- The rent versus buy decision for housing can have a significant financial impact, but it can also play an important role in where we live and
how we spend our time. Making the housing decision
requires careful consideration of both the financial and
non-financial impacts, and the way that they
interact with each other. There is no universally right
way to approach housing. In many cases, contrary
to conventional wisdom and societal pressure, renting is a better option than owning, both financially and from the
perspective of well-being. I'm Ben Felix, Portfolio
Manager at PWL Capital. In this episode of Common Sense Investing, I'm going to tell you how to decide between renting and owning a home. (bouncy rock music) Renting a place to live is
not throwing money away. Financial outcomes for renters
and owners can be comparable. I'll explain why that's
true later in this video, but I wanna start with the
non-financial considerations of the rent versus buy decision. Finances aside, if buying
a home will make you happy, there are a few good argument against it. This raises the question: are homeowners happier than renters? People are really bad at forecasting what will make them happy in the future, particularly when it
comes to major purchases. The 2010 paper, Extrinsic
Value Orientation and Effective Forecasting. Overestimating the Rewards, Underestimating the Costs, explains that people who believe
materialistic achievements, like owning a home, will make them happy can be classified as having
extrinsically motivated goals. Other examples of extrinsic goals are money, fame, image and status. Compared to people with intrinsic goals, like personal growth,
intimacy and community, extrinsically motivated people
are less happy in general and they overestimate
the emotional benefits of achieving their extrinsic goals. True to this finding, a 2020
study using German data, finds that people
overestimate the long-run life satisfaction gains derived from moving from a rented home to a privately owned property and that this overestimation
is more pronounced for people with extrinsically
motivated life goals. The 2011 paper, The American Dream or the American Delusion uses a data set with housing consumption, well-being measures and time use patterns to find that after controlling for income, housing quality, and health, the homeowners in the sample
are not better off than renters by multiple measures of well-being. Instead, they derive significantly more pain from their home, potentially due to the
time used differences between renters and owners in the sample. Homeowners tended to spend less time on enjoyable activities,
like active leisure. The 2019 study, Home
Ownership and Happiness: Evidence for Switzerland, finds that Swiss homeowners are no happier or are even less happy than renters when other variables like
wealth, income, employment, health and housing quality
are controlled for. A 2011 study using a German sample finds a marginal but positive relationship between home ownership
and life satisfaction, while a 2017 study using
a United States sample finds slightly elevated
reflective life satisfaction for owners but finds
that owners experience less intense feelings of
happiness than renters, and that homeowners spend much more time working on their home than renters do. One of the driving issues here is that people tend to hedonically adapt to their circumstances, meaning that a change in circumstances does not have a lasting impact
on how we feel day to day. You can see the problem here. We overestimate how
much happier we will be by purchasing a home,
but once we live there, the home becomes a condition of life rather than an aspiration and its impact on our daily
well-being is neutralized. In the 2010 paper, If Money Doesn't Make You Happy, Then You Probably Aren't
Spending It Right, the authors explained
that experienced happiness is shaped more by how we spend our time than by stable life circumstances, like how we pay for housing. After making a major material
purchase, like a home, many people will suffer
from buyer's remorse. The 2010 paper, The Relative Relativity of Material and Experiential Purchases, finds in their sample that
people are often less satisfied by their material purchases
than their experiential ones because they're more likely to ruminate about unchosen options
with material purchases and their satisfaction with
their material possessions is undermined by comparison
to other available options, to the same option at a different price, and to the purchases of other individuals. homes are positional goods, meaning that their appeal comes from, not only their intrinsic
property as a place to live, but also from how it compares
to the homes of peers. Humans innately compare themselves to the people around them, and empirically we know that comparison matters a lot to happiness. A 2019 study titled The McMansion Effect: Top House Size and Positional
Externalities in U.S. Suburbs, finds that new constructions at the top of the house size distribution lower the satisfaction
that neighbors derive from their own house size. These effects are stronger among people living in larger houses and
they decrease with distance from the larger new constructions. Homeowners exposed to the
