Andrew Allen­tuck – Finan­cial Post

Cana­di­ans have a love affair with their homes, stretch­ing their finances to buy them, sac­ri­fic­ing other things to have a house or condo and remain­ing deeply in debt even when the num­bers sug­gest they would be bet­ter off renting.

Com­ment: I have never seen a good argu­ment that says rent­ing is bet­ter. The aver­age rent for a 2-bedroom unit in Toronto is $2,114 in Q1 of 2013, $2,737 for a 3-bedroom. The aver­age prop­erty sale price is $543,838 in the first half of May, which would cost around $2,360 for the mort­gage (@ 2.99% with 10% down and 25-year amor­ti­za­tion). And the aver­age mort­gage is paid off in 17 years, accord­ing to CAAMP, while rent­ing goes on for­ever. You save $246/month for 17 years (if we are talk­ing 2-bedrooms only), but after that your mort­gage is paid while you have to con­tinue to pay rent. Let’s com­pare 25 years and see what we get. Tak­ing 17 years X 12 months X $246 = $50,184 total sav­ings rent­ing over buy­ing. But for the next 8 years, you keep pay­ing rent of $2,360 (assum­ing it never goes up) so 8 year X 12 months X $2,360 = $226,560 in rent pay­ments. Deduct the rental sav­ings for the first 17 years and you are still left with rent­ing cost­ing $176,376 more than buy­ing. Even over 25 years, that leaves $587.92 per month to pay for util­i­ties and prop­erty taxes. I would say it is pretty much even over that 25-year period. But when you buy, you have the asset – with rent, you have noth­ing at the end. Even with no price increases (as we assume no rent increases) there is an asset of $543,838 for the buyer, $0 for the renter. Explain to me again how rent­ing is better?

It is a pas­sion for own­er­ship that has put Canada in the elite com­pany of coun­tries with esti­mates that more than 70% of house­holds now own their own home. Even young peo­ple have caught the hous­ing bug. Sta­tis­tics Canada says much of the increase in home own­er­ship – the num­ber was 68.4% in 2006 – has been from young peo­ple buy­ing con­dos.

In the dozen years since the begin­ning of the mil­len­nium, home prices rose 225%. Those prices were largely financed by house­hold debt which rose to 160% of fam­ily income in 2012 from 100% in 2000, says Ben­jamin Tal, deputy chief econ­o­mist for CIBC in Toronto: “House prices in Canada con­tinue to defy gravity.”

Com­ment: Well yes, most peo­ple have mort­gages, which is debt. It is the credit to pay for TVs and vaca­tions that is the prob­lem, empty debt. Mort­gage debt is “good” debt, most econ­o­mists will agree with that.

There is good rea­son for that.

“Every­body needs a place to live, of course, and peo­ple can be house proud. They tend to see houses not just in finan­cial terms, but as expres­sions of them­selves in which they like to invest,” says Derek Moran, head of Smarter Finan­cial Plan­ning Ltd. in Kelowna, B.C.

“More­over, there is an expec­ta­tion that we will own homes. Own­er­ship is seen as a God-given right. And you can sell the house with no cap­i­tal gains tax if it is a prin­ci­pal residence.”

In Win­nipeg, Vic Kuzyk, a retired school prin­ci­pal, has owned his own house for 40 years and has added two houses nearby that he rents out.

“The house rents return 5% a year on my equity and they have more than tripled in value,” he says. “They are ter­rific investments.”

And he says they have given him fewer headaches than “wor­ry­ing about my stocks and mutual funds.”

Com­ment: Stocks have returned 9% annu­ally for the past decade or more. This guy makes 5% per year on top of the 300% increase in the value of the ini­tial prod­uct. Beats 9% a year in my book!

The prop­erty play has also pro­duced an unmea­sured but sub­stan­tial effect on the value of his own house. “I bought the first rental house next to my own because it was run down. It could have reduced my own prop­erty value. I repaired it so it now can add to my own value. That’s not any­thing one could do with stocks or bonds.”

Why homes seem like good investments

The idea that a house or condo is a supe­rior invest­ment is based partly on recent his­tory. Home prices rose strongly in the first decade of the cen­tury, dri­ven by falling inter­est rates which reduced the cost of mort­gage financ­ing. In Canada, homes also escaped the worst of the col­lapse of U.S. home prices dri­ven by the vast Amer­i­can sub­prime mort­gage debacle.

Com­ment: Canada escaped the US col­lapse entirely. That is there, we are here. No con­nec­tion or cor­re­la­tion at all. And home prices have been ris­ing for a lot longer than since 2000. I have stats for Toronto that show 41 of 47 years with higher prices than the year before. My par­ents have seen pretty much all increases, but for a brief period in the 1990s. My dad bought his house in 1983 for $180,000 – it is now worth $1,000,000. And that is through the peak and trough of the bub­ble of the late 1980s and early 1990s. That is an increase of 555% in 30 years – which is not exactly recent history.

Apart from macro­eco­nomic forces, home prices are harder to mea­sure and do not seem to fluc­tu­ate moment by moment, as prices of stocks, exchange traded funds and actively traded bonds do, Mr. Moran adds. “The idea of sta­bil­ity becomes a dri­ver of the pas­sion to own a home.”

Com­ment: Heck, from the press cov­er­age every 2 weeks of every lit­tle nuance of the real estate mar­ket, you would think they fluc­tu­ate constantly!

There are other ways to invest but any­one who sat­is­fies lend­ing cri­te­ria can get a con­ven­tional mort­gage with the usual 25% down or a high ratio mort­gage with CMHC or other insur­ance. Few lenders will match those terms on other assets save for cer­tain gov­ern­ment bonds. Regard­less of the mer­its of bonds, they can’t pro­vide a place to lie down at night.

