Thursday, September 06, 2007

Dedicated to all the Renters Out There - Mortgage Payment / Rent Ratio

You are smart. You won't be swindled into paying a premium in order to rent money from the bank and pay more in interest charges than you rent would be. Congratulations!

Clearly there are good times to buy and bad times to buy - guess which time we are in! Generally speaking, as a financial planner I would never recommend an individual buy a home unless mortgage payments are less than equivalent rent.




Methodology:

Mortgage Payment is calculated by using the Benchmark Greater Vancouver House Price, putting 25% downpayment towards the principle and having a 25 year mortgage with blended principle and interest payments. As an aside, the payment is $300 less when using a 20% down with a 40 year mortgage. I don't really know of too many buyers who have $150,000 required as a downpayment though.

Rent data is from CANSIM and purchased with your generous contributions. I would appreciate the feedback on the rent data I used. Here is my issue: CANSIM has rent data for 1, 2, and 3 bdrm apartments but not for single family homes. For comparison purposes I used a multiple of 2.3 times the 2 bdrm apartment rent data to approximate the benchmark SFH rental rates. Do you feel this is too high, too low, or whatever? Should I just use the 3 bdrm and ignore any potential differences?

26 comments:

VAB said...
This comment has been removed by the author.
Luc said...

Can you please clarify:
- what is the morgage amount
- what are the number on the left side of the chart
- "Time To Buy" - is this the name of the chart, or above a certain ratio it's time to buy

In re: "mortgage payments are less than equivalent rent"-
Suppose that I take a 5 yr mortgage for $1000/mo., which is more than the rent, therefore, "Don't Buy". But suppose I take the mortgage for 10 yrs, which translates into $600/mo, less than my rent, therefore "Buy"?

Warren said...

Great graph, thanks.

Luc I think its fair to say you're never going to be in a situation where 5% down over 25 years (plus maintenance, taxes, etc) is going to be below rent. If you're waiting for that you may be waiting a hell of a long time.

From an investment point of view, being cash flow positive with 25% down over 25 years is a good baseline.

Ulsterman said...

For first-time buyers, the concept of 25% down in the GVRD market is absurd. Given that many, many people live paycheck to paycheck, can you even imagine how long it would take to save 125k or whatever 25% down corresponds to.

patriotz said...

Luc I think its fair to say you're never going to be in a situation where 5% down over 25 years (plus maintenance, taxes, etc) is going to be below rent.

Why not? Cash flow positive (including opportunity cost on the down payment) was the norm before inflation took off in the late 1960's (hint: landlords like to make a profit).

Do you really think that any asset can yield less than the cost of borrowing money long term?

So what's the "new paradigm", Warren? If we get declining or even flat nominal prices, just who is going to rent out for negative cash flow?

Re lack of savings for a down payment, that's a bear argument, as we are seeing in spades south of the border. As prices go lower, the required down payment gets bigger.

solipsist said...

It's interesting that the rent values don't fluctuate as the own values do, but rise modestly, if inexorably.

I take it that the rent values are based on that same benchmark home?

patriotz - I'm too tired to understand why "As prices go lower, the required down payment gets bigger." Are you saying that in relation to lending standards? It seems counterintuitive.

patriotz said...

Yes it might seem counterintuitive.

What I was really talking about was the direction of the price change, rather than the level of the price itself.

Lenders were willing to loan 100% of price as long as they thought prices were going to go up indefinitely, because they could foreclose and still net the balance of the loan after costs.

But what if prices are falling? The lender needs a margin of safety to insure that he gets his money back upon foreclosure. The worse the outlook, the more down payment he's going to want. Exactly what's happening in the US. And of course it only accelerates the price decline as fewer and fewer are able to buy.

Warren said...

patriotz
Why not? Cash flow positive (including opportunity cost on the down payment) was the norm before inflation took off in the late 1960's (hint: landlords like to make a profit).

I said a long time, not never. The 60s was a long time ago.

Of course landlords like to make a profit.

