Leverage. Friend or Enemy?

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The Wanderer retired from his engineering job at a major Silicon Valley semiconductor company at the age of 33. He now travels the world, seeking out knowledge from other wealthy people, so that he can teach people how to become Financially Independent themselves.
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Using leverage to buy a house
photo credit: Images Money @ Flickr

In our previous post, we broke down the math behind home ownership attempting to answer the question “In 2012, if we had bought a house instead of investing, would we have been ahead?”

The short answer is no. The longer, more detailed answer is HELL no. The results, which surprised even us, show that even in this weird time period of 2012-2015 when houses and a 60/40 portfolio appreciated at about the same rate (7-8% per year), the added, hidden costs of home ownership ate up most of the price appreciation. In the end, the return earned by investing thumped home ownership by a whopping 2.61X!

But in many ways, that scenario is unrealistic for the average person, as it compares taking $500k and shovelling it into a house or the stock market. Who the Heck has $500k saved up?

No, the average investor doesn’t have anywhere close to that, and must buy a house with a mortgage. It’s the only way to realistically get into the real estate market and participate in that sweet, sweet housing appreciation, and Real Estate agents are all too happy to let people do it. This is called Leverage, they say, and Leveraged Investing is your friend, because it allows you to participate in the gain on a $500k home investment while only putting in a fraction of that cash in yourself.

Leverage is your friend? Really?

Let’s Math This Shit Up

OK let’s say our intrepid investor, who we’ll called Homey the Homeowner, is looking at that same average Toronto house from the previous article. The one that he could buy for $497,130 in 2012 and whose value shot upwards to $622,120. Again, this is a $124,990 windfall in price gains, and represents a fat juicy 7.8% year-over-year gain. Mmmmmm, we definitely want to get us some of THAT action, right?

The minimum down payment you have to have in Canada is 5% for a mortgage from a respectable bank. That means Homey needs to put in $497,130 x 5% = $24,856.50. The remaining $472,273.50 will be the initial mortgage balance. At the time of writing, we can get a 5-year fixed mortgage for the holy-shit-rock-bottom interest rate of 2.25%.

I plugged this information into a mortgage calculator at www.canadamortgage.com, and got this as a result.

Chart explaining leverage

You can play around with the calculator yourself to see how it all works, but basically, each bar is your monthly payment (in this case, $2,057). The blue/yellow parts of the bar is the part of the payment that went towards your principal, and the red is that part that went towards interest on your loan. And the numbers at the bottom are where your mortgage stands at the end of 3 years.

Now, at the end of those 3 years, remember we are sitting on a nice juicy gain of $124,990, so Homey decides to sell. After a brief listing period with a real estate agent, Homey receives a nice fat sale for $622,120. He then pays off the remaining balance on his loan to get a total of $622,120 – $428,530 = $193,590.

Now remember, that full amount isn’t profit. Over those 3 years, Homey paid a total of $43,744 (principal) + $30,318 (interest) = $74,062 in mortgage payments, plus his initial downpayment of $25,000. Expenses incurred in the process of owning this house need to be deducted from the final windfall to calculate profit. So his actual gain is $193,590 – $74,062 – $25,000 = $94,528.

Great! $95 grand. Who wouldn’t be happy with that?

Remember this table from the last article?

Item Cost
Real-estate agent commission (5% to sell): $622,120 x 5%= $31,106
Land transfer tax (municipal AND provincial) $12,085.20 (source: TREB LTT Calculator)
Property Taxes: $3,420.12 (2012) x 3 = $10,260.36 (source: Toronto Property Tax Calculator)
Lawyer fees: $500 x 2 (buy and sell) = $1000
Home inspection: $500
Home insurance: $100/month * 36 = $3600 (source: Toronto Home Ownership Costs)
Maintenance: You should set aside 1-3% of the price of your home for maintenance per year. So let’s say 1%. $4971.3 x 3 years = $14,913.90 (source: Toronto Home Ownership Costs)
Gas, Electricity, Water (included in our rent): $125/month (hydro) + $125/month (gas) = $250/month * 36 = $9000 (source: Toronto Home Ownership Costs)
TV Cable (included in our rent): $25/month * 36 = $900
Furniture We would need to buy furniture to furnish the addition bedrooms. Assuming 10K and a 50% resale value = $5000
Total costs over 3 years $88,365.46

Oh. Right. That.

Yeah, all those costs still apply whether you have a mortgage or not. So that means Homey’s windfall was, over the past 3 years, eaten up by all these extra costs of home ownership that he wouldn’t have had to deal with as a renter. That means his actual gain is $94,528 – $88,365.46 = $6,162.54.

That’s right. Of his $124,990 windfall from record-breaking home price appreciation, with a mortgage and taking advantage of “Leveraged Investing,” Homey gets to keep a whopping $6,162.54 of it.

Wait, What?

This silly little blog has only been up around 3 months as of the time of this writing, and one of the most surprising and rewarding parts of doing this is talking to you, our readers, in the comments and over email. We’ve learned an incredible amount just talking to you, and one of the most surprising things we learned was this:

The reason people don’t have money is NOT because they’re irresponsible with it.

Quite the opposite. We’ve talked to so many people, from Canada, the USA, and abroad. Time after time, email after email, we meet people who aren’t going out and buying fancy sports cars to drive to the casino. They’re hard working, honest people who are doing the best they can to provide for themselves and their family. They’re apparently doing everything right, yet they have no money. Why? Well, we think we have an answer. Over time, by doing more and more case analysis like the one we just did, what we’ve realized is this:

The reason people don’t have money is because it’s being stolen from them.

That’s right. I said it. Stolen.

Only these thieves don’t wear black bandanas and stick a gun in your ribs. These thieves wear $1000 suits, smile, offer you coffee, and tell you how smart you are while robbing you every time you sign a contract you don’t understand.

Homey here got gifted a $124,990 windfall by the twin forces of a rising housing market and cheap money. And yet he only got to keep less than 5% of it.

So who are the thieves here? Where did all his money go? Let’s break it down.

Where your leverage is going

Oh, sorry, did you miss your piece? Here it is highlighted.

Where your leverage is going

That’s you. The homeowner who took the risk, did the supposedly “right” thing, and rode a massive housing price wave to a six-figure windfall. You got 5%. Who got the rest?

  • Your real estate agent. They made off with the biggest chunk. 31k, or 25%. For placing a few signs and hosting an open house, your real estate agent got a quarter of your rightful nest egg.
  • The bank. They took another quarter. Cheap money, they said. Smart move, they said. Sign right here, they said. Boom. 30k gone. 24% gone.
  • The government. Ouch. Land transfer taxes and property taxes are the next biggest chunk. 18% to a government that will likely waste it on first class flights for senators.
  • Contractors. Those people you call whenever a pipe bursts or a basement floods. They took 12% of your money for their services.

And the list goes on and on and on.

And meanwhile, those same people will come out and congratulate you on what a smart investment choice you made, using leverage like a BOSS. Here’s how. They take your gains and divide it by the relatively small amount of equity you put down. So here, you equity was $25000 (your downpayment) + $43,744 (mortgage payment that went towards principle). That means on your $68,744 investment, you made $6162.54, meaning you made a return on investment of $6162.54/$68,744 = 9%!

Woo! 9%! You are SO smart, they will tell you!

Well, of COURSE they’ll tell you you’re smart. See how misleading that while you made $6162.54, they made $118,827.46! Of course they’re going to pat you on the back! They just stole all your fucking money! And they’re hoping you’ll do it again, because housing always goes up Up UP you know!

Now what if he had invested that amount in that 60/40 portfolio instead?

To simulate this, we will have Homey invest the $25,000 down payment as a lump-sum at the beginning of 2012, then we will divide up the amount he WOULD have spent on home ownership + mortgage over 3 years, subtracting the rent he would have to pay. This means every year, he would have been able to invest an additional ($88,365.46 + $74,062 – $850 rent/month x 36 months) / 3 = $43,942.49. This will be a total of $156,827.47 invested. How does this do in the markets?

Year Starting Balance Savings Portfolio RIO Gain/Loss Ending Balance
2012 $25,000.00 $43,942.49 7.00% $4,825.97 $73,768.46
2013 $73,768.46 $43,942.49 8.39% $9,875.95 $127,586.90
2014 $127,586.90 $43,942.49 8.10% $13,893.88 $185,423.27

At the end of 2014, this $156,827.47 has now grown to $185,423.27, a gain of $28,595.80, or 18.2%!

That is 4.64X he made on a house.

No Joke

When we started doing this little investigation of ours, we were expecting that housing would suck, but not to this extent. Even we are floored by how bad these numbers look. Remember, this is a time period where both housing AND a 60/40 portfolio appreciated at about the same rate! An investor during this period would have made over $95k by putting their money into simple, low-cost, Index-hugging ETFs. A homeowner on a mortgage got robbed blind.

THIS is why most people will never accumulate wealth. Not because you are being irresponsible with your money, but because as a homeowner there are so many hands in your pockets bleeding you dry that you will never EVER get ahead. And everyone who robbed you can never be charged for any crime, because everything they did was 100% legal.

So no. No, leverage is not your friend.

Has anyone else been burned by this? Chime in in the comments.

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78 thoughts on “Leverage. Friend or Enemy?”

  1. The flip side to leverage is that although you can make large profits in a market that’s trending upward, you can lose much more than you put in with even a modest decline in prices. If you had borrowed several times your salary to invest in Tesla stock four years ago, you’d be doing fantastically well now, but I don’t think anyone would recommend that.

    It’s often said that “You don’t own your house, the bank does”, but I think with the death of non-recourse mortgages, the real situation is much worse: You own your house, and you owe the bank whatever you paid for it.

    1. Yes, but the shocking thing we discovered here was that even when prices were trending upwards, leverage did not save you. If leverage was free, then yes what you’re saying is true. But because of the way banks front-load interest into the first few years of your monthly payments, it’s possible to break even (or even lose money) even in a rising market.

    2. You may consider using leverage only in scenarios where you can take the heat.

      Using leverage to purchase high fee/expense/maintenance products like a house may not produce as favorable results as borrowing money at low interest rates to buy a uptrending stock (as you mention).

  2. Love it! People can be so bad at math- an acquaintance told me she made $100,000 on a property she had owned for three years after buying it for $380,000 and selling it at $458,000, with, even worse, only 5% down. Um…this must be that “new math” they are always talking about. I might add she was previously renting what appeared to me to be a perfectly respectable house for $1400 a month.

    We don’t have a land transfer tax here, and I assume that Canada does not offer our awful mortgage interest tax deduction, which along with the thirty year mortgage scam inflates home prices to ever more laughable levels.

    I rent for 2k and my landlord keeps trying to sell me the place, which also has hefty HOA fees, for 500k. Headpalm. Facedesk. OTOH my cash flowing rental property seems to be doing decently- nothing like leverage when someone else is paying the bills!

    1. Canada doesn’t have the deductible mortgage interest thing, but it DOES have tax-free capital gains on your primary residence. It has the same effect, and it’s just so ironic how smug we can get looking at our American neighbours during the housing crash saying “well, WE would never do something so stupid.” And then turn around and do the exact same thing.

  3. Home ownership has been rather good to us. We did buy two houses in 2012, and have renovated them ourselves. We were able to get a great deal because we paid cash for our first one. Between not paying a mortgage, and having rental incomes we are now “work optional” and taking a year long sabbatical. Overall I am a huge fan of renting (we rented for 10 years before we bought.) But if you can look at a house in terms of cash flow (instead of hard wood floors and tile tub surrounds), sometimes you can find better deals.

  4. Oh my.

    This is one of the most devastating arguments I’ve encountered in a long, long time.

    Might want to be careful who you share this one with…

    It’s not for wimps.

    1. You should read the hate mail clogging my inbox right now. I think it’s safe to say we’re not getting invited to any ReMax parties any time soon.

  5. Great analysis! Toronto is definitely not a place to buy. And there are many more like it where the prices just do not justify buying. Where we live our mortgage including taxes and insurance come out to $1400. This is less than what we can rent a nice place for. We still do have to pay for all the home maintenance and utilities, but I enjoy doing renovation work. We also have chickens and a garden I enjoy caring for now that I am done working. When we decide to move, we plan to take some time off from being homeowners so we can travel more freely.

      1. While I’ve debated with you on the merit of owning versus renting, I agree with you that buying in a market like Toronto proper where homes are $700k+ for even semis and town homes, it’s a tough call. There is a signficant imbalance between rent and the cost of real estate. Cap rates are abysmal for income properties – you need to put down so much money before being able to generate any cash flow. There was a time when you could put down nothing and generate cash flow whereas now you’re forced to put in way more than 25% down (sometimes 50% or more!). So in present-day Toronto, a serious case can be made for buying versus renting.

        I think it comes down to an individual’s lifestyle and risk aversion.

  6. I’m definitely with you on this one Wanderer.

    I made this same argument on my own blog a few months back…needless to say, most readers too skeptical to believe the math.

    I can’t help but think “maybe real estate investing worked better in the past” for this thinking to be so ingrained into the common psyche.

    Inflation rates were considerably higher and economic growth rates were significantly higher in the past. Maybe that’s part of it.

    1. Absolutely. Our parents’ generation lived during a time of relentlessly dropping interest rates, and relentlessly rising real estate prices. To them, you could throw a rock and hit a home run investment. Those days are long gone.

  7. What about if you pay cash for the house? Oh pay it off in the first year? And at the same time, the renting market is not controlled and keeps driving pices up? Curious on the thought process here.

  8. Thanks for the analysis.
    While I agree with the overall concept, the assumptions behind the math paint an odd picture.

    First, don’t buy a house and sell it within 3 years – that is just speculation and inherently risky.

    Second, rent out part of the house – a young, childless couple doesn’t need a whole house (and it’s not a fair comparison to renting an apartment). Even if it’s just a basement studio, you’re now bringing in about $800/per month in income. Add $28,800.

    Third – drop those last 3 expenses. Utilities, communications, furniture count whether you’re renting or owning. Doesn’t matter if the utilities and comms are rolled into the rent – the rent is simply higher in that case. And furniture – there are no additional rooms to furnish if you’re renting out or comparing similar sized rentals to the house. Add $15,000.

    Add to that $6000 the $28,000 + the $15,000. You get a lot more than the $29,000 made by investing in a portfolio.

    It’s less about mortgage or portfolio than about HOW to do either/both.

    1. Great. Now I’m in a roommate scenario where I’m sharing my laundry machine with some stranger. That’s fine when I’m paying $850 for rent, but not so fine when I’ve take on $500k in debt. What the Hell am I paying for?

      And I’ve run those numbers. They’re not nearly as rosy as you think. That rent is taxable at your marginal rate. And you think that babysitting a family of renters will cost nothing in extra maintenance? You’re dreaming.

  9. Why are you using $850 for the monthly rental cost? We both know that’s way low for even a studio in some parts of GTA, and to keep the comparison equal, we need to use numbers for a rental equivalent of the house in this scenario. A number more like 2-2.3k a month is more realistic…but won’t yield quite the same result.

    Let’s math this shit up but with valid assumptions. There’s enough truth to what you’re saying, if one feels the path you’ve chosen is for them, that you don’t have to stack the deck.

      1. That’d make for a more interesting and realistic comparison.

        If the comparison is done on a home, they should assume the person doesn’t sell, and even they did but had a rental unit in their house renting for $850/month, in 3 years they would have made $30,600 off the rent alone. If they didn’t sell after 3 years (which is never recommended) all those exorbitant selling costs wouldn’t apply and their net worth would be leagues ahead of renting (nevermind that $850/month for rent is ridiculously low unless they are ok with living in a basement, very small place, or not close to amenities and transit).

      2. Re-rolling the numbers for a $2300/month rent, you still get $88,365.46 + $74,062 – $2300 rent/month x 36 months) / 3 = $26,542.48 he’s able to save/invest per year.

        Compounded over 3 years with the same investment gains, that’s a gain of $19,784. That’s still 3X the money he made with housing.

        1. Precisely. So there’s no need to make input parameters ridiculously unrealistic when “mathing shit up” like this blogger did.

          The real answer when it comes to the whole “buy vs rent” shitstorm is “It depends”. Even in GTA, it depends (though the case for buying in GTA or Vancouver is getting weaker and weaker). It depends on a shitton of variables, including interest rates, expected rates of return on investment, costs (Selling with Comfree? Going easy on the renos? Going easy on furniture shopping?)

  10. I’d first like to say this blog is great, I’ve read every post!

    I don’t disagree with this article but I think this relates too much to your personal situation. This was of course the focus of the previous article, but this article is from what I can see is really answering the question “Is Leverage your Friend or Enemy?” in respect to housing and mortgages for a general/average person.

    What would be really nice to see is a more general and direct comparison of renting vs buying a home. This means buying and renting a comparable home over a period of eight years or so. Then of course not including things such as furniture as everyone will have this if they are buying or renting.

    To be clear, I completely agree with the point of these two articles. I just think they focus too much on your situation vs a direct comparison of rent vs buying. Or rent and invest vs buy and mortgage. I think renting will probably win, but the difference will be not so big.

    Also keep in mind it seems you prefer a smaller apartment so the comparison could be on renting vs buying a condo.

    The down fall of these articles are the following.
    1) The space of a $850/month apartment can not be compared to a $500k plus house in 2012.
    2) An intelligent person will not typically buy and sell in 2-3 years. This is because of the many fees associated with that. Yes of course some people might…
    3) The furniture expense is related too much to your situation. Meaning if you are buying or renting you will need furniture. If the rental comes with furniture the rent will not be $850 unless its like a student type bedroom rental. So either you pay a lot more in rent to get furniture or you are living in a bad area/student rental.
    4) $14,000 on repairs is a bit high. Most people won’t spend ~$400/month on repairs at a constant rate. Someone doing this either bought a house cheaper and took these repairs into account when buying the house, or that person just got really unlucky or simply had no knowledge of houses before buying. I would say $2000 per year would be more accurate, this is even high for many DIY types.

    So in summary great articles for your situation! It would just be amazing to see a more general and direct comparison, because of course a $850/month apartment will beat a house at 500k plus (in 2012)!

    1. Ugh condos. Condos are the WORST. Plunk down over $300k for a box in the sky where the condo fees are almost as much as the rent in a similarly sized apartment? They should stop calling those things condos and call them what they really are: Idiot Boxes.

      1. Do you think the owners of the properties that you rent from now and wherever you travel to are idiots or don’t know what they’re doing?

        Consider that Toronto is becoming an international city and in the next 5 years there will be 1 million more people living in the GTA. Housing will keep going up as demand remains strong. The winners will be those who bought now (ideally 5+ years ago) who will be able to charge high rent on the new renter society (much like all major cities – Manhatten, London, Hong Kong) where ownership is something only the rich can afford.

        Also consider that if you’re living off dividends rather than re-investing them, you’re actively removing substantial growth of your investments.

      2. Idiots indeed. People buy essentially pretty glass and cement boxes (was anyone paying attention in science class about what elements conduct energy really well??) then wonder why common fees (which include utilities) are so high. Basic science at work…once those things are built, no way in heck is it possible to properly retrofit them, so they’ll be energy hogs for life.

  11. Great Article!

    I think the only way to have a fair comparison is to use the fair market rent value for that exact same 500k home. Not sure if that makes a big difference but would be more telling. Also, with 5% down there is mortgage insurance to factor. Also to break at mortgage at year 3 of a 5 year term would result in a penalty. Maybe better to do the comparison over a 5 year span or longer since many of the costs/fees of owning comes from selling the house. So one theoretically can realize house ownership gains for greater than 3 years while incurring only one selling cost.

    Just my 2 cents.

    1. It’s funny you should mention that. The mortgage insurance factor actually breaks the entire analysis, turning this whole thing into a negative-cash-flow situation. Glad you brought that up, thanks for that.

      And you can get a mortgage for a 3 year term. We were trying to answer the question of whether a person buying a house vs investing or a specific time frame (2012-2015) would have gotten ahead. You are free to do the math yourself if you want to change the parameters…

  12. This is interesting information and and I’m enjoying these great analyses you and Kristy are doing on MillennialRevolution. I feel a lot of empathy for young people being brainwashed/pressured into buying homes. My husband and I were small apartment renters both in Canada and in Texas until we turned forty. We both had decent paying professional jobs and endured a lot of questions from concerned friends and family on why we weren’t buying a house with “all the money” we were earning, “You’re throwing it away on rent” “You’ll have nothing to show for yourselves.” We tried to explain that we were investing in mutual funds and stocks and some small businesses and that we were having more fun making investments than buying a home. Friends and family were genuinely concerned about us, thinking we would eventually regret not buying a house and have “no place to live” when we were old. We lived fairly frugally during that time since there just isn’t that much to spend money on when you don’t own a home. We only had a limited amount of space in the apartment to keep things so we couldn’t buy that much stuff (sort of a “forced frugality” I guess.) But we still spent enough to enjoy plenty of nice dinners and some very nice vacations with family and friends. Anyway, by the time we turned forty we had saved enough to retire on if we wanted to, without really planning to. (We didn’t start our professional careers until about age 30 due to being in university a long time.) We both NEVER regretted waiting until forty to buy a home. Since we were financially independent by then, we decreased our workloads to just that amount of time that we still enjoyed which also gave us more free time to enjoy the house and travel more. I know what we did sounds weird to most people but it sure worked out well for us. That’s all I can say: do what works for YOU and your significant other and don’t feel pressured to act on “prevailing wisdom.”

    1. Please elaborate for readers how you managed to only start your careers at the age of 30 (presumably with debt), then amass an investment portfolio that allowed you to travel and party throughout your 30s, and then to buy a home at 40. Your professional careers started at 30 yet you were able to save about $500k in your twenties?

      Likewise, is the argument being made that one should invest and use the investment returns to party instead of buying a house only to simply buy a house later in life and be saddled with debt anyway?

      The authors of this blog state they may eventually buy a house, too. If prices keep going up, cost of living keeps going up, inflation keeps going up, the value of their available funds to buy a house will be reduced over time (since all the gains are being spent on traveling, eating out, and so on.

      Please clarify.

      1. Hi Tommy,
        Sure, I’m glad to explain more. We had no educational debt after paying off our student loans 6 months after graduation so no interest was due. We invested the student loans and used the investment income (as well as part time job income) to pay expenses during university. We had no mortgage or housing debt ever as we bought our house with cash age 40 which cost about 5 months take home pay and furnished it with about 1 week take home pay. We have never used any of our investment portfolio or even used any of our investment returns and are still letting our portfolio grow. We’re still saving and investing at least 50% of our take home pay even just working occasionally now.
        I wouldn’t worry about the authors of this blog Tommy! Kristy and Bruce are both far too smart to ever run out of money or to buy an overpriced home. If they do ever buy a home, I think they’ll likely wait for a housing crash or use geographic arbitrage to find a bargain.
        You might look up the MrMoneyMustache blog if you have a chance. MMM often discusses how the knowledge one gains in the process of creating a significant investment portfolio at a relatively young age teaches one such valuable life skills that it becomes difficult to stop increasing one’s net worth. If MMM had started his blog when I was a student, I bet I would be able to build a house by now. I admit, MMM would face punch me as I don’t bicycle enough, I use too much gas traveling and I haven’t smoked pot yet (frowned on in Texas), but I do what I can. Yours sincerely, RocDoc.

        1. Thanks for the additional info, RocDoc. I’m glad it worked for you but I don’t know if it’s applicable to Canadians. In Canada, school is less expensive so loans are quite small (returns on less than $25k invested would be a pittance). However your approach and concept is important to know so thanks for sharing.

          How much did you receive in student loans? At an average rate of 8% they would have needed to be significantly large to supplement your job to pay expenses (housing, food, textbooks, tuition, loan interest).

          Presumably the cost of your home is also a lot more affordable than the crazy markets of Toronto and Vancouver. It’s dizzying reading how Americans can buy a $100k income property with tenants paying $1k in rent. Why don’t those tenants just buy their own place since it’s so cheap!?

  13. I agree with RocDoc is the sense of not owning a home you don’t buy/accumulate as much crap!

    When my parents moved out of the house I grew up in for 19 years they ended up doing 7 trips to the garbage dump to throw away all the junk that never was used or had no value over the years. They kept some valuable assets and stored my dads tools at my uncles, and anything else of value they sold.

    Also, I forget where I read this pole but I am strongly for the opinion, is that you buy the latest gizmo gadget because your neighbor has one, or you want to out-do them! If your renting in an apartment the likelihood of doing so is far less.

    1. Ya know, we’ve been travelling for about a year now, and everything we’ve needed was stored in two regular-sized backpacks.

      People don’t need a lot of stuff. They just think they do.

  14. Not sure about being burned, but we made several million with leverage and real estate. I was very careful to understand expenses though before I went down this path and they were bought as investment properties not based on emotion.

    1. I don’t think this article is commenting on investment properties. Those houses generate income. entirely different. But for your average person buying a house because they are told their principle dwelling will be a wise investment, to see the math. Congrats on making wise investments in real estate. I don’t think this blog is against buying income producing assets even if it’s real estate.

      1. If you rent an investment property to yourself it doesn’t stop being a good investment either. I think that people simply need to do the math on investments and consume less. That’s the real key to financial independence.

        1. Agreed! My husband and I invested in real estate, lived in part of house and rented out the rest in our first venture. We did the math to make sure our monthly costs were equal to our rental. From there all of our real estate investments we viewed as income producing assets. Retired in early 30’s. I agree on less consumerism as well. I love this blog, that while advocating a different method to Achieve financial independence than we followed, I think it’s very helpful and relevant to many who enter the real estate market just because they think it’s the next thing you are suppose to do.

  15. Nobody should be selling there house after 3 years, if ever. Keep the house, pay it off (let tenants help you do that) and you’re sitting pretty… and stable. You’ve got a place to live (nobody can kick you out or increase your rent since you’re the owner), you’ve got cash flow from your tenant, you’ve got appreciation, and you’re good to go.

    1. You have to share with roommates? I did that in University! I thought $500k would have bought you some privacy at least!

      1. Tenants don’t have to come in the form of roommates (although that’s a legit option). Put them in a separate basement apartment.

        You’re buying land (that increases in value over time), control (you get to do whatever you want to your house and get the tenants that you want), security/stability (nobody can kick you out because it’s yours, since you’re not renting; and yes it’s a forced savings account; and thought stock markets crash and take all your money, real estate remains material regardless of crashes), leverage (with small cash you get to live every day inside a home rather than a small rented flat), mortgage interest deductions for the income suite, ability to take out low interest loans in the form of HELOC, increased credit rating/history since you’re paying your mortgage and utilities in a timely manner, sense of pride in ownership (something that can’t be had any other way), more money if treated as income property in the long run due to the combination of rental income and home appreciation.

        The “I did that in university” statement is ironic since I rented in university and renting is what you’re advocating.

        1. If privacy is your number one concern, once your current tenants have helped you pay down one house, buy another home and keep the first as an income property while you live with complete privacy in your second home. That’s another perk – buying your first home can help you buy another one once you’ve built up equity.

      2. Ah, but think about your blog for a moment and the type of people who come read it. Are we really folks to ‘spend’ $500K on ‘privacy’…or are we the type to say, hey, I’ve got this $500K asset, how can I best put it to work? For some, it’s not to buy at all and invest it in the market, for others it might be more of a mix…tennants, shared space tennants, insulation upgrades (cost avoidance), solar panels on the roof…you name it, all can be legit means of attaining the same goal. All that matters is finding a way for the numbers to work for you and your life situation.

  16. Bravo! What an very detailed demo to old parents! I think the key to financial independence is not how you control your expense or save$, but how you can make your hard earn $$$ into a regular out of taxes income, such as TFSA.

    Every time I talk about TFSA, nobody really understand the beauty that Mr. Flaherty had created for our future. No thieves, nor bankers or GOVERNMENT can take away a penny of your GAIN.

  17. Great post. I agree completely. Real estate is the ultimate pseudo investment. It’s a wolf hiding in sheep’s clothing. Most don’t realize this as you have pointed out. Most people should rent or strive to buy the most modest house they can afford. Unfortunately, the vast majority of people do the opposite – they apply for a mortgage and the bank says “You are approved for X”. They then proceed to spend at least that amount on a house. It’s none
    sensical yet the vast majority of homeowners have done this.

    1. I know! It’s madness! I just want to shake these people and yell “WHY?!?”

      But then the Feds would lock me up. As they should.

  18. So when you guys were having lunch with Justin and his wife did you tell them what idiots they wee for owning a house? Doubt it. Your example is loaded up with some ridiculous assumptions. Sell in three years. Does it happen? Sure, and some people buy $1000 worth of lottery tickets every month. After three years you could rent that 500K house and cover your costs. Lots of options there. The relevancy of your point is related to numerous other factors. Location, time, extra income potential (see Robert and Robin Charlton at wherewebe.com or buy foreclosure like Justin did). You make some good points but exaggerate to make them sound better.

    1. Justin’s house was $108k. At that price, everything works out fantastically. We have a much different situation here. To get into the housing market, you have to leverage, and if you do, you get screwed six ways from Sunday. Yes there are options to try to bail yourself out, but I’m not convinced they work. If you think you can math yourself out of it, feel free to try.

      1. Wm Peppers:
        I think Kristy and Bruce are very correct on Justin’s house being a great deal and they have done excellent home analyses in general. Justin lives in the southern United States and many houses are still very inexpensive in this area. I live in the southern US as well and was not motivated to buy a home until prices became very low (and I was ancient by then.) I would never have bought a house in Toronto given Toronto prices and would just have remained a small apartment dweller. As they advise, do the math and see how it works out in your particular situation. Just try to be very cautious in overpriced markets such as Toronto and try to learn from us pathetic Americans! It was a big mess here when housing crashed. For those fortunate enough to have cash to buy, there were great deals to be had in the US following the crash. If the Toronto market crashes in a similar way (not likely to be quite as bad as the US as the Canadian banks are stronger and more regulated but still could be bad enough) young people such as Kristy and Bruce have placed themselves in an excellent situation to have the option of purchasing a home if they ever wish to do so. For now, I think they’re probably having too much fun traveling the world to want to bother with a home. Homes are lots of work.

  19. Another awesome article! I’ve just finished reading most of your site and as fellow millennial living in an expensive Canadian city (Vancouver) I find your example so inspiring! Stay awesome and don’t let the haters get you down!

  20. Nice summary! In a lot of comments I see that it’s too focused on the bloggers’ personal situation or the rental fee they calculate is too low. I think the good thing about personal finance is that it’s personal, so everyone should treat such posts as a guideline only and modify the calculation according to their personal situation and environment. From my side this is what I’m going to do.
    One question to Wanderer and Firecracker: is there and interest rate low enough or a rental price high enough that would make you change your mind about home owning?

    1. Completely agree. If you think it doesn’t reflect your situation, just do the math yourself.

      And to answer your question, I like to use Paula Pant’s (www.affordanything.com) rule. If the monthly rent is 1% or more of the home price, I’d buy (ie if house is $100K and rent is $1000/month), provided the price itself is not insane. This is an easy rule of thumb to remember and gives a wide margin to offset all the pesky taxes, maintenance costs, etc.

  21. This is a fascinating analysis. I did the same calculation for the condo that I bought in 2010. I have the analysis in Excel but I’m not sure how to post it here.

    My analysis shows that I’m around 5% better off having bought the condo, compared to renting an equivalent unit. I would have been around 7% better off (again, emphasis on “slightly”) had I rent a smaller/cheaper apartment for $850/month (as you’ve used in your analysis).

    Here are a few reasons why, in my case, I’m slight ahead after buying the condo (instead of falling behind, as in your example):

    1. Larger downpayment. I made a 35% downpayment on the condo (rather than 5% as you used in your example). Obviously this means there’s a higher opportunity cost (as I could have invested all that in the stock market) but, as you point out, a disproportionate amount of the mortgage payments go towards interest in the first few years. This can never be avoided completely, but it can be reduced by having a larger downpayment.

    2. Longer hold period. I bought the condo six years ago and am still living in it. I didn’t have to pay realtor fees (only the seller pays). It’s true that I had to pay for a lawyer and land transfer tax, but in my case I made the payments once in six years (rather than twice in three in your example).

    3. Buy less than you can afford. I could have bought a more expensive condo (in the sense that the bank would have lent me more money). Had I been pressured to buy a more expensive unit, this would have simply translated into higher mortgage payments each month, and I’m sure I would have fared worse.

    4. Timing. I bought my condo in 2010. I missed out on the big recession, obviously, but that also means I missed out on the large recovery that took place in 2009. Returns since then have been steady, rather than spectacular. If I had tied up all of my capital as downpayment prior to a major bull market, I very likely would have fallen behind.

    I’m not posting this to prove your example wrong. Quite the contrary – I reviewed the numbers carefully and your math checks out. Rather, hopefully anybody considering buying real estate will consider the principles I listed above, as I think it will help them reduce the risk of failure.

    1. Thank you for doing the math and for sharing your example. I think your analysis will help readers understand how to buy real-estate properly and do the math so they don’t get screwed.

      I think of all your points, the most important one is “Buy less than you can afford”. This is what will swing the calculation in your favour, regardless of whether you buy or rent.

  22. Very refreshing and much-needed contrarian view of personal finance! Keep up the great work. Have shared this site with my kids (teens) as they build their knowledge and life approach to finances.

    My wife and I rented a 500 sq. ft basement apartment (most we paid was $520/month in rent) for many years while at the same time all our friends bought 4000 square foot McMansions in the suburbs. After 10 years of aggressive saving and investing, we put 1/2 proceeds in the stock market (blue chip US equity) and 1/2 into a duplex in central Toronto. Fast forward 10 years in which we collected rent ($1900/month) and dividends and we were financially set for life. That entire time we raised 2 kids in 1200 square feet of space, but our costs were under control and we were able to afford interesting vacations (no Disney cruise!), extracurricular sports and eating out. In short, a good, but frugal life. We have chosen not to retire, however we could have many years ago – nice to have the choice! As you state in the blog – if you figure out how to get money working for you, life becomes much, much more enjoyable.

    Keep up the great work – too many ‘sheep’ aimlessly doing what the Banks tell them to do. I try to tell our story to as many under-30s as I can in the hopes of encouraging a contrarian path to financial freedom… really glad to see you doing the same and wish you the best of luck in this valuable public service.

    1. How much money did you and your wife earn while you were renting?
      How much did you actually save and invest during that time?
      How much was half the price of the duplex in Toronto that you bought?
      What percentage was your down payment on the duplex?

      You decided to put half your savings/proceeds into real estate, so you’re obviously not anti-real-estate. You still had to take out a loan from a bank. It seems to me that you benefited from investing AND real estate.

      1. We are not anti-real estate as long as it is viewed as an investment, a “business” with cash flow – in a similar light as you would evaluate a stock.

        To answer your questions and provide some additional context… we bought our duplex in late 1997 (lucky to have hit a low in Toronto real estate prices vs. today’s ridiculous levels).. but the “math” told me it was as good a financial decision as our equity investments (we are value investors and don’t like to pay more than 10X PE for profitable companies). The duplex was $388K.. the annual rent (both units) was just under $40K… we lived in one unit (the smaller one) and rented out the other, so over the course of 10 years we collected approx. $200K in rent – and given the write-offs of mortgage interest, maintenance costs, etc… didn’t pay much income tax on this rental income. We put 25% down. The building has appreciated significantly in this over-heated market. To make it more financially attractive, we could have added a 3rd unit basement apartment but decide not to – in fact 8 years ago we converted it to a single-family home and no longer rent – these decisions for quality of life reasons – we were in a great place financially and wanted the extra space and privacy.

        The important part is to look at any investment – real estate and otherwise – as a business … and if it’s a good business – buy it! Just like a stock. Real estate prices in Toronto – today – are at levels that make finding a good “business”, like ours was, really hard, maybe impossible. But in other places and times you may be able to do the math and make the case. In fact I was speaking with a young friend last night who is on his way to London, Ontario today to do the math on some rental properties – who knows, he may find a great business there. As you advocate – do the math!

        1. Absolutely Jim! Congrats on finding the balance and your financial independence! I am not anti-real estate either, we just need to be be sensible about it. Leveraging yourself to the hilt to by a McMansion is not the smart way. My posts on this follow. Should you feel worthwhile, please share to your friends on the contrarian, but BETTER, path to FI:


  23. You say “leverage is not your friend”, but this sentence does not tell the complete story.

    In the case of purchasing a home, you use leverage to complete the purchase and it assists you in subjecting yourself to the upfront and closing fees, taxes and maintenance costs while you own it. You mention all of this in your nicely designed illustration.

    But leverage is not THE “cause” of the homeowner making only 5% of the pie; it’s one of the causes. Leverage, like other components in the overall system, such as fees, taxes, insurance, market price appreciate/depreciation, supplies, etc all plays a role in the owner receiving such a small payout. Leverage represents one component of the system that produces poor results for the owner.

    I believe blaming and damning leverage can mislead people into writing off leverage altogether where it can be useful in other areas of life and business.

  24. Hi, thx for the article it’s def interesting to read. But either i missed something or your analysis on the house ownership / return is incomplete: you seem neglect the fact that if Homey didnt buy the house, he would have to pay rent. So when calculating the gross profit you should refelct the fact that Homey would not pay any rent anymore for three years.

    In terms of the assumed cost of home ownership, im sure your sources are sound, but def in Europe one would not spend ~EUR4-5k per month on maintenance.. On another note, your analysis on the house ownership included expenditures on gas and electricity.. Fair enough, but your rental assumption of EUR800 pm in the stock analysis appears to neglect this cost item. You can rent for 800 pm in Canada including gas and electricity??

    All in all an interesting article and i myself also like the stock market more than real estate (more liquid, you rebalance, lower concentration risk etc) but i think your analysis is a bit biased though in the example given…

      1. Ok i re-read the article again and i noticed you already highlighted that gas and electricity is included in the 800pm. So essentially you assume a “base” rent of 550EUR as you assumed 250EUR for electricy and gas and 25 of ankther item included in your overall rent figure. I also take it that this base 550EUR rent figure then gets you a furnished apartment.. You included furniture in the house ownership example, so if we compare apples with apples then either your assumed rent of 800 (550 excluding utilities) also refers to a furnished one or you need to add that to the costs in the stock example.. I would say that the assumed rent is too low in this context..

