Performance figures for each account are calculated using time weighted rate of returns on a daily basis. The Composite returns are calculated based on the asset-weighted monthly composite constituents based on beginning of month asset mix and include the reinvestment of all earnings as of the payment date. Composite returns are as follows:

Higher Mortgage Costs Are Here – Is a Seed Change Coming?


Canadians have been increasingly counting on residential real estate to grow their wealth. Increased mortgage rates have the potential to dampen this strategy but the long-term implications are still far from being clear. In this article, I lay out the argument for renting vs buying, and why investors may consider the latter to grow their wealth.

By Christopher Warner, FCSI CFP PFP CIM

Canadians love investing in property – seemingly more so each year. Recent data published by Statistics Canada has suggested that multiple property owners in 4 tracked provinces held an average of about 35% of housing stock (Ontario (31%), BC (29%), Nova Scotia (41%), and New Brunswick (39%))[i]. In BC, where I reside, those stats suggest that the 268,660 recorded multiple-property owners[ii] would own about 580,000 of the roughly 2 million+ private dwellings[iii] in existence. Or to put it another way: if a British Columbian looks down their street or down their apartment’s hallway, about every 4th home or unit is owned by an investor.

These are notable, potentially counterintuitive statistics but they aren’t out of step with the world. The USA, for example, has renters in 30.9% of occupied homes[iv]. Where Canada does stand out is in housing affordability. Currently, we “lead” the G7 for the house price-to-income ratio:

Recent years of historically low interest rates had made it relatively easy for more Canadians to pile into real estate investing. This is apparent in GDP statistics from January 2022 showing Real Estate and Rental and Leasing were a robust 13.4% of GDP[v]. This is only 9% lower from its highest point ever of 14.8% GDP in April 2020, though it’s worth noting that the economy is also stronger today. Today’s “lower” 13.4% represents $268 billion whereas in 2020 the “higher” 14.8% represented only $245 billion.

Policymakers have long been aware of this trend and have been quite vocal in stating that they are seeking ways to reverse its concerning direction. Recently, the Bank of Canada has been raising its benchmark interest rates (25bps in March and another 50bps in April) to help curb high inflation. With more stated rate hikes on the way, one wonders about the implications for the roughly $2 trillion[vi] in mortgage debt Canadians collectively own. In theory, rising rates should help cool the housing market as they make borrowing less attractive and reduce buying power for borrowers.

Real Estate and Rental and Leasing were a robust 13.4% of Canada’s GDP… representing $268 billion.

It’s clear that Canada is heavily reliant on housing as part of its economy. This fact is further complicated by the myriad of related and interwoven issues such as demographic trends, housing supply, construction and skilled labour availability, housing affordability, low rental vacancy rates, immigration policy, and economic trends like wealth inequality. These are complex concepts best explained by economists and sociologists. That said, there is an individual lens through which we can assess rising mortgage rates for a clue as to how impactful they might be.

Home Ownership or Renting?

Let’s take the example of a simple “Buy versus Rent” calculation. The oft-asked question is whether one would be better off financially to buy their home versus renting and investing the difference in costs. Put simply: if we track the same amount of money going into one strategy or the other, what will leave us with more money in the end?

For the last few years, when I’ve done the calculation for clients, the numbers have almost uniformly benefited buying. With increased mortgage rates, let’s revisit this calculation.

Variables and Assumptions

As I’m located in Victoria, BC, I’ll use this market as a reference out of familiarity. We’ll assume we have an investor who has saved $150,000 looking to either buy a principal residence or rent and invest. We’ll use a measurement period of 5 years given that the 5-year mortgage term is most common.

Here are our rate assumptions:

  • 3.84% Mortgage Rate (best available public rate as of 4/28/2022 as shown on RateHub.ca)
  • 2.00% BoC Inflation Target
  • 2.00% Conservative/Minimum Housing Appreciation Rate (Between 1981 to now shows the annual  appreciation as 2.9%)
  • 4.29% Expected Investment Return (70% equity, 30% fixed income 1% fees[vii])
  • 25 years Mortgage Amortization (conventional)

With these variables in mind, let’s find a typical property to compare the costs of and see what leaves our investor with more money at the end of 5 years.

Renting

On the rental side, I can see from currently browsing Kijiji for rentals that an individual could obtain an 876sq ft 2 bedroom, 2 bathroom unit for $2,350 per month, 1 parking spot included but with utilities not included.  We would expect that rent will increase by about inflation every year.

We’ll choose this as our “bogey” – what to compare the costs of ownership against. The investor will need to pay $2,350 per month but can invest their $150,000 immediately. They can also invest any difference that they would be otherwise paying to a mortgage and other fees if they instead bought the unit. To analyze those costs, let’s move ahead.

Buying

Doing some number crunching and utilizing e-Value BC, I estimate that the investor could instead purchase this same unit for roughly $590,000. For a 20% down payment (to avoid high ratio fees), they would need to put $118,000 down. Land transfer tax would be $9,800. Legal fees would be about $1,000. In total, that’s $128,800 out of the investor’s $150,000 pool.

