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Should you rent or buy?

With appreciation slowing and the costs associated with home buying increasing, the decision is not as clear cut as it once was
The question of whether to rent or purchase a home is not always as straight forward as one might expect. Sure, everyone would rather build equity than sacrifice the sunk costs of renting. However, there are two groups for which this question is far more complicated: young first time buyers and retired empty nesters.
These two groups are far more transient than they were in past years. With appreciation slowing and the costs associated with home buying increasing, the decision is not as clear cut as it once was. For example, when homes were increasing in value by four to five per cent, it was advisable to put your money in the real estate market as early as possible. The costs of purchasing would quickly be recouped through that appreciation. And the typical buyer would stay in that home for more than five years — sometimes for decades. But things have changed a bit and that has affected the most junior and the most senior of purchasers.
Let’s focus on the former. Today’s first-time buyer is older than years past, less established in a family unit and more likely to relocate for work. Combined, these characteristics make the likelihood of them selling their property in the first three to five years much higher than past generations. In addition, in slower markets, the appreciation they will earn over that period is less.
In many cases, if they sell in three years or less, they will actually lose money either in real terms, or in terms of the opportunity cost. What I mean by that is, the combination of closing costs when purchasing and fees/penalties when selling may put them in the negative. Or, they may have been better off if those same combined costs had been invested elsewhere (ie the markets). For this reason — and as mentioned above — the decision to buy or rent as a first timer is not a simple one.
If you find yourself in this situation, here is some guidance. First, know what the next three years are going to look like. OK, that’s impossible, but what I mean is that before you even consider buying, make sure you feel confident that you are going to be in your employment level and your location for at least three years. That is the minimal amount of time that gives you some protection against loss. Plan, ideally, for five years.
Next, I recommend a guide of half of one percent. That’s 0.5 per cent. If you can rent the same property for 0.5 per cent over the same five years, it makes just as much sense to rent as to buy.
Here is how that is derived. If you take an average priced home of about $250,000 and sell that home in five years, the total costs (including opportunity cost) of that home average out to about $1,250 per month over that period. This includes your purchase closing costs, fees when you sell, property taxes, mortgage payments, etc, and is based on a five per cent down payment, 2.75 per cent fixed interest rate, and a 25 year amortization. The calculation also assumes a housing market appreciation of two per cent growth which washes with an assumed two per cent growth in the investment market.
Obviously you’d hope both would be better, but I’ve kept those conservative and fixed. The longer you stay, the lower the average cost ($1,250) gets as your fixed costs (closing costs on buying and fees when selling) are spread out over a longer period. Whether or not you understand all that, or agree with the economics/math of it, what it presents is a scenario whereby if you could rent the exact same property for that same amount of $1,250 over the same five years, you would end up no better/no worse off.
As you may have deduced, $1,250 is 0.5 per cent of the price $250,000. This can likewise be applied to a $200,000 home ($1,000) or a $300,000 home ($1,500) and so on.
Now here are some variables. First, if you sell in less than the five years, your average cost of ownership per month goes up. If you sell later, it goes down. Also, this model assumes that if you don’t purchase, you instead take that money and invest it. If you don’t, then the opportunity cost of renting relative to buying increases. Especially because I’ve used a low two per cent level of appreciation for the housing market.
Owning is sometimes viewed as ‘forced’ savings, as you make principal payments each month and typically gain appreciation no matter what. In addition, the properties have to offer the exact same benefit. The enjoyment offered by the owned home and the rented property should be the same if the costs are the same.
For many people, this last point is the key one. Often we get satisfaction out of ownership and the intangible elements that come with it: nesting, a sense of accomplishment, etc. I guess this is what we call ‘pride of ownership.’ It’s a real thing and it is certainly valuable. However, when you know that purchasing as opposed to renting also makes financial sense, you’ll be even more pleased with yourself.

T. CHANDLER HALIBURTON