Is Renting Throwing Away Money?
Young people face a lot of pressure from their parents and peers to own a home. Canadians in general have a high rate of home ownership at around 68%, and in many cases homeowners have seen tremendous growth in real estate prices for the past few decades. For these reasons many people believe home ownership is the ticket to wealth and renting is a waste of money.
But is renting throwing away money? Or, just ‘paying someone else’s mortgage’? We need to show a fair comparison of the rent vs. buy scenario to know for sure.
Is Renting Throwing Away Money?
Most people tackle the rent vs. buy problem incorrectly by framing it as the cost of monthly rent versus the cost of a monthly mortgage payment. The argument goes something like, “if your monthly rent costs as much as a mortgage payment on the same or similar property, then it’s a no-brainer to buy the home and build equity rather than flushing your rent money down the drain.”
Others argue that a better comparison looks at the true cost of home ownership, which not only includes the mortgage payment but also things like property taxes, insurance, and maintenance.
However, neither argument paints a truly fair comparison of rent vs. buy. What you need to look at, is the total unrecoverable costs in each scenario.
For example, a monthly rent payment is a total unrecoverable cost – an expense that does nothing to improve the renter’s net worth. A mortgage payment, on the other hand, only has partial unrecoverable costs – the interest paid on the mortgage. The other portion reduces your mortgage amount and therefore increases your net worth.
A winning point for home ownership, right? Not so fast.
We need to add up all of those additional costs that a home owner bears (property taxes, insurance, maintenance), plus any upfront money spent on a down payment, land transfer tax, title insurance, home inspection, etc. to close on the home.
There’s also an opportunity cost on the down payment and other closing costs. That money could have been invested instead of put towards buying a home.
Rent vs. Buy: Let’s Do The Math
Let’s look at an example of a renter in Toronto who’s paying $2,000 a month to rent a 600 square foot condo. The same condo is listed for $449,000.
To purchase the condo our renter would need to put down 5 percent, or $23,450, plus add another $17,062 to the mortgage due to CMHC insurance (required on all mortgages with down payments of less than 20%), for a total mortgage amount of $443,612.
Our upfront costs are not done, however, as we need to add in land transfer taxes of $10,910, lawyers fees of $1,000, title insurance of $449, plus a home inspection for $500.
Total upfront costs = $36,309. The opportunity cost of this amount in 25 years at 6% a year = $155,834.
Now let’s look at the unrecoverable monthly costs. The mortgage is amortized over 25 years and has an interest rate of 3.50%. The monthly mortgage payment is $2,215. Of that payment, $1,200 goes towards interest and $1,015 goes towards paying down the mortgage principal.
Then we have property taxes coming in at $375 per month, and we’ll also add the difference between home insurance and tenant insurance, which is $40 per month. We also need to add expected maintenance costs, which we’ll estimate at 1% of the property value per year, or $375 per month.
Total unrecoverable monthly costs (interest, plus property tax, plus insurance, plus maintenance) = $1,990
The unrecoverable costs for the renter and homeowner are nearly identical. The total monthly payment for the homeowner, including property taxes, insurance, and maintenance, is $3,005. Just $1,015 of that is building equity in the home. So, back to the rent vs. buy argument.
Rent and Invest the Difference
We have to assume our renter has an extra $1,015 available in their cash flow each month to invest. What are the expected returns for a 60/40 balanced investment portfolio over 25 years – maybe 6%?
$1,015 per month invested for 25 years at 6% per year = $686,627. Add the opportunity cost of the down payment and other upfront expenses and you’d have a portfolio worth more than $842,000.
Historically, many people would be surprised to learn that the return on real estate has been closer to inflation. Certainly with the run-up in home prices over the last two decades one should not expect significant gains from this asset class moving forward.
So the expected future value of the $449,000 condo in 25 years at 2% growth per year is $736,600.
