Читать книгу The Wealthy Renter - Alex Avery - Страница 7

Rent — Something Everyone Pays. Always.

The backbone of the argument most people use to “prove” owning is better than renting is that to pay rent is to throw your money away. That a renter is simply paying the mortgage of the owner of the property.

While this argument seems logical and is intuitively appealing, it’s an over-simplification that ignores two important factors: 1) the owner of the property has invested money into owning the property and is taking on the risk of the property going up or down in value; and 2) everyone who lives in a house (or mobile home or recreational vehicle or tent) is paying rent. Always.

That second point might seem like a ridiculous statement, so let me clarify what I mean. The word rent is defined as money paid for the use of something. For housing, rent is what is paid for accommodation — which can be an apartment, a house, or any other form of accommodation. However, any payment should be considered a rent payment if there is 1) a use or service provided in exchange for the payment; and 2) there is no remaining value after the rental period expires.

The most common rent that everyone is familiar with is the rent that a renter pays to a landlord. The renter signs a lease and agrees to pay a set amount of rent each month, and when the lease is over, the renter leaves with nothing remaining. This type of arrangement clearly qualifies as rent.

But there are three other forms of housing rent: one we’re all familiar with, although we don’t usually refer to it as rent, second, the routine expenses that apply only to homeowners, that might not be considered rent, and third, another you might be less familiar with.

The first of these other forms of rent is the “rent” that a homebuyer pays to a bank when they borrow money to buy a home. The money borrowed is, of course, a mortgage, and the money paid in exchange for the use of that money, interest, is in fact rent. The homebuyer is paying rent for the use of the bank’s money over a period of time. The homebuyer then uses the money borrowed through a mortgage to buy a house — which means the rent they are paying to borrow the money is actually rent they are paying to occupy the home.

Every mortgage has an interest rate, which determines the amount of rent/interest the borrower pays to the bank each month, and there is also a principal payment. The principal payment is part of a mortgage payment that reduces the amount owing, and after many, many payments, eventually the principal payments reduce the mortgage balance to zero. The principal portion that reduces the balance is not “rent,” but a reduction to the service the bank is providing to the borrower. Reducing the principal owing on a mortgage is kind of like shrinking a full cable package until eventually you cancel all together. Once the mortgage is paid off, the rent (interest payments) stops, and the borrower no longer enjoys the use of the bank’s money.

The interest payment is a part of the rent a homeowner pays, but it’s not all of the rent. To figure out what the other rents are, let’s look at all the other payments renters and owners have to pay to live in a home.

Renters usually pay a specific amount of rent, but they also sometimes pay some of the utilities and other costs. The total of these payments should be considered the total rent.

For owners, the rent payments start with the interest portion of the mortgage payment. We can add to that the second type of rents we’ll refer to as non-interest rents, including all the other regular costs of owning a home. These include property taxes, because property taxes are payable every month, and they are meant to be payments to the municipal government for things like schools, public hospitals, highways and roads, sewers, and other infrastructure services. Homeowners are required to continue to pay property taxes for the use of the services provided by the municipality as long as they continue to live in their homes and use those services. (Actually, you have to pay them whether you use the services or not.) Anywhere you live, there are property taxes to be paid as long as you live there. If you leave, you can stop paying them.

It’s easy to underestimate the cost of maintaining a home, particularly because the costs are large and infrequent.

Another non-interest rent homeowners pay that most people don’t think about as rent is maintenance. This one is a tough number to nail down because it isn’t a set number and it isn’t payable each month. In fact, many of the costs of maintaining a home occur only once in a decade or even once every forty or fifty years.

Most roofs will last between twenty years and as long as fifty or sixty years. On the shorter end of the scale, the caulking around a bath tub or shower should be re-done every five or ten years, depending on how much use it gets and what kind of caulking was used.

A new roof costs a lot more than a tube of caulk, but both cost money and they will need to be replaced. Anyone who has owned a home will tell you that maintenance costs happen a lot more frequently than you might expect, and there are a lot more maintenance items than you would think. Homes are complex — they are made up of plumbing systems, heating and air conditioning, at least one bathroom, a kitchen, a foundation, windows, doors, and a whole lot of things that are painted. It is easy to underestimate the cost of maintaining a home, particularly because the costs are large and infrequent. A lot of them can be deferred for a long time without too much trouble. But if they’re deferred too long, like waiting to replace the roof, they can result in much more extensive damage.

A reasonable rule of thumb for this cost is 2 to 5 percent of the value of the home each year. For homes owned through a condominium corporation, most of the costs of maintenance (but not all) are covered by the condo fee. Still, the condo corporation might underestimate the costs of maintenance and end up raising condo fees to make up for deferred maintenance. Or, if they wait too long, they might make a special assessment (a large one-time fee charged to all unit owners) to cover a major repair.

