Whether to Rent or Buy: Part 2

Continuing where we left off during the most recent post … several people contacted me to say that I’m wrong. Just plain wrong in stating that, “paying monthly rent is no more throwing money away than is paying mortgage interest and property taxes.” These folks insisted that rent payments are akin to flushing dough down a Texas sized sinkhole.

I thoroughly appreciate the feedback. Because a broad spectrum of opinion is always welcome. Sharing different perspectives furthers discussion, prompts us to consider alternate points of view and re-examine our own. So in the spirit of stepping back, let’s take another look-see.

images


Have You Considered This and That and This and That and …

Let’s go back to the starting point: should you buy or rent (to be clear, this post is referring to your primary residence)? But let’s not seek an answer just yet. I know its tough sometimes, to just sit with uncertainty. And it feels good, a sort of sense of completion or achievement, when picking a side and saying we’re either for or against.

Still, like many issues in life, this issue does not readily lend itself to an across the board, simplified black or white answer. Because any answer to the question of, ‘should you buy or rent’, is going to depend on evaluating so many factors, and these factors are entirely dependent on your particular situation.

download-1


Dig Deeper

Pay rent and it disappears.

Pay a mortgage and you’re building equity in a valuable asset that will eventually be paid off, allowing you to live mortgage free.

On the surface, no contest. Buying wins. So now it’s time to dig a little deeper.

Rent money, yes, it disappears, doesn’t go toward building worth in an asset. So is renting a lose-lose proposition? Aside from sending money into a void each month, do renters reap any financial benefits?

Short answer: yes. Longer answer: Renters don’t incur ongoing expenses such as property tax, maintenance, repairs, and mortgage interest (know that a significant portion of mortgage payments goes toward paying interest, not principal; if you have a mortgage, look at your statement. It will show exactly how much of your payment is allocated to principal, how much to interest). Nor do renters tie up a hefty lump sum in the form of a down payment. As for the building equity angle, true, renters don’t build equity in their home. But that’s no reason in itself to shun renting.

Smart renters take hold of the money saved on property tax, maintenance, repairs, and mortgage interest, and put that money to work in investments other than residential real estate.

This is where renters build their equity. And this is precisely why renting is NOT on par with being sucked into a deep space black hole. Because renting allows for the opportunity to invest and generate equal or higher returns than that generated by owning residential real estate.

Screeeech! That was the sound of a U-Turn. What if renter doesn’t pursue the opportunity to invest elsewhere? Then opportunity is lost and renter is clearly behind the financial eight ball as compared to homeowner.

download


Home Is An Investment

Is your primary home a good investment? After all expenses, will you come out even or ahead on the money angle when the time comes to sell?

It depends. It depends on your specific situation, how long you stay in your home, whether you bought at the top, bottom or middle of market, the bucks you spend on repairs and renovations, mortgage rate … and on and on. Oh, and really importantly, it depends on the particular piece of earth on which your home is situated.

Meaning? Historically, residential real estate is an investment that keeps pace with the rate of inflation (i.e., returning gains of 2-3%/year). So if your non-real estate investment returns exceed, say 3%/year, then you’re building more equity than the home ownership crowd.

But that’s an average. Real estate is a local game and you have to know your local real estate market. Take San Francisco. If you bought a home in San Francisco sometime in 2008 or 2009 that you still own today, the value of that home likely doubled or more. This, of course, far, far exceeds the historical average return. Heading north, a detached home in Vancouver purchased by a young family back in 2001 would have tripled or quadrupled in price according to today’s insane values. Who needs the heartburn of stock market swings when you have bricks and mortar trucking along at a healthy clip?

Screeeeech! Sure but there wasn’t much dancing in the streets in the good ole’ US of A back in 2007-09 when Wall Street shenanigans brought the red, white and blue house down. More like unbridled panic among many real estate investors, fretting alongside stock market investors. But, like the stock market, if you didn’t sell during the dark days, you’re sitting pretty now.

