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.

12 Responses to “Rent and Invest the Difference. Or Not.”

  1. Weekend Reading – Stress less investing, allure of more, don’t need insurance and #money stuff - My Own Advisor Says:

    […] the subject of home ownership Holy Potato revisited the rent versus buy debate.  We’re not against renting for a few years […]

  2. rental property math Says:

    With your above example what you’re saying is a house with these figures can be rented for $2240 a month:

    Purchase price: $770000
    20% down payment
    Interest rate: 3%
    Taxes: $6600/year
    Insurance and maintenance (on the low side) =$3500/year

    Show me where it’s common a $770,000 house gets rented for $2240….

  3. craig Says:

    well, except that you are only talking about cash flow. you are ignoring the simple fact that a substantial part of your mortgage payment is for principle, which stays in your own pocket. this not only reduces the net expense of owning, but is also available to borrow against in an emergency.
    it is also important to look down the road. with time, you are paying less and less interest on the mortgage, and more of that money is going to principle. eventually, you will own the house and that cost will disappear. if you are renting, the cost will increase over time, and never end.
    not to say that renting isn’t necessarily a good solution, especially in the short term, but get your math right before you make a decision.

  4. Potato Says:

    Craig: There’s a link to a rent-vs-buy calculator in the second paragraph. Here I am talking about the lower cashflow as an additional benefit that comes in handy in times of stress (as we faced). It is not always possible to borrow it back if you need it (you have to refinance if you don’t have enough for a HELOC, or get a pricey 2nd mortgage), and even then you still have the cashflow obligation of paying down the mortgage.

    But for the larger issue, the principal paydown etc is all accounted for in the comparison, and that difference in all-in cost is a big reason why we chose to rent in the first place, though the added flexibility is nice too. The big factor is that the price:rent is so crazy in Toronto (and has been for years now).

    RPM: Toronto (this specific example came from Richmond Hill, but the price:rent is the same in North York). Also, I used a lower interest rate: the asking price on the purchase was actually in the $900k range.

  5. Costa Pintilei Says:

    Without trying to rain over the rental parade, the balance turns back in the favor of the owner in the case where they live in the same house around 10 years more after the mortgage is paid in full. On the example above, just consider the $850/month differential accumulated over 10 years at the same return rate the renter enjoys.

  6. Jimmy Says:

    I’m 53 and I just paid off my mortgage earlier this year. So now I only have to pay maintenance and insurance. I’m very happy right now that I bought instead of rented.

  7. Jimmy Says:

    And property tax. And utilities. But still…

  8. Squash Says:

    I downloaded your spreadsheet and I just ran the numbers for Vancouver. I rent and the annual rent increase is 5% not 2% (as in your spreadsheet). That is a fact based on the BC Residential Tenancy Act. I also calculated based on my actual rent and the cost to purchase a similar condo at the retail rate. At the end of the 30 year amortization I was behind $600K.

    Some other calculations that are not (and could be) computed:

    1) The realization of the property asset at the end of the 30 years. In Vancouver a house purchased for $25K 30 years ago now is selling for $1.25M. The fact that you do not compute the increased value of the property after the mortgage is paid makes you calculations in error.
    You could calculate the 30 year average of the value of real estate.

    2) Add that the return on an investment at 7% is also a concern. I find that 7% return rate a little high. I would estimate a 5% return to be numerically conservative.

    Based on my analysis the property owner may be short of cash the first five years in comparison. However, at the end of 30 years, the home owner is way ahead.

  9. Simon Says:

    The first paragraph “….If you rent and invest the money saved over owning, you can build comparable wealth to the owner.” may or may not be true, depending on the time you live in. It has not been true at all for the last 15 years. Also a mortgage is debt, but it is also a leveraged investment. You put $100K down on a $500K house, you make money on the full $500K asset, not just your down payment.

    But where you lost me on this article is the $2,200 rent in Toronto. I rent my basement for $1,700 a month for goodness sake, and I’m not even close to downtown.

