3 Ways Renting in your Twenties Will Help Your Retirement

I was watching my boy Preet Banerjee on Global News the other day and wasn’t surprised to hear him bring his usual brand of high-intensity charisma and sound advice to the broadcast.  What I was surprised by was the sentiments of the people hosting the segment.  They just seemed shocked that anyone would advocate the idea that renting might make more sense than buying a place to live right now.  This is a good indication of just how widespread the obsession with owning your living quarters has gotten in Canada, as well as one of the chief reasons why housing prices continue to blow through ceilings across the country.

I’m certainly not the first guy to come up the idea that in many cases renting is better than owning in today’s overheated Canadian housing market.  I think it bears reiterating though just why this is so obviously the case for young people in Canada’s urban centers (unlike us country folk who can still buy homes for under 200K).

1) You Can Move to Where the Jobs Are

Renting in your Twenties Will Help Your RetirementI’ve heard several people use the rule of thumb that if you don’t think you will be in a house for at least 10 years then it doesn’t make sense to buy.  This line of thought revolves around the idea that closing costs and the pain in the ass factor associated with buying and selling a home just aren’t worth it unless you are going to put down roots.  If you’re looking at it from an investment point of view, the thousands of dollars you’ll pay in closing costs every time you buy and sell your home will often negate a large part of the equity gains your house has made.

Related: Why Starting Your Career Rurally Makes Sense

More importantly than the raw arithmetic associated with buying and selling a house though, is the fact that owning a home radically affects the mindset of a young person who should be open to pursuing all the career opportunities that are available in today’s economy.  Gone are the days where everyone was guaranteed a job in their backyard due to a rapidly expanding businesses across Canada.  The reality that has supplanted that employment utopia revolves around you moving to where the jobs are as opposed to waiting until they come to you.  This often means spending some time in a place you would not otherwise have considered.  By purchasing a home you are severely limiting your geographical options.

2) Properly Invested Stock Returns Trump House Wealth

Despite what the past decade might have you think, real estate has far underperformed stocks when it comes to long-term returns for each asset class.  If you’re looking at comparing a rental property versus stocks the math gets a little more interesting, but if you’re comparing making a large mortgage payment on a principal residence with making a smaller lease payment and investing the difference, the stock market returns are going to win almost all of the time and under almost under any circumstances.  This is especially true if you have room to invest within your TFSA or RRSP like most people do.

The advantage stocks have as an asset class is enhanced by the fact that as a young person in your 20s you have the luxury of an ultra-long investment horizon.  Because you won’t need to tap your retirement savings any time soon you can afford to take a pretty high amount of risk and allocate 80-100% of your savings towards stocks.

Related: TFSA vs RRSP: Head to Head Comparison

Some people claim that they will downsize when they are older and use that strategy to tap into the pile of cash they have sitting there in their home.  There are a few huge assumptions that I would caution against in that line of thinking, but a final consideration should be that stocks (especially the broad index ETFs that I prefer) are much more liquid than an investment in your house would be.  For another detailed look at this comparison, check out Preet’s article about why he recently sold his house and began renting.  Of course this stock investing strategy only works if you actually invest the money you save with renting and don’t spend it on consumer goods like most people do (as opposed to the forced savings program that is an automatic mortgage payment).

3) Housing Costs = Black Hole

If you’re like me you never really considered the costs of owning a home as you grew up.  The house was always there, mom and dad made sure it didn’t collapse, and it had little to do with money stuff.  Sometimes the realities of adulthood kind of suck.  Many young people fail to take into consideration stuff like mortgage insurance, property taxes, and the inevitable repair costs that come with buying a first house (especially since most first-time homebuyers are buying houses that will require their fair share of maintenance because they are not new).

Related: How to Use the Home Buyers Plan

 

These housing costs can escalate quickly, and if you are already stretched to the limit because of a large mortgage and the other costs that come with being a young adult, then you’re probably going to rely on a steady diet of credit to cover these bills in the short term.  This can quickly spiral and is basically the reason why a lot of young peeps with good jobs still consider themselves “house poor”.  Make sure you go into a commitment like homeownership with your eyes (and wallets) wide open.