Insurance is another non-interest rent cost. Renters don’t notice a landlord paying insurance in case the house burns down, but they’re quietly paying it. Homeowners rarely forget how much insurance costs!

So, in total, the rent a mortgaged homeowner pays includes: 1) interest on the mortgage; 2) maintenance; 3) property taxes; 4) utilities; and 5) insurance — and often a few other items (like mortgage insurance premiums, homeowners’ association fees, security fees, etc).

TABLE 4.1

	Renter	Mortgaged Owner
Primary Form of Rent	Rent	Interest
Rent Paid:	to Landlord	to Bank
Other RentsMaintenance:	Landlord Pays	Owner Pays
Property Taxes:	Landlord Pays	Owner Pays
Utilities:	Landlord/Renter	Owner Pays
Insurance & Other:	Landlord Pays	Owner Pays

It’s cheaper to rent a home as a renter than it is as an owner. Sometimes a lot cheaper.

Paying rent to a landlord is just a cleaner and simpler way of paying for the use of a home, compared to separately paying all of the costs outlined above. Homeowners are cutting out the middleman and paying all of the expenses relating to the home directly, including the interest payable when they borrow the money to purchase the house.

Now here’s an amazing thing about renting: It’s cheaper to rent a home as a renter than it is as an owner. Sometimes a lot cheaper. There are a number of reasons, and we’ll discuss many of them throughout this book, but they include the fact that renters usually rent smaller places than owners buy; many rental homes in Canada are older than owned homes, and often that means fewer modern features; landlords are more practical and financially disciplined when they spend money on maintaining and renovating rental housing; and landlords often undercharge on rent because they

*Average two bedroom monthly rent compared to average monthly mortgage payment, based on average home price, 5% downpayment, and a 2.4% mortgage rate with a 25 year amortization. Source: CMHC, 2013.

expect to make up the shortfall when the property goes up in value (which doesn’t always happen).

It’s true — in every major city in Canada, it is cheaper to rent a home than it is to buy a home.

What about when a homeowner pays off their mortgage? Are they still paying rent? Doesn’t the cost of home ownership drop off substantially once there are no more mortgage payments? In fact, the costs of home ownership don’t go down when a homeowner pays off their mortgage. Not even by a penny!

What does happen is that the mortgage payments, which were a part of rent, disappear, but they are replaced by an “implicit” rent. The implicit rent isn’t a payment that has to be made; it’s a payment you make to yourself.

Just like maintenance, it’s a very difficult number to figure out, and it can change significantly over time. And because it’s not a number you can see each month, it’s dangerous. If you don’t keep track of implicit rent, it can sneak up on you and become much larger than you’d ever imagine.

To understand implicit rent, think about it this way: When you buy a house, you take on a large mortgage, and over a long period of time you pay it o

The amount of income you haven’t earned because you’ve owned your home instead of investing in other things is implicit rent.

ff. When you do that, you’ve actually done two things. First, you’ve saved up a lot of money over a long period of time, and second, you’ve lived in a home.

If we separate these two things, you can look at the act of saving up a whole lot of money and look at other things you could do with all that money. You could buy bonds or dividend-paying stocks, or you could buy a rental property. All of which would pay you a regular income. All that money you would have tied up in owning that home could provide a lot of income,

TABLE 4.2

	Renter	Mortgaged Owner	Unmortgaged Owner
Primary Form of Rent	Rent	Interest	Opportunity Cost
Primary Rent Paid:	to Landlord	to Bank	to Self (and Consumed)
Other RentsMaintenance:	Landlord Pays	Owner Pays	Owner Pays
Property Taxes:	Landlord Pays	Owner Pays	Owner Pays
Utilities:	Landlord/Renter	Owner Pays	Owner Pays
Insurance:	Landlord Pays	Owner Pays	Owner Pays

and you are entitled to that income because it would be your money. That income — the amount of income you haven’t earned — is the “opportunity cost” of owning your home instead of investing in other things. And that is implicit rent.

The amount of rent you pay to live in a home doesn’t depend on whether there is a mortgage or not. It depends on how much the home costs. What changes as a homeowner pays down their mortgage is they gradually shift from paying the bank rent to paying themselves rent.

With the various ways homeowners pay rent, it’s easy to lose track of the total amount of rent there is for a home. What makes it most difficult is the implicit rent.

Try this: Ask a home-owning friend how much their house is worth. You’ll find that 100 percent (or pretty darn close) of your home-owning friends will have a pretty good guess.

Now ask them another question: How much implicit rent are they paying to live in their house? You’ll get nothing but puzzled looks. Maybe 1 percent of friends will even take a guess at this number.

Implicit rent is an opportunity cost, so the cost depends on what alternative investment opportunities are available.

Now ask it another way: How much could they rent out their home for? You’ll get more answers, but probably half will still have no idea, particularly if they live in a neighbourhood full of homeowners.

