Over the past week I put an hour into an economic simulation.
I wanted to forecast out a potential situation where you buy a house or rent for 20 years given a constant amount of income allocation for either housing or savings and either a sizable down-payment or an investment endowment.
Scenario #1 is to take $150K as a down-payment on a house and pay a 2% mortgage (our current rate) on a $300K house over a 10 year term with $2500/month worth of income allocated to housing or savings. In this scenario I calculated a $1.15M gain in net worth over 20 years with 70% of that tied up in a house.
Scenario #2 is to take that same $150K and treat it as an endowment fund. Capital gains (at estimated 8% return) are taken out to maintain a consistent principal. Paying $1200/month rent (which should be comparable to 300K property) by taking from income out of the endowment + the same $2500/month income, with the excess put into an investment account. This scenario results in a $1.58M net worth over 20 years with 100% of that in stocks/bonds.
In both of these scenarios I considered maxing out the tax benefits of savings by maximizing RRSP contributions.
With these scenarios it seems that the right now in the Canadian housing market the best deal is for renting. In these two scenarios renting results in $400K more net worth than buying a house.
Not only does renting provide the net benefits of more money in your pocket but it also puts savings in a more liquid asset. At any point over those 20 year period as a renter you have the ability to pick up and leave with only a month’s notice. You can sell the stocks and buy a house if a killer deal presents itself. You can live in a place that meets your current needs and doesn’t have to provide space for future family demands. Selling a house results in about a 5% transaction cost for realtor and legal fees. Transaction costs on stocks is almost negligible in comparison. Buying a house puts a significant portion of your assets into not only a single asset class but a single asset, putting savings into investments allows for easy global diversification.
Canadians have been sold on the dream of home ownership and in my opinion the market has priced in a perceived value which is not based on economic fundamentals. This coupled with historical low interest rates may have primed the entire Canadian market for a correction. (though I believe Vancouver and possibly Toronto may be exceptions due to external buyers).
Its interesting that even after doing these calculations it is still hard to believe that renting is really a better deal over the long term. The belief that buying a house is a good investment is so ingrained that changing those beliefs is going to take a while.