June 17, 2021

Episode 154: Renting vs. Buying a Home: How to Decide

June 17, 2021

Welcome back to another episode of the sensible money show. The focus this week is the age-old question of housing; whether to buy or to rent. After our preliminary remarks, book review, and a new TV recommendation, we get down to brass tacks on the important things to look at when assessing your living situation. There are some commonly held views on the expenses and sacrifices associated with real estate, and we do our best to share some of the facts as they stand. We get into some meaningful ways to truly compare the costs of each option, looking at the financial aspects, risk, quality of life, and related psychological elements to the debate. The truth is that there will be costs associated with each, but that they may not always lie where you think they do! For instance, it is commonly believed that it is less risky to own than to rent, however, the evidence suggests otherwise. Similarly, many of us assume that the costs of owning a property are greatly diminished once it is paid off, again, this is not necessarily true. Our main argument here is to base your choices on factors more closely related to your physical and mental health, things like stress and relaxation due to noise and travel times.

Key Points From This Episode:

This week's highly recommend book, Noise. [0:05:37.3]
Unpacking the new article by Larry Swedroe titled 'The Misguided Faith in the Fiduciary Standard' [0:11:50.7]
A few thoughts on FIRE, positive psychology, and moral judgements. [0:16:49.2]
The big decision that so many of us are faced with: buy or rent? [0:20:41.7]
Flawed logic around mortgage payments and rental costs. [0:25:55.5]
Opportunity and maintenance costs and the truth about depreciation. [0:29:51.7]
Equating the total costs of renting and owning and making a judgement based on this. [0:36:53.8]
The ration of prices to rent in Canada currently and in the last few decades. [0:39:47.9]
Risk and homeownership; why renting is less risky in many ways. [0:40:50.8]
Keeping the focus on living a good life when making real estate decisions. [0:45:15.7]
The surprising relationship between owning a property and a sense of control. [0:49:16.8]
Weighing all the factors and making an informed decision based on wellbeing. [0:55:30.4]
This week's Talking Sense segment dealing saving, speed of decision-making. [0:56:08.8]
Bad advice of the week: Fidelity's investment initiative aimed at teenagers. [1:00:34.4]

Read The Transcript:

Ben Felix: This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making for Canadians. We are hosted by me Benjamin Felix and Cameron Passmore, Portfolio Managers at PWL Capital.

Cameron Passmore: To kick off this week I have a quick show suggestion for everybody out there, it's on Crave. It's called Mare of Easttown. What a great seven episode series. Kate Winslet stars in it. It has everything in it in this seven episode series. It's got murder, divorce, mystery, small town issues. She's a detective in the town and so much happens so fast, and it's got a crazy twist at the end, which taps into some moral dilemma. Highly recommend Mare of Easttown on Crave.

Ben Felix: Sounds interesting. I don't have Crave though.

Cameron Passmore: I didn't either. We got it for this.

Ben Felix: Wow, it's that good.

Cameron Passmore: It's worth it. It's worth it for that. How long you keep Crave is up to you, but there we go. And with some good reviews we had recently on I guess they were Apple reviews.

Ben Felix: Yeah. It's all from iTunes.

Cameron Passmore: All from iTunes. One was Alan talking about, he comes from a country where stock market trading is considered gambling and he's been avoiding investing in stocks all his life until he saw your YouTube videos instead of listening to the podcast. It totally changed his life. I assume his investing life and changed his views on investing. Now he's invested in globally diversified ETFs. He also appreciates the discussions we've had about happiness and there's other factors involved in that as well. Pretty nice of him.

Ben Felix: Yeah. Very nice review.

Cameron Passmore: Mhmm, let us know that they've been listening for about a year. Got caught up in all the old episodes and also has been enjoying the recent content on happiness and contentment and they enjoy the book reviews.

Ben Felix: Book reviews are a hit.

Cameron Passmore: I know. Nice to hear. The last one or second last one here from Darwin. He let us know that the podcasts and I assume the YouTube channel has completely made him rethink his business. He's an advisor. He says that we're inspiring and he's a financial advisor who completely reinvented his business after binge listening to the podcast, thorough in the approach the great dive in its financial subjects and bring insight into the psychology of money. My clients will thank you guys.

Ben Felix: They are welcome.

Cameron Passmore: That's cool.

Ben Felix: Yeah. That's very cool.

Cameron Passmore: And the last one, maybe we need to do a Bluetooth speaker on our merge to counteract Bluetooth headphones. But anyways, someone bought Bluetooth headphones just they can listen to the podcast while cutting the grass.

Ben Felix: You know what I got, finally? The Airpods.

Cameron Passmore: You got the new ones.

Ben Felix: The AirPod Pro, yeah.

Cameron Passmore: Yeah.

Ben Felix: I never bought the wireless ones. You told me years ago when you got them when they first came out that I had to get them and I never did, finally got them. It's nice.

Cameron Passmore: Yeah. They're pretty sweet.

Ben Felix: t's nice.

Cameron Passmore: Another content I want to put out there. Remember a few weeks ago, we talked about Adam Grant's book, Think again. He was on with Shane Parrish recently and also on 10% Happier Dan Harris, phenomenal interviews, well worth going and looking them up. It's a great interview. Upcoming guests with us next week is Don Ezra, actor and five-time author, including Happiness and Life Two. And then two weeks after that is Rob Arnott, founder of Research Affiliates. And then in five weeks is Bill Schultheis, who is the author of the recently released book, The Coffeehouse Investor's Ground Rules.

Ben Felix: All great books, all great conversations.

Cameron Passmore: For sure. Angelica asked us to remind everyone or to let everyone know that shipping is often delayed to the US and Europe, if you can believe it. We're aware of that, problem there is much we can do about it, but stuff does get shipped. She also asked us to mention to watch out for YouTube fraudsters. I think you know more about this than I do.

Ben Felix: Yeah, it hasn't been bad on Rational Reminder YouTube. But on Common Sense Investing YouTube, they create accounts with the same name. The YouTube account is called Ben Felix and they steal my picture so it looks like me commenting. In the comment sections on my YouTube videos, there's a Ben Felix fake account asking to be contacted on WhatsApp or whatever else, telegram and stuff like that, encrypted messaging things presumably to try and steal your information or something.