The Best Investment You’ll Never Make?

With the IMF and other financial organizations all saying Canada’s housing market is overpriced by any measure (The Canadian Real Estate Association said the average existing home sold for $391,085 in October, a 9.8% increase from a year ago), it should come as no surprise that that in housing-to-rent comparisons we top the G20.  This doesn’t change the fact that if your parents are like most Canadians they probably told you that, “My house is the best investment I ever made.”  The problem there is that is likely the only investment many Canadians have ever made – and it’s not really an investment if you never plan to sell it.  If you buy a house in order to rent part of it out and have an eventual plan to sell it as you downsize later in life, you might be able to convince me it’s some sort of an investment.  This doesn’t fit most peoples’ mindset however.  You also might want to consider that while this sentiment is popular today, after a prolonged period of stagnancy in the housing market, looking at your local paper and seeing the “For Sale” section isn’t quite as uplifting or alluring as during these good times.

There are benefits to having the forced savings of a mortgage payment when you’re in your twenties, but you can easily duplicate this strategy by having money taken off of your cheque through easy-to-implement online banking strategies.  There’s really no excuse for not saving a part of your income anymore (if there ever was).

Before you scramble for your share of the Canadian middle-class dream, think long and hard about the sacrifices you’re making in return for a house or condo.  You just might have to work about 10-20 years as a result!

13 Comments

  1. SST on February 27, 2014 at 9:22 am

    A few points (not necessarily in coherent order, or coherent for that matter!):

    1. People in their twenties have only known a Canadian housing boom. Important psychology. Just as investors (and voters) have short memories, young people have only one point point of reference. Tough to argue a POSSIBLE bubble in the face of a decade of ramping prices.

    2. Years ago some Nordic researcher compiled global real estate data for the last few hundred years. His findings? Real estate appreciates at ~1% annually.

    3. Having said this, there have obviously been pockets of insanity. You can definitely make money if you are accidently in the right pocket or, more difficult, have foresight and a plan. Which is a bit akin to simply buying an index fund (an accidental bull) or seeking out the under-valued triple baggers. Asset class market timing is very possible if you are willing to be astute.

    There’s a reason the most wealthy households are located in British Columbia — real estate. A relative in Vancouver bought ~12 years ago for $300,000, now assessed at $900,000. That’s 16% annually (simple) and now has $750,000 of investable equity at his disposal. Just one example, which dangerously leads back to point 1.

    4. Both renting and “owning” are huge social stigmas in North America. Completely absurd. Remember Bush’s home ownership mandate? It’s a destructive mindset. Most of the world’s population will never experience ownership and yet we cling to a sixty-year old ideal like it’s oxygen and water. If you are entering the current market, the decision should be easy — rent. Sit down for a few minutes with a calculator and you should be able to come up with the same conclusion. When I bought my first house the ratio was about even over 25-years; that is I would pay the same for all-in housing costs as I would for rent, so I bought. But now? Forget about it.

    5. One very important and needed step is the dissolution of the CMHC (mortgage insurance). It’s original purpose has long been negated and rendered useless. I would be bold enough to say that it’s very existence helped fuel, in part, the Canadian RE bubble. If I want to buy a stock on margin, the bank requires I have a very specific amount of cash on-hand and will then lend me a very specific amount of cash. Period. Even though my leveraged purchase is backed by an asset. I cannot tell them I have less than the required level but I have margin/default insurance provide by the government. CMHC needs to go, for a lot of reasons.

    6. When it comes to retirement down-sizing, both housing and stocks face liquidity risk. You’ll see that when the Boomers start retiring en masse (can they?!). There will be a glut in inventory driving housing down, but perhaps paradoxically driving condo prices up. As well, and yet to be seen, when Boomers start cashing in their stocks for living expenses, will the waterfall of sellers create a buyers market? And who will be buying? With so many Canadians in debt and under-earning, where will the money come from?

