Should I Rent or Own a House? – Part 1

Homeownership has long been one of the top goals for many Canadians. We have all been told by parents and grandparents that homeownership trumps renting anyday. The phrase, “Why pay someone else rent when you can put money towards owning your house?” has long been the standing advice passed down generation to generation.

Sounds like sound advice. I mean, fundamentally, it makes more sense to pay yourself rather than someone else. But, is that always the case? Are there instances when renting is more advantageous?

In this first post, “Should I Rent or Own? – Part 1”, I would like to give some guidelines to help you make the decision to rent or own. I will use a simple formula to see if current house prices are under, at par, or more expensive relative to renting.  I will also use London, Ontario as an example to see if homeownership trumps renting.

I will follow up this post with a Part 2 that will go deeper into the rent or own question. I will take into consideration investing, different downpayment abilities, inflation, house appreciation, and behavioural and situational factors that play an important role in making such an important decision.

So what’s the easiest way to compare renting to homeownership?

The simplest method is using a multiple.  The formula is simple.  Take the going rental rate of a similar property to the house you are looking for and multiply the rental rate by 12 to get the annual cost. Then multiply that number by 15. The formula looks like this:

Monthly Rent Price x 12 X 15 = Relative House Price

The analysis is a 3 step process that is very easy to execute.  The process goes a little something like this.

Step 1: Gather your data.
We will need two pieces of data for our calculations and comparisons.  The first is the average rental price in the area that is of interest to you.  If you are looking at owning a 3 bedroom house, then you would need to gather data on a 3 bedroom rental.  Pretty straightforward and logical.

So where can you find this information?

There are a few different places you can find this data.  You could check out listings in your local newspaper classifieds.  The newspaper is still a pretty decent source for rentals.  Check the classifieds and see what the going rates are.

Another option is to use an online source.  This is one of the strongest sources for data because of the quantity of classifieds you should be able to find, but also because of the depth of information you will find in them.

Unlike a newspaper where you basically get a 2-3 sentence blurb about the property, an online source will give you info on each selling point such as bedrooms, washrooms, laundry, parking, air-conditioning, nearby amenities, and so on.  You will also usually have pictures of the property to get a visual idea of what your money can rent.  Some of the best sites to find rental prices includes Kijiji, Craigslist, ViewIt, and Facebook Marketplace.  But be warned.  Unlike it’s newspaper counterpart, there really is no filter for ads that do go up.  This means that the beautiful apartment that has all the features you want at half the going rate, might be – and probably is – a scam.  So be cautious when gathering prices for our formula.

The last place is where I am going to find information for my example.  This is the Canadian Mortgage and Housing Corporation website.  CMHC is a crown corporation here in Canada that insures mortgages for lending institutions.  Since they are a crown corporation, we have access to the information they have to offer.

The CMHC does research on city centres and provides reports on trends in those regions.  It is a wealth of information, but it is a little dry because you are reading the information straight from the source and not in a blog or news article.

In my example – London, Ontario – I used the CMHC’s “Rental Market Report – London, Ontario” report to find the rental information for our formula.

In the report I found the following data for the london CMA region for October 2012:

Average Bachelor = $575/month
Average 1 BDRM = $747/month
Average 2 BDRM = $919/month
Average 3 BDRM = $1050/month

Since I am interested in purchasing a 3 bedroom house in London, I would use the 3 bedroom rental price of $1050 for my calculations.

Step 2: Calculate the formula.
Simply enter the $1050 monthly rental rate we found in the report into our comparison formula.

$1050/month x 12 x 15
= $189,000

Step 3: Compare to House Prices
Now that we have our number, we need to find out how much houses are selling for in the market.

We can find this data in a number of places also.

One of the easiest places to find house price data is from your local real estate office.  They will usually have many listings for the area and give enough information to see if it is a comparable property.

You can also check out your local newspaper for listings or home owner magazines that are published in your area.

For my example though, I want to find the average home price since I used an average rental price.  So once again I turn towards the CMHC.

The CMHC also puts out reports and information on the housing markets in Canada.  This makes it an excellent source for purchase price information.

For my London, Ontario example, I used the CMHC report called “Housing Now – Ontario Region” to find average home prices.

In the report, you will find two different prices.  One is the “Average” price and the other is the “Median” price.  Now it seems like the obvious choice to use would be the “Average”price, but the “Median” is what we want to look at.  I’ll tell you why.

In statistics, there are basically three important analysis numbers you can look at when trying to generalize a population of data: the mean (average), median, and the mode.

The mode isn’t very important to us in our housing example.  The mode is basically the number that comes up the most frequently.  In the following sequence of numbers (2, 3, 6, 3, 5, 8, 6, 4, 3, 3, 3, 8, 9, 100), the mode is 3 because it was the most frequent (5 of the 14 numbers were 3s).

The mean, or average, is calculated by adding up all the values and dividing by how many data points you used.  This is the most common form of getting an average.  The downfall to this method is that if there are large outliers – like the 100 in our example – it can really skew your data and make the average higher than what it is in reality.