Ignorance is bliss.

Ask these questions of anyone who owns a home and lives in an expensive city, like Toronto or Vancouver, and then show them how to calculate the number. Once they do the math, they will be shocked by how much implicit rent they are paying.

Here are a couple different ways to calculate implicit rent. Depending on how you calculate it, you’ll get slightly different answers. Implicit rent is an opportunity cost, and because it’s an opportunity cost, the cost itself depends on what alternative investment opportunities are available. To figure out exactly what the cost is, a homeowner needs to actually change the way they are living — they need to sell their house, rent it out, remortgage it, or somehow otherwise invest the money they have tied up in their home in another investment.

First, how much implicit rent would a homeowner pay if they were to mortgage 100 percent of the value of their house?

To calculate this, take a guess at what the home is worth and multiply it by the mortgage rate you can get from your local bank. Any bank website will have posted mortgage rates. For instance, CIBC is currently offering a five-year, fixed-rate, closed mortgage at about 3 percent per year.

So, for an $850,000 house in Toronto (currently a below-average detached house price), the monthly interest is equal to the price times the mortgage rate, divided by twelve months in a year: $850,000 × 0.03 = $25,500 ÷ 12 = $2,125 per month. (Note that this calculation includes only the interest, or “rent,” portion of mortgage payments.)

This will easily be the lowest estimate of the cost of implicit rent because mortgage lenders in Canada offer very low rates of interest, since Canada subsidizes mortgage rates through its sponsorship of CMHC. This estimate will also be low because lenders don’t actually offer 100-percent mortgages — they almost always want you to put up some money for a down payment. If you borrow the entire amount needed to buy a home, the mortgage rate rises significantly … if you can find someone to lend you all of the cost.

Another way to figure out implicit rent is to look at other things you could do with your money rather than own a home. For instance, in Canada many investors have felt comfortable investing retirement money in defensive dividend-paying stocks, including banks, insurance companies, telecom and cable companies, REITs (real estate investment trusts), and pipelines. Let’s assume an investor invests in a portfolio of large, well-known dividend-paying stocks in Canada, generating an annual yield of 4.5 percent.

Under this scenario, a homeowner could estimate implicit rent by multiplying the house price by the yield on a basket of stocks and dividing by the twelve months of the year: $850,000 × 0.045 = $38,250 ÷ 12 = $3,187.50 per month.

If you aren’t comfortable with investing in individual stocks, you could consider using the yield on the S&P/TSX Dividend Aristocrats Index, which is an index (portfolio) of TSX-listed companies that have shown a regular pattern of increasing dividends over the past five years and have market capitalizations (the value of all the shares of the company) of at least $300 million. In short, the index is designed to provide investors with a conservative portfolio of defensive, income-producing stocks. Over the past ten years, this index has provided an annual total return of about 7 percent (yield plus appreciation of value), and the current yield on this index is about 4 percent: $850,000 × 0.04 = $34,000 ÷ 12 = $2,833.33 per month.

Now remember, what we’ve calculated in the three previous examples — mortgage interest on 100 percent of the value of a home, the value of a home invested at a 4.5-percent yield, and the value of a home invested at a 4-percent yield — has just been the implicit rent or opportunity cost of a home. The total cost of “rent” for a home also includes maintenance, utilities, insurance, and other items.

Another way to look at the cost of an owned home without a mortgage would be to find a home for rent nearby and use the asking rent as an estimate. Depending on where the home is and how nice it is, the amount a home rents for could be a lot more than the implicit rents we calculated, in part because the rent a landlord charges is supposed to cover not only the interest but also maintenance, property taxes, and insurance, among other things.

So for our $850,000-house example, we found implicit rent was somewhere between $2,125.00 per month and $3,187.50 per month, to which we would add: 1) maintenance costs (2 to 5 percent of the value of the home annually, or $1,416.66 to $3,541.66 per month); 2) property taxes (usually 0.5 to 1.5 percent per year, or $354.16 to $1,062.50 per month); and 3) insurance and other costs.

At a minimum, in today’s very low interest rate environment, an $850,000 home in Canada costs between about $4,000 and $8,000 per month to occupy. Regardless of the approach, those are big numbers. And those are the actual costs of occupying a home, whether you own the home or you don’t.

Attention Homeowners!

Before we wrap up this discussion, let’s do one more thing. If you happen to own a home with no mortgage, or just a small mortgage remaining, let’s calculate how much you are paying in rent, see what else you can do with that rent, and see whether you are over-consuming housing.

 Take your house value and multiply it by 0.95, to reflect the transaction costs of selling your house. This is how much you could walk away with if you sold your house.

