The first grownup decision I ever made was to buy an apartment condo with my wife. It was near the end of 2006 and we were moving out of our parents’ homes to a new city to start new careers. We needed a place to live. The only wisdom we had ever heard was, “Why rent when you can buy?” We dove into the real estate market with hardly a second thought.
The housing market in Calgary had been incredibly hot for the previous year. Between 2005 and 2006, the median price of single-family homes jumped from $250 000 to $350 000. We felt that we had to get into the market on its way up, or risk getting priced out of it. It ended up that we perfectly timed the peak of the real estate market. It hovered there for a short time before descending along with the world financial markets in 2008.
By my best estimate, our property lost about 25% of its value. Fortunately, we weren’t planning on getting out of the market any time soon, so we wouldn’t have to “realize” that loss. The situation still stung though. We could have saved around $50 000 by waiting to buy.
Since then, I have cautioned friends and family who have considered getting into the real estate market. I share my experience and get them to consider that renting a home might be the smarter decision, at least in the short term. After years of doling out the advice, I realized I needed more than just intuition. I needed some data to back it up.
Turning friendly advice into financial models
disclaimer: I’m not a financial advisor (not even close). Do not make any financial decisions based solely on this post. Do consider my comments to challenge your preconceptions. Do use the spreadsheet to test your assumptions.
Under what financial circumstances is it smarter to buy a home instead of rent? Since rent is (generally) cheaper than a mortgage payment, would it be better to pay rent and invest the difference? If real estate is a long-term investment, does it always pay off in the long run? With these questions in mind, I wanted to create something that could provide some answers.
Being familiar with spreadsheet-based mortgage calculator tools, I set out to build something using Google Sheets. A quick search for templates yielded two useful tools: a mortgage calculator by Frances Webb and a savings calculator from Vertex42. I used the approach and formulae from both tools when building my own.
I created something to compare two scenarios: pay a mortgage, home upkeep, and property tax, or pay rent and invest the difference between rent and home ownership. The value of each scenario is calculated on a monthly basis through the lifetime of the mortgage. The results are displayed on two graphs, one for the first five years, another for the lifetime of the mortgage.
All the input values are variables on the sheet, making the tool applicable in any market. I calculated some scenarios based on the Calgary housing market. To make these Calgary scenarios as relevant as possible, I used some recent real estate stats, some historical data, some older historical data, and historical rental data. The WebPlotDigitizer was extremely useful in extracting values from the plots found in the online articles.
Intuitively, the most critical variables are annual mortgage interest rate (IR), annual change in real estate value (RE), and annual savings investment return (SR). Changes in real estate value directly affect the outcome of the ownership scenario, changes in investment returns will affect the rental scenario, and changes in interest rate affect both. In reality, these variables are not completely independent, but that isn’t built into my calculator. It is up to the user to ensure the scenario being considered would exist in an economic reality.
Pulling the big levers
To get a sense for which circumstances provide an advantage for either home rental or ownership, I calculated sets of results. For each set, I held two of IR, RE, and SR constant while allowing the other to vary over a range which I consider reasonable. The variables held constant are the control variables, the variable allowed to change value is the independent variable, and the difference between the values of ownership and rental scenarios is the dependant variable.
Other variables were held constant as well: cost of home = $479 000; down payment or initial savings investment = $25 000; amortization = 30 years; initial rent = $1 800; initial annual home maintenance and property taxes = $3000; annual increase for rent, maintenance, taxes = 2.8%.
To display the sets of results, each plot has eight curves. Blue curves for the value associated with the ownership scenario, and red ones for renting. The lightness of each colour is related to the value of the variable, with the lightest for the lowest and darkest for the highest. Curves of the same lightness should be considered together.
I have plotted each set of results twice: once for the first five years, once for the lifetime of the mortgage (30 years).
Varying interest rates
Changing the mortgage interest rate affects the value of both the ownership and rental scenarios. A higher interest rate increases the minimum monthly payment of a mortgage, which creates a larger difference between the monthly mortgage and rental costs. As a result, a renter invests more when mortgage rates are higher thus increasing the value of the rental scenario. The value of the ownership scenario changes less dramatically, only reflecting a slightly different mortgage principle pay down profile.
According to these two plots, mortgage interest rates would have to be at more than 9% to consider renting a financially prudent option. The 30 year plot shows that for 3% interest rate, the value of renting actually becomes negative. This is because while the rent is increasing every year, the mortgage payments are not. Eventually, rent becomes more expensive than the mortgage payments and a renter would withdraw money from the savings investments.
Varying real estate values
Manipulating the rate of change for real estate values has a strong impact on the ownership scenario, but does not affect the value of renting (in reality there is a relationship – see historical rental data , but I didn’t build that into the calculator).
Since the value of the rental scenario is not affected by changes in real estate value, the red curves on the plot are overlain on one another.
In the short term, it is not surprising that renting provides more value than ownership when real estate values are static or falling. In the lifetime of the mortgage, however, the value in renting and owning is close even when the value of the real estate is constant. This is another result of monthly rent increasing above the mortgage payment.
There is as much upside as downside in the value of ownership in the short term, but over the lifetime of the mortgage, the upside far outweighs the down.
Varying savings investment returns
Changing the rate of investment returns has a strong effect on the value of the rental scenario, but does not effect the value of ownership (in reality there should be a relationship, but I didn’t build that into my calculator).
Since the value of the ownership scenario is not affected by changes in savings investment return, the blue curves on the plot are overlain on one another.
In the short term, varying the investment return rate has little effect of the value of the rental scenario, but the effect becomes very dramatic in the lifetime of the mortgage. The rental scenario requires annual investment returns of 10% for the lifetime of the mortgage to achieve almost the same result. The effect of monthly rent becoming more expensive than mortgage payments can be seen for the rental value curves for investment returns of 0% and 5%.
Considering these financial models, it’s hard to imagine a scenario in the Calgary real estate market where it makes sense to rent a home for the long term. However, there are some instances where it does make sense for the near term. Given a financial outlook, the rent vs buy calculator shows if home ownership makes better financial sense.
I wish someone had questioned my assumptions on home ownership before I jumped into the real estate market. And if I had heeded their cautions, something like this calculator would have provided some useful insight. It’s too late for me, but now that I’m armed with more than intuition, I feel much more confident about giving friendly real estate advice.
The read-only version of the tool is available online. You can download it to test/tinker/hack to your purposes. Love to hear if you find it useful.
I decided to use Google Sheets so the calculator would be easily shared. Using Sheets isn’t the most enjoyable experience. However, calculations sometimes took seconds to run, and options for charting were very limited. Given another shot, I’d consider coding up an interactive tool. Someday…