There are many factors that affect one’s decision to rent or buy property. Today we look at just one of them: your net worth.
The Victoria Real Estate Board maintains statistics back to 1978. That year, the average selling price for a home in Victoria was $64,000. Twenty-eight years later (2006) that figure was $521,000. That works out to 8.6% appreciation per year.
No one knows with certainty whether what has happened in the past is a reliable indicator of what will happen in the future, but let’s be somewhat optimistic. Victoria is a nice city and has the best climate in Canada, so, let’s assume that residential real estate in Victoria will appreciate at 6% annually.
I hasten to point out this isn’t a forecast – it’s just an assumption so we can get on with making some comparisons between renting and buying.
As you know, an investment in real estate is typically made with a relatively small down payment and a relatively large mortgage. What does that mean? Leverage!
For example, let’s say you have $10,000 to invest, and that you buy a modest condo for $200,000. We’ll worry about the details in a minute, but did you know that in twenty-five years, that condo would be worth approximately $824,000! Considering you only initially invested $10,000, that’s a very respectable return.
But of course your investment doesn’t end with $10,000. In fact, over the twenty-five year amortization period, you will pay a total of about $386,691 ($180,438 interest, plus your $10,000 down payment, plus repayment of the mortgage principal amount of $196,253).
Now for the details.
Let’s assume you will have monthly condo fees of $100, and annual property taxes of $1,000 a year. Those expenses bring your monthly total to about $1,558.
And in case you are wondering why your mortgage principal is $196,253 instead of the $190,000 you might have anticipated ($200,000 purchase price with a $10,000 down payment), it’s primarily because this is a ‘high ratio’ mortgage requiring you to pay for mortgage insurance. That ($5,253 in this instance) and about $1,000 estimated closing costs, have to come from somewhere, and it turns out they get added to your mortgage.
When you sell, anticipate paying around 3 to 4% real estate commission: let’s round it off to 4%.
Now lets compare renting. Let’s assume you pay $850 per month for a comparable apartment. Next, let’s assume you have the willpower to invest the difference between renting and ‘owning’: about $708 per month, along with that $10,000 you otherwise would have paid as your down payment on your condo.
Finally, we need one more set of assumptions. Let’s assume the annual rate of inflation is 3% and that your monthly rental payment increases accordingly. Also, let’s assume your investment returns 6% per year, after taxes.
If you were to plug all of the foregoing assumptions into this rent or buy’ calculator, the ensuing report would suggest that if you cannot remain in your home for at least 1.9 years, you should consider continuing to rent.
But after that, the results begin to differ dramatically. After twenty-five years, your non residential investment portfolio would have a value of $289,986. And of course, your combined costs for investing and rent would have totaled $386,691 (same as buying).
Which do you think is a better investment?
But that’s not the end of the story. We haven’t begun to look at how income taxes in Canada might affect the outcome of this comparison. So in an upcoming post, we’ll turn to that.
Bye for now,
...Victoria's blogging real estate professional.
