If you follow headlines in the Province of BC, it's hard to ignore the red-hot real estate market with rising housing prices, including the constant pressure on both tenants and homeowners.
With surging prices, weighing pros and cons between renting-a-home versus purchasing-a home becomes increasingly relevant.
A friend recently asked if I'd ever drafted a comparison between renting or buying a home in Vancouver, Canada.
Her question resulted from watching a video posted by the Globe and Mail. The video suggests that millennials don't necessarily need to buy a home - that renting can be just as good.
Watch the 2 minute clip below and see what you think:
The sad reality to this comparison question is that the home a person would choose, and afford, to rent in Vancouver, Canada, is likely not the same property the same individual would purchase. What I mean, is that a person who can rent a 1 bed, 1 bath in downtown Vancouver for approximately $2,000 per month, is likely unable to afford the downpayment and ongoing expenses of homeownership with a price tags anywhere from $600,000 plus.
What became more and more obvious as I worked through this example is the gap between rental rates and true homeownership costs.
To make decisions for myself, I like to draft real numbers to see the differences, and make a decision.
For the purpose of this example, I'm comparing the costs associated with renting an 1,100 square foot condo against purchasing the same property. As the property to consider is 1.4 million dollars, the assumption has to be made that an individual has a minimum of 20% down, a whopping $280,000, and therefore has the decision to make in the first place - use the cash as a downpayment, or tuck it away in savings and rent instead.
The more prevalent scenario are those who can pay rent, but don't have such a substantial downpayment. TOMORROW, I will make that comparison.
There are a million variables which can shift the outcome of today's comparison, so I'm making some decisions/assumptions to work with.
Keep in mind you can follow the below framework to make your own decisions in your own marketplace.
I'm going to work through renting versus purchasing the same property.
Location: Downtown Vancouver, Canada
Description: 2 bedroom, 2 bathroom
Size: 1,140 square feet
Year Built: 2016 - Near New
Approx. Property Value: $1,400,000
Monthly Rental Rate: $3,700
Let's Assume we'll live in this condo for 5 years, so we'll compare 5 years of renting versus 5 years of purchasing.
Cost of Renting, with $280,000 Tucked Away Into Savings
5 Years of Renting is simple to calculate. Multiply the monthly rent by the number of months you'll rent.
So, $3,700 X 60 months (5 years) = $220,000.
For those of you out-of-touch with Vancouver costs, yes, this rental figure is real. And no, the $3,700 per month does not include electricity or cable/internet.
To get a better sense of what kind of earnings a person would need to service this rent, I used an income tax calculator and worked backwards. The pre-tax income (over 5 years) required to service this rental amount is $363,980 or $72,796 per year.
In other words, $72,796 needs to be earned every year, just to cover the rent. At this point, there are no groceries accounted for, lights turned on - just a vacant space to sleep.
In our example though, $280,000 is invested from the out-set. Let's assume it's earning a low interest rate of 3%. At the end of 5 years, it would be worth $324,597.00, resulting in a gain of $44,597.00
So $44,597 was earned and $220,000 was lost to rent. There is a loss of -175,403.
PURCHASING with 20% Down
This part of the comparison gets crazy complicated because there are so many moving pieces to consider. Considerations include the down-payment available (which, by-the-way, must be no less than 20% for properties over 1 million dollars), the interest rate, the strata fees, the future price of the condo.
So, we have to make some assumptions to work through this.
Let's assume, the property doesn't change in value over 5 years.
Let's assume the mortgage interest rate is 2.8%, fixed 5-year, with an amortization of 25 years, and no-lump sum payments are made during the 5-year term.
Below is a list of expenses associated with the purchase:
- Down Payment - as mentioned previously, homes with a purchase price over one million dollars require a minimum 20% down payment.
- Canada Mortgage and Housing Corporation Insurance (or CMHC) - while this insurance premium can becostly for home buyers, CMHC will not insure mortgages with a purchase price over 1 million dollars. In addition, mortgages with 20% or more as a down payment don't require mortgage insurance, so in the case of our example, there would be no CMHC fees payable. If you are considering a home purchase, use the link that follows to calculate any potential premiums: https://www.cmhc-schl.gc.ca/en/co/buho/buho_023.cfm
- Appraisal - prior to lending money, the banks want to ensure that the price you've offered the seller is similar to the actual market value. Todo this, an appraisal is likely required.
