Episode 323 - Renting Versus Buying a Home in Canada 2005-2024

(upbeat music) This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision making from three Canadians. We are hosted by me, Benjamin Felix, and Dan Bordelotti, Portfolio Managers at PWL Capital, and Mark McGrath, Associate Portfolio Manager at PWL Capital. - Nice to be done, Ben. Welcome to episode three, 23. Intro is a bit different this week. We nailed it, right? - I believed in you. - So it's an interesting episode this week because we've got the three of us. Cameron's away. Cameron is, is he in Australia? I want to say. - He's on his first vacation in some ridiculous number or something, yeah. - Yeah, so he is the way, so we didn't want to bring him in at whatever hour it is in Australia. So the three of us will be hosting today, Dan, as many of our listeners will know, joined us last episode or two episodes ago. - Two episodes, yeah. - For the Ask the Spud segment. So he's back today with a very interesting topic about interest rates and bonds. So we're looking forward to that, he's going to stick around for the main topic today, which is these are probably my favorite episodes and it's where Ben has spent way too much time thinking about a particular topic that has totally consumed him for a period of time and it culminates in these like masterstroke articles and papers and episodes that he comes up with. So it's going to be very interesting. It's renting versus buying a home in Canada, which Ben, you've tweeted about this a few times, you've written about it, I think a few times, we've talked about it maybe at a high level, but the level of detail you're going to go into today, I think is going to blow up a lot of people's minds. - It's a different perspective and I can definitely confirm the being consumed by it and spending way too much time on it. I don't know about the masterstroke part, but being consumed by it for sure. But this is a different look because instead of using estimates for all the different variables that matter, like what are you going to pay in rent? How is rent going to grow? How are real estate prices going to grow? Which we've done in the past, we've covered that topic many times, like based on a reasonable assumption what is renting versus buying look like. But in this case, what we did is looked at actual data for historical Canadian apartment prices and rents in a bunch of different cities and just modeled it out to see what ended up being better over this 2005 to 2024 period. - Yeah, so it's going to be very, very interesting. I'm looking forward to that. Now before we get into it, Cameron mentioned on the last episode that PWL was looking at bringing on additional advisors who already have what we call a book of business in our industry, which means they already have some clients. And Cameron's had a number of advisors did reach out to him, which is great. And as anybody who's talked to Cameron, we'll know he's very open, very generous with this time. So there's anybody listening that's hesitant about reaching out to PWL, wants to reach out to myself or Ben or Cameron. Cameron's definitely the one to talk to about this kind of stuff, but we're all, I think, pretty open books in that respect. So don't hesitate, reach out. You can find us on Twitter, LinkedIn, or pretty out there, I think. So do reach out. And then next week, Ben, you and I are going to Futureproof, which is a conference down in Huntington Beach. I've never been, Ben, did you go last year? - I did, yep. - You did? Okay, so I don't know anything about it, except for our friend, Aravind, who is like the unofficial hype man for Futureproof and he's so unbelievably excited that I have like third party excitement just watching him tweet about it. So really looking forward to that. So if you're down in Futureproof next week, come say hi, come find Ben and I. - Yep, it is a great conference. We did a live podcast episode there last year with Hal Hirschfield. So listeners may remember that. And then this year I'm speaking on a panel for Canadian advisors who have considered or may be considering going independent. A lot of Canadians go and apparently they had to move that panel to a larger space because so many people signed up for it, so it should be good. - So you're gonna use that basically to pitch and recruit PWL, is that right? - Literally that is the point. - Nice, awesome, I'll be there. I'll be working the crowd while you're on the stage. - Nice. Okay, anything else are you wanna get into it? Let's go ahead of the episode. (upbeat music) - Okay, welcome to episode 323. Renting versus owning a home in Canada. - So how to pay for housing is one of the most consequential decisions that most households make in their lifetimes. If you look at how much fuel spent on housing, if you look in the consumer price index, it's more than 28% of what statistics Canada estimates, the typical Canadian spends on stuff. So it's important, it's a big expense. And there's this common perception that renting is throwing money away and that owning a home is a universally good decision. But I think that mischaracterizes the costs of owning a home and people that will be familiar, I've talked with this before. Home ownership does offer a leveraged real estate asset