If it's me commenting, you can see the little check mark because I have the... I got the verified account on YouTube and if it doesn't have the account and they're asking for your WhatsApp contact information, you should ignore them and report the comment. It's terrible. It's a big problem apparently all across YouTube, we've identified one possible solution, but for now it's still a very ugly problem.

Cameron Passmore: Speaking of social media, feel free to connect on Goodreads as well as on Peloton, #rationalreminder and I'm CP313. I think we have almost 500 followers now on Instagram so you can see us over there. We are both on Twitter as is the podcast @RationalRemind, I think it is on Twitter. Anything else?

Ben Felix: Nope, that's good. We'll go ahead to the episode. Welcome to episode 154.

Cameron Passmore: As we mentioned last time that you and I were on and reading this book called Noise, the phenomenal new book from Daniel Kahneman, Olivier Sibony and Cass Sunstein, such a good book, highly recommended. I know it's all over Twitter and everyone's recommending it. I think it's number seven on the New York Times nonfiction list. It should be there. It is so good. It's dense, it's slow going, so many times you just stop and just think about what they're saying. Is such a head spinning book in so many ways.

Like I said last time, it's a collision of thinking fast and slow and nudge. And for this trio of authors to come out with this book, I think that's a Testament to how big a deal Noise is in society is kind of everywhere, right? And noise is basically unwanted variability and judgements and judgements are happening all over the place. Some examples on the book, sentences in court on the day following a loss by the local football team have harsher sentences.

They give examples, many examples from this one insurance company where the underwriters who determine premium rates based on facts often have premium rates that are different by up to 55%.

Ben Felix: I think that was where Kahneman first observed noise, I think.

Cameron Passmore: From that interview you listened to.

Ben Felix: Yeah, from when I heard him speak about this book and I'm pretty sure he mentioned that was the first time that he observed it. And then they started studying it after that.

Cameron Passmore: There are so many places in society that they highlight where you don't want noise, like in court, getting into college, universities, business transactions, but we are all subject to noise. And the highlight early on in the book that noise is different from bias and they give this great example to illustrate the difference. It take three teams at a shooting range and each team is shooting at one target and then you take the target back and you flip it around so you don't see where the bulls eye is.

If all the shots on the piece of paper at the bottom left, okay, so they're all close in the same area, that is bias. Everyone's off the target by the same amount. You can correct that bias easily by readjusting the sites in the rifle. The next sheet from the other team, you turn over, you look at the back and it's all over the place, right? That's noise. There's no discernible pattern of bias. And the third team could be everyone say, all right of the target, but some are high and some are low. The fact that they're all right, that is bias. The fact that some are high and some are low, that is noise.

That was a great way to illustrate what noise is. And we are all susceptible to noise and we need to be aware that noise is all around us. But frankly, I thought I was aware of this phenomenon, but I was blown away by how pervasive noise is in our daily lives. And the authors argue that noise is rarely counteracted for deliberately, which is why they wrote the book.

Ben Felix: Yeah, well, they talked about, or he talked about this when I heard him speak about it, that the... In the research they're aware of this, but in public discourse, everyone is focusing on bias. Nobody was talking about noise, but they're saying from an academic perspective, they're equally important. They had to get the message out there.

Cameron Passmore: And so judgments that we make are based on the system, one thinking from thinking fast and slow which means it's based on your memory, but your memory could be flawed. You could have forgotten things. You could have framed your memory based on what you want it to be true. How you recall your memory could change depending on your current mood, depending on the time of day, depending on what people around you are saying at that time, we could be impacted by our health, impacted by relationships at the time.

You could have had an argument with your spouse. They also talk about how you're actually physiologically not the same person all the time. Your brain actually changes over time. They talk about the famous wisdom of crowds example that we've used in seminars before. Wisdom of crowd is very strong as long as each individual is not anchored or influenced by some external factor. Well, rarely in decision-making forums are you completely without the influence of others around you, noise is basically statistics and statistics are hard.

Causes are easy, human seek causes. We seek patterns. Noise is inherently hard. I was telling you about this book last week, you said to me, "Okay, what do we do about it?" I hadn't quite got to the point in the book yet. The answer is you should perform what they call noise hygiene, call attention to the noise and increase awareness of the possibility of noise around you. Be open-minded to the fact that you are likely subject to noise, whether you like it or not.

They talk about try to avoid human judgment that is not rules-based. Seek simplicity, seek sensible solutions. For big decisions, try to separate the team out that should be part of the decision and get them to drive to their own decision uninfluenced or unclouded by others around them. Use algorithms wherever possible, use checklists wherever possible. It's a great book by Atul Gawande, The Checklist Manifesto, but they do talk about how it's often quite possible that even with these efforts you may not see a reduction in noise, and you may not be able to even see if there was a reduction anyways.

They talk about how a lot of these rules when implemented in a workplace they can really take away the individuality of someone's role and potential loss of dignity. They said the real trick is to find that balance where you put in these processes to correct for noise without taking away someone's personal empowerment.

Ben Felix: The judgment piece is really tricky, right? Because you can say judgments are rules-based, but to create the rules, there still had to be judgments that were made, I guess, then you're just making them once and they're going to be consistent at least. But that doesn't mean that they were right. It's tricky stuff.

Cameron Passmore: In our world, managing assets and plans for people, the next story, I thought it was a neat link to this because in our world we try to have checklists and have lots of rules for all the advisors to use with clients to take away that chance of noise, but still it is a very personal relationship with clients.

It's a very interesting challenge, but make things rules-based, algorithmically driven, sensible, simple solutions, but that experience you're like, I can see you're thinking right now that happens all through the book. I can't recall a book I was like, well, I got to go back and think about that and just go back a few pages and reread it. And it's an exceptional book.

Ben Felix: All right. I might have to read it. Somebody in the Rational Reminder community said that I should read it. And I said that I heard Kahneman talk about it. I was like, "Yeah, I got it." And he reiterated, "No, no. You should read it."

Cameron Passmore: Yeah.

Ben Felix: Now you're telling me the same thing so maybe I've got to read it.

Cameron Passmore: This leads us to an article that we came across in Advisor's Perspective, which is a industry publication from our very good friend Larry Swedroe. The article is called The Misguided Faith in the Fiduciary Standard. He starts the article out by saying that believers of the fiduciary standard claim that it will lead to better client outcomes. But it says a new Canadian study by Linnainmaa, Melzer and Previtero of Canadian advisors and their clients who do not adhere to the fiduciary standard challenges belief.