    7. Finally, and argued until the end of time, a house/principal residence is NOT an investment or asset. Neither the “forced savings” not the appreciation can be accessed or utilized expect through an interest bearing loan (i.e. you are paying to use your own money!). You also have to continually pay in order for your “investment” to maintain or increase its value, whereas I can buy a share of KO and let it ride for 50 years without ever spending another red cent. The market decides on the price of both the house and the stock, but the house requires continued input to maintain that market price.

    Just some thoughts. 🙂



  2. Phil on February 27, 2014 at 1:26 pm

    Housing I think comes down to individual circumstances. For myself owning a home has kept me grounded to reality of costs and has taught me valuable DIY skills. additionally entertainment costs from when I was renting also dropped as with the home we chose, we have space to entertain… Now remembering back to when I started out for my first career type job in TO, yep I rented. Why? because I did not have a clue as to what I wanted to become or where I wanted to stake roots. As you mentioned I travelled to where my first job took me to. From Ottawa to TO. I spent 2 years in TO, then returned back to Ottawa for my next venture. Once it was clear this is where I wanted to be, my GF and I started a house down payment fund while we rented. Once we accumulating, we started house location hunting and within a year had a house built outside the city and the rest is history, well sort of I guess we have been in that house now for 15 years now… So as much as I agree with the article for most things, I dis agree that renting is cheaper than owning “now”. Arguably depending on each ones situation there will and has always been a tip point. This is not a recent thing, but rather always a changing thing for each situation. As to the point about “Properly Invested Stock Returns Trump House Wealth”, maybe, but if I calculated the financial benefits for owning my own home, especially from a raising family standpoint, pride of ownership thing and like I said the DIY learning thing… well those items are really incalculable. Now I realize I am only a point in that statistical data set, and that my wife and I are rather unique in how we operate, especially since I am the at home dad, who does not mind vacuuming, cleaning toilets and having dinner ready for when my hard working wife returns home from a day at work… but we are a statistic somewhere in that data set. problem I guess is we are that outlier that most exclude when things get generalized for the masses – Cheers.



  3. Kyle on February 27, 2014 at 7:12 pm

    Thanks for the insights Phil!



  4. Kyle on February 27, 2014 at 7:15 pm

    Great data-driven response SST. Do you have a link to that Nordic dude? I’d be really interested in checking that out. I agree on pretty much everything including the CMHC. For my sake, I certainly wouldn’t mind if a glut of Baby Boomer houses suddenly starting hitting the market – just as interest rates should start edging up in a few years!



  5. Phil on February 27, 2014 at 7:36 pm

    Lots of good stuff, and I cannot disagree. Being an engineer, your comments are very well thought out and calculable. The only thing it does not consider are those things non calculable, like quality of life. For me I have pride in ownership, and accomplishments, and yes, maybe my money might have done better in the market, but I would still buy again if I had to re-live my life. So at present, my 1500sqft house on 2 acre property costs all in just shy of $1500 to operate an maintain. It has appreciated since we bought at a rate of 6% annually since we had it built (160K, now 400K). yes I we have made improvements, but all those costs are included in our $1500/month “rent” cost. Now if I had rented and all my money was invested in the markets back in late 2007/ early 20008, where would I be had I panicked? Home ownership isn’t about just dollars and cents, It is about the quality of my life and what I like to do, under my rules. Again every point you make above is valid, it’s just ownership provides my life balance. I should state, my wife and I paid out our mortgage in 5 years, and used what is now coined the smith manoeuver to invest in stocks while paying down the mortgage. In actual fact over the 5 year period, the bank made 11K off our mortgage, but because of off setting my investment gains and tax credits, it really only cost about 4K… Like I said below, we’re probably unique – Cheers.



  6. SST on February 27, 2014 at 9:03 pm

    @Kyle: there’s no way I could find that ultra-long term “1%” data. I saw the guy on the news or something a few years ago and that 1% appreciation stuck in my head.