and a lot of forced savings through mortgage principal repayments, which are good, probably. But it also requires you to hold this one real estate asset, which is maybe not so good. I think ultimately the things that end up mattering are how much you're paying for housing costs, which could be different for renting and owning. And how the asset that you end up owning, which in the case of an owner is a house and in the case of a renter is something else, ends up performing over the holding period. Home owners purchase an asset that pays sort of like an implicit dividend that's equal to the cost of housing. And then renters are just paying that cost under their income or their cash flow. Both homeowners and renters are paying housing costs, though. The housing costs don't go away. And unlike rent, the costs of living in an owned home are kind of hard to observe and definitely hard to account for. Like people don't really keep track of them. Owners have property taxes, maintenance and depreciation costs, and the opportunity cost of having capital in a home rather than invested in some other asset. Renting gives you the advantage of separating your housing costs from investment. So you can invest in index funds or something else. And so I think that those, I kind of already mentioned this, but the two variables that are really going to matter in the long run for realized outcomes, like who ends up better off are their housing costs and their investment returns. So that's why it was interesting to look at with kind of real data in Canada who ended up better off. And so I'm not going to get to the analysis yet. I got a little bit more in the setup. Any comments from you guys so far? No, I'm just excited for the punchlines. Yeah, I think one of the big variables here is if renting is less expensive months a month, the assumption is that people will save and invest the difference. And of course, we know that that's not always the case. And so I think if you're going to be a renter with that logic, like that this is a better financial decision, you need to be careful that you follow through on the savings investing part. 100%. So I have that in my sensitivity analysis. I have savings efficiency. So I looked at the base case as 100%, which I agree is a big assumption at least. There's a material effect if I drop it down. I think it went 90% and 80% efficiency, which is just like how much of the cost difference does the renter save? And yeah, makes a big difference. We'll get there when we get to the sensitivity. One other thing that I think is really important that I don't know if people really understand is that there should be theoretically an equilibrium in the housing market where the total costs of renting and owning are basically the same. Like that kind of has to be true on some level if you believe markets are even a little bit efficient. This highly cited 2005 paper where they describe how to compare the total cost of owning. They call the user cost of housing to the cost of renting. So those two things, the user cost of housing, like how much do you pay to live in an owned home and rent should be the same in equilibrium. So they define the user cost as the opportunity cost of capital invested in the home. Property taxes, maintenance costs, and a risk premium to compensate homeowners for the higher risk of owning versus renting. Because you've got this concentrated risky real estate asset. And then they also include the expected capital return on the real estate asset as a negative cost. And they subtract tax deductibility of mortgage interest from property taxes, which is something that's relevant in the United States, but not in Canada. So in equilibrium, we would expect the total cost of renting an owning to be roughly the same. But in real markets, like even if you do believe markets are pretty efficient, it doesn't mean that they're going to be perfectly efficient all the time. So I think it is possible and reasonable to expect that either renting or owning may be financially attractive. Both X and E before the fact that you could look at rent and say, yes, it's cheap right now. And X post after the fact where you could look back and say, well, yeah, renting was a better decision or buying was a better decision. There's one really interesting paper, a 2012 paper by Baraka and Johnson. And they argue that emotional reasons to own a home, like the common perception that renting is throwing money away, may cause home prices to rise above their fundamental values. So that equilibrium may be shifted by the fact that people have non-financial motivations to own a home. And if that's true, it would make renting relatively economically attractive. So the market can be irrational and emotional. Yeah, I think it's a pretty interesting argument because it is such a commonly held perception that you've got to get out of renting as soon as possible because it's such a bad financial decision. Did you look at this in other countries? This is such a phenomenon in Canada. If you were to Europe, I'm just using Europe as examples I was there recently, but, and of course, it's not like I'm interviewing locals about their thoughts on housing and stuff. I just don't get the same vibe that everybody is interested in owning