Programming, Investing and FI

Renting Is Pouring Money Down the Drain?!

Buying a home is not necessarily a bad investment, it mostly depends on how much you put in there and how much trouble you’re willing to go through. I still think people don’t understand how volatile this type of investment is. Personally, That’s why I treat it as risky, in other words it should not be the biggest part of my portfolio at all. In this post I am going to explain in more details why I think this way and why renting is not throwing money out the window.

Risk Of Buying

House vs renting Investing

Comparison With Index Investing

Most of us would not invest in the stock market on margin (by borrowing money to do so). So why are so many people buying a house using the bank’s money without have that money at all? A house being a lot less diversified than an index fund, why is it treated like such investment? My assumption is that it’s because it’s a physical asset and its in our culture. People can feel and see it so it’s easier for our mind to accept putting a large sum in. Maybe that’s why everyone buys their first home when they get their first job and get their hands on some money.

On the opposite, investing in a Vanguard Index Fund on the S&P 500 might seem risky for most because it doesn’t really exists. It’s actually the other way around. The amount of work required and the amount of risk involved by an index fund is minimal compared to a property in my view. I am honestly scared just thinking about putting more than 100% of my net worth in a piece of land mixed with a building that’s taxed like hell, requires maintenance to the bone and which is not really mine after all. Again, most people borrow money to pay for their home meaning that they owe more than they are worth, just like investing with money you don’t own.

For example, if I have 50 000 $ in the bank and put 30 000 $ as a down payment for a house that’s worth 160 000 $. Let’s exclude taxes and all to keep it simple, I borrowed 130 000 $, therefore I am now worth -110 000 $. One investment, one spot, lots of depreciated assets in it, taxes, maintenance, what could go wrong?

But wait, why not buy insurance against that risk… that sounds completely nuts, why not simply wait long enough to insure yourself against that risk by having enough money to cover unexpected expenses.

Misunderstanding Issue?

I think the risk evaluation of a property is something that’s not well understood by the population since it’s in our roots to think that a house simply cannot go down in value, not really our fault… All I have to say to that is “remember 2008” and the damage it caused to the United States housing market. Who bets against the housing market, it cannot crash, yeah right!

I am not saying not to borrow money from the bank (or another lender), an idea would be to keep your savings in your investments while borrowing money. This would lower the risk of buying the house cash and tie down a large sum of money in a less diversified investment, even if you have the funds. It would also limit the risk over being down too much in debt. Mortgage is still debt and should not be considered anything else. There is no such thing as “good debt” in my honest opinion. It’s not really to scare anyone as much as to simply remain conscious that a house should be treated as a standard investment and evaluated with the risk involved in mind. I think people buy these things too early in their career driven by the false assumption that renting is in fact throwing money out the window and that an house is the perfect investment. I would say it’s kind of the other way around.

What Can Go Wrong?

Yes, that’s what I asked in the last section. You buy a house and are now below zero in your net worth. You fill your house with stuff that can break and that you’re responsible for. Appliances, computers, etc. Water becomes your worst enemy, but everything that you own can be as well. It’s not so much that an appliance like a stove cannot be resold but it clearly does not keep much resale value. If you need to sell it, it’s going to be at a lost. This is a huge risk if you’re not 100 % sure you’re going to stay in the same spot with the same partner for the next 15-20 years. If you’re below zero in net worth and you start stacking up all this stuff it creates a monster of risk to your money and will make you dependent on your job income for a long, long time.

That might prevent you from asking for a raise in fear that you might lose your job. It’s understandable that you must not lose your job with that amount of debt on your shoulders. Stuck in the vicious circle of society preventing freedom of choice. But hey, isn’t that what society wants us to do?

What’s Involved On The Buying Side

Taxes

It’s just filled with it and your property will never belong to you anyways. It belongs to the city and the country. You will pay property tax, welcome tax, insurance, school tax, and so on. But if I rent it’s included in my rental price you say? You’re right! But I don’t even have to see the bills, I pay one big chunk of money and that’s it, one payment that goes straight from my bank account to the landlord. It’s the same every month and I am not worried about mailing stuff or setting up whatever. One payment, not complicated and that’s all I care about. A lot less risk is involved because I know exactly how much it’s going to cost, no surprise payment to fix the roof or whatever. Taxes are paid to contribute to our city’s services and the like which is good but still pretty high here in Canada. Let’s do some calculation, you’re already paying tax on your income, taxes on the products you buy, taxes on your property… Just run the numbers and you’ll see that if not 60 % of your salary goes back to the government, we must not be far from that!

Ownership Cost

The cost of ownership and the fact that your investment will only start to pay back in about 10-20 years are two deeply bad things. In the end, it’s going to take a little while before you can say that your house is really gaining value, if it does at all because with all the bills and maintenance addedz up, pretty sure it’s close to even. This is part of the risk and that’s a big risk with a big amount. You then add up the insurance and all that stuff comparable to what you would pay with an appartment but on a much larger scale. Then, the amount borrowed and invested in the property will start to justify the “premium” you now pay for everything you buy about the house. In fact, the risk of losing such a huge investment is too big to fall back.

