The change in Toronto’s downtown skyline is amazing. The Skydome (sorry, “Rogers Centre”) now sits in a maze of condos and a new one seems to appear every day. We've lost track of the number of times we've fielded questions about Toronto’s condo market. If you’re thinking about buying or renting a condo, you should definitely read this. Renting can win out, in a BIG way.
Whether you choose to rent or buy, the advantages of condo living are obvious. You’ll likely be closer to work, so forget painful commutes. You'll definitely be closer to nightlife. For millennials still at home, that means finally having a place to host friends before nights out on the town. It might even help you make new friends too, since downtown condos are occupied by many successful, young, energetic people. So if you've made the decision to live in a condo - for these reasons, or any others - the tough question you need to ask yourself is, “do I rent or buy my condo?”
Rewind 10 years, and say you’ve got the cash. Would you buy a Toronto condo or invest in TSX stocks? Most people are quick to say the condo, since we’ve all heard of fortunes made or missed on these properties. You might even recall a huge stock market crash in 2008, when stocks of even the biggest and best companies lost over 50% of their value. Surely the condo wins out as a better investment, right? Nope. And yet we still hear 4 common arguments in favour of condo ownership, but we'll debunk them here as total myths.
Myth #1: Toronto condos have outperformed the stock market by a long shot
You would have been better off in TSX stocks from 2005 to today. We compared an investment in XIC, an ETF following the Toronto Stock Exchange, and the MLS Home Price Index for condos in the Greater Toronto area. Putting $50,000 in XIC and using automatic dividend reinvestments you would have been further ahead an average of 2.85% each year for 10 years, or $30,000 in cash by 2015.
Myth #2: So stocks outperformed, but they’re definitely riskier
It depends on how you define risk. The "old-school" finance professionals define risk as volatility. In that sense, stocks are riskier since they go up and down all the time. But with a modern long-term perspective, risk is defined as a permanent loss of money, not just the short term ups and downs. Since stocks have a higher compound annual growth rate (we checked the last 100 years), there is more gains than real estate. You can bet volatility-focused investors would have been scared off in 2008 and missed the tremendous long-term returns when the market rebounded. The key is to think long-term, have a well-balanced portfolio, and drown out the noise.
Myth #3: I can’t invest in real estate if I put my money in stocks
People are generally surprised when we tell them there are other ways to invest in real estate without concentrating all of your net worth in a home or condo. For example, at Wealthsimple we use the Purpose Duration Hedged Real Estate ETF to get our clients exposure to five different categories of real estate, including condos. The fund even hedges some of the exposure of a rising interest rate, so it's a more isolated real estate play. It gives our clients increased liquidity and reduces concentration in one property.
Myth 4: Renters throw cash away, at least owners build equity
The last myth is the one we hear the most. Both renters and condo owners can build equity. Renters can build equity by building their investment portfolio. Instead of building ownership in a single asset, the renter can build diverse equity positions in a number of different companies, industries, and geographies. The owner does it by relying on the condo.
Okay… so should I rent or buy a condo?
Stocks outperformed condos so everyone should invest in stocks, right? The answer still isn’t so easy. Condos increase the use of borrowed money (ie, mortgages) and this leverage has the power to magnify returns. But leverage can also work the other way, magnifying losses. We’ve narrowed the buy versus rent debate down to four questions. While we definitely don’t advocate market forecasting, we give a lot of thought to risk and think you should do the same. If your answer to any of the following four questions is a definite no, you should take a hard look at renting:
- Are mortgage rates going to stay low?
- Are condos going to increase in price?
- Are equities going to decline in price?
- Am I comfortable having a large portion of my net worth in one asset?
Why these four questions? Let’s assume mortgage rates rise 1%, condo prices stay flat and equities continue as they have for the past 100 years, averaging between 6%-8% per year. Take a look at how the equity of a renter would compare to the equity of condo owner over a 25-year mortgage period:
The renter would be ahead by $300,000. Almost enough to buy a condo outright!
We’re not against owning real estate but we like to own it through publicly-traded securities. This way you won’t be limited to one property, or have a disproportionate amount of your net worth in that property, or have low liquidity. Not only that, but interest rates are at historic lows. If rates move upward, mortgages will follow, and we saw how that can play out in the chart above.
Interested in chatting with a professional about your own rent or buy decision? Our Chief Investment Officer Dave Nugent loves this kind of stuff. You can email him at firstname.lastname@example.org or call him at 647-350-7675.
Feel free to check out our spreadsheet and assumptions on Google Docs. You can also input your own assumptions and play around with the quotes you've received! Rent vs. Buy Spreadsheet
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To get a true picture of comparative performance, investments should be compared on an unlevered basis. Its important to compare apples-to-apples and we did this with our first chart. But people often have to make the decision of whether or not to use leverage when buying a condo so we included the second chart, which takes into account the yearly cash flows of a renter and a levered condo owner. With our assumptions, you can see the difference in their equity at the end of each year. Its important to know that leverage can work for AND against you.
We believe in mean-reversion. Condos prices have accelerated in the recent past and we wouldn't be surprised to see years of flat prices. We also wouldn't be surprised to see years of flat equity prices. The truth is, we don't know what the future will bring, but we like to have an idea of the possibilities.
For U.S. investors you should also know that unlike in the U.S., mortgage interest can't be claimed as a tax deduction in Canada.