The median on the other hand, simply arranges all the data points from smallest to greatest and then picks the data point that is in the middle as the average.  It’s a little easier to show in an example.  Let’s use the series we used up in the mode example:

2, 3, 6, 3, 5, 8, 6, 4, 3, 3, 3, 8, 9, 100

As already stated above, the mode is 3.

To get the mean (average) we need to add up all the numbers.  This series equals 163.  We have 14 numbers in the set, so the mean = 163 / 14 = 11.64.

To get the median, we need to rearrange the set so that it displays from the lowest number to the greatest number.

2, 3, 3, 3, 3, 3, 4, 5, 6, 6, 8, 8, 9, 100

Now we need to find the middle number.  Since we have an even number of numbers in our example, the middle consists of two numbers (4 and 5).  To get a single number we simply add these together and divide by two ( 4+ 5 / 2 = 4.5).

As you can see, our mean and median are quite different from each other (11.64 vs 4.5).  This is because the 100 in the series was such a large outlier that it pulled the average up.

This is why the median is more important in our house problem; it won’t be so skewed if we have a few outlier house that are very expensive compared to the rest of the market.

Back to our example…

The average house price for the London CMA in Q3 2012 is $369,794 and the median price is 330,000 (as you can see, there was an outlier effect that did bring the average price up).

So now we compare the two numbers:

$189,000 for the rental formula and $330,000 for the median selling price.

Using a multiple comparison, a $330,000 house uses a multiple of about 26 in our formula:

$330,000 / ($1050 x 12) = 26 (approximately)

As you can see, owning a house is expensive compared to renting one for Q3 2012 in London, Ontario.  You could rent a place for approximately 57% of the cost of buying one (not including property taxes, interest on the mortgage, and maintenance costs).  So logically, it would make sense to rent than to own in our example… but, maybe not.

Exceptions to the Rule

A multiple of 15 isn’t really a hard limit; it’s more of a guideline.

The reason why we use 15 is because that has been the historical multiple relationship between renting and owning.  Over the years, there has been times when it has been above and times when it has been below, but 15 is the average.

But what if it’s a house that you love?  What if it’s the perfect house for you; has all the features you are looking for?  And you can afford to buy it within your budget?  Well, then that 15 multiple gets a little harder to judge around.

This is how I look at it.  I hate hard numbers.  They never work.  They are simply too rigid.  What I like is a range.

This is how I look at the housing question.

Multiple = 0 – 15
If the rental multiple for the property is below 15, then you are getting a great deal on the place.  You would be foolish to rent because owning would be economically cheaper.  Plus you would own a house where you would accumulate equity as you pay off the mortgage.  Sort of a no-brainer.

Multiple = 15 – 20
In this range, it probably makes sense to buy.  You are technically no better off to rent or to own (breaking even), but the the one factor that leans in the favour of ownership is building equity as you pay off the mortgage.

Basically, when the multiple is closer to the bottom (15), the decision is easier. As it creeps towards the top of the range (20), the benefit becomes less clear.  If it is a perfect house for your needs and you see yourself living there for a long time, then it might be a good idea.

Multiple = 21 or Greater
Here is where it gets really grey and fuzzy.  You are technically paying a premium to own a home in this range (historically speaking). You could rent a place for much cheaper.

But, what about the equity you say?  Well, this is where you need to do a little further inspection of your choices.  You would be earning equity in the house, but your monthly cash flow would be a lot less and you forgo saving potential because you are putting more into your house.  And because you are paying a higher premium for the house, you are also paying more in interest to the bank on your mortgage.

As you can see, you need to do a few more calculations.

This is what I will be going over in my second post.  I’ll take into consideration the following:

1 ) Mortgage rates
2) Cash flow
3) Savings
4) Downpayments
5) Investment rates
6) Inflation OR house price apprciation
7) Time frame
8) Life-stage

Like I said before, this formula is a quick and dirty method for comparing rental prices to home ownership.  It’s a quick and easy way to evaluate current home prices.

I use this method a lot as a filtering process.  I’ll use my knowledge of the average renting price in my area and find out what the price multiple is on house listings.  I’ll then use my 3 ranges (0-15, 15-20, 21+) to see if I should look deeper into the property.

This is also a great tool to use if you are looking to purchase property for renting.  The lower your multiple, the better your return will be.

And to clarify, to get the multiple, use the following formula:

House Price / (Rental Price x 12) = Price Multiple

But, to truly find out if you are making a sound decision you need to look deeper.  This formula method is only the first step.

Stay tuned for the Part 2 follow-up to this post, and I’ll show you how to attack all the angles to tell if homeownership is for you or if renting makes more sense in your situation.

Thanks for reading and good luck out there!

Let me know what you think.  Do you think it’s always better to own.  Tell us why.  Think it’s foolish to own a home these days.  Tell us why.  Share your thoughts and comments below.

Tags: cmhc, mortgage, rent, rent vs buy, rentals