In addition, if the land is contaminated or flooded or whatever, it becomes your problem and I don’t think you will make a huge gain on that “investment” for a while since a bunch of money will go into taking care of the place. As for renting, I don’t care, I pay the price and that’s it. All that trouble is not mine and I got peace of mind. The cost of ownership is not always about money, it can be about having to take care about stuff that you might not want to.

Let’s do a quick experiment! House worth 350 000 $, 70 000 $ down payment which is 20 %. The mortgage is on 25 years and worth 280 000 $ at the start. The rate is variable and of about 3.4 % (kind of generous according to the current rates here in Canada). RBC tells us, using its calculator that we’re going to pay 135 583 $ in interest over 25 years.

350 000 +
135 583 +
1 % – 2 % maintenance costs per year (+/- 150 000) +
134 000 +/- (4000 $ + increase in electricity bill, water and so on) +
80 000 (city taxes, insurance and school taxes) +
cost of buying and seling 30 000 $ (10 000 $ for buying and 20 000 $ for selling at the end of the 25 years) =
average 745 000 $ over 25 years.

Let’s use compounding to estimate the value of the house by 4 % per year (for an idea of how much it is) we will get 933 042. This is an estimate because housing market can vary depending on a lot of factors but that is if everything goes as planned. I do not take into account the time spent to maintain the place and the interest on capital gains you will have to pay once you sell as well as the tax “benefits” of owning a house.

If we lose only one percent per year to go down at 3 %, we’re not going to make it. if it goes higher than 4 % then you’re in luck! You might make money after all. I still consider this more risky than investing in an index fund with all the U.S. companies in it personaly. If you think the money you might make is worth all the trouble of being an owner than go fo it!

I admit that the tax credits can make a bit of an incentive but I want you to notice that you get a tax crecit on stuff you buy, you pay taxes on gains. I think there is food for thought here.

My experiment might not be exactly right on all the points, we would have to go on a case by case to really assess the risk and the potential gains. The end goal is to do these calculations yourself and see before buying, you might be surprised at how much risk you’re taking for the gains in the end. Don’t expect your lender or your real estate agent to point that out!

What are you sacrificing and is it worth it should be the two things to consider the most in my opinion.

Banks and Loans

Bank and Loan

The price of the loan is just as crazy as any other service offered by your financial institution, but just on a much bigger scale. I’m always cautious when the salesman, oups I mean the representative calls me to offer yet another rate on a future mortgage and asks me why I am not buying a house since I work full time. Someone, somewhere must be making big money on this transaction, and it’s not going to be me.

Depending on your financial status, you might also have to pay insurance premium. That’s because poor banks must be insured against you, and they give you the bill for that. Want that house, well we don’t think you can afford it but we will lend you the money if you pay another extra. Like you were not paying enough just yet! I’m still asking myself how this might be a good deal when the mortgage loan insurance issuers also make big money. It’s probably good for them as well!

You see, everyone seems to make a lot of money except the buyer. Now I am starting to understand the concept of an “investment”, for them.

Maintenance

Maintenance, not really the most exciting part for some but others might like it. In my case I want most of the responsibilities I have to be the ones I like. A house involves a lot of responsibilities that I don’t like and that’s why it’s not a plus. On the other hand, if you like taking care of your lawn or fixing things here and there, like painting and so on, then that might be something better for you. I know people who really like to spend time around the house, if that’s your case then it’s definitely a strong point.

Also, maintenance is required all over the place because everything you buy requires fixing to work properly and last a long time. I see every item I own as sort of a timed bomb requiring attention. But maintenance is not only for what’s in the house, it can be what composes the house as well. Like the roof, the ceiling, the foundation, the land, etc. These can be very costly if you cannot do them yourself.

Stuck in One Spot

Yup! You’re stuck in one spot and wherever your work will be, you will have to do whatever is necessary to commute. This means that it will give you less opportunities for a job anywhere in the city or in another city. If your job is now at the other end of the city you will have to find a way to get passed the traffic jam and lose a bunch of money and time on the road. You might also have to buy another car which will be costly as hell compared to owning only one car. Let’s say 18 000 $ over 7 years with interest, maintenance costs and so on. That’s for like a Toyota Corolla, not a big pickup truck! I’m sure we’ll be closing in 45 000 $ all in all after 7 years. Still think that renting is throwing money out the window? If you rent you would have to move closer and you’ve just saved yourself a second car and a lot of time.

Cost of a car over 7 years

Expensive to Buy and Sell

Real estate agents are hard working people and they’re not free. Commission can be very costly for a mistake in your calculations or a change in your lifestyle. A house is very expensive in time and money to sell and buy. Renting? Not so much since you just have to rent a truck to move and invite some friends and family to a nice pizza lunch if you have too much stuff to move. How much will it cost to buy and sell a house? 6 %, 5 % or so divided by 2. It’s huge! It’s not even a fixed rate, it’s a percentage of your house! And you still have to rent that truck because you’ll have way too much stuff to move for sure.