property, you know what I mean? Like I feel like there's been many, many generations of people that have just been happily renting or like New York City, for example. The definition of success isn't whether you own the apartment you live in. It's whether you have a nice apartment. And whether you rent or own it doesn't really matter. And I just wonder, totally anecdotally, if in Canada, because I think we're only one maybe generation removed from the American dream of everyone having a backyard and a picket fence and one income family and a pension and everything else, where that's been like ingrained in us growing up is like you're not successful in this you own a property. And I just wonder if like in like three or four generations that home mentality just disappears. So if we look at the countries where there may be ahead of us from that standpoint, if the emotional aspect of this is the same. - Yeah, I think it is probably different. And that shows up in home ownership rates. Like other countries have much lower, I think Germany, for example, has much lower home ownership rates than Canada. And I don't think people are less happy or wealthy, necessarily because of that. - Yeah, interesting. Yeah, any comments down before we keep going? - Yeah, it's interesting, right? Because I think everybody knows this idea of renting is throwing money away. We've all heard it a million times, especially from the generation above us. But I had never seen it expressed as a kind of self-fulfilling prophecy before. That in fact, if everybody believes that renting is throwing money away, it becomes that. I had never thought of it like that, but it does make sense that it would actually influence the decision. - Yeah, now there are different risks. I think this is an interesting thing too. Is it renting and owning? Neither one is better than the other. Like even if we can say at a point in time, hey, renting is relatively cheap right now. That's fine. That doesn't make it objectively better than owning because renting and owning are exposed to materially different risks. Renting is risky because rents can increase a lot over a short period of time. And we've seen that in Canada since 2015, in the data that I have, there's really this sort of step function change in the rate of change of rents. Where rents had grown a little bit faster than inflation from 2004 to 2014. And then from 2015 on, around the same time, housing prices increased. The rate of change of rents just increased at the time. They started going up a lot, which is interesting. And it's interesting how it coincides with house prices too, because it's like, were we in a housing bubble or does housing costs just increase? Maybe housing just got more expensive. Now owning a home offers a hedge against rising rents and again, to the point I just made, over a period where rents rise a lot, if it's fundamentally because housing has gotten more expensive, owning a home offers a hedge against that. Rents go up, house prices go up. So the cost of housing increased, but you had a hedge against that because you owned a home. I get this question a lot from clients who go to renters. Should they overallocate to real estate income trusts in their portfolio if they are renters to hedge, if they're not going to own, or if they want to get into the market 10 years from now, they won't be able to afford to get into the housing market for say 10 years, should they overallocate from market weights to reach because, as you just pointed out, owning real estate is a hedge against rental increases. Well, owning a property is a hedge against the cost of living in that specific property. I don't know if owning REITs is a hedge against the housing market more generally. Maybe a little bit, but if you buy like a Canadian REIT, I don't know if that's necessarily going to hedge the cost of living in Squamish, or in any other specific place. So I don't know if I love that. One of the other things that we'll talk about later is that individual homes have a ton of idiosyncratic volatility, like individual stocks. So again, there's a lot of house specific risk that goes into how each property is priced. I don't know if REITs really solve that. There's this one paper that talks about how every home is kind of like a perpetual bond indexed to that specific home. So it's like buying 30-year tips or real return bonds gives you a pretty good inflation hedge over that specific time period. It's the same thing. If you buy a house, it's kind of like buying a long-term bond that's indexed to the cost of living in that specific home. But that doesn't necessarily hedge you against the cost of living in some other home in a different part of the country. Right. So I guess the wider geographically you look the less of a hedge it becomes. Like, even that neighborhood? OK, it's probably not a perfect hedge, but it's still probably a pretty good hedge for that neighborhood. But like that township, that province, then you go across the country before you know what it breaks now, probably. Yeah, I think that's right. And it does depend on the correlation in housing markets. So if Toronto and Vancouver, for example, even though they're geographically far, if they're for whatever reason highly correlated, then