He looked at the paper, also called The Misguided beliefs of Financial Advisors, which was published in The Journal of Finance. And get this, they were able to study the activity of over 4,000 advisors in Canada that manage accounts over 500,000 clients for the years 1999 to 2013. And they were managing over $20 billion of assets. The authors focused on the trading behaviors that may hurt performance, such as high turnover, preference for active management, high MER funds, return chasing and under-diversification.

They looked at how the advisors manage their own money and then how they manage their client's money. And the following summary, other findings probably won't surprise a whole lot of people, but they found that advisors invested very similarly to their clients. They trade frequently and chase returns. They prefer expensive funds with an average expense ratio of 2.4%. They prefer active funds and are under diversified. The average client invests almost exclusively in actively managed mutual funds.

Advisors allocate even less, just 1.2% to passive funds, if you can believe it. An advisor's own trading activity, trading behaviors strongly predict, see behavior common among their clients. For example, an advisor who encourages their clients to chase returns typically also chases returns themselves.

Ben Felix: It's cool that it was published in The Journal of Finance recently. This paper though is really old.

Cameron Passmore: Yeah.

Ben Felix: We did a YouTube video on it a while ago. I think it's called the financial advisors know what they're talking about or something like that, or the most advisors know what they're talking about. Covered the same ideas. Yeah. It was basically like advisors aren't being malicious. They're not doing one thing in their own accounts because they think that's right and doing something else in their client's accounts to turn commissions.

They are doing an even worse version of what they're giving their clients in their own accounts worse from the perspective of being detrimental to their wealth because of high fees and high fund turnover and all that kind of stuff.

Cameron Passmore: Precisely, and that's the argument. They believe that's the fiduciary standard they should be following because you wouldn't do worse for yourself of course. That's Larry's point.

Ben Felix: I'm pretty sure we've talked about this on the podcast before. We said that some... Or maybe it was just in a conversation between you and I, not on the podcast saying that there's a fiduciary standard saying that you have to... That advisor have to act in the best interest of their clients only solves the problem to the extent that everybody agrees on what is in the best interest of-

Cameron Passmore: Exactly.

Ben Felix: ...of the clients. And that becomes more of an education issue than a legislation. You can't just say you've got to act in the best interest, if not everybody knows what that means or a reason to what that means.

Cameron Passmore: Exactly.

Ben Felix: I agree with Larry on that one. Absolutely. But it's tough in our world too, because we can say, look at all the data, it shows very clearly that index funds are better, but that doesn't mean that they're in the best interest of a client. If a client has a preference for this, you would get from an actively managed fund. No, this was in their best interest. They wanted the slight chance at a better performance.

Cameron Passmore: But to have a whole client base that wants skewness.

Ben Felix: Yeah. That's maybe trickier.

Cameron Passmore: Unless that's your niche market.

Ben Felix: Yeah, I guess so. But it's not a silver bullet, the fiduciary standard is not a... It's important and for accountability, it's important, but it's not going to solve everything.

Cameron Passmore: Exactly. We jump to the main topic.

Ben Felix: I had a couple of random thoughts that I put into our notes that I wanted to touch on really quick before we jump into the main planning topic today. I was thinking about financial independence retire early. Why is that such a inflammatory topic? Why does it get people so fired up? Because it does on both sides, it gets people fired up. And I was thinking back to the John Zelenski's book that I read, The Positive Psychology textbook

It's actually funny, when I was rereading one of the sections that I hadn't read as closely the first time. He said, I can't remember what he said now, but basically poked fun at somebody who was reading a textbook like, what are you doing reading a textbook? And I was like, I'm reading the textbook. But he said something in there that says, and he's talking about eudaimonia, which is like reflective wellbeing. And hedonia, which is experienced wellbeing. He's talking about how those two things are different. There's a line in there.

He says favoring eudaimonia, so reflective wellbeing, over hedonia is a moral judgment that some things are more important than pleasure. This can be taken to a puritanical extreme that explicitly devalues pleasure, but positive psychologies don't go this far. I was thinking about that with fire. It ends up being, and this is why it's so contentious because there's no facts behind it. There's no way to say, being super lean and focusing on what really matters is better than consumption. You can't say that, that it's better, right?

So then it ends up being a moral judgment, financial independence retire early ends up being a moral judgment that consumption is not good, or is not necessary. And for someone who enjoys consumption, that doesn't feel good to hear in any way. I think that's why it's such a contentious issue because it is moral judgment. And then I also wanted to mention, because interest rates are so low, I keep hearing or having conversations with people about borrowing to invest in stocks because rates are so low. It seems kind of intuitive like money is so cheap.

It should be easier to earn a high return on... A relatively high return on stocks because rates are so low.

Cameron Passmore: The hurdle is lower.

Ben Felix: The hurdle is lower. Sure. But it doesn't work. And it doesn't work because you don't expect to earn the same positive return in all environments. You expect to earn a positive risk premium above the risk-free rate, that risk premium does it change or not over time? That's a whole other discussion. But say the risk premium is constant just for the sake of the example.

If the risk premium is constant and the risk-free rate drops so it's cheaper to borrow money, the risk premium that you expect to earn in excess of the risk free rate isn't changing. So it's not like it's better to borrow because money is cheap. Your risk premium is the same. It just means your total return, you expect it to actually be lower because the risk free rate is lower. But your risk premium is the same, your total return is a bit lower.

Cameron Passmore: You wouldn't expect the premium to increase just because interest rates have fallen.

Ben Felix: Correct. So to say that it makes sense, or is more compelling to borrow to invest in stocks because rates are or low, it doesn't make any sense. And there's data on this too. If you sort stock returns by interest rates, so you take the annual stock returns of countries and sort them by the interest rate in the... The real interest rate in that year, and we're comparing real stock returns. When rates have been low, stock returns have been low. And when rates have been higher, stock returns have been higher, which is evidence of what I just said.

There's no benefit to borrowing to invest in stocks just because rates are low. I'll have this conversation about all kinds of different things, but it comes up with houses like, well, I should take a mortgage, right, because money is cheap and that'll let me invest in stocks. Yeah, but you expect to earn a lower return then if rates were higher.

Cameron Passmore: Okay, so where did this week's topic come from? I know we had two great topics two weeks ago, and apparently mothballed them and found another one.