- Move-In / Move-Out - most condo buildings charge a fee on both the move-in and move-out
- GST - in the province of BC, GST would may be applicable to New Housing. In our example, the home is a re-sale (not new) and therefore is likely not subject to GST.
- Inspection - as part of the purchasing process, a building inspector may be hired to validate the quality of the home.
- Property Taxes - these will be adjusted at closing in most cases. To make our example simple, we can assume that this home will complete on January 1st. For this reason, the property taxes won't be included in the closing costs, but will reappear in our ongoing costs. In the case of Vancouver, $3.1657 is payable for every $1,000 of assessed value. To find your own property taxes, just google the municipality where the home of interest is located and look up property taxes. You should be able to find a current 'mill rate' which you can use to estimate potential taxes.
- Legal Fees - the cost of using a lawyer or notary to complete the sale
- Property Transfer Tax (or PTT) - there are some exemptions for this tax, but generally 1% on the first 200K, and 2% of the balance is payable for Property Transfer Tax. If you want to calculate your own potential PTT, use the following calculator: http://www.bcrealestatelawyers.com/ptt-calculator/
Here is a snapshot of the potential purchase expenses for this property:
The cheque required at closing, would be $308,450.00, of which $280,000.00 is probable equity and $28,450.00 are expenses and essentially 'lost' costs.
Ongoing costs of Home Ownership include the following:
Mortgage Payment - this can be made monthly, bi-monthly, bi-weekly, and weekly. For this example, I'll assume monthly. There is a big acceleration in decreasing the principle owing by paying either bi-weekly or weekly when compared to only making one payment each month. To get an approximate sense of this, I used CIBC's Mortgage Calculator.
Strata Fees: These can widely vary too. The strata fees help to pay for the common parts of a strata. Elevators, parking, overall building insurance, landscaping, water, waste removal, etc. Let's assume these fees are $0.35 per square foot.
Property Taxes: As mentioned previously, the City of Vancouver charged $3.1657 for every $1,000 of assessed value in 2016.
Insurance: Insurance policies can vary widely. For our example, let's assume $500 per year for contents only, as the broader building insurance is covered by the strata corporation.
Note: For the sake of this example, I haven't included electricity, cable/internet, etc. as these would be required in either the case of rental or home purchasing.
Here is a snapshot of these expenses per month, and then for 5 years.
The ongoing expenses equate to $334,919.90. Of course, a portion of the mortgage payments would be applied to the principle resulting in some home equity.
The tricky piece of this comparison is separating the expenses that are lost (interest, strata fees, etc) and those which are savings for you.
In this case, $119,929 of the mortgage payments were lost to interest charges. So were strata fees ($23,940), property taxes ($22,159) and insurance ($2,500). Also, the initial outlay of the purchase itself included $28,450.00 of unrecoverable expenses.
So total lost expenses after 5 years is $196,978.
The remaining/outstanding mortgage (after 5 years) is $953,609.00, resulting in $446,391.00 of equity, again, assuming the property is still worth $1,400,000.
In the case of a purchase, there is $446,391.00 in equity, of which $280,000.00 was already earned. So, $166,391.00 was 'saved' by way of principle payments, and $196,978.00 was lost to expenses, resulting in a net loss of $30,587.00.
In Summary, renting resulted in a net loss of $175,403.00, while owning resulted in a net loss of $30,587.00.
In this example, owning out-weights renting. That being said, one would still need to sell to entirely reap their 'earnings' which comes at a high cost. In addition, the monthly home-ownership costs are VERY high. While renting cost $3,700 per month, owning costs $5,582, it could be argued that if a person could afford the home ownership costs, they'd get WAY further ahead renting for $3,700 and banking the extra $1,882 otherwise spent on maintaining a home.
And, I can't ignore some big assumptions made in this article. One is that the value of the home remained unchanged - many would suggest that the home could appreciate significantly in this time thus bolstering the case for home ownership. I've also ignored the selling costs associated with disposing the property, which can be significant.
Tomorrow, I'll compare a one bed, one bath in downtown Vancouver. I'll make the comparison comparing a $2,000 monthly rental versus a purchase (of the same property) with the minimum of 5% down payment.