Personal Finance

The DEFINITIVE RE vs Stocks discussion! (Including calculations)

  • Last Updated:
  • May 5th, 2015 1:35 pm
[OP]
Member
Jan 6, 2008
295 posts
48 upvotes

The DEFINITIVE RE vs Stocks discussion! (Including calculations)

Because I hate arguing in general terms based purely on opinions, I built a spreadsheet to illustrate the whole rent vs buy scenario.

Assumptions: (rent and condo price/costs/fees based on an actual scenario I know of)
Mortgage interest rate 3.0%
Amortization Period 25 300
Long term stock returns 11.5% http://pages.stern.nyu.edu/~adamodar/Ne ... retSP.html
(after tax) stock returns 9.78%
Long term RE returns 5.4% http://www.td.com/document/PDF/economic ... Prices.pdf
House Price $310,000
Rent Price $1,400
Rent to Price ratio 0.452%
Income Tax Rate 30%


To me, the thing that really hit home was how the leverage of purchasing a home really magnifies risk/reward. Using my assumptions, a home owner can pull ahead of a renter (all else being equal) even with a 5% down in less than a year! Conversely, the risk magnification is really non-trivial. Let's assume the following happens immediately after Month 0 - For the renter, if the stock market goes down by 10%, the paper loss is 10% of the initial investment, i.e. the renter still has 90% of the initial investment. For the home buyer, if the RE market goes down by 10% the paper loss is 10% of the value of the home, i.e. if the owner had put 5% down, they have not only "lost" all their initial investment, but also on the hook for another 100% of their initial investment - i.e. they are at -100%, vs 90% of the renter.

Reverse is also true!

Anyway, on to the calculations:

Image
Image

Also interesting is partly because you are saving on CMHC, and mortgage at that point is much closer to the rent price, at 20% downpayment the owner is ahead of the renter in as little as 3 months!

I know this is going to get taken out of context, misquoted, blah blah blah, but thought it's useful information with interesting insights to be gained. PM me if you want the spreadsheet - or if you have any ideas how best to share this online - I'm a little paranoid about distributing an XLS file openly - yes, I am paranoid.

Here's the link to the actual model - for people who TLDR...

https://docs.google.com/spreadsheets/d/ ... sp=sharing
74 replies
Sr. Member
Feb 5, 2013
592 posts
109 upvotes
Nice start. You should increase rent/tax/maintenance by inflation each year.

Tax is mostly deferred on stock investments so you should use the full rate, but have Net Worth (after tax) reduced by say 20% to account for capital gains taxes.

Of course, the devil is in the assumptions. Raise the mortgage rate to a more historic 5% and things look worse.

But, the RE sale will always go to the buyer with the most rosy assumptions...
Deal Fanatic
User avatar
Apr 20, 2011
5310 posts
484 upvotes
Vancouver
You forgot to mention that there is no limit on the amount of tax free gains from selling a primary residence in Canada while there is a limit of around $50,000 per year tax free from stocks
Deal Addict
User avatar
Jun 28, 2007
3866 posts
1026 upvotes
Good job OP and +1 to all the above comments.

One comment I'll add is less of a financial one and more psychological: As a renter, you will have to be extremely disciplined on two accounts:

a) First, not to cash in early on stock gains, or as it were, "bail out" early when the market inevitably goes down. Instant stock market liquidity means that more often than not, this realization of early gains/losses is a possibility. On the other hand, the paper gains (or losses) for the homeowner are typically not realized till after they sell (which is usually after 5 years but could be longer)

