Summary: Renting or Buying
A caveat: To this point in my adult life, I have never owned a home and I don’t anticipate owning one any time soon. With this in mind, I will attempt to be as objective as possible while discussing the topic of renting or buying your home, as I only have the first-hand experience of being a renter, not an owner.
I often hear people say something along the lines of, “To think of all the money I’ve wasted on rent over the years”. This view inappropriately frames the argument of renting or buying. After all, a place to live ranks pretty high on the list of basic human needs, so in that sense rent isn’t, by definition, a waste of money. You need to live somewhere, and paying rent allows you to accomplish this goal.
“But Max, I could have been putting that rent money towards a mortgage and building equity. I’ve got nothing to show for all of that rent I’ve paid”. This is where the argument gets a little stronger. We’ve already shown that housing is a basic human need, however, there are a couple of flaws that I identify with the equity building argument:
1. Is it a waste to spend money on things besides tangible assets?
No, you don’t have equity in a home that you are renting, but it’s providing you with a different benefit: a place to live. Between vacations, parking spots, and concert tickets, I spend money on all sorts of things that don’t provide me with a tangible asset, and I never think of it as a waste of money.
2. By thinking of ownership in terms of equity, the argument is re-framed as more of an investment decision than a lifestyle decision.
As I’ve discussed in an earlier piece (The Shortcomings of Common Investment Strategies), investing in real estate is not the foolproof strategy that many individuals perceive it to be. Beyond the frictions of transacting in real estate (closing costs, property taxes, mortgage insurance, etc.), there is no guarantee of massive appreciation. We see the growth in property values in Vancouver or Toronto and think that it is representative of the entire real estate market. Just ask residents of Detroit who bought their homes in the 1970s – massive appreciation in real estate value is far from guaranteed.
3. Since the equity building component is an argument in favour of buying a home as an investment, then it is worth comparing real estate returns to the returns of other forms of investment.
With the exception of unsecured loans with punitive interest rates that nearly sunk the housing market in 2008, most people put a down payment on a home in order to get a mortgage. What if you had invested this money into an S&P 500 index fund instead of into a home? On the aggregate, equities have grossly outperformed real estate as an asset class. From 1990 to 2020, the S&P 500 had an average annualized rate of return of 9.9%. If a $40,000 down payment were instead redirected to an S&P index fund (ignoring transaction costs, which are much larger with real estate), it would be worth more than $770,000 today. That down payment would go a long way toward a comfortable retirement.
Beyond returns, there is also the risk involved in making a purchase with leverage (a high amount of debt). The size of the loan will always be the principal remaining, even if the house price drops precipitously. For example, you make a down payment of $20,000 on a $300,000 home and get a mortgage for the remaining $280,000. Over the first few years of the mortgage, you manage to pay down $30,000 of the principal and you now have a $50,000 equity stake in your home. Now say that the big factory that employs everyone in town shuts down and all of a sudden there is no demand for real estate. The appraised value of your home drops from $300,000 to $250,000. At this point, the equity you hold in your home has been erased, and it can continue to freefall into negative territory.
My goal is not to deter individuals from buying homes but rather to push back on the idea that it’s a no brainer to buy instead of renting. There are individuals who do exceptionally well transacting in real estate. They may flip homes, serve as landlords, or develop property. But chances are that most of these individuals have been successful because they have unique expertise, they worked exceptionally hard (and the profits are therefore the result of their labor), or they got lucky. Getting lucky is not a wise investment strategy, so if you lack unique expertise and the willingness to work hard, then there are other forms of investment that may be better suited for you.
Conclusion: Renting or Buying
Home ownership is a lifestyle decision; the associated pride in ownership is a reason why having a place to call your own is a primary component of the American Dream. But just like all big lifestyle decisions, the choice to buy a home requires careful deliberation. There is no right or wrong decision between buying and renting – it simply depends on the individual. I personally will gladly keep paying rent and counting myself lucky that I don’t have to mow the lawn or shovel the driveway.
Opinions are those of the author and may not reflect those of BMO Private Investment Counsel Inc., and are not intended to provide investment, tax, accounting or legal advice. The information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the author nor BMO Private Investment Counsel Inc. shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance. BMO Private Investment Counsel Inc. is a wholly-owned subsidiary of Bank of Montreal.