Saturday, March 17, 2012

Rent or Buy, or Rent and Buy

Another rent vs buy comparison made the CBC website again.

The premise behind the standard buy vs rent calculation, as this one, is comparing two scenarios: buying now and holding for (say) 25 years, or renting now and renting for the same 25 years. Chop off the monthly outlay difference between the two (and putting aside the strangeness of any situation where buying a condo is more expensive than renting, but that's another post altogether!), invest the difference at a "conservative" 5%, extrapolate past appreciation (condos have been appreciating at 5% p.a.), assume current mortgage rates remain for the duration of the loan, and do a comparison. No problem.

The problem, notwithstanding the brazenness of some of the above assumptions, is that there is an embedded out-of-the-money option built into the renter scenario not considered in any of these calculations. That is, a renter need not rent for 25 years; instead he may rent for 5 years and, should prices drop, has the option of buying at lower prices. While lower prices are not an absolute certainty, the option still has value, especially if one calculates a high probability of price drops. (Of course these days landlords are in effect paying renters to hold this option, a bit bizarre when thought of in those terms.)

4 comments:

The Raft Captain said...

Absolutely, one of the things never taken into account in the rent vs. buy calculation is the freedom of renting... at any point you can downsize, upsize, move closer to a new job site, or buy into the market when you feel it makes economic sense (it does NOT in Vancouver, by any stretch of the imagination). When you buy, if prices dip or interest rates rise (both of these will eventually happen), it may take a while to be able to sell and move, and it costs $$$. When you rent, it will cost only the price of hiring movers. Rents in Greater Vancouver are very affordable and there is a lack of suitable renters (since everyone jumped on the condo bandwagon). If you have a good job and seem stable, you can get a whole house in a good neighborhood for under 2 grand, all in (even under $1700 if you look and bargain hard). Just gotta stay away from amateur landlords. I saw a place advertised as a 3-bedroom, for $2000. When I went to see it, it was a 1 bedroom plus den, and a storage closet they said could be a child's bedroom. then they tried the whole "another couple wants it, if you pay $2350/mo and sign a 1 year ONLY lease, it's yours). This unit is still for rent on Craigslist after 6 months... bah.

Traciatim said...

I think it would be better to compare over 5, 15, 25, and 35 years. There are so many variables that you simply can't put in one calculations and asy "Look, X is better for everyone". The advice is totally dependent on local variables that you can't put in to a calculation.

Rents as a general rule are not higher than buying, but only in cases where either rents or prices drop or gain quickly over the other does the discussion come up. Sure Vancouver prices are pretty insane right now, but how about way over on the other side of the country in a suburb of Halifax? You probably can't reliably compare the two at all.

jesse said...

"Rents as a general rule are not higher than buying"

This may seem heresy but renting a car is more expensive than owning it, mostly because the rental car company wants to make a profit.

Not much of a name said...

Jesse, it was a very poor comparison to start with.
The so-called financial advisor overlooked the simple fact that based on the $61k salary, the hypothetical buyer would not qualify for the mortgage for the $470k property.