Why Buy So Early?

Why do people cannot wait? In fact, the more you wait, the safer it gets. I would argue that it’s easier to be in an apartment while your kids are young and then buy later on when they have to go to school and your job is a bit more stable. Let’s say it gives you an extra 4-5 years to save more which can mean a lot if your saving rate is pretty high. If you can come up with 20 000 $ in savings per year, it’s 100 000 $ after 5 years, not even stashed in the stock market or counting any interest.

Another question arises, but what if the current market is favorable? You absolutely cannot know that in any way, in other words, there will always be good deals, whatever the market state. Self-control and planning is the key. A house is too risky to be taken lightly and it’s pretty rare to gain some experience in buying and selling houses unless you’re a broker. Lack of experience in the process simply adds to the risk.

Why Buy So Big?

Why buy a big house when you are only using a few rooms in it? While living simply in an apartment you can assess what you need. For example, I need a kitchen with a dining table, a bathroom, a bedroom and my office to work. Maybe a couch sometimes so let’s add a living room and some space to store my bike. That’s about it. I don’t need any other rooms in which I can put useless stuff. Another room or two for future kids and that’s it. This doesn’t make for a big house. But what if “insert the name here” stays over and we need more room. Foldable or inflatable mattress, that’s it! Conclusion, you don’t really need a big house at all.

Is It Possible To Rent With Kids?

I am not really in a position of giving my opinion on the subject, but I assume it’s possible since I see a lot of kids everywhere in the nearby apartments and semi-detached homes. I think when you’re young, you don’t really care about the house you live in but more about the friends that are close to where you are. You definitely want to stay in the same school as well.

The Numbers While Renting (Saving Rate + Risk)

Renting

Here is specifically why renting can be a smart choice risk-wise and how I see it.

Let’s say my rent + my other expenses including an older car = 1200 $ per month and I make 2000 $ per month after taxes which is pretty average I would say for where I live (not considering living with a partner). My saving rate is 800 $ a month which corresponds to 40 % of my income. I am renting so I technically carry less risk than if I was owning a house and have less responsibilities.

That 40 %, it’s going straight into my investments (index funds), that’s something I don’t have to keep in a savings account. Also I can keep a smaller emergency fund because I have less stuff that could go wrong. Higher saving rate and smaller emergency fund equals more money invested. Note: emergency fund depends on your tolerance but with less risk, it’s understandable that an emergency fund could be smaller.

Buying

With a house, 40 % or 50 % saving rate might be reduced to 20 % or 10 % or less, it doesn’t seem big but it’s a huge difference. Since I have more responsibilities and more things that could go wrong, I need to keep a larger sum of money not working for me (in an emergency fund). I am also less exposed to compounding over the years because I cannot set as much money aside. Finally, I am tied down to one place while I have less work experience and less employment value which means more chances to have to switch jobs.

In most cases, owning is better than renting in the long run (strictly on the money side), but there is still more risk involved in buying. If you want or not to take this risk is your business, but saying that renting is pouring money down the drain is simply not true.

Bottom line, it depends on how you see it, but in my case, I would not want to lower my saving rate and carry more risk to “own” a house earlier in my life.

For When Is The House Then?

A house is great but it depends on what’s important for you. I don’t pretend to know everything, but I am sure that a serious consideration needs to be made in the renting versus buying especially while in your 20’s and early 30’s. I’d say to limit the price of the home you buy to what you can afford to lose in your portfolio. Also to select the size appropriate for the amount of work you want to do around and inside of it. This is to make sure that it doesn’t take you down financially if something was to happen to your situation or your house. If you end up in bad debt and have difficulty with your money, selling your house can be just another hassle in which you’re going to lose big time. Everyone wins except the buyer and the seller.

Renting gives some time to get to know yourself and what you like. It also gives you some time to save money instead of putting it straight in your mortgage (that is, partly in the banks pocket). In my opinion, while you don’t have kids yet or have younger kids, it’s better to save up as much as you can so you can spend more time with them in the future. Renting is not throwing money out the window, it’s a way saving yourself from responsibilities to focus on increasing your saving rate and doing what you really like. A house and all the trouble it brings along can come later. The power of compounding mixed with the huge saving rate that renting give you will launch your net worth to the moon. Just make sure to keep other expenses as low as possible while still living and putting money where it’s important for you.

As for me, the house will come later…

By the way, as I was writing this post, FIRECracker posted an article on CNBC. You can have a look if you would like more stuff to read on the subject.

In addition, here is a classic post from J.L. Collins about buying an house.

Again, this is all my point of view and based on information I get from reading books on investing, on mortgages and from my own experience in life. Take it or leave it but your business is your business, not mine, save and invest responsibly and wisely.

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