Ben Felix: Those ones died. When I sat down to think about the memory when I did the... We did systematic evaluating systematic equity strategies instead. I don't even remember what the other two were. They sounded like good ideas. This topic was about housing. We said that we were going to talk about my decision to buy a home after renting for many years. I tried to put down my thoughts on that topic.

Cameron Passmore: This is to be the last podcast recording in your rental place?

Ben Felix: That's a good question. Yes, it will be. The next time we record, I will be in the new office.

Cameron Passmore: Because those watching this on YouTube will see, it looks like the Repo Man has gone through your office there.

Ben Felix: That was me. I was the Repo Man. Next recording I'll be in the new house. Won't be able to hear the screaming kids anymore, because a lot of thick concrete wall between them. The housing decision, as many people know is one of the biggest financial decisions that we make, that most people make. It's got a big financial impact, but it's also got a big life impact. And we'll talk about some of the reasons why that's true. I think in Canada recently, I mean even in Ottawa, I got lucky finding a house that I didn't have to go into a bidding war and I didn't go over asking and all that stuff.

But everybody else that I talk to in Ottawa right now, it's just crazy. I was willing to buy a house that needed not a ton of work to be livable, but it's a bit dated in a lot of ways and a bit DIY in some other ways so I guess other people weren't interested in that commitment, but anyway, I got lucky. But I think that skyrocketing prices in lots of Canadian cities that that's making this decision even harder, even harder in some ways, but even more obvious in other ways. We'll talk about what that means.

The other thing that's been happening, and this is again, in my case specifically, played a big role is flexibility with geographic location for work, because you can potentially live depending on what you do for work, not close to where your office is like me, because we've been flexible with working from home.

Cameron Passmore: On that topic, Freakonomics interview on work from home, last week, so interesting. People should go check it out. People have been studying this for a long time long before the pandemic and they had an academic on there that talked about the cascading benefits of allowing work from home, which was really interesting. It was one of the academics that had the greatest impact on me was pro work from home. You think about it, let's say you got a promotion and had to move to another city, but your spouse didn't want to go.

That relationship struggle could cascade into the work so it's better for harmony, it's better for finding employees. It can lead to depending on the type of work you do. The example they gave was the patent office where it's very individual research, heavy type work. It was very effective in a work from home environment.

Ben Felix: Interesting. We both read that book on Technology Product Management, and the author was adamant that you have to be for that job for creating technology products, whether he's right or wrong anyway, it's just interesting that there's such strong points of view.

Cameron Passmore: We're clearly in a grand experiment so it will be interesting to see how this all plays out.

Ben Felix: Yup. I don't think that there's a universally right way to approach how you pay for housing. But I think one of the big takeaways, and this is not going to be news to people that have followed our stuff. One of the big takeaways is that the conventional wisdom and societal pressure that owning is better than renting, that's false. We'll talk about some of the math behind that, but in this decision, that's one of the most important inputs is what are the cost differences? If one of the housing options is materially better than the other from a cost perspective, you might be willing to make more sacrifices on the other factors in the decision.

If costs are equivalent, then you make it based on other stuff. We'll talk about how you can find cost equivalency in a second. Now, I've been renting for a while since I've been in Ottawa, so that's 10 years now that I've been living in Ottawa. And before that I was a student and as most students do, I rented. It's been geez, like 15 years that I've been renting. Totally happy. I mean, sure it would have been nice if I owned a home for the last two years in Ottawa with lots of leverage to get some nice tax-free capital gains, but can't predict that.

To start, like I said, we have to talk to the costs of renting and owning renting. Obviously the cost is rent. Not a big deal. You pay renter's insurance, which is very cheap and maybe utilities, if it's not included in rent. The cost of owning is not as obvious and this is the problem. This is what leads a lot of people to believe that owning is much better than renting from a financial perspective. It seems intuitive. And this is again, one of those traps that if you can buy a house with a mortgage payment that's around or less than what you would have otherwise paid in rent, then owning is superior because part of your mortgage payment is going toward principal, which is increasing your net worth.

But 100% of your rent is throwing money away, flushing money down the toilet. That's a flawed. I'm going to explain why it's flawed. The mortgage payment is not the cost of owning a home. You can even take the mortgage out really to properly think about it. And we can add the mortgage back in later. The costs of property taxes, maintenance costs, depreciation, either way you want to look at it and the opportunity cost of the equity in the home.

Like I just said, if we forget about debt, if you say you pay for a home in cash, then 100% of the value of the home is an opportunity cost with leverage that decreases, but not as much as you might think. Property taxes they're going to vary, like where I'm moving, property taxes are cheaper than they are within the city. But for the sake of discussion, we'll say it's 1% of the value of the home annually for property taxes. Property taxes are a lot like rent, actually, because you're paying for services. You're not paying for housing directly.

You're paying for services from the municipality and you don't get any residual value so it's a lot like rent in that way. Maintenance costs, they can also vary a lot. Homes, I think this is another one of the important pieces that often gets missed. Homes are depreciating assets. Land is not a depreciating asset. Homes, the building, is a depreciating asset for two reasons. One is physical depreciation and that's just normal wear and tear and then the other one is functional depreciation or obsolescence.

As a newer construction methods and materials make older homes less desirable, they depreciate, the older homes depreciate. Now those costs you're paying them whether you pay them or not. I know that, that might sound strange, but you're either going to pay for fixing stuff up over time and then the property is going to maintain its value or if you don't fix stuff up over time, if you just let things go, then you're going to pay for the depreciation when you sell the house. Either way, depreciation's going to come out of your pocket eventually.

Cameron Passmore: For sure. I can't tell you the number of people that we've talked to lately that are buying homes. And everyone says I'm going to put one or 200 into it. It's always a bath that needs updating, of course the kitchen is going to be updated. Of course the stone walkway is sagging or whatever.

Ben Felix: And you factor that into the purchase price, like we did the same thing. We in figuring out how much to pay for the house we bought, we factored in not dollar for dollar, because obviously the house has a market price too. But in negotiating how much we were willing to pay, one of the big factors was how much we expected to have to put into it to get it up to current standards. Anyway, so depreciation's there and it's coming out of your pocket no matter what.

Older homes maybe have more depreciation. I saw one study that showed that there was low depreciation on newer homes and then depreciation ramped up for a while. And then as homes got much older, the depreciation slowed down. Anyway, I don't know. I don't know how good that study was, but it was interesting. But the depreciation is going to vary depending on the home.

