When your home isn't an investment property...

Renters - from Garth Turner's Blog www.greaterfool.ca

July 3rd, 2011

Once upon a time when I was still employable I landed a gig in a city half the country away. Looking at houses, we came across a 6,000 square foot, century-old mansion which had been artfully renovated and was offered at $800,000. “Too much,” I said, “but we’ll rent it.”

Turns out the owner was the local newspaper publisher (big man in town) who’d had the place listed for 14 months, and was desperate for cash flow after having been transferred to Toronto (where he lost his job two years later when the chain was sold). So we did. $1,500 a month. Used the extra cash to put a new Bimmer in the garage. Nobbed with millionaire neighbours. Lived like Kate & Wills.

Two years later, new gig. Back to Toronto. Packed and left. The house went back on the market and sold exactly one year later for $475,000. The publisher, now between careers, was crushed.

Today about 11 million families in the States wish they were renters. Currently 27% of all residential property owners there are in negative equity, which means they’re servicing mortgages greater in value than their properties are worth. Typically, this is because house prices have fallen dramatically in their neighbourhoods, not because they borrowed excessively. In other words, victims.

But while paying a mortgage bigger than your house sucks, it’s the loss of mobility which can be the real killer. Most negative equity families can’t afford to sell, since it means giving up the house, walking away with nothing and also writing a fat cheque just to get out. So in a lousy economy, with too much unemployment, an illiquid property can be a financial death sentence if you can’t move to grab a job.

Renting equals mobility. And in this world, anyone who thinks they’re going to nest and stay there for two decades is not paying attention.

But this is just one of the obvious advantages of not swallowing the home ownership Kool-Aid. For many people the greatest benefit is financial. The reason’s simple – as my example above shows – tenants get dumb investors to subsidize them.

This flies in the face of what your mother-in-law tells you, of course. The why-throw-your-money-away-on-rent mantra is repeated endlessly, even when it’s the worst piece of advice possible. If the goal is to become financially independent and build net worth, renting can beat the pants off owning.

A few months ago I used an example from Calgary, where a blog dog was bemoaning the get-a-house-and-be-a-man crap his inlaws were burying him in. Take the average house in Calgary, for example, I said – $454,000. To buy with 5% down requires almost $43,000 with closing costs and mortgage insurance. The monthly at 4% is about $2,100, and with insurance and property tax closer to $2,500. After three years you’d spend $52,000 on mortgage interest, and retire only $23,000 of debt while making $75,156 in monthly payments.

So, the three-year cost of owning the house would be $133,000, and you’d still owe $408,000. To just break even, you’d need to sell for $568,000, factoring in the cost of selling. So to simply avoid loss, Calgary real estate would have to swell in value by 25% over three years.

But Calgary houses have lost about 13% of their value in an equal period. And during that time we’ve had the lowest interest rates since ever (soon rising), the greatest housing bubble in history (now ending), and state-backed mortgages.

So, you can buy with the faint hope of maybe selling and breaking even, with a monthly cost of $2,500, or rent the same house for $1,600. (“Luxury Estate features throughout home, over 2100 square feet with designer finishes, 2 storey 3 bedrooms with, 3 bathrooms, formal dining room & living on main floor, bonus/family room on 2nd floor, double garage, granite countertops, upgraded ceramic/hardwood flooring, designer colors/finishes, maple cabinets, upgraded appliances, master bedroom ensuite with walk-in closet, soaker tub, fireplace, professional landscaped, etc. — $1,595.” Craigslist Calgary).

Over three years a renter would be more than $30,000 ahead, plus still have deposit money of $43,000. If the forty grand had been invested at 8%, it would be $54,000 in 36 months, so you’d have $84,000 in liquid assets.

Most importantly, a renter would have lived in an identical (maybe better) house while building net worth and taking no risk on a seriously wobbly housing market. Zero debt. Total liquidity. Unfettered mobility. Net worth would be greater, not less. Options enhanced.

Now renting is even getting cool. In the last few days the house-humping Toronto Star carried a column headlined ‘Why I sold my house and rent instead’. Words from the 27-year-old author:

Buying a home is the biggest investment most people will make and it can be a life-altering event. It is also an emotional event and when buyers get emotionally attached to a house or condo, here’s what can happen:

• You overpay and stretch yourself beyond your means.
• You end up with an overlay of stress because you didn’t think it through.
• The location may not be what you expected.
• Your lifestyle undergoes a big change.
• You end up regretting the decision.

And not to be outdone, the Globe and Mail published a piece, ‘Why renting can be the right choice for aging boomers.’ The logic is simple: cash out of housing at the top, invest for income, use the income to rent, and live for free – sans mortgage, property tax, maintenance.

When the inevitable comes, renting will connote financial acumen.

But your mother-in-law still won’t get it.