Okay, so play the long game and you’ll be fine, maybe double or triple or smack a home run on your house? Not likely for most of us. There will always be certain cities that ‘outperform’ others when it comes to investment returns; and there will be certain time periods that we look back on and say, ‘if only I would have bought at the market bottom’. But over the long haul, property prices are likely to conform to their historical average.

So how do we know in advance what city or time period in which to buy a home, to get the most bang for our buck? We don’t. And if you proceed on the assumption that home prices, wherever they may be, eventually regress to the mean, then you can expect (with no guarantees) a 2-3% rise in value during your ownership period.

images-1


Home Is Not An Investment

All this talk about renting vs. buying, which one is the better investment, which option costs less or more. Well, there will always be people on both sides of the discussion, convinced that one or the other is the best way to go. But because of all the variables involved, it’s not possible to provide a one size fits all answer.

Not only that but, whether or not to buy a home, a place to live and grow and find peace, is not, at its heart, an investment decision. Rather, it’s a consumption decision. And imbedded in this decision, in addition to financial means, are your values.

Because the most satisfying housing decisions are those made in alignment with our values … and our needs, goals and budget; not market trends and crystal ball gazing at investment growth down the road.

 

 

 

Dividends: The Ultimate Second Income

Bored with the same old games, my 11-year old son and teenage daughter rummaged through the games closet and found an ancient relic, Monopoly. And as I excitedly told them about its history, that is was invented by self-described anti-monopolist, Elizabeth Magie, in 1903, that its purpose is to illustrate the hazards of concentrating land in private monopolies, my kids looked at me as if what they were hearing was, ‘blah, blah, blah’, rolled their eyes in tandem, and walked away.

Not an unexpected response. I mean, hey, the kids just want to be free to play, not weighed down by an adult (that would be me) spewing historical facts and economic theory. And play they did.

From time to time, they would ask me to clarify rules, which I was only too happy to oblige. Eventually, after surreptitiously spying on them from the kitchen, watching and listening as they learned rules and strategy, I came in from the cold and asked, ‘Can I play?’

Of course, being the adult whose headspace has not yet adjusted to the idea of summertime freedom, to the idea that summer is a time for letting it all go, for letting it all be, for being here, now, the Dad in the room (that would be me) had a hidden agenda.

And as I sat on the family room rug, took a seat at the playing board, and chose the Hat piece because the RaceCar was swiped by my son, I prepared to teach the kids a thing or two about the joy of property ownership.

800-c1935_1509312a_deed_ortenn-frbk


Interest and Dividends Rule

In other blog posts (see Property Investing: Need To Knows and Thinking About Investing In A Condo), I’ve discussed upsides, downsides, and things to be on the lookout for when buying real estate as an investment. And I also batted around the advantages of owning Real Estate Investment Trusts (REITs). Whether we’re talking about owning REITs (i.e., stocks that pay monthly dividends) or real property (i.e., bricks and mortar buildings with tenants paying rent), the beauty of both is … they’re Income Generators.

I love Income Generators! What’s not to love? In essence, you’re paid for being the owner. An ‘income stream‘, is the somewhat poetic phrase describing the monthly cash flow that makes its way to your pocket.

While playing Monopoly, I tried explaining the concept to the 11-year old as he insisted on buying RailRoads (a kid with a fervent imagination, a romantic at heart, naturally he finds RailRoads captivating) instead of Marvin Gardens or Tennessee Avenue.

Listen, even if you own all four RailRoads, you collect only $200 each time someone lands on Pennsylvania or Reading or the others.

So.

So? You know how much rent you collect when someone lands on Tennessee and you’ve put up a hotel? $950!

I don’t care. Besides, I have way more money than you!

True, you do have more money. But I have more properties. And eventually, you’ll be paying that money to me for landing on my properties. Then Ill have the properties AND the money, and you’ll be left with bubkus.

I still want the RailRoads.