I think probably a luxury home in a luxury neighborhood probably has higher depreciation than an average home. Maintenance cost might show up as condo fees, which are a little scary, because you have less control over, but no matter what you're paying them. Stats Canada, they have the home depreciation in CPI. Do you know that?

Cameron Passmore: I did not.

Ben Felix: `Yeah, I've peeked through this. They had a study actually, where they explained why they were changing their methodology for depreciation. I can't remember what the original number was, but they changed it to 1.5% and they cited, geez, probably 10 different academic studies. And they cited statistical agencies from other countries for what they're using for the depreciation of principal residence in the CPI basket. The StatCan used is 1.5%, but it's 1.5% on the building, because remember I said, the building is depreciating, the land is not.

To figure it out, you have to multiply the ratio of the building over the land to arrive at the depreciation. So based on some numbers that I saw for what that ratio tends to be, I figured we can arrive at 1%, which is the same number I've always used for maintenance. I think I just arrived at it in a better way on this revision using this StatCan number. The other big thing with maintenance costs is that, like I mentioned, you don't have to actually pay them and they'll show up in the sale price.

But if you do pay them, people don't tend to keep meticulous records. When you sell your house, well, I bought it for this much and I sold it for this much, and they don't say, "And here are the itemized receipts of all of my maintenance and labor costs over the time that I owned the house."

Cameron Passmore: Of course not.

Ben Felix: I think it massively inflates the appreciation of houses and that's one of the issues with the whole, which one's better discussion. The opportunity cost of the equity in the home. This is a huge one. And this is one people say, once you've paid off your house, you don't pay for it anymore. Once you've got no mortgage, your housing costs are just your property taxes and maybe some maintenance costs, but you don't have this big mortgage payment and it's not so bad.

But the reality is your housing costs actually increase once you've paid for your home. Your cash flow costs decrease, but the cost of owning a home in cash, when you factor in the opportunity cost is more expensive than owning a home with mortgage. It's a total illusion. "I don't have to pay your mortgage payments anymore. Great. My housing costs have decreased." But no, because you've got a higher opportunity cost by having a higher equity proportion, your opportunity cost increases.

And if you compare side by side, like we say, let's compare a renter to an owner and compare paying cash versus using a mortgage to finance the home. The cash purchaser falls behind the net worth the renter using 5% as the breakeven rental number, and we'll dig into that more in a second. The cash owner instead of the mortgage borrower falls behind in net worth very quickly within the first couple of years. Whereas if you take a mortgage you're ahead of the renter for a bit, and the renter takes a while to catch up.

I haven't even said what the opportunity cost is. The opportunity cost is the idea that if you pay cash for homes, you take a million dollars and stick it into a real estate asset. The opportunity cost is the fact that you could have alternatively done something else with it and for the sake of this, we're going to assume that the alternative was stocks, total market stocks. I'm ignoring taxes. I know that I just said it was a million-dollar home, so we probably don't have a TFSA that big, but I'm still going to ignore taxes.

Maybe you've got a low tax rate and taxes are effectively zero. If you look at, I use the Credit Suisse Global Investment returns yearbook, that's 121 years of stock returns. They have just over 5% in real terms for historical global stock returns, including Russia and China's market failures, Portugal's unsuccessful market, Austria's successful market. 5%. And then I figured for fees, withholding taxes, and the fact that valuations today are really high, we can call that 4% real return for stocks for this example.

And then you'll look at real estate and there's a paper, the Rate of Return on Everything, 1870 to 2015. They looked at a whole bunch of countries and on average, real estate appreciated about 1% in real terms. 1% above inflation. That difference, and we're going to assume that's the expected appreciation, 1% above inflation. The difference 3% is the opportunity cost. You're going to earn 1% in real terms on this real estate asset, you could have earned 4%. Therefore, your opportunity cost is 3%.

Cameron Passmore: Ottawa mobility prices have increased 43% total over the past two years?

Ben Felix: Well, yeah. That tells us a couple of things, it tells us this can be really hard to see, this reality that I'm laying out here because that can happen. And like I said, I wish I bought two years ago in hindsight, but one of the other ideas that I had in my notes here is that when something like that happens, if it happens in stocks, I'm pretty confident saying that expected future returns are lower. I don't know if the same is true with rent. Maybe the population growth really is backing this up.

Maybe the fundamentals really are that good, but I'm skeptical that's true. Do you expect a 1% real return from Canadian real estate after prices have done what they've done in the last few years for the next 50 years now?

Cameron Passmore: I don't know.

Ben Felix: Let's say we do. Let's say we expect the... I know a lot of people take issue with... When I did the YouTube video on this, that lots of people watched, a reasonable number of people took major issue with the fact that I was using global real estate returns when Canadian real estate returns are obviously going to be much higher than global averages. I think that's a completely absurd perspective, but I've also been wrong about that, I guess, because when I made that video a couple of years ago, we could have the same conversation and prices went up a lot since then, so who knows.

Take all that together, we've talked about property taxes at 1%, maintenance cost at 1%, and the opportunity cost of equity at 3%, you wrap all that up together and it gives you the 5% number. Interestingly, there's a paper that I found from 2004 that took a pretty similar approach, except that they used 10 year treasuries as the opportunity cost, so you could have invested your equity in 10 year treasuries, but they also added a risk premium that owners bear for taking more risk than renters.

I thought that was a very interesting point because people typically argue that owning is much less risky than renting, but this is a published academic paper, a good paper that took a pretty sensible approach and they arrived actually at a 5% number as well. They had some different assumptions than me, but they also got to 5% as the imputed rent, but I just thought it was interesting that instead of using equities for the opportunity cost, they use T-Bills, but then added on an additional risk premium for the owner.

5% imputed rent. That's an important word that I just said there. Another way to think about it is that you're paying rent, whether you own the home or not. It's just a choice of, do you own the home and rent it to yourself, or do you not own the home, own other assets and rent from somebody else? That's basically the decision we're talking about here. You're going to pay a rent either way, but having that number, having that imputed rent number, the 5% number lets you equate the total costs of renting and owning.

That tool I think is really important because without that, it's really hard to say which one makes more sense. Now, I mentioned mortgages and how that plays into all this. If you finance the purchase. You put the minimum 5% down on a, whatever, $500,000-dollar home, the opportunity cost of your equity at the beginning is pretty low, but you end up with massive cash flow costs, relatively large cash flow costs and you take together the mortgage payment plus property taxes, plus maintenance costs.

