Image by Andy Beecroft
UPDATE: New version (v2.3) is now available.
Jin's Note: The following article was written by Jeff Lam, who created the most comprehensive rent vs. buy spreadsheet I've ever seen. The spreadsheet is available here, or by going to the 'Resources' menu, and then clicking on 'Rent vs. Buy Spreadsheet'. If the spreadsheet proves to be popular, I will create a web app version like with the real estate forecaster that also encompasses all the provinces.
I’m a regular visitor to this site, and I would like to share something with you guys. I don’t work in the financial industry, but I am interested in the way it works.
Up until a month ago I've been pretty clueless about the financial calculations and implications that's involved in deciding whether to buy or rent a place (a month ago I also did not see myself spending a few weeks working on a giant spreadsheet). As a result, over the last few years I've just dutifully saved up and followed the general mantra of:
1. Save up enough money to make a reasonable down payment on a place in order to reduce my mortgage.
2. Now is not a good time to buy in Vancouver or other major Canadian cities because real estate prices are due for a correction, which has been repeatedly harped since 2011ish.
Note: Since then, housing and condo prices have continued to rise. People sitting on the sidelines are stumped.
3. Take the money not spent on housing and invest in the market.
Of course, following these three guidelines seemed reasonable. However, I eventually got to a point where I started asking questions like what are the inflection points for buying vs renting? Even if I purchase a home and its price goes down, will it still give me a better return than forking over money to a landlord? How much does the property have to depreciate before it makes more sense to rent, or how much does the rent have to be before buying a home makes more sense even in declining real-estate values? Of course it is expected that real-estate will appreciate in the long-run, just like equities, so what makes more sense in the next 5 years? 10 years? 20 years? What about the difference in return between the two cases, and how much money I can see myself having in the future in each of the scenarios? You get the idea.
To answer these question I started doing some research. What I found was that there's a lot of anecdotal discussions out there, and that none of the calculators are comprehensive enough to paint a clear picture of where I am individually, or is geared towards Canadians. I wanted a model that also includes my income and savings, Canadian taxes, the tax deferred benefits of investing within an RRSP account, the effect of renting out a room in my property, and what I can afford.
I started creating my own spreadsheet at first as an excercise, then I realized that my friends and family can use it too so I beefed it up quite a bit.
You will find the results interesting - and I know that because you’re on moneygeek. For example, if you're lucky enough to own a house in Vancouver and think you've been doing great over the last few years and feel pretty rich right now, still consider this. Between 2009 and 2013 the S&P 500 has returned about 18.5% annually on average, which means a total compounded appreciation of 133%. This wallops the most agressive figure in the increase in housing prices over the same period of 45.3%.
Things I learned or enumerated by using this spreadsheet
- High home price appreciation does not mean that owning your own place automatically comes out ahead since there are the hidden carrying costs of home ownership, and lucrative returns can exist in other forms of investment.
- Depending on the mortgage rate and housing appreciation rate, it could be more profitable to take on a bigger mortgage and amortize over a longer period, since the mortgage acts as form of cheap leverage, even if you're paying more interest over the long term.
- Therefore, for the last few years it made sense to a lot of people to take on a big mortage and buy the most expensive property you can, as mortage rates were low and property values are appreciating at a high rate. They were enjoying great return on their leveraged money. However, conventional wisdom says this trend shouldn't be expected to continue over the long-run.
- Investing your money within TFSA and RRSP accounts makes renting a place and investing the savings even more lucrative.
- Due to the effect of inflation, mortgage payments made 10 years from now will be worth significantly less and be much easier to pay off.
How my spreadsheet is different than all the calculators I've seen:
1 Customized for Canadians living in BC
- Semi-annual compounding mortgage
- Mortgage payments are non-tax deductible
- Bristish Columbia, Canada tax rates
2 Uses your income and registered contribution room to calculate investment returns and taxes
- Considers power of investing within registered accounts
3 Allocates amount of money left over from home ownership to invest in the market
- Say you're rolling in money. After paying your mortgage, painting your audi, and supporting a hungry child, you still have money you want to invest
4 Allows you to rent out rooms in your dwelling
- Considers tax implications of renting out rooms
5 Includes commission for real estate sale
- However, I recommend setting this to 0 in order to have a fair comparison with the renting case, as it does not yet take into account taxes on investments when taken out.
- Planning on adding this eventually, which will take into account tax savings of money invested in TFSA
6 IRR (Internal Rate of Return) calculation
7 Affordability Indicator
- Spits out an error if you can't afford to make payments
- Shows you which year you have a shortfall
8 Calculations are somewhat transparent
- You can see all the steps should you want to
9 Allows for semi-discrete adjustment of mortage and house price appreciation rates
- Possible to enter in an estimate for the next 5 years separately from the long term historical rates. No point fussing over what the rates will be one year from the next more than 5 years from now because the economy will always prove you wrong.
Let me know what you think!