Investoid

It seems like a lot of the personal finance blogosphere thinks home ownership should be a given. I don’t think I’ve seen one blog where someone is advocating renting, or that the bloggers themselves are currently renting. While this conventional wisdom is well known and widely practiced, is it always appropriate?

A home is an investment asset that you must analyze like any other. You need to look at the costs of acquiring and maintaining the asset, as well as estimate its future return. Since you need to live somewhere, you need to compare the asset’s future value versus taking the excess costs of servicing the asset over renting and investing the money in alternative assets. While doing some digging, I’ve found a couple of decent rent versus calculators:

• Strategis (Industry Canada) Website
• Genworth Financial Website

Genworth’s is more of a fluff piece since they don’t take into account alternative investments. I’d like to know how they arrive that their ‘mortgage capacity’ calculation too.

To take into account more variables, I created my own rent versus buy spreadsheet which you can download here. It incorporates assumptions for increases in rent, property taxes and utilities, and I include a field for insurance costs. I also calculated future value either 25 or 35 years out. After playing around with these calculators, I found the following:

1. The end values are extremely sensitive to changes in assumptions for the growth rate in housing values, alternative investments, mortgage rates, and rent increases. Adjusting these values even half a percentage point can affect end values by several hundred thousand dollars.
2. Term does play a factor. Depending on the variables, a buy decision may be appropriate at 25 years but not at 35 years. Thus, the affordability of the home (can you reasonably amortize the mortgage over 25 years) comes into play.
3. The ratio of monthly rent to initial mortgage size is a decent gauge of whether to buy or rent. I found a ratio of over 300 (for reasonable long term growth rates indicative of my area) to be a pretty good threshold to determine whether renting or buying is the right long term choice.

Using my calculator, I’ve plugged in some values that represent the current Edmonton, Alberta market. I’ve used a mortgage of $330,000 with a down payment of $30,000 (this is around the average house price in Edmonton as of February 2007). I’ve used a rent calculation of $1300 per month all inclusive, which I think is roughly equivalent. I assume an increase of 5% annually in rent and a growth rate of 4.5% in real estate value over time (which was calculated based on the long term compound annual return for a representative region of the city between 1981 and 2007 using data from Royal LePage). Taxes and utilities increased on a blended average of 6.5% per year, while the estimated return on alternative investments (eg. North American equity ETFs) was 7.5%.

Using these figures, the ending value in the buying option ($1.68 million) was about $460,000 more than the value in the renting option. So, it seems as though buying may still the appropriate choice in Edmonton, despite the huge runup in prices in the past year.

When I plugged in values for my situation the return is nearly identical. I’m at a point where I need to evaluate what’s the best option for me. Which leads to the obvious questions about the long term viability of the Alberta housing market. Will Alberta’s real estate boom continue? Or are we in a bubble situation? That will be the topic of my next post.