New rules of spending

Real estate isn’t just a place to live anymore



From the November 2016 issue of the magazine.


new rules spending_FB

Real estate isn’t just a place to live…

A home is now an integral part of your financial plan but it wasn’t always this way. According to the Canadian Real Estate Association data, the average Canadian home cost just $76,534 in 1984. It rose to $226,604 by 2004 and currently sits at $442,264, a stunning 478% increase in just three decades.

“At one point, a home was considered a place to live,” says Talbot Stevens, author of The Smart Debt Coach. “It wasn’t part of the investment decision.” But with rapidly increasing housing prices, our attitude toward real estate has changed.

“Real estate is clearly very important,” says CIBC deputy chief economist Benjamin Tal. “Many people are using the valuation of their house as a forced savings plan, but there are negative implications to this strategy.”

Like most assets, housing is subject to market conditions and investor sentiment. But CFP Vicki Campbell with Ottawa-based financial planning firm Ryan Lamontagne points out: “it’s also not like any other investment.” It’s one part investment, one part forced savings plan and one part necessity. (We all need a place to live). “To make a smart housing decision, you need to look at the overall financial picture.” And in this new era of slow growth and low interest rates, the golden rule is still diversification, explains Ayana Forward, CFP, also with Ryan Lamontagne. “You don’t want all your money tied up in a home, leaving you little left over for savings.”

Yet, according to a recent report by HSBC, 48% of working-age Canadians either haven’t started or stopped saving for retirement. And 20% felt that selling their home would help to make up their shortfall.

“There’s this idea that you have to get in before the train leaves the station,” says Stevens. Combine this with two stock market crashes since 2000, and it’s easy to see why property is so tempting. We fail to recognize that record low rates helped to inflate home prices, making “a reliance on housing unwise,” says Tal.

Forget the 30% rule

Don’t spend more than 30% of your income on shelter costs. It’s a popular rule but it’s also “an arbitrary number,” says associate professor of urban affairs at Virginia Tech, David Bieri. “It creates more distortions than it actually solves.” A more practical rule to follow? Try the “residual income” approach: The amount of income left over after all personal debts and expenses, including shelter costs, have been paid. Those with higher incomes will have higher residual incomes so they can afford to pay more in housing costs. It’s also why families with two incomes and no kids can spend more on housing then families with children, for whom more income will go to child-related costs, such as clothing and daycare.

Renting is now the smart choice

Deciding whether or not a house is a good investment comes down to good, old-fashioned budget analysis, says Vicki Campbell, certified financial planner with Ryan Lamontagne. “Decades ago, people bought a house without planning. Now, the move has to be weighed against the costs and the trade-offs.” And sometimes it just makes more sense to rent and invest the savings. It’s a decision faced by many millennials, particularly those drawn to Vancouver and Toronto—where 25% of Canada’s jobs are currently found. In Toronto the average rent for a downtown condo is about $1,700, while the average resale value of that same condo hovers just above $375,000. Factor in the monthly maintenance fees and the cost to own can add $200 or more per month. Rent, invest the extra, and in 10 years you could save $31,300 (assuming a 5% annual return and no change in rental rates).

Busted: Timing the market

“Timing the real estate market is never wise,” explains Ted Rechtshaffen, president and CEO of TriDelta Financial. He explains that when buying a home, “it’s not about the home price, but the mortgage rate.” If you can afford to pay the mortgage now—and you can still afford to pay the mortgage five years from now, after rates have risen, then you can afford to buy the home. For today’s home buyer that means calculating whether or not you can afford monthly payments for your dream home at rates of 4% or 5% or even 6%.

The new rules of personal finance:

The new rules of saving »
The new rules of investing »
The new rules of retirement »

5 comments on “New rules of spending

  1. “According to the Canadian Real Estate Association data, the average Canadian home cost just $76,534 in 1984. It rose to $226,604 by 2004 and currently sits at $442,264, a stunning 478% increase in just three decades.”

    Over the same time period (Nov 10 1984 – Nov 10 2016), the S&P 500 increased by 1,188% while the Dow Jones Industry Average increased by 1,436%. Some quick math shows that while a home bought in 1984 for $76,534 would now be worth $442,264, if you had put that same 76k into the stock market, today you would have between $985,758 (S&P returns) to $1,175,562 (DJI returns).

    Folks, be very skeptical of conclusions that are spoon fed to you by the Real Estate Associations (who have a vested interest in keeping prices and demand high, as their salary depends on it). In the face of potential >1,000% returns, 478% is long way from “stunning”.


  2. I’m new to this, so bear with me. But one thing I don’t think I’ve seen factored into housing investments is the cost of borrowing (the mortage). The fact that I haven’t seen any real mention of it leads me to think I’m the one missing something.

    Here’s what I mean: if I buy a house and have a mortgage of $250,000 at an interest rate of, say, 4% with an amortization period of 25 years, the total cost of that house (assuming I stay in it and take the full 25 years to pay it off) would work out to be about $396,000. Is the assumption that if I sold it at that point the valuation would be significantly more than $400,000?

    I’m seeing these big numbers used to show how much money is being made without any acknowledgement of the cost of borrowing to buy the home. I recognize that a number of things aren’t included in my hypothetical scenario, like inflation, paying off the home early, selling/moving, etc. Would those things ultimately make housing seem like a better investment than what I’m seeing?

    (Again, I realize this may be an elementary question. I’m just having a tough time wrapping my mind around it.)


    • You aren’t the only one 😉 When I debate renting versus buying, I look at total cost of ownership. So it’s not just mortgage costs, but closing costs, repairs + maintenance, renovations, decorating, increased utilities, etc. People also love to forget that for the first five years, you’re mostly paying interest rather than principle.

      It sounds great when people tell you how much their home has increased in value, but then remember how much money they’ve put into their home too.


  3. Don’t forget – you have to live somewhere! And in affordable areas (not TO, Vancouver) you can be sure that rent exceeds carrying costs or an investor wouldn’t invest. Rent is gone forever, whereas the paydown of your mortgage stays with you. The capital gains in your personal residence DO NOT GET TAXED, and furthermore you can easily borrow against the equity and invest in other vehicles (Real Estate or not!). Again, this does not work in unaffordable areas and involves a long-term outlook.


  4. Kyle – You’re absolutely right. The cost of borrowing is never discussed. If that is taken into consideration, the 478% return would be significantly lower (especially since interest rates spiked to 14% in the 1990’s). But this is conveniently brushed over, to make returns on housing appear more attractice.

    Marg – When you buy a house, you have greater costs than just your mortgage. Maybe rent would exceed your mortgage payment, but would it exceed your mortgage + insurance + taxes + maintenance? Plus, sure maybe your rent payment is gone forever, but is the insurance payment on your mortgage (as explained by Kyle).

    Look, I’m not trying to dump on real estate. But too often, people believe real estate is the best investment possible and will only ever go up, forever. Therefore, they stretch themselves to the absolute limit, believing nothing could go wrong. It’s helpful to remember historical perspectives: over the very long term, real estate tends to go up by 3% per year; stocks tend to go up by 7% per year. Real estate has a place in a well balanced portfolio, but it should not be the only asset in your portfolio.

    And please, critically assess any claims made to you by real estate agents/associations; they have a vested interest in seeing house prices go up, as this leads to higher commissions.


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