affordable, or why you couldn’t spend more of your income in a less hot market).

There’s actually a lot of detailed information after that on buying a house, features of a mortgage, and getting wills and insurance, and there’s a lot of promise here… except the FOMO stuff makes it hard to recommend. Not just on getting in before being priced out, but things that are very Toronto/Vancouver red-hot market centric like going in with a “clean” offer, or a bully offer for good measure.

Here’s where I want to take a bit of a side-bar discussion: this is a dumb thing to do. If you actually need financing to close, then you have to including a financing condition, because if for whatever reason you can’t get a loan (which could be due to an unforeseeable event like changes to mortgage regulations or a weak appraisal), you can’t close and are liable for damages that can be costly without that condition as an out.

Realtors put a positive spin on this and call it a “clean” offer, but you might as well call it a “naked” one (and that gets into another sidebar about the incentive to make a deal happen vs. protect a client). Now, in a flaming hot real estate market (such as Toronto has seen up until recently), those are the lengths buyers have been driven to. So if you want to give advice to people that helps them “win” a bidding war and get a house, you have to be pragmatic with the prevailing conditions and suggest they put in a naked offer. And that’s one approach and I get that and it’s fine — but it should also come with the appropriate warning label, and at the very least acknowledge that most readers in the country are not facing such dire competition and can proceed with more sense.

The other approach is to try to give people unpopular advice to protect them, in which case you can acknowledge that the stupid thing is happening, and tell people not to do it. It’s a small risk, sure: most deals close and the buyer finds a way to finance; most pre-construction purchases end with the market flat or higher and a buyer is able to get a mortgage and close. But in a book that also suggests buying life insurance for young healthy people, this is a comparable risk and deserves similar discussion. As a bestseller, it could have helped turn the tide on foolishness. Besides, in markets where you “have” to go in with a naked offer and completely expose yourself to the risks of not being able to close, the price-to-rent might favour renting anyway.

Conclusion

Burn Your Mortgage is mostly harmless. The lead-in ignores the alternatives and serious risks involved in buying, it has a strong pro-buying bias throughout, and there are better sources to go to for frugality hacks, budgeting advice, and side hustle tips. But if you’re going to buy a house anyway, the middle section does have a fair bit of handy information on what’s involved in the purchase and financing process. To be fair I’ve focused on nit-picking the other sections, so the truly helpful middle chunk is not reviewed in detail.

Footnote:

And just as this post was being put up, this from the Star: “Others, who bought unconditionally, have discovered they can’t get the financing to meet their purchase obligation. In some cases, the bank appraisal has come in at a value below what a purchaser agreed to pay, leaving the buyer scrambling to make up the difference.”

Rent and Invest the Difference. Or Not.

August 4th, 2017 by Potato

In some markets there’s a difference in the cash flow between buying and renting. Particularly in Toronto and Vancouver, it can cost a lot less each month to rent a house than to buy the same place (this is why there’s commentary about these cities being in a bubble). You can (should!) save up that difference and invest it, and come out much better as a renter than a buyer.

I’ve been banging that drum for a while. I made a rent-vs-buy calculator to help you estimate how much better off you might be.

But a very important point is that you don’t have to save the difference. It’s not just about how much money you have at the end (though that’s important), but the options you have along the way. You can spend the savings on increased lifestyle if you want — living in a bigger/better house than you could otherwise afford, travelling more, eating out more, whatever it is that you want to trade money for to improve your life. Or have Plan A be save and invest the difference.

When the shit hits the fan, you can use the difference as an important safety buffer on your budget. You may “build equity” with each mortgage payment, but you can’t eat equity, and in the meantime you have to keep paying your mortgage.

So when Wayfare was in the hospital and then continued being sick so we’re down to basically one income, we were (and still are) able to stay in our house. Firstly, because we had an emergency fund. Secondly, because we have awesome parents who can help pick up Blueberry so I could keep that one job (and who gave us the confidence that there was another backstop behind our emergency fund if needed). But also because, as expensive as Toronto rents are, we’re actually able to (almost) afford to live here on (almost) one salary.

Let’s do a quick comparison (not our personal numbers, but taken from real GTA listings of similar houses on the same street, and the ratios would be the same):

  Owned house Rented house
Mortgage/Rent $2933 $2200
Insurance $100 $40
Property tax $550 0
Maintenance* $700 0
Total $4283 ($3583) $2240

(All else equal, see notes, * – maintenance can be deferred/ignored temporarily in a crisis, but not long-term).

When cut down to a single salary of ~$4,350/mo after-tax and CPP/EI ($70k/yr pre-tax), a family in the rental house still has $2,110/mo to spend on food, transportation, utilities, phones, summer camp, and other necessities, so the emergency fund doesn’t get drained too fast with one person out of work. It’s likely a tighter budget than they had before, but they can manage for a fairly long time if needed.

In the owning situation, there’s only $767 left over — not nearly enough to get by on, and then only if they ignore maintenance. The house is eating through the emergency fund, and with nothing being set aside for maintenance they’re one poorly timed major repair away from catastrophe. Unlike the renters, the owners have to worry about a possible forced move on top of the immediate medical crisis.

Having a few years of that kind of cash flow difference with two incomes (and saving the difference) also meant that the renters also go into their medical crisis with a good-sized emergency fund saved up, and instead of being used up in the purchase, the sizeable downpayment is spinning off dividends to help with cash flow. So even if they fell short or lost both jobs, they could manage for a while.

This is why the rent-vs-buy debate matters. In exchange for a little less security of tenancy, the renters gain a massive increase in resiliency and flexibility.

Notes: This is the edge of affordability for a 2-income household where each head makes $70k/yr pre-tax (and on a side note, I had to go north of the 407 to find a matched pair of 3-bdrms to fit that kind of budget, but the price:rent holds in North York). The maintenance amount is a rough estimate and can be deferred/ignored in a crisis for a while. This simple cashflow analysis ignores factors like investment returns/opportunity costs, transaction fees, etc., that would be captured in a full rent-vs-buy calculator. While not our specific numbers, the ratio of the owning cashflow to renting cashflow requirements is still very close to the choice we faced when we moved here.

On Rent Control

April 6th, 2017 by Potato

An important principle in our society when it comes to rentals is striking a balance between a landlord’s ability to make money and a tenant’s security of tenancy. A tenant will call whatever place they are renting home, and deserves to have some reasonable modicum of security that they will get to continue to call that place home.

They should not be kicked out because they got a non-destructive pet, because of their skin colour or religion, or that of their significant other (or the very fact that they may have started dating since the place was first rented). A tenant shouldn’t get kicked out because it would just be more convenient for the landlord to flip the place if it was vacant, or because the tenant didn’t welcome the landlord’s sexual advances – we as a society have said that the laws are going to protect against that.

And none of them mean a damn thing without rent control, because all the landlord has to do is jack the rent to a level no one can afford, and the tenant gets forced out (“economic eviction”). They don’t even have to show that that’s actually the new market rent or find a new tenant at the new price. They could jack the rent from $1000/mo to $100,000/mo, evict the tenant they don’t like (for any reason whatsoever), then rent it to the next tenant they do like at the original $1000/mo and nobody in power blinks an eye.

So in Ontario it’s a big deal that we don’t have rent control on properties built after October 1991. All those new condos built in the boom, many of which are serving as rental stock, are uncontrolled and there are essentially no protections for tenants. This is especially important in the midst of a housing bubble, as people feel there’s no option but to buy (no matter the price) if they don’t have the security to raise kids as tenants. We’ve been seeing that in the news recently in Toronto, with the Premiere picking it up this week when the rent doubled on a few people for an economic eviction.

Now, I think the existing pre-1991 rent control is a very good compromise between security and economics: the landlord can charge whatever the market will bear when the tenant leaves, and they get to put through increases in line with inflation (set by the government) while the tenant stays there. So the tenant gets protection, but not the unit. And to a large extent, the government rate is actually about what rent inflation is. I spent a decade in London, Ontario, and watching the rental market* there, market rent inflation if anything lagged the allowed increases. I know the approximate rent a few people were paying in downtown Toronto near UofT, and running those through the increases to today gets to within 5% of the current asking rent in those areas. Other than the last few years, rent inflation has been really low. And when costs legitimately spike (like when our apartment replaced the boiler or property taxes increased), the landlord can apply for an above-guideline increase, which goes before a third-party arbiter.

