Full Disclosure Finance

By Justin

Here is the continuation of my quest to produce a systematic tool for identifying if you should buy or rent. Keep in mind that when you combine these insights with some diligent research, you should feel confident in making a decision.

The previous post discussed your Plans for Savings and % Down Payment as key indicators. Below is the complete list.

Key Variables affecting the Rent vs. Buy decision:
• Level of Financial Education
• Plan for Savings
• % Down Payment
• Property Market
• Stock Market
• Nature of Income
• Location

4. Property Market
If you consider the purchase of your home to be an investment, it would be wise to investigate the current status of the market for such an investment. In case you’ve been living in a bubble for the past year (actually, you couldn’t because it burst a while ago…..), you’ll know that the US Real Estate Market is tanking. This is a macro trend that doesn’t apply to all areas however. Certain markets in the US are still strong due to good fundamentals. See my post outlining the fundamentals.
Buy or Rent? Let’s account for the status of the property market before making our decision. A large assumption in our calculations is an annual rate of increase in house prices for your area. After researching historical performance, it is important to calculate the average annual increase for the last 5,10, and 25 years.

Combine this with a sustainability check. If you’re seeing rates over 20%, your market is bound to see come cooling in the near future (gradual or otherwise).

If you’re seeing high rates that are not likely to continue, renting might be a good option until you’re able to understand what form the cooling will take.

However, if prices are crawling at 2-4% a year and the area has good fundamentals, buying now is probably a better choice than renting. Either you might see more rapid price increases in the future or continued steady increase. Both are great conditions to be a homeowner in.

In the event your market is experiencing a long decrease there will clearly be some reasons behind it. Examine the fundamentals, and if they look really bad, prices may not reverse themselves in your lifetime! Renting would then be the way to go. In this case, make sure you get your Financial IQ up because you won’t be able to make your money from a primary residence.

In the event that your area has been depressed for a while, but could be on the “up and up” in terms of community development and steady population increases, you may be getting in a little ahead of a boom. Make sure you review the fundamentals thoroughly to ensure things are as good as they appear. Buying in an improving area is every homeowner’s gravy train, so this would clearly be a green light special.

In short, if the fundamentals in your area look strong and price increases have stayed reasonable (0-12%), buying is a good choice, all other factors being equal.

If the fundamentals look bad or your market has been really hot (Hello Saskatoon, or Calgary 2 years ago) with increases well over 20% for 3-4 years straight, find a good rental and wait for things to cool down.

Keep in mind that you should perform a forward looking cash flow and balance sheet analysis for the next 5 years to make sure that your favored option does indeed work out better.

Again, if you’re going to rent, you need to keep piling the savings into investments to truly realize any advantage calculated. Buying cars and trips with the cash will provide no lasting value to your balance sheet.

On a scale from 1-5, give yourself a 1 if the Market in your area is stable or “coming around” with solid fundamentals. You would score a 5 if your area is getting more like a ghost town all the time (bad fundamentals).

5. Stock Market
The other key assumption going into a Rent vs. Buy decision analysis is an expected rate of return on money invested. Your ability to generate a decent return will, along with all the other factors, be critical if you choose to rent. When renting, areas for growing your money are generally equities / funds / derivatives, starting a business, and buying an income property. I suspect most people would favour the first area because it seems easier (just click “BUY” and you’re good to go).

With relevance to the big decision, volatile markets or those that are clearly unstable require a high financial IQ to navigate. Obtaining the required return outlined in Part 1 of this series would therefore be difficult. This means that buying a house would be easier to handle and to count on a stable return.

In times of low volatility or sustained growth, it might be possible to achieve some steady, solid returns. This may give the illusion that renting is the way to go even for those with low Financial IQ. However, keep in mind the required rate of return to match the BUY scenario outlined in Part 1.

Give yourself a 1 in this category if the Stock Market is extremely volatile or going sky-high. A score of 5 would correspond to a market that is just out of a recession and has encouraging fundamentals to drive future growth (see: CHA CHING!). I think currently we’d be around a 3, because we are clearly in the middle of a recession, but there are plenty of good buying opportunities.

The Property and Stock Markets are going to have a large influence on your decision because they are the source of your 2 biggest assumptions in the balance sheet calculations. Your cash flow analysis will not really be affected by these variables as an increase in the value of your home or stock will not put cash in your pocket. Now if you plan to buy an investment with some type of payout (dividend or income trust distribution) be sure to include it in your cash flow analysis.

We’re moving along in the decision making process and I’m sure most of us already have an idea of whether Renting or Buying would be best.

We’ll finish up the analysis next time when we total the points up and look at the Nature of Income and Location.