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In my last commentary I mentioned the theory held by many that owning a home is a failsafe way to build wealth.  This theory is based upon two assumptions – housing prices always go up and in the long-term prices go up at a rate in excess of the cost of a mortgage.  Clearly, these two assumptions do not always hold true in all time periods.  While some folks that bought in the 1960s and sold in the 2020s have ‘won’, there are sadly those that for any number of reasons around location, timing, and interest rates have little to no equity gain for the money they spent ‘investing’ in a home.

Given that my three kids are starting to think seriously about moving out of our home and finding their own place to live I have been thinking more and more about whether they should be renting or buying a home.  The Canadian Institute of Actuaries recently published a paper that I authored titled Rent vs Buy – A Personal Risk Management Framework.  You can find my paper here along with five other papers on the theme of Managing Risks in Uncertain Times.

In a nutshell, my thesis has three components.  Shelter, Investment, and Risk Management.

Gimme Shelter

The media inundates us endlessly with news on housing prices and affordability and all the reasons why everyone should want to buy a home, but at the same time reminding us that many cannot afford one.  What is rarely discussed is the fact that we all need a place to live and short of staying in your parent’s basement rent free forever, sooner or later you have a hard decision to make.  Whether you rent or you buy, you must pay for a place to call home.

Investment

Some think a home is an asset while others will say owning a home is a liability.  In truth it is both.  Surely the fact that a home can be sold for cash means it is an asset.  But a mortgage is a liability and so are maintenance costs and property taxes.  Wading through the complex asset and liability structure of home ownership is not something most people want to do, so most simply follow the advice of others whether it is to buy a home or to rent and ‘save the difference’ (between rent and mortgage costs).

Realtors will point to the winners that made lots of money through home ownership, and investment advisors will show you wonderful illustrations on how the stock market over the last 50 years has had a greater compound rate of return compared to homes.  Landlords will tell you about the uncertainty of maintenance, taxes, and utilities to remind you that a fixed monthly rent makes these uncertainties someone else’s problem.  Everyone with something to sell can give you a reason why you should buy from them.

Unfortunately, comparing ‘investments’ comes with many assumptions and tilting the assumptions in one direction or another drives a conclusion when in fact ‘there is no right answer’.  My paper offers an alternate formula for comparing buying vs renting by focusing on the cost of the mortgage, maintenance, and taxes when buying compared to the cost of renting.  The math is easy, so you know it isn’t precise, just a directional guideline to think about the problem.  For those that don’t have time to look at the paper, the gist is to compare interest, maintenance, and taxes when buying vs renting.  It is a little different than using the mortgage cost since mortgage payments include an investment portion through the payment of principle.

Risk Management

The real focus of my paper is to look at the Rent vs Buy problem as a risk management opportunity instead of trying to optimize investment outcomes.

Most homebuyers mortgage their home which means that they are at risk of jumps in monthly mortgage payments as interest rates change.  Buyers can lock in payments for a period of years, generally up to five, but long gone are the days of twenty-five-year fixed mortgages.  In the most recent eighteen months, interest rates have risen rapidly and buyers with variable mortgages or short-term rate guarantees have been hit hard.  It is unfortunate that central banks lulled everyone into thinking that interest rates would stay low forever.

But while mortgage costs are rising for owners, renters do not get off easy.  Rents are rising with at least the rate of inflation and where rent controls limit rent increases, landlords are incented to sell homes with new owners evicting tenants to move in themselves.

In the end, choose your risk.  Do you want to manage the uncertainty of changing mortgage payments or would you be more comfortable managing changes in rent and the periodic need to move?  Is the comfort of owning your own home more valuable to you than the freedom to relocate as your circumstance change?

Post-script

Many observers think that housing prices here in Canada cannot keep rising and in fact many think at some point prices will have to come down since affordability is at an all-time low.  I have not reached that conclusion.  I think housing prices will continue to rise for the simple fact that demand exceeds supply and the cost to build new houses has risen as well.  Inexpensive homes seem in short supply and worse, kids starting out today want to have a home as nice as the home their parents have so the demand for inexpensive homes is low at the same time.

That said, the point of the paper is to not bet on housing prices one way or the other but rather think about what you can afford to pay for a place to live.  Starting with monthly rent/mortgage comparisons will tell you how nice of a place you can ‘afford’ and being attentive to the risks of changing prices gives you an opportunity to build some margins in your budget if you want to think like an actuary.