馃攳
Renting vs Buying a Home: How to Decide - YouTube
Channel: Ben Felix
[0]
- The rent versus buy decision for housing
[2]
can have a significant financial impact,
[4]
but it can also play an important role
[6]
in where we live and
how we spend our time.
[9]
Making the housing decision
requires careful consideration
[12]
of both the financial and
non-financial impacts,
[15]
and the way that they
interact with each other.
[17]
There is no universally right
way to approach housing.
[21]
In many cases, contrary
to conventional wisdom
[23]
and societal pressure,
[25]
renting is a better option than owning,
[27]
both financially and from the
perspective of well-being.
[31]
I'm Ben Felix, Portfolio
Manager at PWL Capital.
[34]
In this episode of Common Sense Investing,
[36]
I'm going to tell you how to decide
[37]
between renting and owning a home.
[40]
(bouncy rock music)
[43]
Renting a place to live is
not throwing money away.
[46]
Financial outcomes for renters
and owners can be comparable.
[50]
I'll explain why that's
true later in this video,
[52]
but I wanna start with the
non-financial considerations
[54]
of the rent versus buy decision.
[56]
Finances aside, if buying
a home will make you happy,
[60]
there are a few good argument against it.
[62]
This raises the question:
[64]
are homeowners happier than renters?
[66]
People are really bad at forecasting
[68]
what will make them happy in the future,
[70]
particularly when it
comes to major purchases.
[73]
The 2010 paper, Extrinsic
Value Orientation
[76]
and Effective Forecasting.
[77]
Overestimating the Rewards,
[78]
Underestimating the Costs,
[80]
explains that people who believe
materialistic achievements,
[83]
like owning a home, will make them happy
[86]
can be classified as having
extrinsically motivated goals.
[89]
Other examples of extrinsic goals
[91]
are money, fame, image and status.
[94]
Compared to people with intrinsic goals,
[96]
like personal growth,
intimacy and community,
[99]
extrinsically motivated people
are less happy in general
[102]
and they overestimate
the emotional benefits
[104]
of achieving their extrinsic goals.
[107]
True to this finding, a 2020
study using German data,
[110]
finds that people
overestimate the long-run
[113]
life satisfaction gains derived
[115]
from moving from a rented home
[116]
to a privately owned property
[118]
and that this overestimation
is more pronounced
[121]
for people with extrinsically
motivated life goals.
[124]
The 2011 paper, The American Dream
[126]
or the American Delusion
[128]
uses a data set with housing consumption,
[130]
well-being measures and time use patterns
[133]
to find that after controlling for income,
[135]
housing quality, and health,
[137]
the homeowners in the sample
are not better off than renters
[139]
by multiple measures of well-being.
[141]
Instead, they derive significantly
[143]
more pain from their home,
[144]
potentially due to the
time used differences
[146]
between renters and owners in the sample.
[149]
Homeowners tended to spend less time
[150]
on enjoyable activities,
like active leisure.
[153]
The 2019 study, Home
Ownership and Happiness:
[156]
Evidence for Switzerland,
[158]
finds that Swiss homeowners are no happier
[160]
or are even less happy than renters
[162]
when other variables like
wealth, income, employment,
[164]
health and housing quality
are controlled for.
[167]
A 2011 study using a German sample
[170]
finds a marginal but positive relationship
[171]
between home ownership
and life satisfaction,
[174]
while a 2017 study using
a United States sample
[177]
finds slightly elevated
reflective life satisfaction
[180]
for owners but finds
that owners experience
[182]
less intense feelings of
happiness than renters,
[185]
and that homeowners spend much more time
[187]
working on their home than renters do.
[189]
One of the driving issues here
[191]
is that people tend to hedonically adapt
[193]
to their circumstances,
[195]
meaning that a change in circumstances
[196]
does not have a lasting impact
on how we feel day to day.
[200]
You can see the problem here.
[201]
We overestimate how
much happier we will be
[204]
by purchasing a home,
but once we live there,
[206]
the home becomes a condition of life
[208]
rather than an aspiration
[209]
and its impact on our daily
well-being is neutralized.
[213]
In the 2010 paper,
[214]
If Money Doesn't Make You Happy,
[215]
Then You Probably Aren't
Spending It Right,
[217]
the authors explained
that experienced happiness
[220]
is shaped more by how we spend our time
[222]
than by stable life circumstances,
[224]
like how we pay for housing.