b) Second, as a renter you need to keep on investing the amt saved from owning but there WILL be times when this difference will be compromised because of various circumstances. In reality, I think most people realize that the temptation is too great not to dip into this source of disposable income. For homeowners, on the other hand, the principal payments used to build equity are a "forced savings"
[OP]
Member
Jan 6, 2008
295 posts
48 upvotes
Good point on inflation - I had initially used the inflation adjusted long term return rates, but found some better non-inflation adjusted averages.
Tax free gains are taken into account - by virtue of applying cap gains tax to the stock market returns.
Of course, the model can't take into account "life happens" scenario - home owner might have to move for work and lose money due to having to sell the house too early and various transaction costs etc blah blah. That's not the point. The point is to compare, all else being equal, how the two would compare. Special cases can be taken into account by building additional scenarios, which I'm not going to do ;) .
Sr. Member
Dec 3, 2002
502 posts
36 upvotes
BC
Maybe considering listing the specific assumption on utilities.
Some rental places are all-inclusive (water, gas, electricity).
So your scenario is assuming the utilities the renter pays for will be equal to that of owning. Unless you are trying to cover for that under the strata amount.
I know that some condo stratas are only for maintenance and reserve fund, while others include heating.
Deal Expert
Mar 25, 2005
22223 posts
3058 upvotes
popbottle wrote: You forgot to mention that there is no limit on the amount of tax free gains from selling a primary residence in Canada while there is a limit of around $50,000 per year tax free from stocks
It's a capital gain...
Deal Fanatic
Dec 6, 2006
5520 posts
1738 upvotes
Toronto
Another source of argument:

House Price $310,000
Rent Price $1,400

Is a $1400 rental place really equivalent to an owned place of $310k in terms of living condition? May be, may be not.... depending on cities & locations.
Deal Addict
Aug 12, 2004
4505 posts
2165 upvotes
Calgary
boyohboy wrote: Another source of argument:

House Price $310,000
Rent Price $1,400

Is a $1400 rental place really equivalent to an owned place of $310k in terms of living condition? May be, may be not.... depending on cities & locations.
In Calgary, rent at that price would actually be on the lower end, to the equivalent 310K place.
Deal Addict
Jan 24, 2015
1021 posts
309 upvotes
Canadian in USA
Kasakato wrote: It's a capital gain...
Yes it is, and it is also exempt from capital gains tax.

One thing NOT included in this analysis is the premium for being in control of your own environment.

I originally bought my place in Toronto because I got tired of bugging my landlord to upgrade appliances and sand the wood floors in the unit. So I bought my own place and spent my own money on appliances and any renovations were up to me -- so long as I had the cash, I could do whatever I damned well pleased with my place, at least within the limits of what the condo board allows. Only issue that ever caused is I couldn't get the blinds I really wanted, but all else I could do.

Now I have rented that place out to someone else, and moved to Seattle, where I am myself renting again. I have a pretty nice apartment here, but I have some complaints about it. I would like to replace the washer/dryer and put in more modern toilets. But it's a rental unit, so... I can't. I have to live with what the landlord has provided, whether or not I like it. Sure, I could try negotiating with them, but they are a big corporate landlord, not going to help me out.

Don't have a down payment to buy a second primary residence right now but I do the math on a regular basis trying to figure out how to get back into my own place again. Not because I think it is necessarily the best financial choice, but because I would like to have whatever damn toilet I want in my own bathroom.
Deal Addict
Jul 24, 2011
1099 posts
236 upvotes
So.... Looks like Buying was the right call for me :) . Great work OP!
Deal Fanatic
Dec 6, 2006
5520 posts
1738 upvotes
Toronto
Firebot wrote: In Calgary, rent at that price would actually be on the lower end, to the equivalent 310K place.
rj2wells wrote:
One thing NOT included in this analysis is the premium for being in control of your own environment. ... but I have some complaints about it. I would like to replace the washer/dryer and put in more modern toilets. But it's a rental unit, so... I can't. I have to live with what the landlord has provided, whether or not I like it. Sure, I could try negotiating with them, but they are a big corporate landlord, not going to help me out...
What rj2wells said... that's part of the "living conidtions" I was referring to.

When you're renting, you're really at the mercy of the landlord or managment company. Especially with large management company, you'll get the cheapest and crappiest workmanship for all and any repair jobs in your rental unit. I rented the last place for ~ 2 years.... the buillding itself changed managment and they did reno on the building (and increase new contract rental price by a HUGE amount). The reno is low quality and drags on FOREVER. It has been 18 months and still the elevators handrails are broken (replaced, broke, replace, broke again). On my bath tub the corner tiles were broken. Took weeks to replace. Not even 2 months all the new caulking has black mold, and you could tell the backing were all soaked and damaged. Whatever cheapest useless caulking they used, I have no idea. Then I filed repair reports again for MONTHS and they didn't even bother to come look at it, let alone fixing it again. Balcony door was broken and took 1/2 year to replace.