And from a cash flow perspective, the renter ends up ahead, which means that they can save more into stocks. Relatively speaking. Their housing cash flow needs will be less than the owners. They can invest the difference in stocks. That's the ticket. It does take the renter longer to catch up in net worth to the owner, but over a typical 25-year mortgage amortization, a renter catches and then quickly surpasses an owner.

And I mentioned before, if the owner pays cash, the renter gets ahead much more quickly. This is one of the other common rebuttals to this whole concept that I see as well. You can get so much leverage with real estate and that alone makes it a better decision than renting because you can't get the same amount of leverage to invest in the stocks. And it's advantageous, but mortgage debt is not an unsecured line of credit where you're making interest only payments.

And then I guess if the owner continuously strips out equity to invest, okay, well, if we're going to do that, then on the renter side, then we should start using margin at some point to make the comparison even. Anyway. Leverage is not a silver bullet in the case of owning a home that makes it a lot better. How this can be used as a tool if you find that $500,000 home that I mentioned, if it could be rented for 5% of that value, which is $2083 per month, then your cost as a renter will be very similar to your costs as an owner.

If you find a more expensive home, say you find a million-dollar home, and I don't know if it... Well, maybe in Ottawa you could find this right now. If you find a million-dollar home that could be rented for $2083 a month, then renting is a screaming good deal relative to buying. That's all it says. From a cost perspective, you can compare the two.

Cameron Passmore: Right now in Ottawa, where we live, our area, you can rent a townhome, which goes for about 700,000 for around 2000 a month, so it's close to three, three and a half percent rate, because that would bias you towards renting not owning.

Ben Felix: In that situation, yeah. But the same was probably true last year and prices jumped 40%. It doesn't mean it's a bad decision, just a bad outcome, at least for now. We'll see how long these new high prices last. I don't think that's unusual, the situation that you've just described, Cameron, where rent is relatively inexpensive compared to owning. There's a chart that we can put in the video from The Economist showing prices relative to rents in Canada for the last 50 years.

It's crazy how much prices have risen relative to rents in Canada. It's almost at the top of the chart in terms of how much that ratio has increased over the last 50 years. That's the cost side. I know we just spent a lot of time talking about that, but it's important. That's the cost side. The next piece is risk. As a homeowner, you're taking a lot of risk. And I mentioned a second ago that there's a perception that the opposite is true, that the renter is the one taking more risk, but with an owner, you're taking a very concentrated bet on a single asset.

Real estate as a whole, and I think this is where people get the idea that it's safe. Real estate as a whole has had strong returns when you account for rent, whether that's as an investment or imputed rent as somebody living there, the returns to real estate have been again from 1870 to 2015, from that paper, real estate returns were in their studies, similar to stocks in magnitude, but with much less volatility for real estate.

That does make it look pretty good. They referred to it in the paper as a bit of a puzzle, but the reality, and this is maybe one of the explanations for that statistic that I just said, it's really hard to diversify in real estate relative to global stocks in their sample, in that paper, Spain, Italy, the UK, and the US, all trail global stocks. So as a whole, global real estate and global stocks, very similar returns, but lots of countries in the study that trailed stocks.

But I think it's even worse than that, because even if you pick the right country, if you pick the wrong province, or even if you pick the right province, if you pick the wrong city, you can still end up with a bad outcome. You don't get the asset class return when you're buying a home. I consider that to be a pretty significant random risk that again, gets masked by Ottawa's recent experience with real estate and Toronto and Vancouver's recent experiences with real estate, but forward-looking, I think that's one of the big things that people need to be thinking about.

Maybe even more so, if they're in a city where have gone up a lot recently. And it's not just wealth accumulation either, I think the price risk that we're talking about can also affect mobility. You see it on Reddit often enough where somebody bought in Edmonton and now they feel like they're stuck because they're underwater on the mortgage. That's a real economic risk and not just the price risk, that's affecting your human capital potentially at that point.

Mobility is a big one. Especially like I mentioned, my little Edmonton example, if you have a big mortgage that is just exacerbated. Yes, leverage can benefit on the upside, but it can be pretty nasty on the downside. That's the first big non-cost factor. We mentioned cost, we mentioned risk, related to risk and thinking whether to rent or own. I think one of the big factors is how long you think you're going to live in that place.

And I would even say that if there's no one possibility, and obviously you can't know all possible outcomes, if there was no one possibility of moving within 10 years, I wouldn't buy. I wouldn't buy. And it's not just the price risk and the potential mobility risk, there's also transaction costs. You get smoked on transaction costs. Like the appreciation you have to get, or have to expect in order to overcome transaction costs if you move frequently is unrealistic.

Although it's been realized in the last little while in lots of Canadian cities, but it's an unrealistic expectation even if that's what's happening. And I think that kills the idea, at least in my view, of a starter home. The idea that you get into the real estate market with a smaller home that you know you're going to grow at a fair rate quickly, and then you trade up over time. I think when you take price risk and transaction costs into account, that idea is completely ridiculous.

All of that stuff matters. Cost we've talked about, risks, talked about the time horizon of living there, I guess like with stocks actually. When you invest in stocks if you know you're going to need the money in 10 years, real estate is a risky asset too. And there are lots of different reasons why you might have to move. Work, growing family, aging parents, those are the ones that you could maybe, maybe plan for, or at least consider. All that stuff's important.

But then I was trying to think, what really matters? If let's say we solve cost, we solve risk, or we account for it, once that's all done, what really matters? At the end of the day, everybody just wants to live a good life. Really. We talked about this in the investing in happiness episode. People just want to live good lives and that's what the objective should be in all of this stuff. How you pay and how much pay can play a role in living a good life.

One of the ways where it doesn't is with upgrades, excessive upgrades to a home. I say this sincerely as someone who's in the middle of renovating the kitchen of the house we just bought. Doing stuff like that doesn't tend to increase happiness because of the adaptability concept, where if we improve our circumstances, it doesn’t tend to have a major impact on happiness because we adapt to them very quickly, both good and bad. And this is a real problem for owners. It really is.

In the book, The Wealthy Renter, Alex Avery, who's a real estate analyst, he calls it an investment creep. I don't know. He probably didn't invent that term. I don't know if I need to do attribute it to him, but it's a good way to think about it. Buildings are depreciating assets. They're being consumed when we live in them. They're not investments. So yes, you've got to do upkeep to keep pace with depreciation.