[226]
After making a major material
purchase, like a home,
[229]
many people will suffer
from buyer's remorse.
[232]
The 2010 paper, The Relative Relativity
[234]
of Material and Experiential Purchases,
[236]
finds in their sample that
people are often less satisfied
[240]
by their material purchases
than their experiential ones
[243]
because they're more likely to ruminate
[244]
about unchosen options
with material purchases
[247]
and their satisfaction with
their material possessions
[249]
is undermined by comparison
to other available options,
[253]
to the same option at a different price,
[255]
and to the purchases of other individuals.
[257]
homes are positional goods,
[259]
meaning that their appeal comes from,
[260]
not only their intrinsic
property as a place to live,
[263]
but also from how it compares
to the homes of peers.
[267]
Humans innately compare themselves
[269]
to the people around them,
[270]
and empirically we know that comparison
[272]
matters a lot to happiness.
[274]
A 2019 study titled The McMansion Effect:
[277]
Top House Size and Positional
Externalities in U.S. Suburbs,
[281]
finds that new constructions
[282]
at the top of the house size distribution
[284]
lower the satisfaction
that neighbors derive
[287]
from their own house size.
[288]
These effects are stronger among people
[290]
living in larger houses and
they decrease with distance
[293]
from the larger new constructions.
[295]
Homeowners exposed to the
construction of larger houses
[298]
in their suburb put a
lower price on their home,
[300]
are more likely to
upscale to a larger home,
[303]
and they take on more debt.
[304]
One of the best ways to deal
[306]
with our poor affective forecasts,
[308]
hedonic adaptation, buyer's
remorse and social comparison
[312]
is to make more frequent
experiential purchases
[315]
rather than few big material ones.
[317]
Taking a friend out for dinner,
[319]
signing up for a class
in an area of interest,
[321]
spending on an engaging hobby,
[323]
or buying things for other people
[325]
are all approaches to spending money
[326]
that bring persistent happiness
that we do not adapt to.
[330]
Buying a home is the antithesis
of small frequent purchases.
[333]
The term house poor comes to mind.
[336]
A circumstance that we do
not tend to adapt to is debt,
[339]
which is, for most people,
[340]
a big part of purchasing a home.
[342]
In their book, "Happy Money:
[343]
The Science of Happier Spending,"
[345]
Elizabeth Dunn and Michael Norton
[347]
explained that although the relationship
[348]
between income and
happiness is fairly weak,
[351]
there is a stronger
relationship between happiness
[353]
and difficulty paying the bills.
[355]
In other words, Dunn and Norton say,
[357]
"What we owe is a bigger predictor
[359]
"of our happiness than what we make."
[361]
Households with more debt
exhibit less happiness,
[364]
and couples with more debt
have more marital conflict.
[367]
Another circumstance
that we don't adapt to
[369]
is commuting in traffic.
[371]
Even after years of commuting,
[372]
people who commute in
traffic arrive at work
[374]
with higher levels of stress hormones.
[377]
This matters for people who
move further away from work
[379]
to get a bigger house.
[381]
They quickly adapt to having more space,
[383]
but they do not fully
adapt to the commute.
[386]
All right, all this happiness talk is moot
[388]
if renting is a terrible
financial decision.
[391]
But renting is not a
terrible financial decision.
[394]
The cost of renting is
very straightforward.
[395]
It is the rent that you pay,
[397]
plus the cost of renter's insurance,
[399]
which is typically much less expensive
[400]
than homeowner's
insurance, plus utilities.
[403]
The cost of owning a home
is less straightforward
[405]
and leads to many people
incorrectly believing
[408]
that owning is a better
financial decision than renting.
[411]
The costs of an owner are
property taxes, maintenance costs,
[414]
insurance costs, and the opportunity costs
[417]
of the equity in the home.
[419]
Property taxes can vary a lot
depending on where you live.
[422]
For the sake of this discussion,
[423]
I will use 1% of the value
of the home annually.
[426]
Property taxes, like rent, are
paid in exchange for services
[429]
with no residual value.
[431]
Homes are depreciating assets.
[433]
Depreciation takes two forms.
[435]
Physical depreciation,
[436]
the normal wear and
tear resulting from use,
[438]
and functional depreciation,
or obsolescence,
[441]
as newer construction methods,
standards and materials
[444]
make older homes less desirable.