construction of larger houses in their suburb put a
lower price on their home, are more likely to
upscale to a larger home, and they take on more debt. One of the best ways to deal with our poor affective forecasts, hedonic adaptation, buyer's
remorse and social comparison is to make more frequent
experiential purchases rather than few big material ones. Taking a friend out for dinner, signing up for a class
in an area of interest, spending on an engaging hobby, or buying things for other people are all approaches to spending money that bring persistent happiness
that we do not adapt to. Buying a home is the antithesis
of small frequent purchases. The term house poor comes to mind. A circumstance that we do
not tend to adapt to is debt, which is, for most people, a big part of purchasing a home. In their book, "Happy Money: The Science of Happier Spending," Elizabeth Dunn and Michael Norton explained that although the relationship between income and
happiness is fairly weak, there is a stronger
relationship between happiness and difficulty paying the bills. In other words, Dunn and Norton say, "What we owe is a bigger predictor "of our happiness than what we make." Households with more debt
exhibit less happiness, and couples with more debt
have more marital conflict. Another circumstance
that we don't adapt to is commuting in traffic. Even after years of commuting, people who commute in
traffic arrive at work with higher levels of stress hormones. This matters for people who
move further away from work to get a bigger house. They quickly adapt to having more space, but they do not fully
adapt to the commute. All right, all this happiness talk is moot if renting is a terrible
financial decision. But renting is not a
terrible financial decision. The cost of renting is
very straightforward. It is the rent that you pay, plus the cost of renter's insurance, which is typically much less expensive than homeowner's
insurance, plus utilities. The cost of owning a home
is less straightforward and leads to many people
incorrectly believing that owning is a better
financial decision than renting. The costs of an owner are
property taxes, maintenance costs, insurance costs, and the opportunity costs of the equity in the home. Property taxes can vary a lot
depending on where you live. For the sake of this discussion, I will use 1% of the value
of the home annually. Property taxes, like rent, are
paid in exchange for services with no residual value. Homes are depreciating assets. Depreciation takes two forms. Physical depreciation, the normal wear and
tear resulting from use, and functional depreciation,
or obsolescence, as newer construction methods,
standards and materials make older homes less desirable. There is no escaping
these costs as an owner. You either pay for the cost
of maintenance with cash as you consume the home over time, or you pay for the depreciation through a lower sale price in the future. Either way, the cost is in there. In "The Rate of Return on
Everything, 1870 to 2015," the authors find the maintenance costs between 1 and 2% historically. Their estimate includes depreciation and all other housing-related expenses, excluding interest, taxes and utilities. Statistics Canada uses 1.5%
of the value of the home as a depreciation expense
in the CPI basket. This figure is in line with
multiple academic studies and the statistical
agencies of other countries. 1.5% is for the building only, so it has to be multiplied by the ratio of the building value over the land value to arrive at the depreciation
cost for the home. Based on this, a 1% maintenance cost is probably a reasonable assumption. Home maintenance cost can sneak up on you and they don't typically
get included in the numbers when people tell you how well they did on their home's appreciation. Those weekly trips to Home Depot add up. The opportunity cost of equity measures the cost of having
money invested in a home instead of in something else. Something else could be a
lot of different things. I'll assume to start
that the opportunity cost is relative to owning a low-cost portfolio of total stock market index funds in a tax-free investment account. In his book, "Irrational Exuberance," Robert Shiller shows, based on global data
dating as far back as 1628, that real home price appreciation has been between 0.2% and 0.4% per year. In "The Rate of Return on
Everything, 1870 to 2015," the authors estimate the real annual historical increase of home
prices in 16 countries, from 1870 to 2015, at 1.1%. Eh, I think we can
easily round those to 1%. In many cities in Canada, recent history has shown much
greater price appreciation, but that doesn't tell us
much about the future. In fact, if it tells us anything it's that we can expect lower
price returns in the future as the current ratio of prices-to-rents is a historical anomaly. High prices relative to rents have historically been resolved by falling house prices,
not by rising rents. In our recent Financial
Planning Assumptions Update, the PWL research team estimates the expected real annual return on a 100% stock portfolio to be 4.28%. To account for fund ownership costs, like fees and withholding taxes, we can run this figure down to 4%. A 4% expected real return on stocks and 1% for real estate amounts