Ya well, kids see something special about trains and RailRoads. I get it. As for that particular game, it played out as expected, the kid coming up short. Same in the next game. But the third time around, the kid’s romantic heart took a back seat to his competitive nature. Taking a page from my playbook, the kid gave first priority to property accumulation, knowing that this was the eventual way to riches. At least in the game of monopoly.

unknown


Knowing The Deal

Let me back up a moment. I’m not saying you’ll become wealthy if you own property. It may happen but it’s far from certain. But I am saying that property ownership is a truly excellent, outstanding way to generate income. That said, income is only one half of the equation. The other half being expenses.

When you own real property, like a condo (Thinking About Investing In A Condo), it’s absolutely essential to get a firm handle on expenses. Because if expenses outstrip income, then you have to revisit the question of … what’s the purpose of this investment?

If it’s not about generating net income, then it’s all about capital gain, i.e., expecting property value to increase before you sell the property. And if capital gain is the sole purpose, then you’ve ratcheted up risk level because you just don’t know what the property will be worth tomorrow or ten years from today.

Personally, I’m a big fan of REITs. And I’ll step outside my usual commentary and say that I prefer individual REITS over a REIT Index Fund. Why? Because while the REIT Index Fund typically offers less price volatility as compared to owning one or two or a handful of individual REITs, it will also pay a lower dividend, sometimes much lower.

So, I’m willing to trade off more volatility for more income. And I’ll do so knowing that REITs in general are not a volatile group like, say, technology stocks. And they usually do not see wild price swings.

Granted, you also won’t see price gains like you might in the technology sector. But I’m good with that. I’m good with owning stable REITs that offer relatively smaller price gains and a healthy dividend.

And I’m real good with watching the monthly dividend deposits to my account, knowing my total ownership expense is $9.99 for each purchase and sale.

unknown-1


What Kind Of Income Are We Talking About

Let’s say you have a spare $100,000. And you want to invest in property. You could apply that 100k as a down payment toward a condo. Incur the costs of taking on a mortgage, monthly condo fees, legal fees, title fees, any property transfer tax. Then find a renter. And hope the renter is reliable, cares for your property, and minimizes your maintenance costs.

And maybe you would turn a profit each month. It just depends on the numbers involved. And you, being a BuddhaMoney enthusiast, would crunch, crunch, crunch all the numbers before making your purchase decision. I’m not trying to be a wet blanket here; these are just some of the realities of property ownership.

Or you could take that 100k and buy a few REITs. I lean toward REITs listed on the Toronto Stock Exchange because their dividend yields tend to be much more generous than those offered by companies with U.S. listings.

While there’s a whole bunch to choose from, I’ve listed a few below (though I want to emphasize that I’m not advising, telling, suggesting or otherwise whispering in your ear to go out and buy any of these REITs without first doing your research):

  • Pure Industrial REIT (TSE:AAR.UN). Pure Industrial’s portfolio concentrates on industrial properties located in both Canada and the U.S.A. It pays a yield of 4.65%.
  • Slate Office REIT (TSE:SOT.UN). Slate owns Canadian based commercial properties, with an emphasis on office buildings. It pays a yield of 9.65%.
  • RioCan REIT (TSE:REI.UN). RioCan is Canada’s largest REIT with a market cap near $8 Billion (CAD). It focuses on shopping centers, retail and mixed use properties. It pays a yield of 5.80%.
  • Dream Office REIT (TSE:D.UN). Dream owns a stable of office properties throughout major urban Canadian cities and pays a yield a whisker under 8%.

So for simplicity sake, let’s say on 100k the average yield for these four REITs is 7%. That’s $7,000/annually, less trading fees which would equal $9.95 x 4 = $39.80. And the bonus is that dividends are taxed at a lower rate than interest income (think rental income) meaning more money in your pocket.

Putting money to work for you. Generating an income stream. All helps toward building your wealth.

 

Build Wealth. Buy Real Estate.

My grandmother (let’s call her NaNa), a shrewd businesswoman with a big heart, invested her family’s minimal excess income in real estate.