Toronto could be a hedge for Vancouver. But there are also lots of reasons their prices could diverge. So there's this pretty famous 2005 paper by Sinai and Sue Lele's where they show that the risk of owning declines with the households expected time horizon. So if you're going to live there for a very long time, owning is less risky. And with the correlation of housing costs in future locations, which is kind of what we're just talking about. And then rent in their analysis gets increasingly risky at longer horizons because you're just exposed to inflation risk for that period of time. By lesson, but Termiae, and we had Sebastian but Termiae on the podcast, he talked about this paper. They're the ones that describe homes as perpetual bonds index to that specific home. And so in that model of owned housing, owning a house is a risk-free asset for the homeowner. It's a liability match asset against a really important liability for households. Now, the other side of that is just like a long-term bond. Like if you buy a 30-year real-over-term bond, yes, it'll hedge you against inflation for 30 years, but in the intermediate term. And Dan, you had a post about this years ago talking about why you don't use real-over-term bonds. And I thought it was super insightful. But it's like, if you have a 30-year liability, a real-over-term bond hedges inflation over that period. But in the end term, like two years in, it can be really volatile. Well, we saw that pretty dramatically over the last couple of years with inflation spiking and real-return bonds were not behaving the way I think people expected them to behave. Yeah, exactly. As the same with houses, like sure it's a hedge in the long run, but it's still a really risky asset in the short run. And that doesn't show up in real estate indexes. That's a really important point. People will look at a real estate index and say, well, it realitates less volatile than stocks. There's a bunch of papers on this, though, that look at the idiosyncratic volatility of individual homes. They come to different results, but they're all around 10% higher than index volatility. So if you look at a standard deviation of a real estate index, and it's whatever, so it's 5%, you should expect individual homes to be an additional 10% more volatile. It's funny, I had this conversation with a client just yesterday saying the reason your house isn't volatile is because somebody's not knocking on your door every two minutes offering you a new price for it, right? Like they are with the market. You just see your assessment at the end of the year. And be so you can end your assessment on the property value. And you're like, OK, so it's just fewer data points, essentially, which gives you the feeling of it being less volatile, which isn't exactly what you're saying with the index. But I guess the index is just more diversified than an individual house, and that's why. Individual stock volatility is higher than stock index volatility. It's the same idiosyncratic volatility that goes away in the more diversified representation. OK, so there's these conflicting things, right? The house prices are super volatile, but they're also hedges. So it's kind of hard to say whether buying a home is objectively a good thing. And then there's also that piece about psychological motivations, maybe driving prices up beyond their fundamental values, whatever that means, and also hedging demands. If people have really high hedging demands, someone who doesn't need to hedge the cost of living in a specific home might be overpaying for housing. If they don't care about the hedge aspect, whereas someone who really wants the hedge, hey, that's great. So one way to test how his housing performed as an asset is looking in the historical data, which is what I kind of got excited about doing. Although I'm not going to talk about my findings quite yet, you can't just look at price returns of real estate in isolation. That's one of the other important things. People look at Canadian real estate. Me too. My prior going into doing this analysis was that real estate looked better over this period, because price returns have been really high. But you also have to look at rents. It's what I said earlier. You have to look at how much should you pay for housing and what were your investment returns in the asset that you invested in, whether that's a house or for an owner or something else for a renter. So an analytical model that includes prices, cost of owning, cost of renting, and returns on some other asset, is kind of what we need to understand the trade-offs of buying compared to renting empirically, like over a specific time period. So there's the one paper that I mentioned earlier, Barack and Johnson 2012. They simulate the rent versus buy decision at different times and locations in US historical data. And they're looking at 1978 to 2009. And they look at the US as a whole, 23 major metropolitan areas, and four major regions of the US. And they find that renting beats owning most of the time in their sample. And they're the ones that said that the psychological reasons to own a home may make renting economically attractive. And so their analysis is kind of supporting that. And there's another paper, "Cox and Follow Well 