But, it doesn’t have to be that exact system: we could add enough rent control to prevent economic eviction, but allow double the rent increases for places built after 1991, or have regional inflation rates, or permit any increase to market rent, with the burden of proof on the landlord to apply to a board or ombudsman that that’s actually the new market rent and not a ploy for economic eviction.

Some people on Twitter and elsewhere have railed against rent control for buildings after 1991 – including Ben Rabidoux, who I usually agree with – as it would dis-incentivize building rentals. But I simply do not see it here.

First, there was hardly any building of rentals after the exemption was put in, and we’ve had almost three decades for that to do something. So evidence suggests it was not effective as an incentive, and taking it away isn’t going to change that.

Second, deciding whether to build a rental building depends on a number of factors: how much it costs to build and operate versus how much you can bring in in rent. The current market conditions and base case projections on inflation and financing costs are massively more important to that decision than rent control rules. Having free reign to increase rents only helps you in the scenario where rent inflation increases rapidly and where tenants do not turn over very often and where the government doesn’t recognize the inflation in the guideline increases. For more normal scenarios, the lack of rent control is a nice option (mostly to skirt eviction rules) but otherwise doesn’t really affect the economics of your building — doesn’t sound like the make-or-break incentive to me. Indeed, for most cities over most of the last few decades, the provincial guidelines (and occasional above-guideline requests and vacancy de-controls) have been plenty to keep your units at market levels. So yes, putting in rent control will be a dis-incentive, but a relatively minor one compared to the other costs of building and operating, and is nowhere near something that should out-weigh the social need for some measure of rent control (without which all other tenant protections are toothless).

And the fact is, cap rates are garbage right now. Rent control or not, we’re going to get hardly any serious purpose-built rentals in the GTA simply because people are willing to pay far more for a condo for consumption than a rational investor would for a rental (driving up land and construction costs). There are many other incentives to condo building (including that you get to crowd-source your funding and punt the risk to individual saps), and disincentives to purpose-built rentals (including the property tax regime). Despite the fact that at the moment there is no rent control on the books for future rental units, I’m amazed that there are any being planned in this environment, and I’m sure that there is a story about back-room dealing with the city to have made that happen anyway.

So I say bring on rent control for buildings after 1991: as it is for others, or a weaker compromise form if necessary, but something to provide more security of tenancy than the current economic eviction free-for-all.

* – note, there are no good data sources on market rents that I know of. Everyone complains about CMHC’s because it only tracks large apartment buildings, which tend to be older. Many rentals don’t show up on MLS so the realtors don’t have a good picture, either.

HCG TL;DR

March 17th, 2017 by Potato

Home Capital Group (HCG) is a company with some troubles that is being shorted by some colourful and entertaining (and IMHO likely correct) characters. But the implications of the story go beyond just a stock market tale.

Brief Recap:

Home Capital issues mortgages to borrowers, primarily in Ontario, with a focus on “homeowners who typically do not meet all the lending criteria of traditional financial institutions” (pick your euphemism as long as it’s not “subprime”), as well as traditional business that gets insured by CMHC. Around Sept. 2014 a whistleblower lets them know that several brokers were allegedly sending them fraudulent mortgages (independently, reports come out about people in the industry who help people forge documents). HCG’s CFO announced a retirement in November 2014.

In documents released yesterday, (H/T @TaureauResearch) Home Trust appears to notify CMHC about the issue at the end of October, 2014. CMHC seems amazingly chill about the fraud – no mention publicly or in the documents about cancelling the insurance, adjusting guidelines, or even reviewing anything. Hell, they say this: “CMHC thanked Home Trust for coming forward with the information and for being proactive in working together with CMHC to prevent fraud.” [page 90] The most that seems to happen is to schedule a review for over a year in the future (Jan 2016).

