Friday, July 22, 2011

Renting vs. Homeownership - Real Estate Overheat in Canada

The question as to whether to rent or to own a home is a dilemma for many people in modern economy. In Korea, it has long been regarded as a norm that you should buy a house once you can get the loan sufficient to back up your seed money. After buying the house, you rent it, of course. You rent another house for your own use. That is happening here in Canada these days, according to the most recent Canadian Business magazine.

I was forced into this question actually a few years ago. I was to stay in Korea for about a year, and wanted to live right next to my workplace so that I can walk to my office. Even in Seoul, a city well known for top-of-the-world housing price (yes, I admit that Tokyo and Moscow are even worse) the vicinity of my workplace (the Central Government Complex of Korea) was notorious for its price level. Everything (even a piece of bread) was at least 20% more expensive there, so I had to run a cold hard calculation regarding my largest chunk of expenditure – housing.

It was a small studio in an officetel building. Buyout price was $170,000. Monthly rent was $925. The opportunity cost of the buyout is about $850 per month at 6% interest rate APR. Did I have an investment option of 6%? Not really, but it was something like 5.5%, which is close enough. Then the difference is $75. Considering tax and utilities, the difference gets smaller. Another big factor to consider is the time horizon. Because of the peculiarity of time (yes, the financial crisis) it was uncertain if the price would go up. Usually, going up was taken for granted, but time has changed. Then there is the administrative cost, the biggest chunk of which is the commission paid to the broker. All considered, it did not make sense to buy. So I rented. It was a very straightforward calculation.

Something similar appears in the Canadian Business magazine, for the situation today in Canada. Buyout price is $850,000. With $400,000 down, the monthly mortgage payment is given as $3,000. (The article appears to assume 7%, 30-year mortgage.) The opportunity cost for the downpayment is $2,000 per month at 6%. The monthly rent for the same house is $3,500. To rent wins by a landslide.

I travelled Europe long time ago as a back-packer and was impressed by the culture of lifelong renting. Back to Europe more than 10 years later, I found Norway getting caught in a real estate buying spree. Construction was going on in every corner of the city of Oslo, including one construction site blocking the path from my apartment to the nearest supermarket. A Norwegian friend told me of his own story of buying a house and then seeing its price jump threefold in about 5 years.

Everyone heard of the episode of the tulip bubble in the Netherlands back in the 17th century. People buy with the hope of someone else buying from them at even higher price in the future. This can’t last forever. I see this kind of dangerous race in the housing market in Canada these days.


  1. Very dangerous. Because of the cost of land is so expensive here - are businesses more likely to relocate somewhere cheaper?

    Does high prices mean a loss of business headquarters. Could be devastating for BC's economy.

  2. I agree, Kyle. News is that Vancouver is hosting only 84 HQs out of 500 largest companies in Canada, 4th place after Toronto, Calgary, and Montreal.