But I think a lot of people probably end up over investing when they own the home because they think of it as an investment, but the reality is if you put an out extra 20K into the kitchen, because it's going to look nicer, it doesn't mean you're going to get the extra 20K back. You're probably not. You're probably not going to get it back, but there are some circumstances, a nicer kitchen not being one of them.

There are some circumstances that are not easily adapted to and I think these ones should play into the housing decision from Happiness hypothesis from Jonathan Haidt which we talked about in a bunch of past episodes, actually. Noise, especially variable or intermittent noise interferes with concentration and increases stress, so living next to a busy intersection or otherwise a noisy area may not be ideal and there are even studies that find evidence of some adaptation to the noise, still find evidence of impairment to cognitive tasks.

Haidt says in the book that if a Victorian mansion were being given away on a busy street, he would not take it. I have not found noise to be too bad living in the city, but it's noticeably quieter where our new house is. Being in control or just the feeling of being in control increases wellbeing. There's a study from David Glass and Jerome Singer, where they expose people to random loud bursts of noise. One group is told that they could stop the noise by pressing a button, but they were asked not to press it unless it was necessary, while another group was not given any perception of control.

The group who thought they were in control, even though that they didn't actually press the button performed much better on cognitive tasks after the experiment. There's another famous studies by Ellen Langer and Judith Rodin. They gave the responsibility of choice to residents in a retirement home. On one floor, residents were encouraged to rearrange their furniture, they were allowed their choice of plants, which they would then care for and they were allowed to choose on which night they would see a movie.

And then on another floor in the same retirement home, the residents were not given the option to choose how their furniture was rearranged. They were given plants. They didn't get to choose them and the nurses cared for the plants and the residents were not given choice over which night they would see a movie. The residents that were given control in this study ended up being happier, more alert, and having better health. And then there was, I think an 18-month follow-up and the number of deaths in the group that had control was much lower than the group that didn't.

Now, this one's interesting on the renting versus owning decision, because I can hear people thinking, well, as an owner, you have much more control, but I thought about this and lived through this a lot as a renter and I think a lot of that is a perception. In some cases, that may not be true. I remember when I was in university, I lived in off campus housing that the university rented. It was technically university housing, but it was in an apartment building and because we were in an apartment building, we felt like we had more control and we could get our own furniture and stuff like that.

But you weren't supposed to, and we did, and we got in big trouble from the university and that felt terrible. That felt awful, but in real life, not in university housing, I think you have a lot more control in a lot of cases when you realize as a renter. In The Wealthy Renter, Alex Avery gives some anecdotal examples of people that he's known that have actually gone to the landlord and said, "Listen, I'll pay for the cost of renovating the kitchen if you let me do it." And the landlord says, "Sure."

That may sound crazy, but when you remember that you're not necessarily going to get the money back as an owner either, it's not so crazy.

And I did this, the place we lived before this, I went to the landlord and he was a builder and I said I would buy the materials or pay for the materials if he built us a deck. He's like, "Sure." Because to him, it's like that's free money. He gets a deck. He does the labor and that was great. Anyway, I think this concept that you live in the rental and you can't touch anything, you can't change anything I think that's flawed thinking.

Commuting is another big one and this is one of the ones that's interesting with work from home particularly commuting in heavy traffic increases stress, and it's not easily adapted to. In studies, people who had been commuting for years in traffic, they still arrive at work with higher levels of stress hormones compared to people who do not commute in heavy traffic. And this is a big one when people move further away from their office in order to get a bigger house and it's a problem, there's a disconnect there.

It's a disconnect because you will adapt to the bigger house quickly. It might make you happier briefly, but it's not going to sustain the happiness, but you will not adapt to the longer commute in heavy traffic. And this was a big thing for my wife and I when we made the decision to buy a house because ever, since I've worked at PWL, I've lived within a 15-minute walk from the office so that I could walk to work every day because I refuse to commute.

I've been aware of studies like this for a long time plus my own actual lived experience with commuting, just nope, not going to do it. I always lived very close. Once that was not as important or once my commute would be less frequent, made a lot more sense or made less sense to live close to the office. And then the other thing that I think is important is when people think of commuting and they think of going to the office, but the longest commute of my week used to be my drive out of the city to go kayaking or go hiking or whatever.

I'd have to drive 20, 25 or sometimes 40 minutes, depending on where I’m going to get outside, which wasn't so bad when it saved me from having to commute to work every day, but now all of a sudden my commute to the office is the walk down the hallway. All of a sudden those 25 minute drives out of the city become the Most annoying part of my whole week. Moving closer to nature for me just made sense because it eliminated what was then my longest commute. And this not just me making a moral judgment that being close to nature is important.

In John Zelenski's textbook, Positive Psychology: The Science of Well-Being, he explains using a ton of academic sources more than I'm going to list here, that being in nature makes people happier, makes people have higher life satisfaction and positive moods and reduces stress and it encourages prosocial behavior, which improves health. There's a large UK study that found living near green space is associated with a longer life. There was a Canadian study that I think he had in the book too, that had a similar finding.

And then the other interesting thing is once we made that decision, we want to live closer to nature, the rental opportunities are not as frequent. Renting in the city is fairly easy. Rental supply, I think has been a little bit tighter, but it's still... It's not that bad, but you decide you want to go live in the country, not a whole lot of rental supply. For us, we made this decision based on all of the other stuff and then understanding that the cost difference between renting and owning is...

For me, the numbers ended up working out that my total housing cost is a tiny bit higher with the new house than it was with my rent in Ottawa, when you take everything into account. We said, cost is immaterial here, make the decision based on all of the other factors. We're at a point now where we're not growing our family anymore, we're not planning on moving around. My parents are settled in Ottawa, so is my sister, so no reason to move, no need to expand the house. Family is close by.

Buying made sense for all of the non-financial reasons, which is why we finally pulled that trigger. Yeah, I think strictly speaking from a housing cost perspective, people have to understand that renting and owning can be comparable. It's definitely not automatic that owning is a good financial decision and in a lot of cases, I think it can actually be a really bad financial decision. Even if you get a good outcome in the last couple of years, it can still be a bad decision and rising real estate prices in many Canadian cities, like I just joked have masked that reality that buying can be a bad decision.