    However, Credit Suisse published a 2012 report which included a G6 composite of housing prices1900-2011.
    Australia came out in the lead with an average of 2% per year; the US came in last with 1% per year.
    (Interestingly, Australia also had the best performing stock market of the last century.)

    The report also states:
    “…one must remember that a home is a consumption good, as well as an investment. Investors can never build a properly diversified portfolio of housing. The attributes of a home are a by-product of its intrinsic utility to those who dwell there.”

    Draw your own conclusions.



  7. Richard on February 28, 2014 at 7:42 pm

    I used to own a house and I rent now. The monthly cost is half as much and someone else does major repairs for me. Not learning DIY skills is fine with me when I’m being paid to let someone else do the work for me 🙂 On the other hand my entertainment costs have gone up a bit because I now have time to enjoy myself instead of fixing things around the house. It also gives me more time (and cash) to increase my income so I’m pretty happy with it.



  8. Kyle on February 28, 2014 at 9:38 pm

    Thanks SST, that is very useful information to have. Is there any room in your estimation to say that as the world reaches is population saturation point that RE might become more profitable? I guess even if RE as a whole becomes more profitable, it doesn’t really help the idea of having your house as an investment being ridiculous.



  9. Kyle on February 28, 2014 at 9:42 pm

    Having more time to spend money on stuff you want isn’t a bad “worst part of the deal” to have eh Richard? Where abouts do you live if you don’t mind me asking? Also, what sort of ammortization did you have on your mortgage – just so we know what you’re comparing.



  10. SST on March 1, 2014 at 7:35 am

    Kyle — by “more profitable” do you mean ever-increasing valuation or an increase in landlordism?

    As states earlier, a homeowner — as opposed to a mortgage payer — cannot access the “profit” in the real estate except through a loan or a sale of said property, but then the utility of the property has been lost.

    A landlord could see more profit if he were to raise rents in parallel with market prices, but would he have any tenants? He could also access any equity in his properties to acquire additional properties to increase income. In this scenario outright ownership isn’t as important as cash flow. Don’t know how this compares with other regions, but I recently read that ownership in Vancouver is 50%, meaning 50% of the people are holding 100% of the profits (as well as the risk).

    And I would question to whom does the profit flow? In my personal example, over the last decade my property tax has increased more than the assessed value of my property on a percentage basis (both tax and assessment are government issued). As witnessed countless times, the gov’t does as it wishes with us; ever-higher RE valuations may simply mean above-and-beyond levels of taxation, negating higher profitability.

    (I also believe the global “population saturation point” will be exceptionally long after we both bite the dust, so no use worrying about that! If it does come more swiftly, I’d forget about housing for profit and seek agriculture investments. Lot’s of ways to create affordable housing/shelter, not so many ways to grow food.)



  11. Kyle on March 1, 2014 at 11:30 am

    Yup, that all makes perfect sense SST. I was speaking more from a landlord’s perspective, but again, you’re comment about agriculture seems completely logical. I envy many farmers out there today for this very reason! Talk about an inheritance to pass on to your children!



  12. mpars on March 3, 2014 at 12:56 pm

    I’m currently renting a townhome with my common law partner and I couldn’t be happier. Yes, the rent is the cost of what we’d be paying for a mortgage payment BUT these are the things we are not paying
    -condo fees
    -repairs (like the $1k+ to fix a furnace venting issue)
    -upkeep (furnace +AC checks, deck staining/replacement etc, replacing parquet floors that are starting to come up)
    -replacing appliances (DW, stove, fridge, washer, dryer, furnace, AC unit)
    -taxes, mortgage insurance, home insurance (we have contents insurance, landlords have home/structure insurance)
    -closing costs, real estate fees etc

    We like to think we are pretty financially savvy people so we’re putting away and investing the difference (plus some) for a possible downpayment if we ever choose to buy in addition to putting away retirement savings. Our landlords said that they may consider selling to us as they liquidate rentals for their retirement, so that is also an option.