Final thoughts
Is renting really a waste of money? Hardly. This is just one example showing how to frame the rent vs. buy comparison, but you can make a strong case for renting and investing the difference of the true cost of home ownership. Plus, we didn’t even get into the opportunity cost of the homeowner forgoing RRSP and TFSA contributions due to the higher cost of home ownership.
Related: Read Ben Felix’s take on renting in retirement
Who comes out ahead in this case? Clearly it’s our renter, who invested steadily for 25 years and ends up with a portfolio of $842,000. That’s compared to our homeowner who has a mortgage-free home in 25 years worth $736,600.
The next time you hear an argument that renting is throwing away money, stop and consider things like unrecoverable costs and the true cost of home ownership before drawing your own conclusion.
Absolutely fantastic, Robb! I don’t like it when I hear people say that renting is throwing away money and I love that you have done a comparison using actual numbers.
For some reason, Canadians have some kind of built-in aversion to renting. This can get someone into trouble, as they buy something they can barely afford and then when a roof repair, special assessment, job loss or, oh, I don’t know, a pandemic comes along, they can’t afford the payments or to pay for the roof, etc. This is when lines of credit and credit cards come to the ‘rescue’ and we end up where we are now, with historically high debt-to-income ratios.
I strongly encourage anyone who wants to buy to do serious number-crunching well in advance of making their decision. Can you still pay for repairs, save for retirement, kids education, etc.?
You’re either renting space or you’re renting money, so in the end, we’re all renters.
Thanks Steve! That’s why I like Rob Carrick’s real life ratio calculator. Rather than just asking if you can afford the mortgage just by comparing rent vs. mortgage payments, it takes into account unrecoverable costs as well as things like, I don’t know, can you still save for retirement or afford day care.
The argument for renting is only valid if one does the behavioural requirement of investing the difference. Often the mindset of a renter is short range and uses the lesser costs of renting to “spend” on other items of perceived value such as a nicer car. While the cost comparison of renting vs owner is not as glamorous as you have outlined, the one that buys the home is forced to fund the long term obligation of a mortgage and will have equity when completed. The renter may not have stuck to the optional investing plan and hence squandered the potential gain.
Very good point, most people won’t in invest the difference. Also some draw backs to renting are having a landlord who does not maintain the dwelling. Another downside to renting is you could be asked to move because the landlord has a family member needing a comodations.
Maybe I’m missing something but if I rent I get taxed on my investments then I pay the rent with after tax money. If I own my home the capital appreciates tax free and when I sell I don’t incure a capital gain tax. What’s not to like about that?
But you have not factored in things like annual (possibly significant) rent increases and the possibility of being evicted through no fault of your own (New owner, renoviction, etc). This also assumes that the renter will in fact invest the difference. Realistically, how many actually invest the full difference? Even if the numbers prove out, there are other considerations that may be just as, if not more, important. Stability comes to mind.
Well done. The are other more complex aspects like taxation and leverage. But that leads to many many obfucating factors that are best omitted.
Robb: Thanks for a great article. I’d like to add one wrinkle–I know people with three kids who have bought a large home, and turned the bottom floor into two basement suites. They live upstairs with the three little ones, and will eventually take over the bottom floor when the kids are older and their mortgage is paid off. Having two sets of renters makes a big difference to their mortgage payments, I am sure.
Not everyone has two renters, but I do know of others who’ve bought a home with a basement/in-law suite already set up, or they renovate to create one themselves. Not sure how that changes the calculations of renting versus buying….there are costs to having a tenant for sure, but in large cities even basement suites can command a good rent. Thoughts?
It complicates things for sure. If you’re renting out at a profit, great! However, if that’s the case you’re likely in an area where buying makes sense in the first place, and so it’s a separate question and not really a wrinkle on the core rent-vs-buy debate. If it’s close to break-even then you’re having to share your space and take on the risks of landlording to save yourself a move. And of course, many people have trouble with the rent-vs-buy math in the first place, and may actually be worse off in both ways by taking on the risk.
