Rent vs. Buy Calculator - v1.0

Yesterday the topic of rent vs. buy calculations came up in a thread, and it reminded me I had done something of one on a spreadsheet a few months ago with the intention of sharing, but forgot all about. So, figured, what the heck, lets throw it out there.

I tried to balance keeping it as easy and intuitive as possible, while still making it highly functional... most others I've seen are a little too overly simplified. So, you need to have some understanding of personal finance like opportunity cost, but it takes care of much of the messy and confusing stuff like insurance and accumulated principle.

There were a couple practical allowances made for certain items. Like for opportunity cost and rental income figures, because both of those represent taxable benefits, but as there are an infinite number of rates those could be taxed at. Also if you're going variable rate, or expected rents, or market depreciation/appreciation, etc, to change you need to factor or estimate that in for yourself.

For the comparison here I did a quick search and found two comparables, one for rent, and one up for sale. Both two bed, two baths, in the same building and about the same size. Used todays 5-year fixed rate, and filled in some of the other variables, but you can play with those at your own leisure and you can see for yourself how the results change.

Everything after "Calculations" is generated automatically, you just have to fill in the three input sections. I corrected some formula errors that were pointed out, so hopefully it's right now, but please pipe up if you find more, or have any other comments, questions, concerns or suggestions on how to make it better.

It can be downloaded via this link, just click "File > Download As >" and pick your poison.

Who's to blame?

My opinion on whether there was a housing bubble is well documented, but my thoughts on what caused it have never really been explored in much depth. Thus, today I present my not-humble-what-so-ever take on what the underlying causes of the housing bubble were. So, without further ado, on with the show...

Consumer
That right fellow babies (channelling my inner Johnny Fever), you and me. Well, perhaps not you and me specifically, more in a general sense, you know what I mean. Ultimately the buck stops with all of us... and it's going too, and in more ways then one when you figure in our role as taxpayers.

We do dumb things, myself included, just ask my dad, he could reel off chapter and verse most of the first 18 years of my life... and probably more then a few of the ones since. We're prone to herd mentality, susceptible to greed, lust, a need for social acceptance, status... not to mention the most terrifying force known to man, the nagging significant other!

*Shudder*

Houses are a deeply emotional purchase for most. They're not just shelter, they're "home," they're family, they're status, and they most often the largest purchase we make in our lives, and can take most of your working life to pay for.

So, first and foremost, the consumer must bear the stain of this bubble, and certainly will... we signed the papers, we dug the hole, now we have to climb out of it. There were other factors though, and now we'll discuss some of the usual suspects.

Realtors
Ah yes, the brand name masquerading as a "profession." They're an easy, and seemingly popular, target for scorn. Which they largely bring it on themselves... but are they responsible for the bubble? Nah.

Beneficiaries of it? Absolutely. Contributed? In some ways, perhaps. But no one had a gun held to anyones head when they were making offers, and I'd hanker to guess that even if the agent told the prospective buyer it was a bad idea, that buyer would just find another agent that would sing the tune they liked.

Bottom line, these guys are in commission sales. So, if you're expecting any message out of their associations/boards/agencies other then "buy", you're only fooling yourself. Those groups only exist to further the interests of their membership, their membership wants transactions. You do the math.

The ethics of these obviously self-interested parties parading themselves as experts is questionable at best. Regardless, the public must take responsibility for their own actions, and consider the source. Think about it, would you expect the CEO of Ford to say anything other than people should buy vehicles? Ultimately it's all marketing, and should be viewed as such. So, while a case could be made for them contributing to the bubble... they had little if anything to do with the underlying causes.

Brokers
Another group that certainly benefited, but really didn't have anything to do with the causes. These guys are just middle men, they grease the wheels and take their cut. If anything these guys probably behaved themselves the best out of all those discussed in this article.

Bank of Canada
Carney and Co. are another popular target, particularly of late. They've even kicked off the finger pointing, conveniently singling out lenders (convenient because if they point it anywhere else it'd be directly or indirectly at their overlord(s) in parliament). Ultimately though, interest rates are largely determined by the market, and that is well beyond their control.

