It may seem strange for a site that advocates buying real estate to encourage people to rent instead of buy, but there are times when it makes sense. After a discussion last night, I’d like to outline one such scenario which could affect many first time home buyers (these are homes for living in, not an investment).
Let’s say, for the sake of argument, that you are a first time home buyer in Edmonton. The average home price in Edmonton right now is a little over $350,000. You find a house for that price, put down 5% ($17,500 of your savings, or more likely your parent’s savings), and lock the remainder ($332,500) in to a 5 year mortgage at 4.5% amortized over 25 years (for now, let’s forget the $1–3,000 in closing costs for a lawyer, etc. and assume that the property came with appliances, which would be another $1,500–2,500).
By my calculations, your monthly mortgage payment is $1,848.14, not including property taxes (which I believe are around $2,200 annually for an average house in Edmonton).
Statistics Canada says that the average Canadian moves every 7 years, but your mortgage came due, so it’s a good time, not to mention that a lot has changed in your first five years of home ownership (marriage, kids, better job, whatever). At the end of five years, you will still owe $292,127.73 on your house.
I personally think that the homes in Edmonton are overpriced. Most people I talk to agree to this, at least in part. So, for the sake of this scenario, lets say that home prices turn out to be 10% overpriced and drop by that amount over a five year period. Your home is now appraised at $315,000, giving you $22,872.27 in equity.
Realtor’s, on average, charge 7% on the first $100,000 and 3.5% on everything thereafter, so your fees to sell comes out to $14,525 (again let’s forget about closing costs of $1–3,000). So you still come out with $8347.27.
Let’s look at what you invested to make $8347.27 .
- Downpayment : $17,500
- Total mortgage payments: $110,888.40
- Taxes: $11,000
You’ve invested $139,388.40 in owning your home for five years, and managed to only come out with $8,347.27. Remember, we didn’t include any closing costs, appliances, property tax increases, or maintenance over the five year period. Even had the property increased in value by 10%, giving you $92,872.27 in equity before realtor’s commissions (now $16,975.00), I think you can see that you are loosing money on this deal. Real estate makes money over a long term, meaning more than 10 years, or when you use other people’s money.
Now let’s look at renting. You can get a nice two bedroom condo for $1,100/month, as opposed to the monthly mortgage payment of $1,848.14 (a savings of $748.14/month). You don’t need to borrow the downpayment, but you do need a damage deposit, say one month’s rent ($1,100 instead of $17,500, a savings to you of $16,400). Property taxes, maintenance, appliances, etc. are all included in the rent.
So, at the end of 5 years where are you? Well in the worst case scenario, you come out of the project with no house. What did it cost you? $66,000 in rent but, you also saved $44,888.40 by paying rent instead of a mortgage , $11,000 in property taxes and $16,400 from the downpayment for a total of $72,288.40 in savings (plus no realtor’s fees) which you could have invested over the same time period.
Some may argue that rent can change on a year to year basis but, when the value of real estate goes down, the rents are unlikely to increase. Another argument would be that the house is bigger/better than the condo and to get something equivalent would cost more, say even $2,000/month. $2,000/month would have cost you only $120,000 over the five year period, still less than the $139,388.40 that your mortgage did (of course the number should be adjusted for equity, and other expenses if you really want).
Lesson: I’m not against home ownership, however I don’t think renting is really throwing your money away either. Especially if you’ve got the discipline to invest what you’d really be paying in a mortgage. Wealth in real estate comes from leverage and other people’s money, not from ownership.
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4 comments
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Johanus
July 14, 2010 at 8:56 am (UTC -6) Link to this comment
It’s good to see the straight-froward explanations you have! Awesome site! There is one small thing, though: you keep using “loose” instead of “lose” throughout the site.
admin
July 14, 2010 at 10:38 am (UTC -6) Link to this comment
I corrected the 3 places it occurred…let me know if there are more typos.
Lily
March 8, 2012 at 1:28 pm (UTC -6) Link to this comment
I just realized that you are in Canada, not US. How are you finding ANY cashflow positive properties in Canada? With the booming real estate market, I just don’t see any opportunities. Owning generally costs more than renting in Canada now, and the only hope of making money comes from price appreciation, which is not sustainable.
admin
March 8, 2012 at 1:49 pm (UTC -6) Link to this comment
There are always deals to find, but I admit you have to be patient and be ready to strike when you can. I, generally, agree that Canada is overpriced, but I also found a couple of three bedroom apartments…
The places were sold a few years ago to foolish investors for around $180k each (no way to make them cash flow, and they still needed renovating) from a crooked “developer”. The building was never “developed” property (three storey walk up to condo conversion, which wasn’t completed), and the market had a slight correction. Needless to say most of the units went into foreclosure, and I was able to pick up the best units cheap (about 60% off). Now, I had to help organize a condo board, hire property manager and finish the conversion, but I’ve got some great cash flow as well as a significant capital appreciation once the final foreclosures sell and the property returns to market value.
There are always deals available, you just have to keep looking.
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