The total mortgage would be $472,000 with a fixed monthly payment of $2,450 (The mortgage is $472,00 after putting the 20% down payment of $118,000. The monthly payment is based on the mortgage rate of 3.84%). We also must consider the extra costs and that these will likely be correlated to inflation. Those are annual property taxes ($1,867), monthly strata fees ($268), and annual property upkeep ($1,000) for a total of $6,083 per year. The monthly cost for everything is $2,957 per month.

Comparison

To recap our two scenarios:

  • Renting
    • $2,350 per month in costs
    • Can invest the full $150,000
    • Can keep investing the difference in costs between renting and buying
    • Rental costs will grow at inflation
  • Buying
    • $2,957 per month in costs
    • Can only invest $21,100 of savings after all purchase costs are covered
    • Mortgage costs will be fixed
    • Property tax, strata and upkeep costs will grow at inflation
    • The market value of the home will grow at inflation

Totals

When we put the net of both calculations together, we see the following:

If you are interested in how these numbers were arrived at, please scroll to the end of the article for an analysis of the two scenarios (renting vs. buying).

By the 4th year*, the higher initial cost of homeownership eventually leaves our investor with a higher net worth than if they had rented and invested the difference in costs. Assuming the variables were to stay constant, this trend would continue each subsequent year, pointing in favour of homeownership as a means of wealth generation

*Note that we are only assessing net worth at the end of 5 years. We have not considered other factors like the investor’s freedom to move/sell the home due to complexity of variables. There are many other factors that could change this calculation including realtor fees, mortgage renewal rates, inflation, home appreciation/depreciation, etc.

Conclusion

Given high Canadian indebtedness and participation in the housing market, higher mortgage rates will undoubtedly put more pressure on the housing market. This is especially true for those already finding their mortgage payments a challenge and whose terms will inevitably expire, causing them to potentially renew into higher mortgage rates and payments. Credit delinquencies will be a key indicator to watch as rate hikes continue but current signs (including sale volumes, listing prices and trendlines, supply-demand curve, and real estate sector GDP) still point towards a softening rather than recession.

As well, today’s rate environment continues to show ownership benefits for those who can afford to make the choice between renting and owning. The example calculation will not be uniformly consistent across all of Canada but likely will align to general trends with other major cities. This suggests that most Canadians won’t likely be considering a move to renting quite yet. It also suggests that those with rental properties should still be able to generate income above market rates. Rates alone, while concerning, shouldn’t be dramatically shifting the landscape anytime soon.

 

This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required securities commissions.


 

[i] https://globalnews.ca/news/8754816/multiple-property-owners-housing-stock/

[ii] https://www150.statcan.gc.ca/n1/en/pub/46-28-0001/2019001/article/00001-eng.pdf?st=zHjou2ZJ

[iii] https://www12.statcan.gc.ca/census-recensement/2016/dp-pd/prof/details/page.cfm?Lang=E&Geo1=PR&Code1=59&Geo2=PR&Code2=01&SearchText=Canada&SearchType=Begins&SearchPR=01&B1=All&type=0

[iv] https://www.census.gov/housing/hvs/files/currenthvspress.pdf

[v] https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=3610043402

[vi] https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=1110006501

[vii] https://www.fpcanada.ca/docs/default-source/standards/2021-pag—english.pdf

Renting vs Buying Side-by-Side Analysis

Renting

As you can see, Annual Rent equals $146,753.93 over a 5-year period, whereas the Annual Home Purchase Costs (comprised of Property Tax, Strata, Upkeep & Mortgage Payments, and in year 1, the one-time purchase fee of $10,800) equal $189,456.38.

When we subtract Annual Home Purchase Costs from Annual Rent cost, we arrive at $42,702.45 which can be invested into our portfolio. You can see exact figures of extra contributions on a yearly basis under the column [Extra Contributions (Home Purchase – Annual Rent)] and the Annual Growth based on a 4.29% Expected Investment Return.

Buying

Argument for buying laid out in a chart

When we look at purchasing the $590,000 home, after a 20% down-payment of $118,000, and using our 3.84% mortgage rate, we arrive at $2,442.05 for the monthly payment (for simplicity in the calculation, we have rounded the monthly mortgage payment up to $2,450, which brings the yearly Mortgage Payments to $29,400.

Mortgage Balance shows the reduction of your mortgage based on your payment minus interest. Now, as we did not invest the initial $150,000 into the portfolio, we were only able to invest $21,200.00, which no additional yearly contributions. Annual Growth again is calculated at the 4.29% Expected Investment Return rate.

Total: Renting vs Buying

However, as the value of your home appreciates by the 2.0% Annual Home Growth rate, your Net Worth will grow at a higher rate than if you were to rent. As illustrated in the table below which shows the total net worth of renting vs buying a home.

Renting vs buying a home in BC comparison