What influence they do have, is largely ceremonial. For the most part they just follow the United States lead, as to not upset the apple cart and cause undue fluctuations to the exchange rates... which would wreak havoc on that rice paper castle that is this so called "recovery."

And as far as our bubble here in Alberta, we arrived long before the current ultra-low rate environment came around. Sure it added another big season of sales which effectively just dug us a bit deeper, particularly in regards to defaults, but we were plenty deep already... we just have a bit more company now on the domestic front.

Banks/Lenders
We're getting warmer, and typically this is a group that should take heat for situations like this... but they would usually also have some skin in the game. And that is where the true root begins to expose itself.

Historically market forces keep the lender honest. On mortgages they make their money on the margin, they get access to capital at one rate then lend it out at a slightly higher one. In return for this payout, they bear the risk of the borrower defaulting... and as that is typically a timely and costly occurrence, that is why they do such thorough vetting of the borrower to ensure they are credit worthy.

In modern times we've seen a move away from this model though, particularly when it comes to high ratio loans. In Canada, we've seen the establishment of the CMHC. They basically insure all high ratio loans (those with less than 20% downpayments), this takes the risk largely away from the lenders, who can then lend to everyone at the same rate, above which the borrower pays a risk premium indirectly to the CMHC (who is then on the hook for any deficits in the event of default).

This situation presents a moral hazard then to the lender, particularly recently as prices have rocketed up and downpayments have dwindled. They are now still largely in charge of vetting the borrower, but as they now bear no risk for default... thus, it's entirely in their interest to lend as much money as possible, to as many people as possible. As long as the CMHC signs off on the borrower, the lenders have no skin in the game.

They can just sit back, collect their margin with no worry if rates shoot up or the market goes to seed and the borrower defaults, cause the CMHC has them covered. It's something of a licence to print money, and all the lenders know it. That's not to paint lenders as the bad guys though... they're playing by the rules, and exhibiting behaviour entirely predictable given the circumstances.

CMHC
And that brings us to the CMHC... we're really starting to heat up now. These guys will probably be a real lightning rod for years to come. Though again, they were not so much the generals as they were the soldiers.

Their actions were what really fuelled the bubble here, which is now largely nation wide. It was the stripping of lending standards that turned a hot but sustainable real estate market in Alberta in '05, into a overheated time bomb from '06 on.

They pretty much threw gas on the fire. At the begging of '06 a borrower had to have at least 10% down and had a maximum amortization of 25 years... then it became 30 years... then months later 35 years with 0 down... then finally before year end, 40 year amortizations... and just in case that wasn't enough, you could go as long as ten years without putting a penny towards principle.

The bar was lowered, and lowered and lowered some more, and Albertans came rushing in with cash in hand... well, maybe not so much with cash in hand, but I digress. The floodgates were thrust open to a whole new group of buyers that otherwise would not have qualified, and even for those that would have it made available much larger sums.

Such rapid and extreme lowering of lending standards made the conditions rife for a bubble, and one formed. But ultimately it was not the CMHC that made those directives, they merely did the bidding. You see, the rest of the true blame lies with the...

Federal Government
I can hear the wailing already in ever so Tory blue Alberta, but I'm really not a partisan nor have an axe to grind. If you held a gun to my head and made me pick between the Conservatives, Liberals and NDP... I'd say pull the trigger.

I'm more a moderate libertarian than anything, not to be confused with the assholes of epic proportion that largely make up the ever so prevalent Randian variety (but those with borderline personality disorder need something to read I guess). I'm no more a trusting of big business then of big government, but in the presence of the former I acknowledge a need for the latter. But enough about me.

Can't hang it all on Harper and Co. though, there were moves originated all the way back to Chrétien that helped pave the way, chiefly among them removing the price ceiling. But it was mainly Stevie-boy who blew the doors of the barn with all those moves discussed in the prior section.

Then when the air started to leak out, down came the directive to approve "high-risk" borrowers in greatly increased numbers, which really fuelled the '09 surge. If things had stayed at 10/25, while something of a bubble may still have been possible, it would have been but a small fraction of what became.

To their credit, they apparently saw the error of their ways to a degree, and did away with the 0/40's, now the best you can do is 5/35... but most banks will lend you the 5% anyway, so effectively 0/35.