Hi Mona,
While renting out part of your home is certainly a great way to earn income that can be used to pay down the mortgage, keep in mind that you’ll have to declare the rental suite to CRA and you’ll be taxed on your net rental income. Also, when you sell, you’ll have to distribute the ACB and the sale price between the rental section and the principal residence section of the home to determine what portion of the capital gain is taxable. So having part of your principal residence as a rental suite means if you realize a gain when you sell, it’s no longer 100% void of any capital gains tax.
There are a lot if unknowns like rent increases etc., but it is an excellent point that the taxation is different. Behaviorally, I have several friends not good with money and being ‘forced” to invest in theur homes monthly has saved them from financial ruin
First of all -thanks for the calcs – it is a good article. That said, I think the question has to be framed beyond just a maths calc.
The article doesnt address the emotional element (which is probably the most imp element in this decision) – for most ppl, buying a house gives a sense of ownership, of having their own space that a rented unit can never provide (however wrong it may be since bank owns the house even if u purchase it with 20% DP). Secondly, in the last few years, there has been a huge runup in real estate prices and even if prices drop 10-20% (as being currently predicted), they will still be v expensive. So, if you were a renter 10 years back and are still renting vs, someone who bought a property at that time, I am sure you would have wished that you had bought the property (as prices have skyrocketed). That said, who knows how the real estate market will perform going forward.
However, the article assumes people will stay invested in the market for 25 years – this is not a correct assumption as very few ppl stay invested for long periods. A large number of ppl like to get in and out of markets and this will hamper returns. House on the other hand is a fixed sort of investment – not that easy to get in or out.
So, while the calcs are all good, I think an individual should consider the above points in making a decision.
Very good analysis
There were also some very good comments from above and it would be good to redo the calc taking into account more issues. Especially things like the tax impact and the inflation on the rent. I think the numbers may be similar. But as someone who does some financial coaching I always say that the forced savings is a major benefit and I also suggest that a house is not an investment (although people use if for that) In every case I have seen where some goes sideways in (later) life it is an awesome and comforting feeling to know that you have a place to live with NO mortgage. Do a survey and I suspect 90% or more of people who own there home in retirement are much better off than those who choose to rent. The real challenge for many people is that they just buy too big of a house and they have few options in spending/saving elsewhere.
One challenge I have with my financial planning clients is what to do with the paid-off home in retirement. More often than not the clients want to remain in their home and so it gets added to their estate. Or, they’ll look to downsize and move locations – only to find they spend a similar amount on the new place – no financial gain.
I guess the point is: when does the homeowner realize these tax-free gains?
Yes, you need incredible discipline to come out ahead as a renter. Homeowners also need discipline not to get in over their heads. At the end of the day you need to live somewhere, and both renting and owning provide financial AND emotional benefits.
I say all of this as a homeowner myself, knowing full well the cost of home ownership goes beyond just mortgage payments.
Great article as well as added comments. My big item first and foremost I ask to those contemplating buying is if your furnace needed replacing could you afford it? ie as an owner repair and maintenance are your responsibility. Most young people cut the edge fine on affordability to get the largest house, so the answer is no.
Also as others have alluded to in 20 years the owned house appreciation capitol growth is not taxed (primary residence) vs the savings ( TFSA helps mediate some of this) IF you have extra money (renter mentality many times do not save). The forced saving of being a home owner helps many people that are not savers put money aside.
My biggest point….. WHAT are the tax implications between the two variables. As they say “it is not what you make, but what you have at the end of the day that counts” But beware, who can foresee the future tax implications as the article is about foreshadowing 20-25 years. Simply eliminating the capitol gains for primary residence allowance swings way wide to renting for me.
