The Rent vs. Own Decision: What People Get Wrong
Ben Felix, Chief Investment Officer at PWL Capital, discusses common misconceptions surrounding the rent versus own decision for housing. He emphasizes that the conventional wisdom often overlooks critical financial factors. He clarifies common misunderstandings about home ownership and its financial implications.
Important Note: Ben Felix emphasizes that he will never send emails, especially from a Gmail address, and warns viewers of potential scams.
Common Misconceptions About Home Ownership
Homes as Investments
People often assume that homes are great investments. However, Felix argues that they generally are not. Focusing solely on the purchase and sale price can be misleading due to salience bias, the tendency to overemphasize emotionally charged or prominent details.
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Example: Buying a home for $40,000 in 1974 and selling it for $2 million in 2024 might seem like a fantastic return. However, the compound average growth rate over that period might be less impressive when compared to other investment options like the stock market.
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Data shows that, historically, stocks have often outperformed housing as an investment.
The True Cost of Owning a Home
Another frequent error is ignoring the total costs of home ownership. These costs are often hidden by salience bias.
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Ongoing expenses like maintenance, depreciation, renovations, and property taxes typically amount to 2-3% of the home's value per year.
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This cost is often overlooked when comparing the purchase price to the sale price, leading to an inflated perception of the home's return on investment.
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Academic research and data from Statistics Canada support this 2-3% estimate, emphasizing that a significant portion of home value increases is attributable to homeowner costs.
Mortgages as Wealth-Building Hacks
Many people believe that mortgages are a foolproof way to build wealth. While they can help, they are not a guaranteed path to riches.
Paying Off a Mortgage Reduces Housing Costs
It's a common belief that once a mortgage is paid off, housing costs decrease. Felix argues this is not always the case because it raises housing costs.
- The opportunity cost of having a large amount of equity tied up in a home, rather than invested in assets with higher potential returns, can outweigh the savings from eliminating mortgage payments.
Home Ownership and Happiness
The idea that owning a home automatically leads to increased happiness is another misconception. Studies suggest that the impact on life satisfaction is often less than expected.
- In some cases, home ownership can even decrease happiness due to the burden of maintenance and debt.
Renting vs. Owning: A More Accurate Comparison
Felix proposes a different approach to evaluating the rent versus own decision. This model considers several factors.
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It compares the long-term outcome of buying a home versus renting and investing the difference in costs.
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Renters invest the would-be down payment and closing costs in a stock portfolio.
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Renters save (or draw from their portfolio) depending on whether their rent is lower (or higher) than the homeowner's cash flow costs.
Model Outcomes and Considerations
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Using national average data, the model can demonstrate situations where renting and owning have comparable financial outcomes.
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The model allows users to input their own city-specific data for a more personalized comparison.
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Key factor: disciplined renters save and invest the cost difference between renting and owning.
The Value of Mortgage Debt
Mortgages are generally a favorable form of financing, but not necessarily a surefire path to wealth.
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Mortgage debt allows for early exposure to assets.
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The renter's potentially higher returns on invested assets can offset the owner's leverage.
The Wealthy Homeowner Myth
The perception that homeowners are wealthier because they own homes is misleading.
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Homeowners often have higher net worth due to other factors like age, income, and saving habits.
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Owning a home will not solve financial problems stemming from low income or poor saving habits.
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Property appreciation plays only a minor role in wealth differentials.
Tax Implications
In Canada, increases in the value of a primary residence are not taxed, which can be a significant advantage.
- For taxable investors, the opportunity cost of home equity is lower.
Benefits of Home Ownership
Despite the misconceptions, there are some valid reasons to consider home ownership:
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Tax advantages: Specifically, the tax-free capital gains on a primary residence in Canada.
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Hedging: Home ownership hedges against rising housing costs in a specific location.
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Commitment Device: A mortgage serves as a powerful forced-savings mechanism.
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Availability: Certain types of housing might not be available for rent.
Conclusion
While many common arguments for home ownership are flawed, renting isn't automatically superior. A disciplined renter can achieve comparable wealth to a homeowner by:
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Matching rental costs to the total cost of ownership.
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Saving the cost difference between renting and owning.
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Investing in higher-return assets.
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Avoiding costly investment mistakes.