And of course, they are also a minority government, which means they couldn't have done this without some help (or at least tacit approval from the others). It was a rather shrewd political move by Harper actually... he knows the masses are happy with the illusion of wealth created with rising home prices, and figured that could be enough to get him that precious majority.

Even if the other parties were smart enough to recognize the potential dangers of a housing bubble, telling the populous that they're not as rich as they think would not be greeted warmly. The opposition parties don't want to get blamed for popping the bubble, and for the same reason the Conservatives don't want to apply the brakes.

Thus, we continue our trip down the primrose path blissfully believing "it's different here," even after having ring-side seats to see the United States blaze the trail of libertine indulgence. We just dig ourselves deeper and deeper, until the inevitable...

Up

Yesterday the CBA released the September mortgage arrears figures and... cue the broken record... they're up. The Alberta rate now stands at 0.67%, drawing ever closer to our record high (0.69%), up from 0.34% a year earlier and 0.65% in August.

Nationally the rate held at 0.43%, and Manitoba swapped places with Saskatchewan for the lowest rate in the country (0.26% and 0.28% respectively). Alberta continues to widen it's lead at the opposite end of the spectrum, while the Atlantic provinces are next worst at 0.49%. B.C. and Quebec were both up a tick at 0.37% and 0.36% respectively, and finally Ontario held at 0.43%.

In an effort to freshen things up, I did some digging and found some comparable numbers from the US. These are from Fannie Mae and Freddie Mac (I'm sure you've heard those names, they operate something like the CMHC does in Canada for those unfamiliar with them).

These graphs are of their "serious delinquencies," which are those that fall three months or more behind on their mortgages... so, virtually exactly the same as our much discussed "mortgage arrears." They have three different figures respectively, credit enhanced, non-credit enhanced, and total.

Afraid I'm not intimately familiar with exactly where the line is between credit enhanced and non, or how these relates to the CBA figures (I think we can safely assume from the data 'credit enhanced' are likely those with less then stellar credit ratings) ... so for our comparisons between countries I'll include both the total and non-credit enhanced figures and let you interpret the data for yourself.

Here we have them all charted together. We can see that traditionally non-credit enhanced US figures are very close to those we enjoy here in Canada and Alberta, while the total figures track about a half point higher (at least until their bubble burst).

While the national numbers are only starting to creep up here in Canada, the Alberta figures are tracking a pattern quite similar to those in the US 18 months earlier. Now, that doesn't mean we'll end up as bad off as they are down south, but it's worth noting the similarities... so it's not out of the question that we could be on the same road. It was also around that time that phrases like "foreclosure epidemic" really started to make the rounds.

Bear in mind, these are national numbers in the US, and foreclosure problems vary greatly amongst regions/states. I'm going to try to find some state numbers for future months... but looking at the magnitude of the change in the US as a whole leaves little doubt that foreclosures have become a national issue.

Fannie and Freddie have changed what they've reported periodically, so the best I could piece together for a longer term comparison is their total figures. It's interesting to note here their total delinquency figures were quite close to the Canadian equivalent up until '01-'02. Why and how it's difficult to say, could be anything from a change in lending practises, to a change in methodology.

In any case, what I think we should take away from this is that before we get cocky about how low our level is currently in comparison, remember, it was not even two years ago they were right where we are now... and we've had a ringside seat to witness that slippery slope.

Rental Market Update

The fall CMHC fall report isn't due out until next month, but last week I was leafing through some old Boardwalk financial reports (or whatever the digital equivalent to 'leafing' is, scrolling I guess), and found some info that could be of interest to you all. Unfortunately they seem to change just how and what they include in their reports when it comes to the non-financial statement stuff, but I've been able to scrape together some good data.

For those unfamiliar with them, they are a major player in rental market here in Alberta as well as Saskatchewan, and are expanding into other markets throughout the country. According to their reports, they have just over 20% market share in Edmonton, and just under 15% in Calgary. Anywho, on with the show, lets start with vacancy rates...

Here is a look at Boardwalks internal data on Edmonton and Calgary (currently they have 12,144 units in Edmonton, and 5,227 in Calgary). It's kind of erratic, but we can see that the rate dipped well below their long-term averages in both cities from mid-'05 through the end of '07.

