Renting is often a better deal than buying. That’s because of how expensive it is to own a home

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Renting is looking like a good deal in many parts of Canada. While there is a common perception that renting is just “throwing money away,” it’s important to understand the true costs of owning a home.

The full cost of renting is obvious: it’s the rent. The total costs for a homeowner are less obvious and often hard to measure. The big expenses are property taxes, maintenance costs, depreciation, and the cost of capital – which includes not just mortgage interest costs, but also the opportunity cost of not investing that down payment you worked so hard to save.

Property taxes don’t need much explanation. Maintenance and depreciation costs are more of a challenge to calculate. Homes are depreciating assets. Land appreciates, but buildings depreciate. Spending on maintenance reduces, but does not eliminate, depreciation.

Building depreciation comes from normal wear and tear (like the need to eventually replace a roof) and obsolescence (construction methods, materials, and finishes becoming less desirable over time.)

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A 2007 paper in the Journal of Urban Economics finds that the cost of U.S. housing depreciation is roughly 2.5 per cent per year when maintenance spending is included in the figure. This is in the same ballpark as what Statistics Canada uses to measure the cost of owned housing in the consumer price index.

There is no single “correct” way to cost out maintenance and depreciation, and it will vary by property, but anywhere from 1 per cent to 2 per cent of the property value per year is likely reasonable. My experiences as a homeowner would make me lean more toward 2 per cent when I run these numbers for myself.

Next is the cost of capital. When you own a home, you are investing in a real estate asset rather than other assets like stocks. A reasonable expectation for stock returns is around 5 per cent after inflation. Let’s drop that down to 4 per cent for this use case. For real estate, a realistic expected return based on long-term historical data is around 1 per cent after inflation.

If you’re scratching your head at how I arrived at those numbers, you can read about it here. Based on these figures we have an opportunity cost of 3 per cent per year for home equity. Most people will also have the cost of debt financing. The total cost of capital will depend on the mix of debt and equity used to purchase the home.

When the estimates for property taxes, maintenance costs, and the cost of capital are added up, we will typically get a number somewhere between 5 per cent and 6 per cent per year of the home value as the total cost of owning a home. This means that a $500,000 home costs somewhere between $2,000 and $2,500 per month to own.

In perfect equilibrium, renting and owning should cost the same because house prices and rents adjust such that the cost of paying for housing is the same either way. But it doesn’t work like that in the real world. A 2012 paper in Real Estate Economics suggests that demand for homeownership, fuelled by perceptions that renting is throwing away money, may make renting even more economically attractive.

The authors test this by simulating the rent-vs.-buy decision at different times and locations in U.S. historical data. They look at eight-year holding periods (the average holding period for homes in the United States) and find that renting beats owning over most of their 1978 to 2009 study period.

A 2007 paper using Canadian data finds that over the period 1979 to 2006, renters could have accumulated the same amount of wealth as owners in seven of the nine cities studied. The authors note that for renters to match owner wealth it would require discipline, low investment fees, and high expected return investments like stocks.

For people making the rent-vs.-buy decision today, PWL Capital has released a free online calculator that lets you plug in assumptions including home prices, rents, mortgage rates, and other key variables, and project the relative wealth outcomes for owners and renters over a long horizon.

In this tool it’s quick to see that renting can be a good option. For example, the benchmark price for a condo in Toronto was $679,200 in July, based on the MLS Home Price Index, while the market rent for a two-bedroom was $3,199, based on rentals.ca data.

Doing the rough math based on a 5-per-cent to 6-per-cent cost of owning, we can see that the costs of renting and owning are similar. Using the PWL calculator we can see more precisely that after 25 years of saving and investing the renter would be expected to have a net worth of $1,527,512 while the owner’s would be $1,524,860.

There are many worthwhile financial and non-financial considerations in the rent-vs.-own decision for housing, but a fundamental starting point is understanding how much you will be spending on housing. When you know how to compare total costs, you see which of renting or owning is a better financial option for your specific decision.

If renting is cheaper, as it often is – likely owing to the cult of home ownership driving up prices – it may be a better financial decision to rent. As demonstrated in two studies, renting has been economically attractive in both the U.S. and Canada.

Importantly, a financially successful renter needs to be highly disciplined with their savings, pay low investment fees, and capture the returns that financial markets are expected to deliver.

Those may sound like simple tasks, but many people lack discipline, pay high fees on their investments, and get into and out of the stock market at the wrong times, reducing their returns. For these people, owning a home is likely a wise decision.

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Benjamin Felix is the chief investment officer and a portfolio manager at PWL Capital. He co-hosts the Rational Reminder podcast and has a YouTube channel. He is a CFP® professional and a CFA® charterholder.