    Also, final point, and this maybe is the biggest one. As @Jimmy says, once it’s paid off, the primary cost of living (paying for a roof over your head) goes away. If you rent all your life, you may be looking at 30 years or more in retirement with a cost that is increasing and income that is at best stable. I doubt many people who rent can afford to retire at 60. Probably more like 80!

    Buying a house is not the certainty it once was. But to put it in accounting terms, it needs to be put into the long term context of building value in your lifelong balance sheet, rather than looking at it through a myopic lense of monthly cash flow and income statement. Your shareholders – your dependents – will thank you for it!

  10. Potato Says:

    Costa: Depends on a lot of factors and assumptions, but not at these levels, no. By the time the owner has the house paid off, the renter has more than enough invested to just buy one in cash.

    Jimmy: I know you’re trying to tempt me to break my solemn vow, but I still won’t use the TARDIS for selfish ends.

    Squash: rents long-term are constrained by income and track inflation pretty well (they’re a big component of what inflation is). But in the short term it’s another story. So predicting what estimate to use is tough — you should run a few scenarios. Here, I put 2% in at first, and rents around here actually fell short of that for a few years, then in the last few years jumped in leaps and bounds, averaging about 3% over the last 7 years. For the first point, property appreciation is explicitly included. Again, try a few values and think about the long-term. Is it reasonable that the boom that led to many people calling a bubble will continue apace another few decades? If you think it will crash then renting is a no-brainer. If you think 10+%/yr will continue, buying is a no-brainer. But what about a “soft landing” where growth returns to near-inflation levels? Then you have to math it a bit. The 7% default is a nominal value, so it’s only a 5% real return which is pretty conservative already. Again, use your own values and assumptions — and test out a few scenarios.

    Simon: The listing I grabbed here was from Richmond Hill (because places in the 416 wouldn’t pass affordability checks for the comparison even before dropping one person out of the workforce!) but the price:rent is the same as North York. Trying to find a few sample listings in less than 10 minutes of searching: Here’s a few in Armour Heights ranging from $2500/mo – $3800/mo. Similar ones for sale are around $1.4M. So a price:rent of 368 – 560X.

    Be careful of outcome bias. If you knew property appreciation was going to be as strong as it actually was, you shouldn’t have stopped at just one house. But that kind of prescience is impossible, and looking into the future I’m confident in my choice, given the information I have today. Also, I would not have made that statement 15 years ago because price:rents were no so out of whack — that’s only been the case for the last 10 or so.

    And don’t ignore the power of investing or the importance of price:rent. If you took an owner like Jimmy who bought in the 90’s when a place that rented for $1900/mo sold for ~$400k, then it made decent sense to buy (price:rent was ~200X, and even if you had the money to buy in cash/a paid off house, you needed to earn a fairly high return to pay the rent out of the pile). But now that place rents for ~$2900 and sells for $1.4M. On the road to get from there to here, yeah, owning was awesome. But today someone like Jimmy could sell the paid-for place, and only needs to earn ~2% to pay the rent on an equivalent/same place (net of maint/ins/etc but also net of taxes). Bit more growth to keep pace with inflation, which is not a stretch… a different set of risks, but also a different set of opportunities. But for someone in those shoes (whether it’s Jimmy or my in-laws or whoever), they have enough that they can make choices on non-financial factors and they’re fine either way. In our situation, we have to be more cautious.

  11. craig Says:

    well, i have to say that the spreadsheet does look pretty good! it is rare to see someone looking at the multiplicity of factors, as well as pointing out the grey areas involved in estimating various rates and numbers.

  12. Jack Says:

    In my case my mortgage, strata and taxes is far less than rent comparable in Vancouver. Bought place a few years old too. The equity alone in three years is same as salary for doing nothing. Renting would net me nothing. Light on fire and burn but place to live of course. Not to mention rent increases and landlord renovictions not ever going to happen. I bought in Vancouver and well under budget and think others could do the same and benefit. I reduced all debt so got variable mortgage rate and via monolender so penalty to break mortgage is minimal and very low rate.

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