Maintainence for your own place is not cheap if you're not DIY-smart... but at least if you really WANT and NEED to get it done, you have control.

How much does this worth when consider rent vs own? It's all personal.
[OP]
Member
Jan 6, 2008
295 posts
48 upvotes
Yes, rental is very dependent on location etc. As to the question whether the living condition was the same - I used numbers from a building I was familiar with both the sale and rental price of the same condo unit. These were in 2008 or so, mind you, but as valid a starting point as any.

What's also interesting is if I do a pseudo sensitivity analysis - for the 5% downpayment scenario, base case 3% mortgage rate
- Even at 7% mortgage interest rates (assuming the owner can keep up with mortgage payments), the owner still pulls ahead at 43 months!
- Accounting for inflation - the owner now pulls ahead at the 3% mortgage rate case in 14 months
(everything from this point on accounts for inflation)
- If rent goes to $1800, owner pulls ahead at 10 months.
- If strata fees goes to $400, owner pulls ahead at 13 months.

In terms of the added benefits of home ownership from a psychological perspective - I totally agree. Yes, it sucks to have to spend money to fix your place sometimes, but I also really enjoy the projects that I take on around the house.
Deal Fanatic
User avatar
Apr 20, 2011
5310 posts
484 upvotes
Vancouver
g.henderson wrote: Can you try this scenario?

Rent: 1500/month

vs

Buy: 400K
Prop Tax: 2.5K/year
Condo Fees: 3.8K/year
Holy mother of jesus. $2500 per year in taxes on a $400,000 property? In Vancouver that would only be about $1200 on almost any $400,000 property.
Member
Sep 29, 2007
487 posts
183 upvotes
Toronto
popbottle wrote: Holy mother of jesus. $2500 per year in taxes on a $400,000 property? In Vancouver that would only be about $1200 on almost any $400,000 property.
I don't disagree with you. But in Toronto, that number is very normal. Hence, I have to use it for my calculations.
[OP]
Member
Jan 6, 2008
295 posts
48 upvotes
g.henderson wrote: Can you try this scenario?

Rent: 1500/month

vs

Buy: 400K
Prop Tax: 2.5K/year
Condo Fees: 3.8K/year


Using general assumptions, renting comes out ahead at least below:
http://www.nytimes.com/interactive/2014 ... 0002&abg=1
Sure, suing your numbers above,
At 5% down, the owner comes out ahead at 25 months.

Neat link! They consider some additional costs I've left out of mine for simplicity's sake. Good thing though, is if I standardize their model so it's comparable to mine, and lower the rent to their rent "inflection" point, the owner stops coming out ahead :) . It's a simple model, but now it's a simple validated model.
[OP]
Member
Jan 6, 2008
295 posts
48 upvotes
popbottle wrote: Holy mother of jesus. $2500 per year in taxes on a $400,000 property? In Vancouver that would only be about $1200 on almost any $400,000 property.
yeah, we are "spoiled" in Vancouver (we pay in other ways, but that's another story). In Edmonton and some surrounding areas, Property tax is at about 1 to 1.2% of property value (snow removal etc). In Dallas TX, it's at about 3% (no income tax).
Member
Sep 29, 2007
487 posts
183 upvotes
Toronto
kivyee wrote: Sure, suing your numbers above,
At 5% down, the owner comes out ahead at 25 months.

Neat link! They consider some additional costs I've left out of mine for simplicity's sake. Good thing though, is if I standardize their model so it's comparable to mine, and lower the rent to their rent "inflection" point, the owner stops coming out ahead :) . It's a simple model, but now it's a simple validated model.

Also you don't include buying and selling costs. This could be substantial if you plan to move every 5 years or so.
[OP]
Member
Jan 6, 2008
295 posts
48 upvotes
I do include buying costs - not selling costs...Selling costs will not be a huge difference. In your example, if I increase the buying costs by 2% (which amplifies the effect vs end of term), the home owner still pulls ahead, at 37 months now instead of 25 months.

Top

Thread Information

There is currently 1 user viewing this thread. (0 members and 1 guest)