Investing vs. Renting: “In Principal”
From The Condo Bible for Canadians, Everything you must know before and after buying a Condo, by Dan S. Barnabic. Copyright © 2013 by Dan S. Barnabic. Reprinted with permission of Neon Publishing Corp.
For many people, it is more advantageous to own rather than rent property. Over time, the value of property appreciates, and equity in the property increases as monthly mortgage payments gradually reduce the principal amount of the mortgage. Renters, in contrast, pay a set monthly amount to the owner for use of the space. Instead of building their own equity in the rented property, they are helping the apartment building owner build equity.
But on the other side of the coin, the renter remains worry free with regard to mortgage payments, maintenance costs, taxes, assessments, and fluctuating interest rates. The privilege of peacefully enjoying the rented premises at a set monthly rate may be more advantageous to some than tying themselves to often considerable and unpredictable financial obligations.
It all comes down to a matter of principal and affordability. While most people buy property to build equity or wealth, others choose to build their wealth by saving or investing in business opportunities other than real estate.
To those who think that, over time, real estate is a better asset than the stock market, consider this: $100,000 invested in Coca-Cola stock in 1990 was worth $1-million by the year 2000. Of course, it would have taken one hell of a fortuneteller to convince an investor to put that kind of money into the stock market and all on one stock, to begin with.
This is perhaps an extreme example, and I am by no means suggesting that investing in the stock market is always better than real estate. The fact of the matter is that any investment carries risk.
This chapter tells the story of Mr. Jones and Mr. Smith as a case study of renting vs. owning.
Mr. Jones owns a condominium unit. Mr. Smith rents a unit of the same size in the same complex. The following comparison is based on a five-year period and may apply equally to individuals with small or no equity and those with larger equity in their condominium units. In our example, both Mr. Jones and Mr. Smith start with $67,000 in their savings accounts and earn similar wages, which makes them financially equal.
Mr. Jones decides to invest his savings in the purchase of a condominium unit.
Mr. Smith decides to invest his savings in municipal bonds and use the investment and the interest they earn to defray his rental obligation. The municipal bonds yield 5 per cent per year and mature in five years. For the sake of this case study, even though his monetary return is realized at the end of a five-year period, we will consider it to count as recouping his rent paid during that period.
Mr. Jones buys his condominium unit for $250,000 with a 25 per cent down payment equalling $62,500. In addition, he incurs the closing costs, such as legal fees, mortgage arranging fees, land transfer tax, and other disbursements, all totalling about $4,500. Therefore, his total out-of-pocket cash investment is $67,000, the actual amount of money he had in his savings account before the purchase.
He obtains a five-year term mortgage for the balance of the purchase price of $187,500, amortized over 25 years at a 5.5 per cent yearly interest rate with a monthly payment of $1,132, including principal and interest combined. In addition, Mr. Jones is responsible for a $350 monthly maintenance fee, plus realty taxes of $150 per month. His total monthly obligation comes to $1,632. After five years (60 months), his carrying cost amounts to $97,920. If we add to that his down payment and closing cost of $67,000, Mr. Jones’ overall financial exposure amounts to $164,920.
In comparison, by paying a fixed monthly rent of $1,400, Mr. Smith spends $84,000 during those same five years (60 months) on his rental accommodation cost. Having invested his available cash of $67,000 into municipal bonds, his overall financial exposure after five years amounts to $151,000.
The difference in financial exposure between them over five years comes to $13,920, in favour of Mr. Smith. This difference is important to remember, because, notwithstanding Mr. Jones’s equity position after five years, his overall financial exposure was higher. From this perspective, Mr. Smith comes out ahead of Mr. Jones.