There are many factors which impact the decision to rent versus buy a home. The math is relatively easy, but the behavioural considerations are anything but.
There are two parts to this post:
1. A video which runs about nine minutes but is imperative to understanding the comparison. I strongly suggest watching it first.
2. A spreadsheet you can download so you can plug in your own numbers.
I’m posting a beta version of this rent vs buy calculator publicly, in the hopes that people can provide feedback for improvement, and for the masochists out there, let me know if any of the formulas or results are wrong. There are a lot of formulas and references in the spreadsheet, and in my experience, one person putting together something like this rarely gets it perfect the first time.
So help me try to break it, in the hopes that we can make it better and/or more accurate.
- This assumes you are a first time home buyer in the City of Toronto
- Therefore it assumes two levels of Land Transfer Tax (Provincial and Municipal)
- It also assumes you are eligible for a rebate
- You can model moving two times during the 25 years and all the transaction costs are automatically calculated (CMHC, Land Transfer Taxes, Realtor Fees, Legal Fees, etc.)
- The Monte Carlo simulations assume a normal distribution for both real estate and stock market returns. If you have suggestions on the variables to use for a non-gaussian distribution, let me know.
- There are cell comments for all the input fields
- I’ll add cell comments for the outputs later (if we think they are necessary)
- Please do not send your downloaded copy of the spreadsheet to others, instead refer them to this page where I will keep an updated copy of the spreadsheet
- Assume it is wrong until I have a few independent sources go over it in more detail (Another reason to not distribute it)
With house prices in Canada having had a spectacular run for a long time, and rents in some locations not increasing nearly as quick, at some point people will wonder if renting can make more financial sense in certain circumstances.
Most people have heard the usual rhetoric: “Renting is just throwing your money away” or “Why would I want to pay my landlord’s mortgage when I can pay my own?”. I am currently a renter and I’m confident that I’m not just throwing money away when you make a more apples to apples comparison, but I also believe that most people would be better off as owners.
To understand this somewhat paradoxical statement, I’ll refer you to a saying I have been known to trumpet from time to time: Managing your personal finances is 90% psychology, and 8% math. (The missing 2% is a testament to how unimportant that math is.)
In other words, if you took two otherwise similar homes where the only difference was one was for sale and one was for rent, then depending on your assumptions about growth rates and the ratio of the sale price to the monthly rent, you could see what would increase net worth faster: 1) Owning, or 2) Renting and taking all the upfront, and monthly cashflow differences and investing it. In one case your net worth would be driven by increasing the equity in your home. In the other, your net worth would be increased by how fast your investment portfolio grows over time.
While understanding that the projections are only as good as the assumptions (sketchy at best), far more important that the math are the psychological factors. For example:
- If renting and investing the difference is currently favourable, will you actually save the cashflow differences? In my experience, this is rarely the case except for the most disciplined of individuals.
- It’s *harder, but not impossible* to make mistakes as a home owner when it comes to getting the return available in the market. In other words, if there was a housing correction, most people wouldn’t panic and sell their homes. They would be more likely to ride out the downturn. The same is not true for people and their stock/bond/mutual fund portfolios. History has shown that investors do not often get the returns available in the market due to constantly making changes to their portfolios. (Edit: As per John Robertson, author of the new and recommended book The Value of Simple: A Practical Guide To Taking The Complexity Out Of Investing, “there’s an added risk on the home ownership side in that you can be forced to sell if you have to move to a different city for work or family reasons, but as a renter you can take your investment portfolio with you.”)
- On the other hand, some homeowners can sabotage themselves by accessing the equity in their homes too liberally. Some people renovate too much, fueled by rising home prices creating equity that can be tapped, oblivious to the fact that housing markets can correct, and sometimes viciously. Others may continually upgrade their homes by renovating or moving into more expensive houses time after time.
- There are less tangible benefits of owning: such as the pride of home ownership, having roots or a stable base for raising a family.
- Younger Canadians without families might also realize a benefit of renting instead: mobility. If you were offered a fantastic job in another province or country, are you more or less likely to take it if you’ve just bought a home? Is this important to you?
There are many other factors to consider, but for now, let me just say this: I don’t care if you own or rent. I have no horse in this race.
If you just want my opinion on what the average person should do, it’s this: Save up a healthy downpayment, make sure you find a place you don’t reasonably expect to move from for AT LEAST 10 years, buy a house that’s about 2/3 of the size of the mortgage you’re pre-approved for so you can be an owner and have money left over to invest in the stock/bond markets as well. Don’t over-think it.