She started by buying a duplex. Her family lived in one part of the duplex and rented out the other half. Rental payments covered her mortgage, general expenses, and allowed for a bit of extra cash. Maintenance costs were held to a minimum, as my grandfather took care of repairs.

In time, NaNa saved enough for a down payment on a second duplex. With much of the rental income being deposited into a savings account, she soon had enough to buy a third property. Eventually, the family was rewarded the luxury of not worrying about taking care of their basic needs.

Nana Teaches The Son

Ever a keen and interested observer, my father learned from NaNa. She taught him a whole lot about property investing, including:

  • What issues to consider when evaluating a potential purchase.
  • Benefits of maintaining a property’s value.
  • Importance of being fair and respectful to tenants.
  • How to draw a budget.

Having the advantage of NaNa’s tutelage, a university education, and an extraordinary work ethic matched by ambition, by the time my father reached middle age, he had assembled a decent-sized portfolio of apartment buildings that he referred to as his retirement fund.

And all of this was accomplished in his spare time, outside of regular work hours. That’s just who he was. Some people play tennis for fun, others get their kicks out of working, building, creating.

The Next Generation Adds A Twist

In my late twenties, starting to accumulate savings, I considered following in my father’s footsteps and buying apartment buildings as a way to build wealth. But I didn’t. Not because I didn’t want to but because the cost of apartment buildings had rocketed out of my financial league.

Small, independent property owners like my father had been bought out by deep-pocketed corporations who owned and managed thousands of rental units across the country. These corporations are known as Real Estate Investment Trusts (‘REIT’).

The Beauty of REITS

Instead of taking on the risk of a huge mortgage to finance the purchase of an investment property, and spending time learning the nitty gritty of property management, I turned to REITs as a way to dive into real estate investing. But before I chatter on about why REITs are an excellent investment, one worth getting to know better, I’d like to offer a few chewy bits about this asset class:


Chewy Bits

  • A Real Estate Investment Trust (short form: REIT, rhymes with ‘eat’), is a company that owns or finances income-producing real estate.
  • Most REITS trade on public stock exchanges (i.e., New York Stock Exchange; Toronto Stock Exchange).
  • REITS are income oriented and usually offer a higher dividend yield than most common stocks (the income component is one part of their attraction).
  • REIT shareholders earn a share of earned income, and participate in capital gains (yahoo!) or losses (boo!) just as with any other company trading on a stock exchange.
  • Commonly, REITS have a specific focus, such as apartment buildings, hotels, industrial facilities, office buildings, retirement homes, shopping malls, storage centers and student housing.
  • REITs typically provide investors with a monthly income stream; most paying dividends anywhere between 2.5% – 9%.
  • Think of REIT investing this way: the monthly dividend you receive is like collecting rent without the attendant headaches of managing your own property. Really, after you click to buy the REIT stock with your online broker, you can just sit back and watch your monthly dividend be deposited into your account each month. Sweet.
  • Since 1991, as a group, U.S. REITs have outperformed the S&P 500, 11.2% to 9.1%.
  • REITs are not highly correlated to the price of stocks and bonds. Meaning, since the price of REITS do not necessarily follow stock or bond market movements, they may play a part in smoothing out portfolio volatility.

For all these reasons, you may want to start a love in with REITs, in the wealth building sense that is. Ahem. That said, know that, like other asset classes, the finance gods did not create all REITs equally.

Hint, Hint: Be patient, and diligently research which REITs are a good fit for your portfolio.

Apartment Building REITS

Personally, I’m a big fan of Apartment building REITS, and not just for sentimental reasons. Rather, my crystal ball brings up images of a North America that is heading in the same direction as some Western European countries, where home ownership is much less prevalent.

Look at Switzerland, with home ownership at 38%, Germany at 41%, France at 55%, compared to about 68% in the US and Canada. Why the difference? Because property is so, so, so expensive in these countries that most people cannot afford to buy. And for a good percentage of those who do own a home, it was passed on to them by their parents, or grandparents or great-grandparents, etc.

