Tuesday 1 January 2008

Rent vs Buy: a Couple of Good Calculators

Many people automatically assume that buying your home is a better investment than renting, probably because your principal residence in Canada enjoys freedom from capital gains taxes. Well, it ain't necessarily so.

Check out the Rent vs Buy calculator at Industry Canada to plug in your own assumptions and see how the balance can easily change between renting and buying as the best option from a purely investment point of view. The calculator was constructed by a top notch expert who is a familiar name in this blog - Moshe Milevsky, a Finance prof at York University, along with researchers at the Individual Finance and Insurance Decisions (IFID) Centre in Toronto. Critically its takes account of the tax difference amongst other variables. As usual the numbers entered in the assumptions are all-important - the Garbage-In Garbage-Out principle still applies. Milevsky himself has elsewhere noted other investment disadvantages of home ownership (not incorporated into the calculator) such as the lack of diversification since a huge proportion of your wealth ends up being tied up in only one asset, i.e. a house suffers from the "too-many-eggs-in-one-basket" risk and possible market slumps.

Another worthwhile Rent vs Buy calculator resides at the website of the Citizens Bank of Canada. It has the merit of showing results graphically, which shows you the cross-over point between renting and buying, as well as how closely the lines follow each other. Much of the trade-off seems to be influenced by house and mortgage one-time costs.

When I tried entering the same assumptions on both calculators, both showed the home purchase to be superior but the Citizens Bank gave an estimate almost double that of Industry Canada after ten years. One difference is that the Citizens Bank calculator includes mortgage insurance and transaction costs but the IC one does not. Without the formulas to examine, it's impossible to figure out why they differ so much. Caveat emptor applies to calculators too, it seems.

Most assumptions that I tried out seemed to show home ownership coming out ahead. But not always. Hopefully this will provide some comfort to those, including at least one of my relatives, who missed the property ownership boat and feel their retirement will suffer as a result.

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