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Real Estate and Business

Paying Extra to Own a Home: Renting Versus Owning

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It is well-known that in the long-run it has been proven over hundreds of years that it is more lucrative to own your home than it is to rent it. This is especially the case in Canada given our capital gains exemption on principal residences. However, though this is usually the case an the case in the long-run, it isn’t always the case at specific points in time.

It is more lucrative to rent, rather than own your home when the market is in a bubble and it is about to go through a correction. That is something that hasn’t happened in Toronto for decades.

The belief and desire that home ownership is the best thing to do drove millions of Americans to purchase homes they could not afford leading up to the 2007-2008 liquidity crisis and  housing crash in the United States. This blind desire to own a home, fueled by the media and misunderstanding of the economics of home ownership, contributed to the skyrocketing of real estate prices. What made it worse was the government’s willingness to help families buy homes when it made more financial sense for those families to rent. Yet, the calculation of whether one should buy or rent is very straight forward.

The cost of renting your home usually includes:

  • Monthly rent
  • Utilities used
  • Tenant insurance

The cost of owning our home usually includes:

  • Mortgage payments (principal and interest)
  • Maintenance fees (if a condo unit) or maintenance costs
  • Insurance
  • Property taxes

When you add up the costs if you were to rent or own a specific home there are years when it is cheaper to rent and years when it is cheaper to own. Theoretically, the cost of renting should be equal to the cost of owning a home (less the principal repayment component of the mortgage payments). Leading up to the devastating collapse of the United States real estate market the comparison clearly showed a significant premium in owning a home. In other words, it was about 25% cheaper to rent than to own. So, home prices were over-inflated and out of equilibrium. It was only a matter of time before the market adjusted itself.

In Canada, the situation includes two additional significant factors; 1) the heavy immigration rate driving increasing demand and 2) the capital gains tax exemption on primary residences. These two items work to drive demand and produce a higher financial return on home ownership.  With increasing demand comes increasing prices for rent… and for home prices.

Very simply, the more people that need a place to rent, the more a rental unit will rent for. The more a rental unit rents for, the greater the value of the unit and the property it is located at. Though in Canada, the price of housing increased at a greater pace than rent, due to rent control. After a few years of rising housing prices, the pressure was put on by tenants to offer more rent to secure under-priced rental units.

In Toronto, the housing market continues to be in a state of disequilibrium as demand outpaces supply, which is kept tight by regulations and policies of all levels of government and the development and tax costs forced on developers by those governments.

Though a young professional might be tempted to rent a lower-cost unit in Toronto (if they can find one), the reality is that if they don’t buy their own place, their chances of home ownership might be worse in the future and certainly their accumulation of wealth will be significantly hampered.

To take advantage of the housing market returns, many millenials are renting in Toronto to live and buying in smaller communities where prices are low and they can get a rental income as the property appreciates in value. They can then use the equity in that property to buy their Toronto home down the road.

Is The Toronto Housing Market Shifting?

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The number of headlines and proclamations that the Toronto Housing Market ‘Bubble’ is about to burst has increased over the last few weeks. So, let me clarify things for you…no one knows exactly what is going to happen in the future. This is all either speculation or reference to specific pieces of data that has been obtained of what has already happened. Anecdotal examples of what is happening is often contradictory. Quantitative data is poorly collected, incomplete, or unreliable.

Headlines this last week proclaimed that there is a flood of listings on the market. Among them:

Daniel Tencer wrote “Whoa: Toronto Housing Market Actually Softens As New Listings Soar” …HuffPost Canada (May 3, 2017)

Carolyn Ireland wrote “Toronto market turned on its head as flood of listings overwhelms buyers” …Globe and Mail (May 18, 2017)

Tess Kalinowski wrote “Toronto sees April home prices grow as listings soar”…Toronto Star (May 15, 2017)

Daniel Tencer wrote “4 Signs Toronto’s Housing Bubble Has Started To Deflate“…HuffPost Canada (May 15, 2017), in which he points out:

1. Sales are down
2. New home listings have soared
3. Buyers are hesitating
4. There’s been a spike in searches for “housing bubble”

Then this morning the Globe and Mail published ‘Flood of Toronto listings not all that it seems’  by Carolyn Ireland. In the article, Ireland focuses on how the TREB is reporting the same house as listed two or three times. Some sellers are taking their house off the market and relisting the following week if they don’t get the price they expect. She refers to quotes from some realtors that suggest this is throwing the statistics ‘out of whack’.

However, they’re missing the key point here. The fact that sellers have expectation above the market, which are not being met, in and of itself indicates that there is a shift happening in the market. The question in my mind is whether this is a temporal occurrence or is it the beginning of a more significant long-term term and systemic shift. I also question which housing styles and neighbourhoods this is happening, as I’m pretty sure it won’t be consistent in magnitude throughout Toronto.

Jane McFarland wrote “Canada at risk of housing correction, Moody’s warns“…The Globe and Mail (April 11, 2017). In the article, McFarland writes “The Moody’s report likens real estate price increases in Canada and the other three countries to the gains seen in the United States, Spain and Ireland in the years leading up to their housing peaks in the mid-2000s, prior to major market corrections.” However, the article does downplay the magnitude of a possible correction and its impact on the Canadian economy.

From my personal experience this feels a lot like the Toronto real estate situation in the late 1980’s. The headlines are similar, the sharp appreciation in house prices in the last days are similar, the contradicting arguments among economists, realtors and bankers. The difference is that now the proponents of continued appreciation are pointing to heaving migration and foreign investors as opposed to local speculators. Regardless, whatever is motivating these demand sources can also change and deter them.

The bottom line is that no one has the complete picture, no one can predict specifically when there will be a ‘correction’  and it is more important to some homeowners than others. If you’re in your 30’s and buying your first home, then I wouldn’t be too concerned about cycles in the real estate market. In the end, given that land is a limited resources (they’re not making any more of it and we’re unlikely to colonize other planets any  time soon) and the population keeps growing, real estate should continue to outpace inflation and other long-term investment performance.

However, if you are speculating, then consider it a form of gambling which can result in short-term losses. These losses could translate into long-term losses if you don’t have the cash flow to keep up with financial commitments associated with the property and you are forced to sell the investment. So, be careful what type of real estate you buy, where it is located, and how you finance it.

If you’re looking to downsize anytime over the next 5 years, you might want to consider making the move sooner rather than later. If there is a correction, you could feel the pain of the extra $100,000, $200,000, $300,000, $400,000 or even more that you could have gotten for your home. I can give you a pretty good indication of what your house will sell for in this market. It gets difficult to predict what it’ll sell for next year. The best way for me to get this point across is by stating that I can safely say that there is about a 99% chance that your home will sell for between 40% and 150% of its present market value within the next year.

Call me for a market assessment of your home – Baldo Minaudo, M.B.A., Broker: 416-564-0245.