Stagnating home prices and high rents beg the question, is it better to rent or buy?

The Millennials' Choice: Rent or Buy?

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With the exception of condo markets in Toronto and Vancouver, this year’s spring market is very different from what Canadians are accustomed to. Home sales in April reached a seven-year low for the month, with home prices in most markets declining.

Canada is no longer a sellers’ market, and unless you are shopping for a detached house in Toronto or Vancouver, two of the country’s priciest cities, you probably haven’t seen home prices decline.

But renting isn’t cheap either. Forty percent of 4.4-million Canadians who have a landlord spend over 30 percent of their pre-tax income on rent. If rising interest rates and tougher mortgage rules continue to develop, things could get worse for Canadians, pushing them further in the rental market.

Canadians are left with a difficult decision, which is the better option in this era of stalling home values and sky-high rents: being a tenant or a homeowner?

Many argue that renting is a waste of money, as you are not building equity in your home and not reducing your future housing costs.

Others argue that since rent is cheaper than owning a home, you can build wealth by investing in what you are saving by not having to pay homeowner costs.

While common wisdom has it both ways when it comes to the rent vs. buy question, it ultimately depends on your individual situation and the conditions of the market.

Rent vs. buy? The case of a Toronto semi

Toronto is a great place to test the rent vs. buy math. When it comes to larger and more expensive homes, the real-estate craze of the past couple of years has dissipated. At the same time, rents are among the highest in the country.

In the case of a three-bedroom, two-bathroom home semi-detached home, the average asking price in the GTA is around $744,000, according to Bungol.ca.

With a 20 percent down payment of $148,800 and a five-year fixed rate mortgage of 3.49 percent, the monthly mortgage payment would be $2,969, according to the online mortgage calculator provided by rate-comparison site RateHub. Add property taxes, home insurance, utilities and home maintenance costs, and spending $3,800 a month at least.

On the other hand, the average rent for a comparable property is around $2,450 a month in the GTA, according to Bungol. That’s a difference of a staggering $1,350 in monthly costs compared to being a homeowner.

What can we make of this?

If you assume that home prices will stay relatively flat for the next 25 years, it doesn’t make much of a difference whether you rent or buy that Toronto semi.

A tenant with an initial investment portfolio of $151,800, equivalent to what the buyer would likely spend on the down payment and purchase transaction costs, would end up with around $1.35 million 25 years down the line, assuming an annual return on investment of 5.5 percent before inflation.

The homebuyer would end up with roughly that amount in home equity.

Rent or buy? The case of a Toronto condo

When you look at small condos in Toronto right now, those who can afford to buy still seem to have a clear advantage.

The average list price for a two-bed, one-bath apartment in the GTA is around $412,000, according to Bungol, which works out to roughly $2,000 in mortgage payments and $2,650 in carrying costs.

Renting a comparable unit, on the other hand, will cost you around $2,330 a month. That’s a mere $320 difference in monthly carrying costs.

Let’s break it down.

Even “a conservative 2 percent annual property appreciation assumption results in almost $700 of gain per month, over time. That’s quite a bit more than [the] rental savings,” said Robert McLister, founder of rate-comparison site RateSpy.com and mortgage planner at intelliMortgage.com

“In most urban markets, it’s hard to beat buying long-term when your rent payment is higher than your mortgage payment for the same property,” said Robert McLister.

However, in small towns where few homes are available for lease, it can also be a tough market for renters, said Jason Heath, a fee-for-service financial planner and managing director at Markham, Ont.-based Objective Financial Partners.

In communities where the supply of rental properties is limited, it’s not uncommon to see yearly rent payments equivalent to between 7 and 10 percent of the market value of a comparable home.

Generally, if a year’s worth of rent adds up to less than 4 percent of the market value of a similar house, you’re probably looking at a renters’ market. If yearly rent works out to 5 percent or more, buying is more likely to be the better option financially, Heath said.

Still, there are all sorts of variables that can skew the calculation. For example, the faster home prices rise, the harder it is for renters’ investment returns to keep up.

On the other hand, you won’t be building much wealth as a homeowner if you keep tapping into your home equity to borrow, Heath noted.

And if you have a generous workplace pension with your employer matching contributions, renting and being able to make larger monthly deposits into your retirement savings account might make more sense, Heath added.

The 4-percent rule of thumb is only a starting point, he said.

“It’s important just to know when to ask more questions.”

For more information on renting and buying homes, please contact us at info@millennialschoice.com