Why I Invest in Real Estate But Rent the House I Live In

What?

For sure renting a house for personal use while owning multiple rental properties is an unconventional decision...but I think if you read the rest of this blog you'll understand why I do it and it might even make you think about how you make decisions regarding your own housing (although I very much doubt anyone else will actually start renting their primary residences!). I also want to point out that I should probably save this post for better economic times as this is literally the worst time to own the kind of real estate I do but I'm putting it out there anyway because it still barely makes sense in this environment and I know from experience that it works very well in better times...

Classic Rent vs. Buy Analysis

You see lots of articles about whether you should rent or buy in both the mainstream media and from personal finance bloggers. Some of these are good but most of them don't really help (if you'd like to know why this guy's analysis is so out to lunch let me know and I can show you but otherwise it's beyond the scope of this blog...). Anyway, here's how I approach this problem with some real life examples.

Let's pretend you live in Calgary (like me) and want to buy a pretty average house (the Calgary Real Estate Board has the average detached home costing ~$520,00 as of November 2015). For the sake of argument let's call it $500,000 and let's say this is the house you're looking at buying. Next let's find a comparable rental and it's renting for $1,800/month. From here we have to make a few assumptions and start using Microsoft Excel...

As far as assumptions go we need to make assumptions about how much the house may increase in value over time and how much your rent may increase in time as well. Needless to say, these assumptions should be linked (if the house is more expensive the rent will be too!) and I generally assume the increase will be 3% or 4% per year. This may be a little conservative as a few years ago Re/Max suggested that from 1981 to 2006 the actual appreciation was 5.3% but they probably cherry-picked the range so I'm happy assuming prices will increase 3% per year for the sake of this analysis.

Other than that we need to assume what mortgage rate you'll get (3% is typical right now for a 5 year fixed mortgage), how many years you'll amortize over (25 years is the max now for CMHC and quite typical), what you'll pay in real estate fees when you sell (7% on the first $100K and 3% on the rest is typical in Alberta although that has been changing), and then we need to compare this to a theoretical investment of the down payment. This is obviously up for debate but assuming you had an all stock portfolio invested somewhere in the developed world I'm going to say you should get something near 8% return. This article refers to a study by Credit Suisse showing that over the last 112 years stock markets in the developed world returned an average of 8.5% per year so I don't think 8% is too out of line. Anyway, below you can see what happens when you plug all these numbers into Microsoft Excel (if you'd like I can send you this spreadsheet and you type in your own assumptions to see what the results would be. My email is bstutheit@gmail.com).

If you're struggling to read this I would be happy to send you a copy of the spreadsheet so you can see it better but basically this analysis is saying that as long as you stay in the house for at least 2 years and as long as you don't pay a mortgage prepayment penalty you are better to buy this house than rent and invest the down payment. The analysis doesn't always turn out this way as the housing market changes over time and so do mortgage rates but in general this result is typical from what I have seen. Whenever I do this analysis I tend to find that you would be better to purchase the houses as long as you plan to live in it for a minimum period of time. I've seen the time required be as low as 2 years (like above) and as many as 5 years but overall it seems like a reasonable strategy to buy a home provided you don't move too frequently.

Doesn't This Mean You're Doing it Wrong?

Obviously, that analysis doesn't make me look very good...I will have been living in my current home for 3 years this spring and based on the table above that means I definitely should have bought it instead of renting. The reason I'm still comfortable with my decision though is that I did not simply take the down payment and invest it in a stock portfolio. Instead, I invested it in another form of real estate and when I compare the return I would have received on my personal residence against the return from that property I'm still very happy with my choice.

To keep this example real let's consider investing in the exact same type of real estate as I did (a condo downtown Calgary) with our $100,000 and see how that compares to buying a home with it. This unit is actually in the exact same building as one of the suites I own so it should be a pretty good comparable...it's also listed for exactly $500,000! As far as rents go in this building this listing shows that a unit like this should rent for ~$2,600/month right now (regrettably this particular building has lots of rental suites now and combined with the current economic environment this rental rate is down from $3,500 only 1 year ago...that said it'll still win this analysis.).

So let's compare purchasing that condo and renting it out for $2,600/month against using the money to purchase a home. As far as assumptions go for this analysis most of them are the same as before. I've had to add in additional monthly expenses for the condo (like condo fees, utilities and telecom which get included in the rent) and I've also added a vacancy rate for the condo of 5% (this matches my historical vacancy over the last 7 years). With that out of the way though let's look at the results.

Again the image might not be great but what it should show is that no matter how long you hold the properties for this time the condo is always a better investment decision. It's slight right now (~$4,000 over 6 years in this analysis) but it's also probably the worst time in a very long time to be renting out furnished suites in Calgary...and had we done this analysis a year ago with the properties worth ~$550,000 and the condo renting for $3,500/month it would look more like this.

So on this final chart the conclusion is that purchasing the condo would result in more than $60,000 more for the condo owner than the home buyer over a six year period! Obviously in real life there are good years and bad years (this year is bad) but in my experience there have been many more good years than bad (6 to 1 so far) and the extra work required to rent out this condo was definitely worth the time and effort to be a landlord.

Last Thoughts

Deciding whether or not to purchase real estate is a big financial decision and to really know if you've made the right decision or not requires a fair amount of research and work. Obviously, some people would simply prefer someone else do this work and provide them with straight forward answers to questions like, "should I rent or buy?". From what I've seen you can provide general advice like, "provided that you will live in the home for at least 5 years you should buy." but that's not always true and not a substitute for a doing a proper analysis. Personally, I can't live with a simple answer from a so-called "expert" so I've built the model above to help me evaluate future decisions. As it turns out, this approach has also encouraged me to try an unorthodox approach to real estate investments that have worked out very well.