From the risk perspective, I think owning can be a lot riskier because of the concentration in a single asset and the potential mobility constraint on human capital. Once you account for all that stuff, I think the decision's got to be made based on wellbeing as every financial decision should be anchored in. And it's pretty simple, minimizing noise, minimizing long commutes in traffic. I didn't mention, commutes not in traffic and ideal driving conditions are not actually stressful. They don't decrease happiness. It's just traffic that you've got to avoid.

Feeling in control, even if you're not in control, being close to nature. Those are all favorable attributes of a housing situation, and I think that whether that's achieved by renting or owning is secondary.

Cameron Passmore: You're ready for Talking sense?

Ben Felix: Let's do it.

Cameron Passmore: These are from the card deck The University of Chicago Financial Education Initiative. We have not seen these cards before. Why do you think you or someone else might not save money? I know someone like that, they basically work to have a life of freedom in the wilderness, and you would not believe, I'm not going to share the name, but unbelievable pictures that they post and I just know that saving money is not their priority.

Ben Felix: What?

Cameron Passmore: That's just one that comes to mind. I don't know their financial situation. I just know that living to be outside and mountain bike and ski in the winter, that is their... They work enough to have the life they want.

Ben Felix: What about when they can't work anymore?

Cameron Passmore: I don't know them well enough to know that answer. I don't know if they have pinched, I don't know enough about their situation. I could be completely misreading it, but someone decides that living life to the fullest now, I could see that as a priority to not save money.

Ben Felix: Yeah. It's that moral judgment comment that I made earlier. Some people want to consume now. They value consumption now more than consumption in the future. That's really the answer to the question. What was the question again?

Cameron Passmore: But it's their situation. Why do you think you or someone else might not save money? Why would you ever not save money?

Ben Felix: I definitely make decisions where I'm saving less than I could have because I'm choosing to consume stuff. Like I took the kids to the new house last night and we went kayaking in the Gatineau River and afterwards we went out to eat food and there was some utility there where it was too late for me to go home and cook dinner, but it was also just nice, but that's money that I probably would have otherwise saved. Favor and consumption.

Cameron Passmore: Now, card number two, which after your discussion on housing, I think we'll know the answer. Do you prefer to spend lots of time gathering information before making a decision or do you prefer to make your decisions quickly? I make a lot of decisions quickly depending on, I guess, the amount of money at play, but I tend to be quicker than slower. Certainly your housing decision, you put a lot of... I don't know how much time you put in to gather.

You think about this all the time, but you knew your framework here, you're allowed as well to make the decision I'm guessing.

Ben Felix: When we made the decision, it was actually really quick. I didn't agonize over it, but you're right. I already had the calculator, the literal Excel calculator built, not just the mental model to figure out the financial side of it and then all the other stuff that we just talked about was somewhat intuitive at the time they were making the decision. But when I was doing all that happiness research, there is a paper that talks about price shopping being detrimental to wellbeing, but I think I'm more like you from that perspective of I'll tend to make decisions more quickly.

The podcast is a great example. We just decided one day to make a podcast. We didn't agonize over that. We ordered the equipment and started recording.

Cameron Passmore: Right. But to do all this research, to buy a $400 TV, really? They're all pretty good.

Ben Felix: Who gives that example?

Cameron Passmore: I used to, when the TVs used to be three or $4,000 and my income was lower, but now TVs are almost disposable and they're all so great.

Ben Felix: Yeah. I was listening to Planet Money, I think and they were talking about how TVs are basically sold at their cost of production today. There's a company called Monoprice where they'll find high quality electronics and see if they can make them cheaper and one of the main takeaways from the episode is that Monoprice does not sell TVs because all of the other companies that make them basically sell them at cost, so there's no room for somebody to come in and take the margin away.

Cameron Passmore: I don't know how they make a TV, ship it around the world and sell it at the local store for $300. I don't get it.

Ben Felix: I don't know much about TV economics, other than that they're sold at cost.

Cameron Passmore: Okay. Quickly on the bad advice of the week. I'm not certain this is bad advice so we can debate this, but I know many of our listeners have seen the news that Fidelity Investments is giving teenagers access to financial markets by providing investing and savings accounts to 13 to 17 year olds. They will be able to trade US listed stocks, Fidelity mutual funds and most ETFs without any fee or commission.

The article made, there's a couple of articles on this, but they made the argument that if you've ever regretted waiting too long before you started to invest, here's a chance to save your teen from a similar fate. Now, the teens will not be allowed to trade crypto or options. Neither of those will be allowed. This option is only available to teens whose parents or guardians have Fidelity accounts. The parents will be able to monitor the accounts and the intention is to boost conversations obviously about personal finance and investing with their children.

I think that is great linking back to the talking sense cards, not quite sure the article talked about this, how they're able to get around the age of majority rules that we have to follow and that Robin Hood states they have to follow in the US but the article does say that when the child turns 18, the account reverts to their own names. Maybe it's quasi and their parent's name, but the kids have control over it. I'm not sure. Is there a risk to the strategy? We've read a lot about Robin Hood gamifying the investment experience.

Is there a risk that if the team does well in picking stocks, they become overconfident? Is it good just to learn how trading works, how account broker statements and how the system works? Is that a good idea? Is it simply chasing Robin Hood and creating future Robin Hood investors? Does it over glamorize the whole thing? Would a teen, would a 13-year-old actually want to do asset class investing to learn about indexing?

Ben Felix: Who knows?

Cameron Passmore: Where would they learn it from? How did the parent... There's so many questions. I'm not sure if it's good or bad. I don't know.

Ben Felix: Depends how it's marketed, I think.

Cameron Passmore: I just think the regret. Have you regretted setting up or saving on your own too late, but you can just see it becomes this stock picking nightmare. And then we're seeing that losing your money is actually making a ton of money with a small amount of money could turn a return on a small amount of money, and then becoming overconfident. That's what I would worry about and they'd think it's a game. It's not a game that they do end up becoming stock pickers. Can they migrate to asset class investing later? Would they? I don't know.

Ben Felix: If this becomes big enough and if Fidelity gives up the data, there will be studies for sure showing how teenagers do relative to other retail accounts, because there are studies now showing that mutual funds make their most profitable trades trading with individual investors. There have been US studies on that and I think Taiwanese studies on that to see if teenagers do better or worse than the average retail investor.