In May 2015, HCG releases its first quarter results, with no mention of the potential fraud issue, despite noticeably lower originations. The release just has a vague phrase about reviews. “The first quarter was characterized by a traditionally slow real estate market, exacerbated by very harsh winter conditions. The Company has remained cautious in light of continued macroeconomic conditions and continues to perform ongoing reviews of its business partners ensuring that quality is within the Company’s risk appetite.”

On July 10, 2015, they state that originations were down in the second quarter, and that they had terminated their relationships with certain mortgage brokers.

On July 29, 2015, they clarified – at the request of the OSC, they note – that in 2014 they were notified about “possible discrepancies in income verification information submitted by certain mortgage brokers. […] The investigation determined that falsification of income information had occurred but that there was no evidence of falsification of credit scores or property values.”

It’s not until after this that CMHC seems to get activated about the possible fraud (that they’re insuring!) On August 4th they ask if they’ve done any analysis about the exposure to the fraud, and on July 30 someone sends around the total exposure to Home Trust (again, redacted so hard to say for sure, but without an analysis of that issue), and that they’ll have a closer look then. On July 31, someone at CMHC appears to say that they can’t transmit information (on the brokers) from one lender to another (page 36, French, partially redacted), in response to an email asking if they have the list of 45 brokers from CMHC (page 37). Not until December 2015 does someone ask if anyone checked whether the brokers in question originated loans through other lenders.

Why Does This Matter?

The matter with HCG itself is just a symptom. It’s important for investors (and short sellers) of that company to understand those events are going on, and to consider what your opinion is of management that waits that long (with a poke from the OSC) to disclose an issue like that. But HCG is just a small player. Beyond that, it’s a sign of what’s happening in the housing market.

Yes, fraud exists in the market (and I’m not talking about HCG here: more generally). But more importantly, moral hazard exists, and there is a huge outcome bias at play. CMHC at first seems to care little about the issue: there are few arrears, so no biggie. But there are few arrears in a housing bubble anyway – no one defaults when their house appreciates 10-20%/yr. Everything seems great until the music stops. Similarly, many voices (including MPs) argue against tightening regulations and that Canada’s financial system is strong because arrears are low.

The message heard by players in the industry then is that there are no consequences for bad behaviour. If arrears pile up 5 years later, well then people may care but it will be too late. In the meantime, fraud is happening in the market (and I’m not alleging at HCG specifically), and there is no sense from the government or the banks that there’s anything wrong. They even call it “soft fraud” or fraud-for-shelter – bending the rules to get a house, which can’t be that bad as long as they pay the mortgage, right? (The one that they can’t technically afford if rates rise.)

There are things that could have been done. Instead of being reactionary, there could have been more proactive actions at CMHC (which to be fair may have happened but not been captured in the FoI release, or been redacted). They could have flagged the brokers in question and checked for any past or future loans with other lenders – and sources suggest that the brokers that HCG stopped doing business with are still in the business, sending loans to other lenders. They could have put the loans back on the lender and cancelled the insurance without waiting to see if there was a claim. And nowhere did I see any mention of whether Genworth was in the loop on the goings-on.

Insured mortgages require the least amount of capital on the balance sheet. Simply putting them back proactively (perhaps with an investigation and some work on improving underwriting processes), even without a fine, would have an impact as the company would have to use capital to hold on to those mortgages, potentially slowing their growth or forcing them to go to the market to raise money. That would have been a small step, but one that would have sent a message that fraud is not cool.

But the bigger issue is that it was reactionary: there’s no evidence in the released documents of CMHC doing anything to prevent these brokers from continuing to write taxpayer-insured mortgages, or even quantifying the exposure until July 2015. It’s not until the matter becomes public and there’s the risk of backlash and people like Ben Rabidoux asking questions that anyone seems to bother to even quantify the potential risk, let alone do anything.

People like to state – with very little supporting evidence – that Canada’s financial system is safe, stable, conservative, etc., etc. But this example seems to show that nothing is actually checked in depth, and rules are only lightly enforced until something breaks into the media and public consciousness.

Yes, today arrears are low and the banks aren’t failing. The point of making a good system with oversight and strong regulations that are actually enforced is to keep it that way.