Since then though they've generally been above the averages, particularly in Edmonton, but as of their most recent reporting (3Q-'09) they have returned to the mean. It would be interesting to compare these figures to the CMHC numbers, but that will have to wait. Maybe in a coming week, or maybe when the CMHC report comes out next month.

Now lets add rents to the mix. Unfortunately they've only reported market specific rents going back to about 2006, but beggars can't be choosers I guess. I believe 'Market Rent' is their average advertised rents for new move-in's, while 'Occupied Rent' is the average of exactly what their tenants are paying. The occupied rent would be far more sticky, as leases are grandfathered in, and increases/decreases are phased in over time.

Seems the two figures were very close through the end of '05, then market rent started to take off in a big way and didn't top out until mid-'07... no coincidence, that's the exact same timeline and behaviour the resale market exhibited during that period. Occupied rents continued growing through mid-'08, as the company were phasing in increases on those that previously enjoyed lower lease rents.

Market and occupied rents met again in late-'08, and have both been tracking down since. Just as it rose faster, market rents are falling faster, now down $218 or 17% from peak. Occupied rents conversely down $30, or 2.6% from its peak. So, anyone living in a Boardwalk community might want to drop down to the office and get yourself a little reduction... if you've been a good tenant, you can probably leverage yourself a deal a fair bit better then even advertised.

Now we'll look at Edmonton and Calgary individually, lets start with the capital. Remembering their long-term average vacancy for Edmonton was 4.56%, we can see during the period where vacancies were below that mark, market rents were rising rather quickly... then when vacancies jumped above it, just as suddenly, rents started dropping. The rents have a pattern very similar to that of Alberta as a whole as we looked at earlier. That's no surprise though as Edmonton accounts for over 60% of their provincial portfolio.

Now onto Cowtown. This graph looks a little different, as it seems Calgary's vacancy rates were lower earlier, and we kind of missed their big decoupling of market and occupied rents. Their market rents kind of plateaued even though vacancies were still well below their long-term average of 4.85%. Perhaps they hit a ceiling, or maybe they could have went higher.

In any case, once the long-term average was broached, rents started to fall... then vacancies fell back below and rents went back up... then vacancies went back up and rents resumed falling. That long-term average might be an important figure in light of such negative correlation with rents, though vacancies have again dropped below that mark and yet rents are still trending down.

It'll be interesting to compare these figures with those in the CMHC release next month, as it seems, at least in the case of Boardwalk, things have stabilized. Vacancies are back in their normal range, but rents are still going down slowly but steadily.

Just wanted to throw this in cause it's an interesting little graphic they like to include in all their reports. This one is from their most recent report, released last Friday. It's quite intuitive when you think about it, and it's interesting to note the position of the markets.

According to their little graph it seems those in Edmonton and Calgary can await a move toward increased incentives, and then rent decreases. Having tracked some of their building rates on their website, it appears consistent, as over the summer rents have been fairly stable, but the advertising of incentives have been much more prominent.

They have sporadically included incentive figures in their reports up until '06, but I hadn't seen it since then, until their most recent report. For what it's worth, in 2Q of '06 they were offering about $15 per unit in incentives... in 3Q of '09 it was now at $145 per unit.

Quite the increase, but it should be noted that in 2Q '06 that was right in the midst of the big run up in rents (at least here in Alberta, which makes up over half of their portfolio)... conversely now we're in a period of higher vacancies and thus they're trying to lure people in, whereas in '06 they were practically beating them off with a stick (get your head out of the gutter!).

I'll do some more digging into their reports and see what I can dig up, but I figured this was a pretty good update for now. Hope your Monday is going well, tak'er easy guys!

Fixed vs. Variable

This has been a much requested topic, and one I would have touched on sooner but I made the mistake of over-thinking the question initially. It wasn't until BMO came out with a report last month, that I realized it was far simpler an analysis... in fact, incredibly simple.

Now, obviously all the variables cannot be accounted for as we know banks generally lend variable at rates of prime-plus-, or prime-minus-, thus leaves an infinite number of possible combinations... but with a little intuition we know that whatever the rate is relative to prime would merely result in a shift in data. So, you can use your imagination, we'll be doing all the calculations using the average five year rate straight against the prime rate.