Com­ment: Exactly. Any invest­ment out­side of real estate has to be off­set by the cost of hous­ing. If you rent and buy stocks, you must deduct your rental costs from any prof­its in order to com­pare apples to apples.

Mort­gage lend­ing has extended the afford­abil­ity of homes. Once in a home, peo­ple tend to stay to avoid mov­ing costs and sales com­mis­sions. These costs, usu­ally paid by the owner who is sell­ing, make rapid flips costly and unat­trac­tive for many. So most hous­ing is not on the mar­ket at any one time, unlike stocks that are for sale at least at some price almost all the time. That makes home prices seem sta­ble and solid. Price sta­bil­ity becomes a self-fulfilling prophecy.

Com­ment: Peo­ple stay in their homes for many rea­sons out­side of avoid­ing costs. Kids and schools for one, access to tran­sit, great house, etc. Some peo­ple just don’t need to move. And stocks/mutual funds/etc. have fees asso­ci­ated with them, let’s not pre­tend they are free to buy and sell. Some mutual fund man­age­ment fees and com­mis­sions can hit 1.5% of the investment’s worth.

There are price trends in hous­ing. Though the frac­tion of all owner-occupied hous­ing for sale is a small part of the total in exis­tence, the pric­ing and afford­abil­ity of what there is to buy is based sub­stan­tially on inter­est rates and demo­graph­ics, explains Bren­don Abrams, an ana­lyst spe­cial­iz­ing in real estate invest­ment trusts with invest­ment dealer M Part­ners Inc. in Toronto.

When rates rise, peo­ple will get less space or other mea­sure of home for each dol­lar of mort­gage pay­ment. When rates fall, as they have done and remain at near record lows, they can afford to buy more house or condo or, for any amount of space, they can pay less. Thus low inter­est rates have spurred and sup­ported the high level of home prices. Those prices have been held up by pres­sure from new arrivals com­ing to Canada who need a place to live, migra­tion to high eco­nomic growth areas such as Alberta, and sheer lack of space in mar­kets like Vancouver.

Com­ment: While that makes sense in a gen­eral way, it is not true. Like play­ing roulette, just because the last spin was black does not increase the odds of the next spin end­ing up on red. Graph the past 50 years of mort­gage rates against the past 50 years of home prices. Mort­gage rates went up and down until they stayed down in the past 5 years, while prices have pretty much risen year after year. Dave the Mort­gage Plan­ner wrote a great piece about it. Peo­ple also for­get that inter­est rates go down when the econ­omy is bad, and they rise when the econ­omy is good. When the econ­omy is good, more peo­ple are employed and they make more money. This spurs home pur­chas­ing, thus inversely tying ris­ing rates to higher real estate sales.

The finan­cial attrac­tive­ness of home own­er­ship also builds on infor­ma­tion bias. It is not hard to find peo­ple who have owned their homes for decades and have seen their homes’ prices rise two, three, four or more times in those peri­ods. It is harder to find peo­ple who have held a sin­gle stock for twenty or thirty years. The typ­i­cal period of stock own­er­ship is months for ordi­nary share­hold­ers and even less for pro­fes­sional port­fo­lio man­agers. In these shorter peri­ods, a stock’s price is likely to rise very lit­tle. Short term trad­ing can also gen­er­ate losses.

Com­ment: But you make the point well, for either stocks or real estate, those who hold for a long time make money while those who try to flip quickly tend to lose out.

Price trends

Home prices have soared for the last decade. But stock prices, hav­ing gone through the Twin Tow­ers tragedy of Sept. 11, 2001, the dot com melt­down from 2000 to 2002, and the sub­prime mort­gage bank­ing col­lapse that drove down world stock mar­kets in 2008, have stag­nated. Now, how­ever, the tide may be turn­ing, Mr. Tal says.

Com­ment: And all of those events drove down inter­est rates, per­versely fuelling the real estate market.

Stocks are recov­er­ing while house prices, which got ahead of the under­ly­ing long-term aver­age annual com­pound rise of 2%, are likely to be soft. “The real estate mar­ket is now at the end of its game while the equity mar­kets are com­ing back.”

Com­ment: Long term aver­age of 2%? Heck, Toronto has seen a com­pounded rate around 5.6% for the past 16–17 years now. That is a pretty long term. And this also falls into the trap of com­par­ing now to 1973. It is not the same time, every­thing is dif­fer­ent now.

That is not a rea­son to dump your home. Even if house and condo prices soften, owner-occupied hous­ing has a ter­rific tax ben­e­fit. In the U.S., mort­gage inter­est is tax-deductible, sub­ject to some lim­its, while in Canada, all cap­i­tal gains on one’s pri­mary res­i­dence are free of cap­i­tal gains tax.

Com­ment: Those who have sold, think­ing we were at the peak, have only lost. One per­son I know of sold their place 2 years ago. They lost about $100,000 in lost value and rent pay­ments. Do not try to pre­dict the mar­ket, no one has ever been able to do it.

“Your home is like a huge tax-free sav­ings account with no con­tri­bu­tion lim­its,” says Nathan Janzen, an econ­o­mist with the Royal Bank of Canada in Toronto. That means that homes have both the value of a place to live and ter­rific invest­ment char­ac­ter­is­tics. Even when there are tem­po­rary price declines, the long-term owner should do fine on price and very well after tax. In that sense, you can’t beat a home of your own.”

Com­ment: Could not have said it bet­ter myself!

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Con­tact the Jef­frey Team for more infor­ma­tion – 416−388−1960

Lau­rin & Natalie Jef­frey are Toronto Real­tors with Cen­tury 21 Regal Realty.
They did not write these arti­cles, they just repro­duce them here for peo­ple
who are inter­ested in Toronto real estate. They do not work for any builders.
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