— Landlord Relief (@LandlordRelief) December 14, 2014
Introduction – The Questions of Owning vs. Renting Continued
I once heard a Toronto renter comment that:
“I can pay rent or I can pay interest”.
One pays “interest” through a mortgage. At some point the mortgage will be “paid off” and the house will be owned “free and clear”. “Rent” payments will continue forever. Does this mean that “rent” (in the long run) is more expensive than “interest”? Not necessarily. Remember that “capital has value”. Remember that the “equity” in a home can be tapped for other purposes. I don’t think there is a clear answer to the question of whether “renting” or “owning” makes more sense economically. That said, life is about more than economics. There are many lifestyle, family and emotional issues that impact on the “rent” or “own” decision.
The Economic Analysis …
There are many who presume that owning is always better than renting. Is this always true? Not necessarily. I have explored this question in a variety of posts. There are clear instances where it can make sense to rent rather than to own. Real estate is a capital asset. The question is often how to make best use of your capital. Should your capital be tied up in your home? Should your capital be used for other investments?
Real Estate is a capital asset
Capital has economic value. Capital can be used to “save you money” or to “make you money”. (Recall that old adage: “A penny saved is a penny earned”.)
The capital invested in real estate can be used:
1. Saving you money: If you own a home, the capital in that home is used to save you the expense of renting);
2. Making you money: Capital can be used to invest The return on that investment is income That income can be used to pay your living expenses. Tthat’s why some “boomers” consider selling their home and downsizing). The proceeds of the sale will be invested (making you money). This is possible because the Government of Canada has made the sale of a principal residence a “tax free” capital gain. In Canada you can sell your principal residence, retain that capital, invest that capital and earn income from that capital.
Survey found that 24 per cent of Canadians plan to use their home as their primary source of retirement income. http://t.co/klvuhz5ICt
— Landlord Relief (@LandlordRelief) December 14, 2014
That’s why many Canadians will:
A. invest in a principal residence;
B. Allow it to increase in value.
C. Sell it and take the “tax free” capital gain.
D.Downsize and live off the capital.
Note that this strategy works for everybody except U.S. citizens in Canada. U.S. citizens in Canada do NOT receive a tax free capital gain on their principal residence. (In general those Canadians who were born in the United States are burdened with U.S. citizenship. For a U.S. citizen to preserve the capital in his principal residence he must renounce his U.S. citizenship. Interestingly, U.S. citizens in Canada are forced to renounce U.S. citizenship in order to protect their retirement capital.)
To “rent” or “not to rent”, whether tis better to …
The issue from the tenant’s perspective …
In general terms, those who “rent” pay money for the right to “use of the property”. But, the right to “use the property” is different from the cost to “maintain the property”. For example you can rent a house which gives you the right to “use the property”. But the house will require “maintenance costs” (examples include, heat, hydro, taxes … The cost paid to “use the property” is separate from the costs to “maintain the property”.
Rental agreements are generally of two types.
Type 1 – A fee is paid for “only” the “use of the property”. The renter (tenant) is required to pay the expenses associated with maintaining the property separately. These expenses may include utilities, taxes, etc. (This is a lease where the tenant pays the utilities. This is typical of the rental of a house.)
Type 2 – A fee is paid for both the “use of the property” and “maintainig the property”. This is a lease where the tenant makes one payment for both the “use of the property” and “maintaining the property”. (This is typical of the rental of one unit in a multi-unit building.)
The issue from the landlord’s perspective …
1. The costs of owning the property
This cost includes the actual cost of purchasing the land and the building. This is the purchase price. Note that the structure is a depreciating asset. The land is “traditionally” an “appreciating asset”. The property is typically financed and the cost of owing the property is typically a combination of:
A. The opportunity cost on the money that is invested in the property (down payment, etc.)
B. The financing costs.
2. The costs of maintaining and running the property
There are costs to maintain and run a property. These costs include:
The monthly rent paid to rent an apartment in Toronto
A. From the perspective of the tenant
The tenant will typically pay a monthly rent that includes all costs associated with the property.
B. From the perspective of the landlord
Is the monthly fee paid by the tenant a payment for the property or a payment for the cost of maintaining the property?
The landlord will take that monthly fee and pay his expenses. Some of these expenses are the cost of “owning the property” and some of the expenses are the cost of “maintaining the property”. But, how much of monthly fee is actually for the use of the property? How much of the fee is actually “rent” for the use of the property?
Definition of rent: The amount paid toward the cost for the right to “use the property”. From the landlord’s perspective this is a return for his “owning a property”. I am NOT defining “rent” as including the cost of “maintaining the property”.
If the rent paid by the tenant is only enough to cover the cost of maintaining the property the landlord is receiving no compensation for the cost of owning the property.
If the tenant is not paying anything for the cost of “owning the property”, then:
The tenant is effectively living “rent free”!
Q. How is this possible?
A. There are tenants who have lived in Toronto apartments for many years and are still benefiting from the original Ontario rent control laws. The monthly fee that they pay is only enough to cover the cost of “maintaining the property”. The tenant does NOT pay enough to compensate the landlord for owning the property. In other words:
The tenant is living “rent free”.
Is it possible for a tenant to live “rent free” in Toronto? It certainly is and many do.
Should a tenant who is living “rent free” purchase a property?
Tenants often consider purchasing a condominium. What if the rent on the apartment is equal to the condominium fee and taxes paid to own the condominium – only the cost of “maintaining the property”? In this situation the monthly fee paid by the tenant is the same amount he would pay for “maintaining the condominium”. The tenant is already living “rent free”. By purchasing a condominium, the tenant will actually (because he must now pay for the right to use the condominium unit) begin “paying rent”.
Why would a tenant start paying “rent” when he/she is living “rent free”?
No, it does NOT always make “economic sense” to own.
This is particularly true when the question remains: