Renters’ Road To Financial Freedom
This MSN Money article by Jack Hough of SmartMoney is a must read if you’re a renter. I love this article for a number of reasons; it’s provocative, but more importantly, it’s like seeing myself in the mirror, since we share so many similar opinions together!
It’s not easy being a renter. Letting the world knows you’re a renter is like walking around town with a prominent “L” on your forehead. It’s just human nature. Renters are stereotyped as financially irresponsible people, however that’s simply a myopic view. There are just as many irresponsible buyers who live beyond their means by borrowing high-ratio mortgages. I don’t see homeownership as a necessity. Rather, it’s a culture, and sometimes, it’s even a status symbol like owning a BMW. No offense to Beamer owners.
Jack Hough starts his article with a confession that he rents despite having enough to buy a house. The reason? Stocks returned 7% inflation-adjusted over the previous century, while …
the average real return for houses over long periods might surprise you: It’s virtually zero.
Surely, that has to be a mistake! In the midst of one of the most glorious housing booms in Vancouver, homeowners roll their eyes when all the evidence point to double-digits return. Let’s not forget that over this short period (yes, 5 years is short), anything goes, but they don’t call it average for nothing. Sometimes prices overshoot, but eventually they’ll revert to the mean.
Over the long haul, home prices rise in tandem with rents. When prices race ahead of rents, the equilibrium is disrupted temporary until either (a) prices fall or (b) prices plateau in order for rents to catch up. In the case of Vancouver, rents haven’t gone up as much, so price appreciation comes mostly from valuation expansion. To steal an analogy from the stock market, a stock can trend higher via P/E expansion even with earnings remain flat, but P/E expansions aren’t sustainable. Only fundamental improvements like earnings growth can push the share price higher over the long term. To give you some perspective, we sold our home in Nov 2006. The earning yield (which I inflated to satisfy any nit picky readers) was 3.9%. It was 5.2% when we bought 3 year earlier, and 7% when our former neighbors bought theirs.
Make no mistake about it. Renting and investing the difference in the stock market isn’t for the faint at heart. If you don’t have the stomach to face recurring setbacks in your portfolios, the little butterflies in you will hinder the execution. This post aren’t to encourage readers to sell their homes, but to point out that diverse point-of-views exist and they’re just as rational.
In his article, Jack Hough tackled a few common objections to this approach:
“You can’t live in your stocks” or “Renters throw money down the drain.”
No, but with a combination of diversified income trusts (read my income trust series) and dividend yielding stocks, it’s possible to derive close to a 3.9% yield to cover most of my rents. Moreover, yields from dividend-paying stocks and growth-oriented income trusts will outpace inflation, while rents will move in tandem with inflation.
“What about the pride of homeownership?”
Pride of homeownership is overrated to me, though I admit it’s a matter of preference. Similar to Jack, I relish the pride of owning successful businesses. When I have the urge, I munch at my favourite Korean food court to admire the Telus building across the street. On a good bicep day, Scotia Bank is also only a stone’s throw away from my office.
Another one that I heard, “income trusts and dividend-paying stocks aren’t diversified”
That’s true to a degree, but it’s still considerably more diversified than a home. The leaky condos fiasco in the late 90’s serves as a reminder to complacent homeowners that a single misstep can send anyone to bankruptcy. Contrast that to REITs where with a few mouse clicks, your portfolio is instantly diversified across the nation and different real estate segments including residential, office, retail, hotel, industrial, storage and nursing homes.
I think you should look at your principal residence as a luxury. Most people won’t make money out of their own home. Therefore, you are technically better off renting an investing the difference on a financial point of view.
But as it is the case with riding a Beamer, you might really enjoy your house even if there is a cost related to it.
Cheers,
FB.