2018." They also find over multiple holding periods in the US from 1984 to 2013. They're looking at six metropolitan areas. They find that renting has often been attractive relative to renting. I think I wrote that backwards in my notes, just in case you guys are confused. But the paper actually finds that renting is usually more attractive than owning in their sample. They do find that at longer holding periods, they look at a bunch of different holding periods. At longer holding periods, owning tends to look better because transaction costs are so high. And they also find that for taxable investors, ownership becomes increasingly attractive, which I think we'll touch on that later too. Then there's another paper that's from a profit UBC and some co-authors, Summerville 2007 paper, unpublished, but still really interesting. So they look at nine metropolitan areas in Canada, 1979 to 2006. And they find that renters could have matched owner wealth in seven of the nine areas. But they do talk about how, and you touched on this earlier, Dan, they talk about how their finding would have required extreme discipline, low investment fees, and high investment returns. 'Cause I think they looked at both GICs and stocks as the alternative investments. And GICs didn't look so great. - Do you know which two of the nine were the cities they couldn't match wealth in? - I don't remember, no. - It was summing to Vancouver and Toronto, but. - In my analysis, that is true. I don't know about theirs. 'Cause it's a different period, right? I don't know. - Do they know the details? - 1979, right? It's pretty far back. - And they do make a comment at the end of the paper where they say that the relative simplicity of building wealth for home ownership, maybe it's greatest benefit. 'Cause like, you just buy a house, and that's it. Or as the renter has to worry about investing, saving the right amount, keeping their fees low, not making mistakes. And I think it's a pretty strong argument for home ownership. So the analysis is that we've done here. It starts roughly where that sample ends. So I think they went to, what did I say? 2006, yeah, so we started 2005. I think this is an interesting period because Canadian real estate has been like this global spectacle. Like everybody kind of knows that Canadian real estate's been insane. Over that period, roughly, maybe more so in the last 10 years, but still. And like I said earlier, my prior going into this was that only would look better all over the place. But it doesn't end up being true. So I built this model of a hypothetical renter and owner making the housing decision in January 2005. They have some cash for a down payment. They could have chosen to rent and invest. Or they could have chosen to own a home. Okay, before I jump into the model, any comments from you guys? - No, I think you've covered everything. - Okay. So we had to get data, obviously. This is the big thing. CMHC does publish rental market survey data. So they're like literally calling people, landlords and residents and ask them, how much do you write your place over? How much are you paying in rent? And they do this for both primary market and secondary market rentals. And I'll talk about what that means in a second. We use the composite rents for apartments, which represent the weighted average of all unit types. So that's like batch their one bedroom, two bedroom, three bedroom, plus covered by the survey. And the rental survey is updated as of October each year. So we use the October of the previous year as the starting rental amount for the following calendar year. So our sample starts in January 2005. So we use October 2004 rent as the starting rent. So these rents represent rents in both new and existing structures. And they're the weighted average of both vacant and occupied units. That is a really important point. I was talking to somebody in Vancouver about this recently actually where they've been renting for a very long time and their rent is much lower than market rent because of rent controls. Vacant units, like if you call a landlord and ask how much is your vacant unit listed for, they'll tell you information about market rents, like the price of renting a new place today. But occupied units that people are currently living in, in many cases, and the data show this, in many cases they'll lag market rents because of rent controls or maybe some other agreement with landlords if it's in a place without rent controls like I think in Ontario buildings after 2018, you don't have rent controls anymore, which cause problems for a lot of people. Residential leases are typically a year, sometimes people can extend them. So rents will tend to, for a given renter, tend to stay still for at least a little bit. - I mean, the rental caps apply after the, well, at least in BC, like even though the rental lease is a year, after that you're on month of month, but I don't believe they can just increase the rent to market rates at that point, like they're still searching for the caps. - Yeah. - Yeah, you're right. Okay, so primary market rental data cover purpose built rentals with three or more units. So think like an apartment building that has been built to be rented out. And then secondary market data cover units excluded