Why Not To Panic About Buying a House.
Plus a few other corrections to the old world financial wisdom.
As we've established, finding a place to live can be both expensive and challenging. Today, I want to discuss why the age-old wisdom about buying property may not be as wise as it once seemed, whether for shelter or investment.
Why You Shouldn't Worry About Buying Property to Live In?
Believe it or not, I'm not about to provide a cost comparison or breakdown of renting versus buying. Why? Because it's overly simplistic and misleading. The amount you end up paying for either option depends on various factors: where and when you live, your life stage, your income sources, and family size. Making assumptions that cover all these aspects simultaneously won't be useful to any single person.
Instead, I'll compare what remains consistent over time, place, and personal choices.
First, Liquidity Problems
Liquidity measures how quickly you can exchange one asset for another. Cash, especially when held in a credit or debit card, is the most liquid asset, readily exchangeable for almost anything at any time, with few exceptions.
Houses or apartments, on the other hand, are highly illiquid. While it's true that properties in hot markets like New York, Toronto, or Vancouver can be sold relatively quickly compared to other regions, selling a house still involves several steps: hiring an agent, listing, finding a buyer, price negotiations, financing arrangements, and dealing with tax implications even after the sale.
While this, by itself, isn't a major issue, it leads to other problems and risks over time.
Renting, on the contrary, doesn't involve these complexities. Typically, you only need to provide first and last month's rent plus a deposit. When you decide to move, you give notice and collect any owed money from the landlord.
Second, Mobility Issues
Mobility measures how easily and swiftly you can move from one place to another. Having the majority of your net worth tied up in property seriously limits your ability to relocate.
For instance, imagine you live near your workplace with a 10-minute commute and then receive a lucrative job offer across town. The new job pays more, but the commute is an hour each way. If you value your free time, those two hours daily matter significantly, be it for a part-time job, hobbies, or business ventures. If you're renting under normal market conditions (i.e., your landlord isn't family), moving to a rental near your new workplace may be the better choice. However, if you own, you'll likely endure the lengthy commute for the sake of simplicity.
This problem becomes even more pronounced if you reside in the suburbs or if the job offer comes from a distant location.
Moreover, being tied to one location makes you vulnerable to fluctuations in local real estate prices. In places like Rio de Janeiro, sudden changes like new construction projects or rising crime rates can render once-desirable areas unattractive, leading to property value collapses. If your wealth is primarily invested in a declining area, it becomes challenging to recover your investment.
This highlights one of the fundamental issues with property ownership: it assumes that property values will perpetually rise, a presumption that doesn't align with the realities of climate change, an evolving job market, and increasingly unpredictable global movements of people and goods.
Third, It's All on You
When you own property, you bear sole responsibility for all maintenance and upkeep. While many maintenance costs and renters' insurance are included in rent, there's a crucial difference. Large landlords wield substantial buying power, allowing them to secure cost-effective bulk contracts with tradespeople like plumbers, paint suppliers, and landscapers. This translates to lower costs per unit compared to what a homeowner would pay individually.
Why Small-Hold Property is a Poor Investment
Real estate may have been known for its potential to generate passive income and facilitate early retirement, but this no longer holds true in today's English-speaking world.
The relationship between landlords (owners) and tenants is strictly regulated in most places, granting tenants significant influence over the rules governing their relationship. This influence can lead to complications, often requiring costly and time-consuming tribunal proceedings to resolve.
Investment properties share the same issues of illiquidity and mobility, compounded by the fact that investors also need a place to live simultaneously.
These challenges intensify in a world with higher interest rates and 30-year mortgages becoming the norm. After factoring in property, income, and corporate taxes, along with expenses related to managing the property and dealing with problematic tenants, the likelihood of turning a profit over 30 years falls significantly below 100%. Comparatively, other investments can offer better odds, especially when risk mitigation is a priority.
The most evident advantage of diversifying your investments lies in the potential for risk reduction. Stocks, ETFs, and mutual funds all carry their own risk, but diversifying across different asset types and industries can largely mitigate these risks.
Additionally, other assets are more mobile and easier to sell when the need arises, reducing the comparative risk associated with property ownership in that regard.
So, What Should You Actually Do?
The answer varies for each individual. Some people have specific needs or interests that necessitate property ownership. Renting also carries its risks, including eviction and sporadic rent increases, while some landlords may charge condo fees on top of rent, narrowing the cost gap between renting and carrying a mortgage.
However, for most people, considering the overall balance of risks, renting is likely the more prudent choice.
Regarding income-generating investments, if you're interested in the real estate market, you're better off doing so through REIT (Real Estate Investment Trust) shares. REITs are akin to ETFs for real estate, allowing you to invest in a diversified portfolio of properties, including condos, offices, hospitals, and industrial buildings. Their shares have faced challenges due to rising costs and interest rates, a topic I'll delve into in a separate post next week.
Final Thoughts
Renting sacrifices some flexibility in how you use your space, while buying property limits your financial options and long-term mobility. It also reduces your ability to diversify your wealth.
In the grand scheme of things, no one can definitively declare what's universally right or wrong. The best approach is to understand your medium-term goals and assess how the balance of risks applies to your specific situation.
That concludes this week's newsletter.
Sincerely,
James R. Davies