Finances & Real Estate Why it’s not always better to buy

Why it’s not always better to buy
Jason Heath | Sep 18, 2012

Financial Post

Many people take it as a given that buying is always a better financial decision than renting real estate. That said, there’s little doubt that Americans who bought homes in the past five to seven years would have been better off renting than buying. So recent history, not far from home, suggests one should question this rule of thumb on home ownership.

It’s hard to blame Americans for following a rule of thumb when it meant following a well-entrenched American dream. And how could they resist when former Federal Reserve chairman Alan Greenspan was suggesting things like: “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.” The financial industry followed suit by introducing exciting, innovative products like interest-only mortgages, 110% loan-to-value – all while borrowers flocked into variable rate loans.

Greenspan helped the cause by lowering the Fed’s key interest rate to 1% in 2003, a 45-year low at that time. Furthermore, the Fed largely abandoned loan standards in the next few years, because institutional investors who purchased sub-prime loans from the banks effectively helped “securitize” these rather unsecure debts.

And when George Bush signed the American Dream Downpayment Act to provide downpayment assistance to sub-prime borrowers and reduce real estate closing costs — a novel concept, in theory — it’s not surprising that real estate values surged. What is surprising is that current Federal Reserve chairman, Ben Bernanke would declare in late 2005: “House prices have risen by nearly 25% over the past two years. Although speculative activity has increased in some areas, at a national level, these price increases largely reflect strong economic fundamentals.” Oops. Even central bankers make mistakes.

Thankfully, our central bank and politicians, despite our own relatively strong economic fundamentals, seem to have different views on mortgage debt here in Canada. We’ve seen a decrease in the past six years from 40-year mortgage amortization periods to 25 years for insured mortgages to reduce excessive borrowing on new homes. Since June, Canadians can now only re-finance their homes up to 80% of the appraised value, to limit over-extending oneself on their current home. All the while, the Bank of Canada continues to warn us about real estate prices and high Canadian debt levels.

So while arguably, Canadian officials have worked harder to stop some of the same stimuli that led to the U.S. real estate bubble and subsequent crash, there’s no doubt that Canadian real estate prices are frothy in some areas, if nothing else.

But to me, the decision to buy versus rent isn’t so much about timing real estate markets as it is about other lifestyle decisions.

For one, if you expect to move within a short period of time — say, under five years — you may be better off or in a similar position financially if you rent. If you buy a home and it simply rises in value with inflation of 2% per year every year for five years, you’ve had about a 10% gain on the property. But if you have to pay a 5% real estate commission to sell and then land transfer taxes, legal fees, mortgage penalties, moving costs, etc. of another 1-5%, you might end up giving up a good chunk of your potential home price profits and not be that much further ahead. Furthermore, the monthly costs of owning tend to be more than renting, probably to the tune of another 1% per year, so you arguably need a 15%+ gain on real estate to break even over a five-year period. Plus, you’ve tied up the money you used for your downpayment.

So what to do at this juncture? If there’s one thing for certain, it’s that the future is uncertain. Real estate prices might rise 15% in the next year. They might fall 15%. My feeling is that they’ll be somewhere in between — flat. There’s been a lot of real estate activity in recent years given low rates and many people are getting close to being overextended. New mortgage rules and eventually higher rates will likely keep the lid on real estate.

But at the same time, there could be good reasons Canadian real estate has held its ground, given the alternatives – low bond yields, knee-jerk reactionary fear of stocks, unprecedented government debt problems and the like. Then there are all the great resources that we have that everyone else, namely China, wants. And beyond that, one can’t help but wonder if Canada is the home of the new American dream?
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