        On the house analysis.. So you have gross profit of 125k and then you deduct the assumed costs.. Coming back to my earlier comment.. You would have to add back 800 (rent) * 36 months to the gross profit of 125k to make an honest analysis as Homey would stop paying this rent.. This obviously changes the entire calculation

        1. We have European readers? Holy crap!

          The rent for our place was what we actually paid, I have absolutely no idea how much it costs to rent where you live (or where you live). The math is still the same though, so feel free to roll your own numbers.

          And I’m subtracting rental off the rent scenario already. I don’t need to re-add it to the housing scenario since that’s not extra money I’m getting. That would double-count the effect of rent.

          1. Yes in Europe we also are tired of the rat race 🙂 unfortunately, there aren’t that many European FI blogs that i at least know of…

            So on your comment:

            My view is as follows:

            In your housing example you essentially assume a gross profit of 125k (sale – purchase price) and then you subtract a set of cost items..ultimately leading to your net result..

            But if you assume that Homey before he bought the house was renting, he was then previously paying 800pm before the purchase..

            So a T=-1 he has annual rent expenses of 12*800 and T=0 he buys the house and saves the previous rent expense (9600p.a.)..
            During the period (3yrs) he owns the purchased house he has saved 3 * 9600… This amount should be added to his gross profit (which you have calculated as 125k)..

            After subtracting all the assumed costs you can compare this figure to the one in the stock scenario..

            In the stock scenario you indeed assume Homey pays rent (as he doesnt own a house) and you take into account the cash flow Homey would have paid for owning a house and deploy that into his investment in the stock market..

            I dont see how the above would lead to double counting…

            1. The fact that the rent is saved is accounted for because we’re running two scenarios: One where he continues to rent and one where he buys instead. Each scenario is tallying up income – cost of living. Rent is on the “Continues to Rent” scenario, while it’s absent from the homeowner scenario so that’s how to properly account for it.

              Think of it this way. Scenario A is someone eats hotdogs every day for $1. Scenario B is someone eats hamburgers every day for $2. (Replace with European equivalent. Baguettes?)

              At the end of the month, A spent $30, B spent $60, so A wins. You don’t say “B no longer has to eat hot dogs, so he saves $30 a month, so you have to minus $30 from B’s spending, so B actually spent $30, so they’re tied.” That’s double counting the effect of the hot dogs.

  25. Good post. Inspired by your earlier post, I wrote an article that you and your readers might find interesting: http://tenfactorialrocks.com/house-fever-global/

    Since you get a wider readership base, feel free to use the article in your next write-up. We both could use the data in other countries beyond what I have covered in the article. People like us may be outliers in the whole ‘house fever’ spell across the world, so let’s do our best to educate everyone there is no nirvana in buying a leveraged, expensive house!

  26. While I can see the funny side of your hotdog/hamburger example, I don’t see any relevance to the original scenario at hand…

    don’t wanna go around in circles here but just assume the following example:

    scenario 1:
    I have a monthly income of 4,000 euro and pay 1,000 in rent and no other costs whatsoever. I am left with 3,000 euro.

    scenario 2:
    I now buy a house which reliefs me from paying rent. For the sake of simplicity we ignore all the transaction costs etc, and assume the following cash flows:

    I still have my monthly income of 4,000 euro, pay 1,000 in interest (mortgage) and 500 in principal. I am left with 2,500.
    after three years I make a gross profit on the house of 50k.. bear in mind that compared to scenario 1 I may have 1,500 in mortgage costs, but essentially it only translates into an incremental cash outflow of 500..

    scenario 3:
    I continue renting and I invest the amount of money I would have spent on the house in scenario 2 (1,500 euro p.m. interest + principal) in the stock market…
    I continue to have the monthly income of 4,000euro, invest 1,500 in stocks, pay the rent of 1,000 and remain with 1,500eur. After three years I make a total profit on my portfolio of 60k

    In your example of Homey you deduct the mortgage payments from Homey’s gross profit. That’s fine, but you simply ignore the fact that in that scenario (or in my simplified scenario 2) the house owner has freed up cash he normally would have spent on rent. Your analysis misses the cash flow perspective… put more simply, your analysis of the scenario where Homey buys and sells the house underestimates the amount of money he has saved as you only take into account the cash outflows related to the mortgage payments, but you fail to take into account that the incremental cash outflow was less..

    The fact that you consider rent in the stock scenario doesn’t mean you can ignore the positive effect going from a rent to a rent-free situation in the house scenario.. For every scenario* you just need to model the cash flows reflecting the reality that Homey faces.

    * you could model three scenarios: base-case scenario where one merely rents and then simulate respectively the house purchase and stock purchase scenarios)…

    1. I get your confusion. You’re wondering why I get to credit Homey for the money he would have spent on the house while not doing the opposite for not spending on rent.

      This is because when you go from a situation where you spend LOTS of money to a situation where you spend LESS money, because I’m assuming your income didn’t go down at the same time you effectively free up money you would have been spending to allocate towards something else. When you go towards spending MORE than before, you don’t get the same boost because now you have to earn more to pay for the added cost.

      What you said would be true if Homey inherited a paid off house so his housing costs go lower. If he was paying $1000 monthly rent and now he pays $200 in taxes + utilities because he has no mortgage, you could then credit him for the $1000 he WOULD have been spending anyway, freeing up $800 to, say, upgrade his house or whatever. But in this situation where owning the home costs more, you can’t do that.

  27. and again…you even did it yourself in the analysis…the real estate and land transfer is essentially 50% of the cost which looks WAY better when you amortize that cost over a longer than 3 year time period.

  28. 3 years? Your numbers are skewed if you are using a 3 year timeline. As a rule of thumb, it’ll take 5-6 years before you can break even from the transaction costs of buying a home, at least here in the US.

    But the agents do take way too much. In fairness to them, they take the commission and give a huge chunk to the newspapers for ads.

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