from the primary rental market, which includes things like rented condominiums. So this is someone who goes and buys a condo and then rents it out. That's called a secondary market rental, but then like a reach or something that goes and builds an apartment building and rents all units out. That's a primary market rental. The secondary rental market data are a little bit more sparse. They start in 2007. And sometimes they're a little messier, like just fewer data points and things like that. So CMHC comments on the quality of each data point. And the secondary market rents were more often of lower quality than primary markets. But they're also generally higher than primary market rents, which is why I wanted to use them. At first I was looking at just primary market. And I was like, I wonder how different the secondary market rents are. Turns out they're quite a bit different. So I was like, okay, well, I've got to include that information too. Then I waited it by the number of units. So I have data on how many primary rental market units are available and an estimate of how many secondary market units are being rented out. So I did a weighted average of the rents, based on those two points. Tenants insurance and home insurance, I found estimates of getting those types of insurance in each place today and deflated them back in time, based on statistics Canada, like CPI measure for those costs. The renter's portfolio, so the way the model works is that the renter saves the difference between their housing costs and the owner's housing costs. They invested, they stick it into a portfolio. On the initial year, there's the down payment the renter's investing that. And then every subsequent month, if the renter's paying less than a housing cost than the owner, the cost difference is being invested in a portfolio, which means a lower level of rent relative to the cost of housing results in the renter's saving relatively more. Unimportant and potentially contentious assumption that I make is that the investment returns are not taxed. I'm looking at a non-taxable account, which means they're either using an FHSA, an RSP at TFSA or some combination. The RSP was available through the full sample. TFSA appears in 2009, FHSA more recently in 2023, but based on the amounts being saved, if you were buying a house in 2005, would investing the down payment in an RSP be sensible? Like did the amounts line up? So the highest down payment was in Vancouver $43,220, which based on the median income level at the time, would have been roughly four years of accumulated RSP room. So I don't think it's crazy. And then the future savings after that would be much lower than the annual accumulated RSP room. So I think it's reasonable enough. And the average person's not maxing out the registered accounts. So if we did include taxes on investments, and I've done this in the other, like in forward looking analysis, and the projection type analysis instead of the historical, adding in taxes makes owning look better and increasingly so at higher personal tax rates. 'Cause your aftertax investment return becomes lower and lower. So that kind of implies that in cases where registered accounts have been maximized, owning a home is relatively attractive and then increasingly so for high income earners. The portfolio I use is 30% MSCI Canada, IMI, gross dividend, and 70% MSCI, all country world IMI net div. Net div just means there's an estimate in there for form of holding taxes taken off. And then I net out a 0.25% fund of fee, rebalanced monthly. Now that asset allocation was not available for 0.25% in 2005. Later in the sample, it is, like you could buy VQT today for a little bit less than 0.25%. I do think that over the full sample, 0.25% is reasonable enough. It would have been more of a hassle to try and recreate an actual ETF portfolio, for example, or to use different fees over time. There's one other thing I thought about for this, just as a reasonable in this test. But the gross of fees return on the portfolio over the full sample period is nominal 8.19% annualized. So this is the other thing I thought about. XIC, which is the I shares core SMP TSX capped composite ETF, was available at the beginning of the sample. And foreign ownership limits in the RSP account were only eliminated in 2005. So it would have been reasonable for someone to be all in on Canada back then. So a lot of home country bias. And it was really in 2013 that a full suite of proper low cost ETFs like what people are used to today became available to build out our target asset allocation. So I can imagine a scenario where someone invested in XIC until 2013 and then added more diversification. And if they had done that, Canadian equities outperformed the global allocation until June 2015. So in that scenario, they would have been better off than the actual model. Anyway, that's just my mental justification for the 0.25% fee for the full sample. Any comments before I keep going here? - No, I think it's reasonable. Like the number of people that actually had the exact experience you're trying to describe is probably six, right? And so like you have to make some reasonable assumptions to find something to take away from this, right? - Yeah, yeah. Okay, so the home