to a 3% opportunity cost for having equity in real
state instead of in stocks. Taken together, property
taxes, maintenance costs and the opportunity cost of equity tell us the total user
cost of owning a home. Based on 1% each for property
taxes and maintenance cost, plus 3% for the opportunity cost, we have an imputed rent
of 5% of the home value. This is what it is costing an
owner to live in their home. Another way to think about
this is that you're paying rent whether you own a home or not. The 5% figure tells us what level of rent relative to price equates the
cost of renting and owning. Mortgages make the economics
of owning look better by reducing the initial
opportunity cost of equity. But due to the large cash
flow commitment of a mortgage, in addition to property
tax and maintenance, the 5% user cost figure
equating the cost of renting and owning still works out. From here, we can have all sorts of fun. If you're looking at a $1 million home, your user cost is estimated
at $4,166 per month. If you could rent for the same or less, renting is financially equivalent. A more aggressive investor, for example, someone tilting their portfolio towards small cap and value stocks, would have a higher
opportunity cost of equity, and therefore, a higher
rent equivalent threshold, while a more conservative
investor would be lower. So far I have ignored
taxes on investments, assuming that the renter
is using their RSP and TFSA to invest. Real estate price growth
is not taxed in Canada on the primary residents. A renter investing in a taxable account would have a lower after
tax opportunity cost, and therefore, a lower user
cost equivalent rent level. There are some other
economic considerations. Buying a home with a mortgage
means forced savings. People are much more likely
to skip an RRSP contribution than a mortgage payment. This requires discipline
on the side of the renter to make the numbers work. Additionally, an owned home
is a hedge for housing costs. Even in crazy markets like we're in today, owners total costs are likely
to be more stable than rents, which landlords may want to increase. While hedging housing
costs is a good argument for a long-term homeowner, house prices in the short
run can be volatile. A volatile price is not such
a big deal for a forever home, but price volatility can
become a substantial risk If you need to move. Renters have much more
freedom of mobility. They can easily move if
there are unexpected issues with their home, their neighborhood or their employment situation
without needing to worry about short-term price fluctuations. Sure, owners can't be rent-evicted by a greedy landlord in a rising market, but they're taking on
a lot more price risk in the event that they need
to move in a falling market. Owners are more often forced
to commute than renters are. The literature relating
happiness to home ownership makes it clear that homeowners are not happier than renters
just because they own a home, even if they expected to be
when they decided to buy. Other aspects of life,
like being in nature, being good at something, being connected to
things outside yourself, feeling in control and
having strong relationships are much better predictors of
happiness than owning a home. Guiding the housing decision
based on these inputs is a lot more sensible
than rushing to own a home on the pretense that
it will make you happy. From a financial perspective, renters can expect to match
the wealth of homeowners as long as they understand
the user cost of owning and keep their housing
costs within that range. Owning can result in the kind of windfalls that we've seen in Canada
over the last decade, but it can go the other way too. Buying a home today on the expectation of unrealistically high housing
appreciation in the future is more likely to do harm than good. In the interest of full
disclosure (chuckles), I recently bought a house after renting for all of my adult life. I bought a forever home in a secluded area within walking distance to
a small town with amenities, hiking trails, and a body of water. I have a garage big enough
to work on my hobbies and I'm still within a
45-minute drive to my parents. And since I'm able to work from home, I don't have a commute. There were no rentals
available in this area, which swung my decision
in favor of buying. When I lived in the city, where I knew I didn't wanna stay forever, there were more rental options available within walking distance to my office, which at that time, I had
to commute to every day. It was an easy decision to
rent when I lived in the city. In both cases, I made the decision based on what worked for my lifestyle, not some extrinsic or financial motivation to be a property owner. Thanks for watching. I'm Ben Felix, Portfolio
Manager at PWL Capital and this is Common Sense Investing. If you enjoy this video, please share it with someone who you think could benefit from the
information. and let's be serious. A lot of people could benefit from this information right now. If you want to hear more like this, we discussed similar topics
in episodes 154 and 170 on the Rational Reminder podcast, which is available on YouTube
and on podcast platforms. (upbeat electronic music)