So people rent. And that’s just fine. In European countries, there is no stigma to renting like there is in some pockets of North America where ‘the dream’ of home ownership in a white picket fence neighborhood is relentlessly marketed to us by the usual suspects: banks, mortgage lenders, home builders.

Not to mention the social pressure we feel from friends and family (after all, we are encouraged to live our life in a similar if not the same manner as those who came before us). And, our own dark angel contributes to the desire for home ownership: the human propensity to covet thy neighbor.

Now, this isn’t to say that there are not thoughtful, legitimate, excellent reasons for owing a home such as:

  • Control. The house is yours. Do whatever you want with it, repairs, renovations, etc.
  • Stability. Unless you go into default on your mortgage, no one can force you to move.
  • Capital Appreciation. You benefit from any property value increase.
  • Forced Savings. Each mortgage payment gives you more equity in your home. Especially important for those who are challenged in the … I Really Don’t Want to Think About Investments Because It Hurts My Brain department.

Okay, so you see, I’m not anti-homeowner. Not one bit. To borrow a phrase from two creatures who live with me known as ‘teenagers’, I’m ‘just saying’ that renting is a viable alternative, sometimes a preferred alternative depending on several factors including how pricey property is in your town.

And as property values continue to increase, outrageously in some urban centers such as San Francisco, Vancouver, Manhattan and Toronto, more people turn to renting. The result being that apartment buildings maintain high occupancy rates, which is good for apartment building REITs, and puts a smile on the face of REIT shareholders as they reliably collect monthly dividend payments.

Crunch, Crunch, Crunch the Numbers

My friend, Condo Lover, doesn’t agree. He says the better investment is a condo that you rent out. With a small down payment and mortgage financing to cover the balance of the purchase price, you’re now the proud owner of a condo.

But you don’t live in the condo, you rent it out. The rent payments cover your mortgage, maintenance and repair costs, and property tax. If you’re lucky, there’s change left over for spending money. So cash flow to cover condo costs isn’t a problem, and you sit and wait until property values increase to the point where you can sell the condo and cash out a sizeable capital gain.

I get it. I see the potential benefits of buying a condo as an investment. But if the condo is used solely for investment purposes, not as a second home, then I would take a pass.

Here are the primary issues, and the risks, I see:

  • Assuming I don’t have enough in the kitty to pay all cash for the condo, I’m taking out a mortgage. What if I can’t find a solid, upstanding tenant who pays their rent on time each month, or who pays their rent at all? Will I still have enough to cover mortgage payments?
  • If I’m going in with my eyes open, I’m factoring in repair costs, general maintenance, property tax and increases in property tax. Ideally, a steady stream of rent checks pays these expenses. But what if they don’t? Do I have other resources to cover expenses?
  • What if I want to sell the condo but the real estate market is weak, the timing of sale is unknown, and I have to drop my asking price, possibly taking a loss? Am I prepared for this scenario? Could I absorb the financial hit without breaking stride?

Compare this to being a property owner via a REIT. I buy shares in the REIT with cash held in my investment account. I don’t borrow to pay for the purchase.


Chewy Bit

Buying on Margin. This is an investment term that means you pay for a certain percentage of your stock purchase and borrow the balance owing from the investment brokerage. DON’T DO THIS! EVER! Leave buying on margin for the speculators. It’s not for reasonable investors.


As a REIT shareholder, I don’t have to worry about bad tenants destroying my property or not paying any expenses associated with the property. And when it comes time to sell, well, I only buy fundamentally sound REITs, meaning there is always a liquid market (i.e., sufficient volume of buyers and sellers), so I can sell any time I like. I collect a monthly, purely hassle-free dividend (amount of dividend dependent on the individual REIT), and if I purchased a REIT when it was out of favor (i.e., price was down; we here at BuddhaMoney love buying investments on sale), there’s the opportunity for capital gain when I sell.

Now, tell me, what’s not to love about REITs?