[446]
There is no escaping
these costs as an owner.
[449]
You either pay for the cost
of maintenance with cash
[451]
as you consume the home over time,
[453]
or you pay for the depreciation
[454]
through a lower sale price in the future.
[456]
Either way, the cost is in there.
[459]
In "The Rate of Return on
Everything, 1870 to 2015,"
[463]
the authors find the maintenance costs
[464]
between 1 and 2% historically.
[467]
Their estimate includes depreciation
[468]
and all other housing-related expenses,
[470]
excluding interest, taxes and utilities.
[473]
Statistics Canada uses 1.5%
of the value of the home
[476]
as a depreciation expense
in the CPI basket.
[479]
This figure is in line with
multiple academic studies
[481]
and the statistical
agencies of other countries.
[484]
1.5% is for the building only,
[486]
so it has to be multiplied by the ratio
[488]
of the building value over the land value
[490]
to arrive at the depreciation
cost for the home.
[493]
Based on this, a 1% maintenance cost
[495]
is probably a reasonable assumption.
[497]
Home maintenance cost can sneak up on you
[499]
and they don't typically
get included in the numbers
[500]
when people tell you how well they did
[502]
on their home's appreciation.
[504]
Those weekly trips to Home Depot add up.
[506]
The opportunity cost of equity
[508]
measures the cost of having
money invested in a home
[510]
instead of in something else.
[512]
Something else could be a
lot of different things.
[514]
I'll assume to start
that the opportunity cost
[516]
is relative to owning a low-cost portfolio
[518]
of total stock market index funds
[520]
in a tax-free investment account.
[522]
In his book, "Irrational Exuberance,"
[524]
Robert Shiller shows,
[525]
based on global data
dating as far back as 1628,
[528]
that real home price appreciation
[530]
has been between 0.2% and 0.4% per year.
[534]
In "The Rate of Return on
Everything, 1870 to 2015,"
[537]
the authors estimate the real annual
[539]
historical increase of home
prices in 16 countries,
[542]
from 1870 to 2015, at 1.1%.
[546]
Eh, I think we can
easily round those to 1%.
[549]
In many cities in Canada,
[550]
recent history has shown much
greater price appreciation,
[554]
but that doesn't tell us
much about the future.
[556]
In fact, if it tells us anything
[557]
it's that we can expect lower
price returns in the future
[560]
as the current ratio of prices-to-rents
[562]
is a historical anomaly.
[564]
High prices relative to rents
[566]
have historically been resolved
[567]
by falling house prices,
not by rising rents.
[571]
In our recent Financial
Planning Assumptions Update,
[573]
the PWL research team estimates
[575]
the expected real annual return
[577]
on a 100% stock portfolio to be 4.28%.
[581]
To account for fund ownership costs,
[583]
like fees and withholding taxes,
[585]
we can run this figure down to 4%.
[587]
A 4% expected real return on stocks
[590]
and 1% for real estate amounts
to a 3% opportunity cost
[594]
for having equity in real
state instead of in stocks.
[597]
Taken together, property
taxes, maintenance costs
[600]
and the opportunity cost of equity
[601]
tell us the total user
cost of owning a home.
[605]
Based on 1% each for property
taxes and maintenance cost,
[607]
plus 3% for the opportunity cost,
[610]
we have an imputed rent
of 5% of the home value.
[613]
This is what it is costing an
owner to live in their home.
[617]
Another way to think about
this is that you're paying rent
[619]
whether you own a home or not.
[621]
The 5% figure tells us what level of rent
[623]
relative to price equates the
cost of renting and owning.
[627]
Mortgages make the economics
of owning look better
[629]
by reducing the initial
opportunity cost of equity.
[632]
But due to the large cash
flow commitment of a mortgage,
[635]
in addition to property
tax and maintenance,
[637]
the 5% user cost figure
equating the cost of renting
[640]
and owning still works out.
[642]
From here, we can have all sorts of fun.
[644]
If you're looking at a $1 million home,
[646]
your user cost is estimated
at $4,166 per month.
[651]
If you could rent for the same or less,
[653]
renting is financially equivalent.
[655]
A more aggressive investor, for example,
[657]
someone tilting their portfolio
[658]
towards small cap and value stocks,
[660]
would have a higher
opportunity cost of equity,
[663]
and therefore, a higher
rent equivalent threshold,
[666]
while a more conservative
investor would be lower.