Do you really think that any asset can yield less than the cost of borrowing money long term?

Of course not, now you're just putting words in my mouth. Read my previous comment to see what I really said.

mohican said...

I would appreciate the feedback on the rent data I used.

Here is my issue:
CANSIM has rent data for 1, 2, and 3 bdrm apartments but not for single family homes. For comparison purposes I used a multiple of 2.3 times the 2 bdrm apartment rent data to approximate the benchmark SFH rental rates.
Do you feel this is too high, too low, or whatever? Should I just use the 3 bdrm and ignore any potential differences?

RentingSucks said...

I was thinking rent seemed a little high but I assumed you were using SFH data directly. I'm not sure about SFH rentals. It is pricey to rent a whole home and most landlords would prefer to suite the top and bottom and get more revenue that way.

I have noticed in the past though that the cost for a 3 bdrm apartment is usually substantially mroe than a 2 bdrm and approaches SFH values so maybe this is a good metric.

I think the "rent a whole SFH" market is not that big because it costs too much. When faced with 2500 for a whole house or 1500 for the top floor 3 bdrm suite you go for the top floor. I would take a quick look at craigslist for whole houses to give me an idea of current market rates (scaling down a little because people sometimes ask the moon on craigslist).

What are the implications for a graph such as this? Is it a valid metric if most people are renting suites? I think it is. You can suite your house and capture a portion of this value if necessary even if you couldn't afford the whole thing.

Warren said...

mohican,

I'd agree with rentingsucks, assuming we are dealing with SFHs that are exclusively rented out, the best estimate is probably that they are renting the top and bottom separately, and I'd say they are both going for the 2bedroom apartment price, on average.

I think your rates are close enough to make the graph valid. There are so many variables at play, since a great deal of new homeowners are renting a basement out for lets say $1k/month, impacting their ability to "afford" a mortgage vs. rent.

The obvious argument there is they aren't getting full use of their SFH anyway.

jesse said...

Hi Mohican,

Thanks for taking a stab at rental rate estimates. In the suburbs rentals of the entire house (sans suites) are more common so I would look in local papers' classifieds to validate your numbers. I think the asking rates there will be roughly correct.

Vancouver proper gets fuzzy because of the basement suite issue, which if present would decrease rental rates of the upstairs portion of the house. Also suites are effectively priced into the house prices (decreases mortgage payment by $500-1K) so using Vancouver for this type of comparison should be done with caution.

Quick clarification: your mortgage rent payment ratio includes interest+principal, right?

freako said...

It's interesting that the rent values don't fluctuate as the own values do, but rise modestly, if inexorably.

That is because rents are not forward looking but based on current conditions, which are not nearly as volatile.

Prices are forward looking because a property can earn rental income far far into the future. Tweak the expected growth rate a smidgeon and the present value shifts dramatically.

JMK said...

Great chart!

I'm a little suspicious of the rental numbers - those sound the same as CMHC's, which are based on institutional appartment housing only: no suites, and no owner-rented condominiums. I think part of the reason real rents in the Sauder data have dropped according to this measure is that there have been very few institutional appartment buildings built since the 70s. They are getting crappier and crappier, and condos are filling in the higher-end rental market.

Recently CMHC decided to start including condos and suites in their Vancouver rental surveys. However, that will take a few years to be useful.

VAB said...

I looked at quite a few SFH for rent last year before settling on one in East Van that rents for 1600. This house is priced at 700K. I think this is an unusually large differential, but I also think 2500 is too high as an average. I saw lots of SFH in East Van for less than 2K. In Van West 2.5 sounds about right, and certainly there are some out there going for a lot more than that, but I don't expect to be able to buy a house in Van West for 700 K (which I assume was your figure for the average SFH in Vancouver). I would probably put the average SFH rent last year at between 1.8 and 2.

freako said...

I'm a little suspicious of the rental numbers - those sound the same as CMHC's, which are based on institutional appartment housing only:

Sauder uses Cansim data, just as Mohican. Not sure if CMHC buy the same data or produce their own.

