It's our second move in as many years. I'm admittedly tired of moving at this point so I locked in a longer-term lease.
We've got rid of a lot of crap in the process and would say we are well on our way to minimalism. There are very few things left in our possession which we have not actually used or received meaningful benefit from in the past year.
Our first house was a massive; we bought a fixer-upper a few years ago, did a complete renovation, and eventually sold it for next to zero profit – even in a slightly rising house market. That house was a 1970s split entry with 2,000+ sq.ft. finished area. I estimate our wage rate on all the hours of work we put into the renovations was about $10/hr.
A year ago we moved to a still-too-large-for-us duplex which we rented. (Our first experience renting). It was not ideal and didn't help our vehicle costs or other life costs. But it did get me switched on to the ease of renting. I would estimate that house was approximately 1,500 sq.ft. of finished space plus a full unfinished basement.
Just a few weeks ago, with the help of a few friends, we downsized once again into a 2 bedroom, 2 bath row-house. This place is around 1,100 sq.ft. finished area with a double car garage. The size is just about perfect for us, especially considering we live in a city with 6 months of winter. We spend a fair amount of time indoors during those months!
A Financial Evaluation
As shared in a post a long time back, in my former rental duplex I was better off renting than owning by a whopping $400 a month. Twenty-five years down the road, I could reasonably expect to be $250,000 wealthier renting that duplex vs. plunging into ownership.
Once again, I did some calculations before deciding to rent our new townhouse. Ownership is always an option, so it should be considered.
Let's do some Moose Math to figure this one out.
- Purchase Price: $320,000
- Downpayment: $64,000
- Mortgage @ 3%: $1,210/month
- Exterior Maintenance/Condo Fee: $280/month
- Interior Maintenance Est: $100/month
- Insurance: $75/month
- Property Tax: $190/month
Total Ownership Cost: $1,855 during mortgage, or $645 after mortgage is paid off
- Rental Fee: $1,550/month
- Insurance: $25/month
Total Rental Cost: $1,575
Required Savings: $1,575 (rent) - $645 (ongoing ownership costs) = $930 x 12 months x 25x Rule = $279,000 Savings Requirement
Downpayment Future Value: $64,000 (1.06^25) = $274,700
Compound Interest on Monthly Difference: $1,855 - $1,575 = $280 [(1.005^300)-1)/0.005] = $194,000
Total Future Value in 25 Years for Renting: $468,700
Simply put, in this evaluation I could choose between fulling owning a mortgage free $320,000 townhouse in 25 years, or having a $468,700 savings account. (All in today's dollars).
Naturally we chose renting once again. I firmly believe most renters who invest will be better off than homeowners in the coming decade.
I'll also mention that our former home equity has grown substantially in the past year of renting. At this point the investment gains alone will pay for several years of rent fees.
Based on my math, our former home equity has grown to the point where it will easily cover the net rent costs (Rent Fee - Ongoing Ownership Costs) for the rest of our lives using a 4% Rule.
Investing the downpayment and rent cash flow difference is a key factor here. The fact that house prices are absurdly high in many parts of Canada just makes this an easier win for renters.
Of course, some would say that I'm discounting the outsized historical return of housing, forgetting the leveraged return aspect of homeownership, or just that stocks are "riskier" than houses.
Well let's dig into some of these commonly held beliefs.
Housing Historical Return
Housing in Canada has been on a tear since the 1980s. You shouldn't be surprised about this. But don't kid yourself, it's not a coincidence and it's not a "new normal".
In the past decades, interest rates on mortgages have dropped from 20% to just 2.5%. This has made the cost of borrowing for housing cheaper. Yet, as a percentage of our income, we are spending more on our housing now than we did back then.
In the 1980s, the typical Canadian family spent 20% of their gross household income on mortgage payments. Today that number is more than 26% of gross income. Considering nearly 30% of our incomes get sucked up in income taxes, this is huge!
Lower interest costs plus higher spending as a portion of income means a huge boost in the value of the underlying product – your house. This can give the illusion that housing is a good investment. But most economists disagree.
It's more likely that we've hit the "max" of our budgets that can be spent on mortgage costs and we've also hit the realistic low of mortgage rates. I believe house prices are only likely to go down relative to income from this point.
Already there is substantial evidence the Toronto market is collapsing. With a peak early this spring, house prices have fallen as much as 20%! There's a lot of home equity being wiped out there.
Pretty much everyone who bought a house in the GTA in the past year is in a negative return situation after selling costs now. As our country's largest market by far, this can set the trend for the whole country.
Over very long periods of time, it's generally accepted that housing returns are comparable to the inflation rate. This is expected since inflation rates and wage rates go hand-in-hand.
Housing in Canada is a highly leveraged asset. With at least $1.35 Trillion in mortgage debt alone – nearly the size of Canada's entire economic output in one year – it's apparent that houses and debt go hand in hand.
High leverage can make gains seem great, but losses really really hurt. When buying with 5% down your leverage ratio is 19:1. This means you realize a magnified gain or loss compared to the base asset.
To put this into realer numbers, take a $500,000 house and you put down 5% ($25,000). If the price of the house goes up 10%, your return on equity is actually 200%. If the price goes down 10%, your return is -200%. Closing costs not included.
In housing, because of the structure of mortgage pay down, your leverage ratio declines over time. This means that a 10% gain in house prices during the first year after purchasing looks a hell of a lot better than a 10% gain 20 years after purchasing. Likewise, a 10% loss in value is much more damaging in the first years after homeownership.
One way to maintain leverage rates at a reasonable 65%, diversify your assets with some real investments, and be on the right side of the tax equation is to use the Smith Manoeuvre.
It's important to remember that leverage works both ways. It looks really smart when your asset goes up in value, but should be avoided when prices are flat or going down. A lot of investors who appear very successful get wiped out by taking too much risk with leverage.
Risk In Housing
Risk can be measured in many ways. One method is to evaluate loss. In the U.S., during their housing crash of 2006-2012, house prices collapsed nearly 40% nationwide.
In the most overheated housing markets of Florida, California, Nevada, and Arizona, house prices fell as much as 70%. That would be devastating, but it's not out of the realm of possibility. What happened before can happen again. A 70% skid would see Toronto homes under $500,000 in the future.
A passive stock-bond portfolio can see a drop up to 50%. If you invest following the Dual Momentum strategy, your max loss is about 20%. Depending on your indicators and limits use, your max loss with trading rules can be less than that still.
The worst market conditions in history during the Great Depression, and not even globally diversified, saw a 70% drop in U.S. stocks.
In my view, housing is roughly as risky as a properly invested stock portfolio. Don't over-leverage, don't assume its not risky just because it's a roof over your head, and certainly don't believe housing prices never undergo severe corrections.