[668]
So far I have ignored
taxes on investments,
[670]
assuming that the renter
is using their RSP
[672]
and TFSA to invest.
[674]
Real estate price growth
is not taxed in Canada
[677]
on the primary residents.
[678]
A renter investing in a taxable account
[680]
would have a lower after
tax opportunity cost,
[683]
and therefore, a lower user
cost equivalent rent level.
[686]
There are some other
economic considerations.
[689]
Buying a home with a mortgage
means forced savings.
[692]
People are much more likely
to skip an RRSP contribution
[695]
than a mortgage payment.
[696]
This requires discipline
on the side of the renter
[698]
to make the numbers work.
[700]
Additionally, an owned home
is a hedge for housing costs.
[703]
Even in crazy markets like we're in today,
[706]
owners total costs are likely
to be more stable than rents,
[709]
which landlords may want to increase.
[712]
While hedging housing
costs is a good argument
[714]
for a long-term homeowner,
[716]
house prices in the short
run can be volatile.
[718]
A volatile price is not such
a big deal for a forever home,
[721]
but price volatility can
become a substantial risk
[724]
If you need to move.
[725]
Renters have much more
freedom of mobility.
[728]
They can easily move if
there are unexpected issues
[730]
with their home, their neighborhood
[732]
or their employment situation
without needing to worry about
[735]
short-term price fluctuations.
[737]
Sure, owners can't be rent-evicted
[739]
by a greedy landlord in a rising market,
[741]
but they're taking on
a lot more price risk
[743]
in the event that they need
to move in a falling market.
[746]
Owners are more often forced
to commute than renters are.
[749]
The literature relating
happiness to home ownership
[751]
makes it clear that homeowners
[752]
are not happier than renters
just because they own a home,
[755]
even if they expected to be
when they decided to buy.
[759]
Other aspects of life,
like being in nature,
[761]
being good at something,
[762]
being connected to
things outside yourself,
[764]
feeling in control and
having strong relationships
[767]
are much better predictors of
happiness than owning a home.
[771]
Guiding the housing decision
based on these inputs
[773]
is a lot more sensible
than rushing to own a home
[775]
on the pretense that
it will make you happy.
[777]
From a financial perspective,
[779]
renters can expect to match
the wealth of homeowners
[782]
as long as they understand
the user cost of owning
[785]
and keep their housing
costs within that range.
[788]
Owning can result in the kind of windfalls
[790]
that we've seen in Canada
over the last decade,
[792]
but it can go the other way too.
[794]
Buying a home today on the expectation
[796]
of unrealistically high housing
appreciation in the future
[799]
is more likely to do harm than good.
[801]
In the interest of full
disclosure (chuckles),
[803]
I recently bought a house after renting
[805]
for all of my adult life.
[806]
I bought a forever home in a secluded area
[808]
within walking distance to
a small town with amenities,
[811]
hiking trails, and a body of water.
[813]
I have a garage big enough
to work on my hobbies
[815]
and I'm still within a
45-minute drive to my parents.
[817]
And since I'm able to work from home,
[819]
I don't have a commute.
[820]
There were no rentals
available in this area,
[823]
which swung my decision
in favor of buying.
[825]
When I lived in the city,
[826]
where I knew I didn't wanna stay forever,
[828]
there were more rental options available
[830]
within walking distance to my office,
[832]
which at that time, I had
to commute to every day.
[835]
It was an easy decision to
rent when I lived in the city.
[837]
In both cases, I made the decision
[839]
based on what worked for my lifestyle,
[841]
not some extrinsic or financial motivation
[843]
to be a property owner.
[845]
Thanks for watching.
[846]
I'm Ben Felix, Portfolio
Manager at PWL Capital
[848]
and this is Common Sense Investing.
[850]
If you enjoy this video,
[851]
please share it with someone who you think
[853]
could benefit from the
information. and let's be serious.
[856]
A lot of people could benefit
[857]
from this information right now.
[859]
If you want to hear more like this,
[860]
we discussed similar topics
in episodes 154 and 170
[865]
on the Rational Reminder podcast,
[866]
which is available on YouTube
and on podcast platforms.
[870]
(upbeat electronic music)
Most Recent Videos:
You can go back to the homepage right here: Homepage