Commentary
Canadians seem overwhelmed by the state of the economy in general and housing costs in particular. Rents have soared to levels that would have seemed incomprehensible only a few years ago. Although house prices have declined somewhat over the last two years, increases in mortgage rates have led to an increase in monthly payments.
Putting aside the question of “pride of ownership” issue, people have always had to ask themselves whether it was financially better to buy or rent. This question is not as obvious as one might think. Depending on the average income of Canadians, as well as house prices and interest costs at any time, the percentage of the population that can even entertain buying a house varies dramatically. Right now, saving for a 20 percent down payment and carrying a mortgage, given the after-tax income of average Canadians, effectively makes home ownership impossible for most young people. This is especially true if they live in Toronto or Vancouver.
However, for the few left who have the option of renting versus buying, what is the best choice at this time?
The world has changed in the last three years. Three years ago, a three-year mortgage term could be taken out for about 3.5 percent. Today, an unfortunate homeowner faced with a rollover would be faced with a new rate of about 7 percent, or double their previous rate. The average house price in Toronto was $900,000 in 2021. Assuming a 20 percent down payment, or $720,000 principal, monthly payments would be about $3,600 based on a 3.5 percent rate three years ago. At 7 percent, monthly payments would soar to $5,040, an increase of 40 percent or $17,280 a year. Even though home prices appear down 25 percent from their peak, the average price is about $1,200,000.
Perhaps we should not feel too sorry for our homeowner in question since their equity is up $300,000. Their equity has increased from $180,000 (the down payment) to $480,000 without including paid down principal. A $300,000 return on an investment of $180,000 is nothing to scoff at over three years. Of course, the story would be very different if the home was bought at the peak of $1,600,000.
Clearly, home ownership, if possible, is the way to go most of the time as house prices tend to rise. Very few rental markets have cheap enough rents relative to home prices to make renting the better decision. There are exceptions, though. For example, in the late 1980s home prices in Toronto were high relative to income, albeit much less so than today, with interest rates around 10 percent, and rent was cheap due to an onerous government rent-control system.
We should be careful using average numbers, and need to point out that home prices at any given point in time are difficult to precisely estimate. Real estate is very local. Different cities, different neighborhoods, and even different types of homes can vary in price over time.
Also, unlike stocks, there is no daily market pricing on individual homes as there are on stocks and bonds. There is no accurate overall Home Index as there is an S&P 500 Index. A wonderful neighborhood a generation ago may have turned into a slum. A slum a generation ago could have been gentrified into a desirable place to live. The Detroit of 1960 is very different from the Motor City of today. The same is true for Nashville, Tennessee, but in a very different way.
Thanks to high rates of immigration and a lack of new housing due to maladaptive government policies, rent has almost doubled over the last decade. Average rent in Toronto for a two-bedroom apartment has soared from $2,200 a month to $3,400 in only three years, an increase of 55 percent. Our “average” homeowner we cited faced a 40 percent increase in monthly payments over the same period. The mortgage-to-rent ratio declined from 1.64x to 1.48x.
Should a person rent or buy? My advice for someone thinking of buying: Don’t. Yes, buying is usually the correct decision for many financial and non-financial reasons, but we are not in normal times. The value of homes relative to income is still unsustainable. Baby boomers are retiring and will cash in their equity, putting downward pressure on prices. Increased population will not help as much as your friendly real estate agent would have you believe because young people and immigrants simply cannot afford to buy homes at these levels.
The situation is somewhat like the late 1980s when prices were also high and eventually collapsed in real terms. The income-to-house price ratio improved, and it will this time too. The ratio of the value of residential homes to GDP is about three times, or a total value of $6 trillion. This ratio will eventually decline due to a combination of falling inflation-adjusted home prices, price inflation, and rising incomes. Rent now and save your money for a down payment if you can and wait for prices to fall.
One last cautionary note: Be careful when you are ready to buy. We are in quickly changing times. Real estate is always local and always timely. Urban decay and economic strains will continue all over North America. The last thing you want is to be stuck in a neighbourhood that is in decline.