 Take that number and multiply it by the Dividend Aristocrats yield (http://ca.spindices.com/indices/strategy/sp-tsx-canadian-dividend- aristocrats-index), and divide by twelve to get your implicit monthly rent. A good conservative and rough estimate, if you can’t find the current yield, would be 4 percent.

 Add to that number all of the other “rents” you pay (monthly costs of property taxes at 0.5 to 1.5 percent per year, depending on what city you live in; estimate of maintenance cost at 2 to 5 percent per year; plus utilities, insurance, and any other regular expenses related to your house).

This is what you are spending to live in your house, on a monthly basis.

Now that you know that number, there are two things you can do with it. First, spend a bit of time comparing that number to the costs of other housing options you would consider. They could be nearby single-family houses, rental apartments, condominiums (for rent or sale), or even housing in another location.

If the amount of money you’re spending to live in your home on a monthly basis is significantly more than what your other housing options are, spend a bit more time thinking about what you would do with the extra money you would save by selling your house and moving to less expensive housing. If you were to save $1,000 per month, you could spend that money on four $3,000 vacations a year. Or you could take classes on something you’ve always wanted to learn about. Don’t be shy — think of the most fantastic thing you could spend money on, and you could probably figure out how to pay for it with the sale proceeds of your home!

It might sound reckless to suggest selling your house to spend money on other things you enjoy, but what we’re actually looking at is how much money you are spending on “consuming” the housing you are living in. Whether you spend that money on continuing to live in your house or on cars, antiques, or sporting events, it’s all consumption.

If you own a home, have run the above math, and really want to improve your financial position, you could look at selling your house, finding cheaper accommodation, and, instead of consuming the savings, re-invest the proceeds of the sale in other investments, like the Dividend Aristocrats Index. Then you could re-invest the dividends from your income-producing investments, creating even further personal wealth!

Now for the second thing you can do with your monthly housing cost number:

 Take your total gross monthly income (before taxes) and add to it the implicit rent you calculated earlier. That was the number you calculated by multiplying the value of your house by 0.95 (95 percent) and again by 0.04 (4 percent). This is your gross monthly income, including the rent you are paying yourself to live in your house.

 Now take your total monthly housing cost (including property taxes, utilities, insurance, and maintenance) and divide it by your total gross monthly income plus the implicit rent you are paying yourself.

This is how much of your total income you are spending on your housing. I like to think of this number as the amount of money a person spends on consuming housing. It is consumption because every component we’ve included in this calculation is a rent — meaning there is no residual value.

CMHC suggests you spend no more than 32 percent of your gross, pre-tax income on your housing costs. CMHC’s gross income doesn’t include implicit rent in either your gross income or your housing costs. I think that’s because the measure is designed to determine whether a person can make the monthly payments required to stay current on their mortgage.

However, the test we just calculated does ask you to include the implied rent you are paying. In doing so, it is designed to show you how much you are spending of all the possible income you could be earning on housing. It is also designed to make you question, once you know that number, whether you want to be spending as much of your income on housing as you are.

Figuring out how much of your income you’re spending on housing is so much simpler for renters, and I think that’s one of the reasons renters usually don’t get in over their heads with housing costs. For renters, take your rent, plus any utilities you pay, and divide it by your gross monthly income to determine how much of your total income you’re paying on housing.

Now both renters and owners have their numbers.

If the number you calculated is over 50 percent, you should probably spend some time looking into whether the housing you are spending so much on is really as important to you as the percentage of your income it is consuming. You could very well find that there are lots of other things you might prefer to spend your money on.

If the number is between 32 and 50 percent, then you are above the upper limit of what CMHC recommends you should be spending on your housing. That might be fine with you, if you really like the home you have and don’t want to move. But it might also mean there are some significant savings you could find by moving to less expensive housing.

If you are under 32 percent, congratulations! You have made housing decisions that have you spending less than the maximum recommended amount, according to CMHC. This puts you on the safe side of disastrous, in terms of consuming housing you can afford. As we’ll discuss later on, if you want to build wealth, there are much better things to spend your money on than housing. Minimizing consumption of housing is crucial to building wealth.

This chapter has had quite a bit of math, and I know not everyone loves math. I don’t even love math. But it’s an important tool. The key idea of this chapter is that, just because homeowners aren’t paying rent to a landlord, it doesn’t mean they aren’t paying rent. They just pay rent to themselves. And when you pay rent to yourself, it’s easy to lose track of how much rent you are paying, and you might end up over-consuming housing.

If you’re still having trouble with the idea of implicit rent or are dismissing it as “interesting in theory, but not a real cost,” you should know that it’s not just me who recognizes implicit rent as a real cost. If you live in Switzerland and you own your home, you have to pay taxes on the implied rent you are receiving, as the owner of the house, paid to you, from you, the tenant in the house. Fortunately for Swiss taxpayers, they also get to deduct all of the costs of the house, including mortgage interest, from that implicit rent income they receive from themselves.