I think part of the reason real rents in the Sauder data have dropped according to this measure is that there have been very few institutional appartment buildings built since the 70s. They are getting crappier and crappier, and condos are filling in the higher-end rental market.


Don't know if the rental data is quality adjusted, but since CPI calculations use the same data, you are basically suggesting that inflation is understated.

patriotz said...

Luc I think its fair to say you're never going to be in a situation where 5% down over 25 years (plus maintenance, taxes, etc) is going to be below rent.

8:29 PM, September 06, 2007

I said a long time, not never.

6:42 AM, September 07, 2007

Of course not, now you're just putting words in my mouth

No, just using simple arithmetic on your claim. Negative cash flow means an asset is yielding less than the cost of borrowing money.

And yes, I understand that in an inflationary environment an asset can be negative cash flow early on and be positive cash flow later. This is because you're getting real income but are paying back a nominal debt. But I don't see that on the horizon, at least in the case of rents which track incomes. Not enough to put things on the plus side in aggregate at current prices. I don't think the 70's are coming back.

Nominal prices have to come down.

Clarke said...

I suspect we may end up with more institutional rental complexes. There are lots of condo complexes, the bulk of which seem to be speculator owned, and are currently rented out. Assuming prices tank, there are going to be lots of these places up for sale.

talus said...

Victoria SFH's seem to run about $1800-$2200 per month (for a true SFH rental no up/down).

My current rental was just purchased for $750K in April and we rent for $1850/mo. I would say we are getting a bit of a price break on this one as the new owners wanted it rented quickly. That said only 5 couples showed up to the agent "open rental house" and only 2 couples qualified.

The house is 2000 sq/ft and I would almost bid rental houses at $1 sq/ft. depending on the area of town and quality of house.

patriotz said...

My current rental was just purchased for $750K in April and we rent for $1850/mo

That alligator is eating over $2500/month just in interest, never mind taxes, maintenance, and insurance.

I would say we are getting a bit of a price break on this one as the new owners wanted it rented quickly. That said only 5 couples showed up to the agent "open rental house" and only 2 couples qualified.

But I thought everyone wanted to live in Victoria.

Bubble? What bubble?

Patiently Waiting said...

"That said only 5 couples showed up to the agent "open rental house" and only 2 couples qualified."

I wonder how many of them would have qualified for a 40 year mortgage on that house?

talus said...

That alligator is eating over $2500/month just in interest, never mind taxes, maintenance, and insurance.

And in need of a further 150K (conservative) worth of foundation drain tile, new roof, new kitchen and baths.

That puts the total at 900K for a corner lot - 2000 sq/ft home.

Yup - things will only go up as every single person over 60 moves to Victoria. There is no other place in Canada to live --- right?

patriotz said...

And another problem. If Victoria loses appeal as an "urban" destination due to problems like this, just what is there to justify a price premium for retirees over the rest of the Island?

Drive from Victoria to Campbell River some time. It's a really, really big place, and it's not going to come close to being full, regardless of how many retirees have the means and desire to move there.

talus said...
This comment has been removed by the author.
talus said...

I couldn't agree more with the National Post article. I used to work downtown Vancouver and parked on the East Side. Victoria is very quickly working it's way to East Side Standards.

As for space - the drive to Campbell river only gets you 1/2 way up the island! There is an enormous amount of space for growth. Much of it with ocean, lake, river, and mountain views. All of it ready for development.

Or you could suck it up and take the 40 year mortgage on the 530K crack house.

Better yet -- the local rag (Times Colonist) had a nice little article on the how affordable a prime piece of Oak Bay real estate was and what it's future may hold. Unfortunately, negotiation may be a little slow... since the owners are all DEAD --- due to the 5 person murder-suicide.

Yup -- the realty pumping does not even stop here while the bodies are cooling.

talus said...

Here is a link...
http://tinyurl.com/2h6rdd
(best on an empty stomach)

Nice description - except for the blood stains on the walls and carpet now.