    We are also childless and starting our careers so we enjoy the flexibility of being able to stay as long as we want and move with short notice if needed.

    I’m firmly in the “pro-renting” camp but that is ONLY because we’re diligent about saving the difference and investing it properly to ensure that we’ll have equivalent equity to a home once we’re ready for retirement. Just because rates are low doesn’t mean we are following the advice to “get in while we can” because we don’t want to be squeezed out when we can’t. The best advice I have ever heard is: The best time to buy a house is when you’re ready to buy a house.



  13. R on March 6, 2014 at 7:51 am

    I think that you (generally everyone who is interested enough in personal finance to read blogs about it) under estimate how bad at saving most people are. I totally agree with the idea that if you live in a large city centre and are disciplined enough to save and knowledgeable enough to know where to invest, you can be at the same or better place than a homeowner financially.

    But what if you’re average and both aren’t good at saving and don’t know where to invest? For those people, which is most people, it’s better to buy a house as soon as possible and live in it. Most people are motivated to save enough to pay their mortgage. The same people may not be motivated to save $500/month and then “spend” that $500 on an investment that they won’t get to spend on something fun until they’re in their 60s. Or even worse, give up spending $500 on something fun now, let it grow to $5000 in their retirement and even then, only spend the $5000 on some necessity instead of fun.

    Let’s say some young couple in their 20s buys a $300,000 house with only $15,000 down payment. Even worse, it was gifted from their parents because they’re too bad of savers to save it themselves. They start out with a mortgage of $292,500. And let’s say they are afraid of their budgeting skills if the rate went up, so they locked into a 5 year fixed mortgage instead of a variable one. Their rate is 3.99% and their monthly payment (yes monthly because they would rather use their 3 pay check months to buy more stuff than to buy more house) is $1537/month.

    After 5 years, their mortgage debt will be $254,500. Let’s say their house went up in value 2% per year. So the market value is now $331,000. They list it for $340,000 and get an offer of $325,000, they’re a little disappointed but hey, they take it.

    After 5% realtor fees, they’re left with $308,750. Then they pay legal fees of $1,750, mortgage of $254,500 and their parents the $15,000 (yes, interest-free loan).

    They’re left with $37,500 before house repairs. Let’s say they spent $2000/year maintaining their house. So the grand total that their net worth has grown from owning a house is $27,500.

    Let’s say the other scenario is that they rent an apartment and pay $1200/month to live in it instead and do not get a down payment gifted from their parents.

    In theory, they could save $337/month or $4044/year + $2,000/year. So even without investment appreciation, they could have $30,220 and be ahead of the home owning scenario.

    But first of all, would they save the additional $2,000/year that they had to spend on home repairs? Or would they only save the $337/month. Probably only the $337. In which case, it would take a 10%+ return on investment to get to the same $27,500 range.

    The only flaw that I can see so far in my numbers is that 2% per year increase. That seems pretty conservative to me but perhaps it’d be lower in some areas.

    So my main point is that for the average person, not the savvy, disciplined investors, their house is probably the best investment they will make because they aren’t disciplined, savvy investors and in spite of that, they can actually grow their assets and net worth. And they continue to be motivated because they see their house every day, it’s in front of them, whereas long term investments are so far away they can’t see them and touch them and they’re harder to care about.

    I agree, it’s silly. People should be better savers and investors than they are. But until they become that way, they should stay with the tried and true and own a home as soon as possible.

    I don’t think that renting and not saving is better than buying a home and not saving. I don’t think renting and investing the difference but being an amateur investor who doesn’t understand the markets or how to invest properly is better than owning a home and investing less or not at all. It’s only those good, disciplined savers and knowledgable investors that can profit from that situation. Since those people are rare, it’s better to encourage people to buy homes.

    People growing their assets only in their home is better than renters losing money on the stock market. Yes, a home is not an investable asset. Yes, it maybe shouldn’t be included in your net worth etc.



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