Two years ago Pat and Kelly decided to punt their suburban Vancouver OSB McMansion, invest the bundle for income, and rent. Happily, this pathetic blog played a role. “Not gloating or arrogant here,” says Pat, “but there but for the grace of God and Garth, go I!!! I’m so glad I found you and decided finally after 50 or so years of life to stop being a greater fool and switch to being a somewhat lesser fool :).”
The landlord lives in HK, tried to sell the house for $900,000, and now leases it to P&K for $2,250. “I figure that unless they had a quadruple whopper of a down payment, they are losing money at tsunami proportions just to keep up the payments on their ‘investment’”, Pat says.
Two weeks ago, as the term came due, the landlord announced a rent increase. Days later came another email, rescinding the increase. “I just have time to check the rental in Burnaby area yesterday afternoon,” it said. “After checking, I’m offering to keep the rental intact at in order to be comparable to market rental despite rising miscellaneous costs.”
Huh? Why would an absentee owner, already in negative cash flow, waive a rent hike? “Seems rents are starting to inch downward,” says Pat, who looked around after the rent notice arrived “and there is certainly lots of supply. I even restricted my search to pet-friendly places (we have a dog and a cat). If those restrictions were removed I’m sure the list would be much longer.”
Like this place, in Surrey – where similar houses (about 400 of them) are listed in the $900,000 range. Monthly rent: $2,250, half of which can be recovered from renting out the downstairs suite. And no yard work, since the LL lives next door. How handy is that?
In fact here’s an example of how delusional offshore investors are subsidizing smart people like P&K. The same principle applies to all those snappy Toronto specuvestors who own condos and humanely subsidize their tenants. After all, in the absence of capital gains on real estate churned out by a rising market, owners lose and renters win. It’s especially true when the massive cost of acquiring and selling real estate is factored in, along with the lost opportunity cost of the money invested in equity.
All of that is handily represented in what’s called the price-rent ratio.
This compares the cost of owning with that of renting. The complicated method involves adding annual mortgage payments, property taxes, closing costs, insurance, monthly fees and the missed investment returns on the down payment and accumulated equity, and comparing that to rental income. The simple formula is (List Price/Rent*12) – in other words, divide the market value of the real estate by the annualized rent. See what ya get.
Here is one way to measure the result (as suggested by US real estate site Trulia):
- P/R ratio is lower than 15 = Listen to your mother-in-law. Buy the place.
- P/R ratio is between 16 and 20 = Nah, better off renting
- P/R ratio exceeds 21 = Your landlord is a munificent god.
The price-rent ratio on the house Pat & Kelly lease is 33. Ditto for the one they sourced in Surrey. And this may well be on the low side of the equation.
To put things into context, the OECD recently issued a report comparing price/rent ratios around the world. Guess what? Only Norway is more screwed up than we are. In fact, the organization divided countries into four categories: (a) Where houses are correctly valued, like the US, (b) Where houses are cheap and getting cheaper, like Greece or Ireland, (c) Where houses are undervalued but prices rising, like Germany, and (d) Where houses are dumbass, stupid expensive and still swelling, like Canada. Oh yeah, and Norway.
“Economies in this category are most vulnerable to the risk of a price correction – especially if borrowing costs were to rise or income growth were to slow.” And guess what?
“In the meantime,” says Pat, “I remain happy with my decision to trust my learning and research. Dreams can come true!”