Sunday, August 4, 2013

Should I rent or own my residence?


This is another of those perpetual investment decisions everyone faces in their life. My answer is: ‘It depends’.
First of all, buying real estate is an investment – often a big investment. It takes time to make it worth your while. If you buy a house you pay lawyers, transfer taxes (unless you live in Alberta), in some cases you pay GST, etc. When you sell, you pay lawyers, real estate commissions and all kind of taxes. Typically, the first 6 to 8% of your property's appreciation goes towards paying for those transaction costs. That means, with a typical appreciation cost of 3 to 5% per year, that the first 2 years of appreciation (if it is straight line) goes toward paying the transaction costs. I use as rule of thumb that real estate investments should be held at least five years and probably forever. Thus, if you are in that stage of life where you don’t know where you want to live or work then rent rather than buy. Does that make sense?
In everyone’s financial decisions there is the choice: buy a liability or buy an asset. A liability is something that costs money and other than enjoyment of ownership it provides no growth in your net worth. An asset is bought to create increased net worth.  A personal car is a liability; a real estate property is an asset.
To make matters a bit more complex, a car required for work is an asset as it allows you to earn money. But would you buy a $200,000 car or one that is priced based on how much you will earn from work. I would say the price should be as cheap as the circumstances allow.  We all know that a car depreciates every year and it costs money to maintain. So if your monthly pay cheque is $1000 would you take on $700 in monthly car payments and other costs? Not likely – you would probably buy the cheapest piece of junk that you can get as long as it brings you safely from point A to B.
If you bought anything more expensive, the car would no longer be an asset, it would become a liability. You may actually want to own a more expensive car but that would be for your personal enjoyment.  You would conclude that to make money from your car, you’d do with a $600 clunker but there is more to life than sitting in a cramped piece of junk. You want a radio in the thing. In fact you desire a Bose system! The increased car expense is due to your lifestyle choice and now your car is now not quite an asset and not quite a liability.
If you buy a rental property, you expect to make rental income offset by maintenance, property taxes,  advertising, etc. These operating expenses are strict necessities to create maximum profits from this asset. Now, to whom would you rent it to? 
A tenant would be renting the place based on various factors. The place could be fabulous providing a lifestyle fit for a prince! Alternatively, the place could be functional and provides the tenant a place to eat and sleep while the rest of his time the tenant plans to work.  In the first case, the princely lifestyle is typically intended for the tenant’s enjoyment and the place is a liability for the tenant – the rent is mostly consumerism.  In the second case, the rent is kept to a minimum, the place is required by the tenant to do his job and maximize his savings. The place is an asset for the tenant.
A functional home (?)
Now, who do you, the landlord, think would constitute the most reliable tenant for this property? Who would stay at the place for years while you collect rent without worry?  The answer is: You! You are the most reliable tenant.  You already made at least a 5 year commitment to own the place – anyone else who gives you a five year lease? 
And if you chose the place as an asset needed to do your work, renting it from yourself, would augment your net worth because it represents the lowest cost of living, while it provides you with land lording profits as well.
Now, if you were the tenant who wanted the princely lifestyle, you’d still make the land lording profits but the tenancy is mostly a liability. It is consumerism that does not add to your net worth!
When contemplating buying your residence, analyse it as if it was a rental property. Then switching to the position of tenant, ask yourself what lifestyle you want – what is the utility/consumer ratio that you’re after?  Are you mister frugality; are you living pleasantly but below your means, or are you splurging like a Saudi Prince?
You see, now the question of ownership can be just as easily answered as if you buy or lease a car. My choice: I’ll own my residence but I don’t want a place that is too spacious and expensive. I want a place where I can enjoy my neighbors, entertain friends and family while living comfy but… well below my means.

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