Friday, 15 December 2017

Should I rent or buy?

Written by Posted On Tuesday, 06 September 2016 20:59

Having grown up in Toronto (and currently renting in a Liberty Village Condos), every day I have to hear the same things from my parents, aunts/uncles and family friends that I’m helping fund my landlord’s retirement and not my own. While putting together an extremely basic budget will quickly debunk that myth, most millennials are blinded by the dream of home ownership (and their parents advice). I'm not advocating or suggesting that prices will collapse, the value of homeownership has fallen compared to our parents' generation. 

If you haven't been following the Toronto real estate bubble (one that even Canadian banks agree on), the average single detached home price in the Greater Toronto Area (GTA) has jumped to $1.28 million in May 2016, with the average price home price reaching a record $782k. TO give you an idea of growth, National Post published the following chart only a few months ago:

National Post Average Toronto Housing Price

However, the average sale price of a single detached home doesn't really paint an overall picture of the market. With the average home price (including condos), at a record $782k, it really doesn't leave much hope for us millennials trying to get into the market. Here is a chart of average prices across Toronto since 1995 (works out to around a 7.4% return annually). This includes trendy areas such as fort york condos in Toronto, Cityplace Condos and Condos in King West.

Average Home Prices Toronto

With 7.4% being an unlevered return, older generations who purchased real estate (including multiple properties) with 15-20% down, it's easy to see why they are so keen on pushing the value of homeownership on their children and grandchildren (despite the growth in real estate prices, lack of income increases and high debt levels). TREB publishes a more interesting chart, an affordability indicator, which shows the average $ amount of household income used to cover mortgage payments (principal and interest), property taxes and utilities on the average priced GTA resale home:

TREB Affordability Indicator

 

Household affordability (or lack thereof) reached 38% (a percentage not seen since 1992 when the real estate market was falling. What's scarier this time, affordability continues to deteriorate even in the face of record low (and currently falling) interest rates. With a decoupling of interest rates to household affordability, we're adding additional instability to an already high-levered Canadian consumer.

While that provides a bit of a primer on what's going on with Toronto real estate, more importantly, how does that impact millennials. Anecdotally, I have friends and colleagues who are afraid of getting priced out and feel that landlord's are stealing their money (I'm sure their parents have something to do with this), however, these friends and colleagues are looking to buy blindly without looking at their income levels or finances. For example, a couple are currently looking to purchase a $500k condo in the downtown core while they currently rent close by for just under $1,000 / month (including utilities). 

In the case of this young couple, investing in the condo market comes at a very expensive cost. In two examples, one where the couple could rent that exact same place for $1750 and another where they continue to live in their current place at $985 / month, I look at the difference in their networth:

Rent vs Buy - Toronto

In the first example, the renter would have an additional $200k in net worth (in addition to the value of the property + capital appreciation gains). As a side note, I do not take into account tax advantages for capital appreciate gains on property (which would work in favour of purchasing, slightly). In the second example, staying put would net them an additional $707k over and above the value of the property.

Ill educated parents, who have been fortunate to have caught the bottom of a 30 year housing bubble, pushing their kids into real estate is a losing proposition in the long term. Lack of job security and long-term wage stagnation (atleast here at home) are other reminders that investing in "stable" real estate is as risky as ever.

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