Here is a look at how the two have moved over time. Obviously track very similarly, though prime is generally lower (but not always). These are spot rates though, and to get an idea of how the two stack up in practice over time we much take into account how they perform relative to each other over their 5 year terms, and even over the entire life of the mortgage.

This is a more useful presentation of the data, comparing the 5-year fixed rate at any given moment against the moving-average of prime over the next five years. You'll notice it is remarkably similar to the graph from the BMO report, that's cause it's the exact same data, except their's only goes back to 1975.

As we can see, in general variable has provided the more beneficial choice the vast majority of the time, as BMO noted, 82% of the time since '75, even higher at 89% going back to '51... and it has exclusively been the better choice since 1987. That is not surprising though, as rates have going down generally since 1981.

The times fixed has been the better option has been during periods immediately proceeding large spikes in interest rates. Beyond that, during periods of generally rising rates (the period up to 1981) even when fixed is the less preferable option, it tracks much closer to how variable performs.

So, as rates have for all intents and purposes hit absolute bottom, such info is worth considering going forward as rates are sure to rise above current levels in the years to come. That goes for whether you're buying, or if your mortgage is coming up for renewal. This may be an ideal time to hedge your bets and go fixed, at least while rates are still near record lows.

Here is a bit of a different perspective of the previous data. Any time the line goes into the red area, fixed was the cheaper option... conversely, when it's in the yellow, variable was the cheaper option.

We kind of already discussed this, but this just gives you an idea of the proportional difference in these cases. It went as high as 4.4% into fixeds favour, and as low as 8.8% into variables. Over the presented period, the average was -1.33%, and median of -1.14%, both in favour of variable.

So, on average there is certainly something to be gained by going variable, but it's usually only a 1-1.5% advantage. So in times of uncertainty, such as now, you need to carefully weigh the potential positives and negatives of either route when you make a call like this.

This is another take, assuming if a person went fixed or variable at the start, they stayed with it through the remaining renewals for the full life of the mortgage. Here we can see how payment advantages from prior periods can compound over time. This is because at different rates, you also pay off different amounts of principle during any given term (except the final term of course)... basically, the lower the rate, the more principle you will pay off.

So if you make the right choice in one period, it will pay off for the remaining life of the mortgage... conversely if you got the other way, you'll be paying for it for the rest of the mortgages life. This measure is a measure of how much is saved relative to the more costly option.

We can see that over 25 years (five terms) the scale of the advantage is much larger. Going as far as 28% in favour of variable. But again, remember this is over periods when the majority of the life of the mortgage would be while rates on going down.

We're not in that situation today, in all likelihood rates are heading up at least a point or two in coming years, thus, pay particular attention to the data in the 50's and early 60's when in a similar situation. During that period, the results were much more mixed.

The dotted area is of mortgages and/or terms have not year completed, and the further right you go, the younger the mortgage, and thus the more the data will respond to future data. Those plots/figures have not been included in any figures I've discussed, they're just there in case you were interested in such things.

Finally I just threw this one in for shits and giggles, this is what they'd look like if we had 30-year fixed rates like they do in the US, rather then our preference for the 5-year terms. This is using the Canadian data as I'm too lazy to look up the US numbers, and from experience their 30-year rates are close, if not often lower then our 5-year rates (no wonder our banks are so profitable huh?!) and prime would be very similar.

We can see here the results are more muted then the prior graph. During periods of increasing rates, fixed performs better, and during ones of lowering rates, variable does. No surprise, that's what intuition would suggest.

I know real estate is still ugly in the states, but you gotta figure in a lot markets prices have returned to their long term trendlines, if not dipped below. That combined with this current interest rate environment, there may never be a better time to buy if you're a potential first-time buyer south of the border. Even if prices slide a bit further, you've locked in at a sweetheart rate, and thus probably still better off.

We north of the border on the other hand, are at the opposite end of the curve, still near the top (or in some cities, right at it) of the bubble. We still have a world of hurt to come before we return to market conditions that are ripe for those looking to enter the market, buying in now is more a debt trap then anything.

Anyway, hope this answered some of your questions about the historical performances of fixed vs. variable rates. But, if you have any more, fire away!