Other points to consider is the stability of your employment and the possibility of moving. You lose your job or see a great opportunity in another location and you act on it. Now you own a house in the previous city and you have to sell. Now you encounter the selling costs, whereas if you rent then you pay a penalty on the lease. Much easier and less stressful than selling a house.
You make a great point S O’Brien. Buying a home is/should be a long-term investment. Factor in the cost of broker fees and land transfer taxes and any short-term profit is likely eaten up. I’ve seen many families come and go on our street in Toronto after just a few years. A new job may not even involve changing cities, just moving across town which in major centres could create long commutes. For the younger generation, it could be far better to remain flexible by renting. Also to consider is the possibility of relationship breakdown resulting in the need for new living arrangements.
Excellent article Robb. I concur with everything outlined in your analysis.
While I appreciate the merit of forced savings with a mortgage, and the capital appreciation often associated with long-term homeownership, the issue a lot of people encounter in retirement is that they’ve relied too heavily on these and they’ve neglected to sufficiently invest outside of this in an RRSP, TFSA, etc. And as a result, many retire house rich and cash poor.
I was never great at math. But after that house is paid off it’s a pretty nice feeling. If you are mortgage free at 55 vs being 55 and renting for the rest of your days I’ll take the paid off house anytime.
Jim,
Totally hear you and this is something I have thought about as well. The thing with owning is the expenses never stop. There will always be property tax, maintenance/repairs/upgrades/renos and in the case of condos/townhouses, special assessments.
These are expenses a renter will never have and the calculations I have done for people (and for myself) show that even after a mortgage is paid off, it is close in terms of cost.
I have been renting a basement since 2008 when I started to work with annual salary of 36k. Now I make 3.5 times more than what I made in 2008 but didn’t change my lifestyle and my rent has increased only $100 including utilities in the recent years. I have been investing since 2013 and my ROR is around 7%. I have seen many tenants lived and left in that house and the landlord had to go through a lot of hardship with some tenants. Home ownership or rental property business is not for everyone. I don’t know how to fix many things in a house, that’s why I buy REITS and happy with the performance.
If buying and selling houses are so much profitable as people think, sometimes I wonder why Warren Buffett doesn’t buy many properties in the North America with his 130B cash.
I guess it’s not for everyone and for me it wasn’t even about investment. It’s about a comfortable place to live and raise a family. I wouldn’t want to live in anyone’s basement and the privacy of a single detached home is hard to beat. Investing and home ownership doesn’t have to be an either or proposition. We have maxed rrsps maxed tfsas and a paid off house. All the money in our investments is just a bunch of numbers on a page that I look at every once in a while. The house on the other hand comes in pretty handy everyday. I guess I would hate to be a tenant and for me there is a ton of value in not being one.
This was a great read and likely pros and cons for both sounds like it all comes down to the ‘chicken and the egg’. I heard a joke where it was said “I ordered a chicken an an egg on line…I’ll let you know”
In the end it comes down to individual tastes and their means. This article has prompted ‘food‘ for thought.
I had someone tell me that when they retire they will sell their home and then rent. Their thought is that if they sell their house for $400 – $500k they can downsize and the money will provide them enough rent to cover many years of worry free retirement.
Similar to investing there are so many choices but building equity and a sense of security helps many sleep better. I have seen many get in over their heads and end in divorce which is equivalent to a stoke market crash where it all goes up in smoke. My final thought would be stay true to your values and create a plan, then stick to it as best you can.
It’s apparent by all of the comments above that the rent vs buy debate is definitely complicated.
I think that it’s a personal decision and one that should be made factoring both the numbers and the emotions. The problem is often times one side of the equation is not considered. Or the numbers being used are not the true numbers.
Thanks for your realistic breakdown of the numbers. Now someone can use this formula to evaluate their own situation and make an educated decision for themselves.
This is always a heated topic and great coverage of it 🙂 But I agree with one of the commenters above, that the renter will come out ahead if they invest the difference. Many people don’t do this though (invest the difference).