price data come from the MLS home price index for the apartment benchmark. So the HPI, it's called the HPI home price index. The HPI is a hybrid model that merges repeat sales and hedonic price approaches to creating a home index. I can probably skip over the details of how that works. But basically they create a benchmark home based on what they think is a representative home in each area for a given period of time. And then the index is based on changes and how each of the individual features are valued over time. So it accounts for stuff like how many bedrooms you have and how close you're out of transit and stuff like that. And those are all incorporated based on other past sales of homes with shared characteristics. They calculate how a benchmark home changes in price over time. It does not account for the idiosyncratic volatility we mentioned earlier because it's a more diversified representation. So that's just an important thing to think about and I didn't try and model that. But I think it's just worth keeping in mind. For transaction costs, I had 2% for closing costs, which was based on a 2008 paper and I had a 6% selling cost which is based on the 2012 Broncon Johnson paper that's what they used. And I think that's pretty reasonable. If people had a lot of real estate transactions, like we model one, they just buy that house. If they had four, they would decrease the owner's wealth because of transaction costs. - And that's probably common, right? Like it's rare that so many buyers one has never leaves. - Yeah, I've had trouble finding data on how frequently Canadians turn over their primary residences. In the US, one of these papers has data from it's a bit dated now, but it's about eight years, a typical holding period for a US owned home. I'm not sure what it is in Canada. Now, the other thing that's important here is that while renters don't have transaction costs, they do have that risk of going from below market rents to market rents if they move. - And I think it probably depends on the timing of the purchase, right? Like many people are saving and saving and saving and renting until they're 35, 37, 40 years old and then buying, right? So the turnover for somebody who does that, maybe they buy their family home in age 40, whereas somebody who gets into the market at 26 is probably buying a condo and then maybe a townhouse and then a family home. So it's gonna be different for depending on the timing of the purchase. Like in the life cycle. - The other thing that I think is kind of interesting and I don't try to analyze and don't even have any comments on my notes on, but I'll mention it is I think when people buy homes, they'll often buy for their future selves. Like they'll buy a bigger home than they need now to avoid having to move. That really just increases your housing costs relative to if you'd rented something more reasonable for your current situation. But just anecdotally, I've talked to people who are like, yeah, I'm thinking about renting a two bedroom or buying a four bedroom house. - Yeah. - Future proof. - Yeah, future proof, right? Okay, depreciation maintenance cost. This one man is hard to pin down and it's also it's another contentious assumption, but I think it's really important. I mean, I know it is 'cause it shows up in the analysis results. So the HPI index we're looking at does not factor in the cost that a home owner has incurred over time in terms of depreciation in maintenance. So we're looking at these historical index returns but they're reflecting money that has been added to the asset over time by the people living in the homes. The depreciation that a specific home owner might experience from year to year and how well or poorly a specific home has been maintained are both going to affect the home value at the time of sale. But again, the HPI won't necessarily capture that. So we need to make some adjustments to the home price index returns. Buildings are depreciating at assets. Whenever I make content in this, people are like, you're crazy. Like buildings don't appreciate it. No, buildings appreciate land appreciates. People look at real estate over time and see it goes up. That's land. And money that people are adding to buildings but the buildings themselves are depreciating over time. There's normal wear and tear. Like stuff just getting used, it's consumed. Housing gets consumed. Like you need to replace your roof, for example, but then the other thing is obsolescence. My house is built out of ICF insulated concrete forms but the version of insulated concrete forms that was used to build this house in 2003 are now outdated. So it's therefore less valuable than a newer ICF home just as an example. So maintenance spending over time reduces but doesn't eliminate depreciation. So what number do you use for this? There's a response to a 2006 paper. So there's like a critical response to a 2006 paper on this topic. The critical response suggests a two to three percent for maintenance and capital expenditure. There's a 2007 paper that looks empirically at US housing. And they find that it depreciates roughly 2.5% per year gross of maintenance and 2% net. So people are adding back 2.5% in maintenance spending but they're still depreciating at 2%. And then there's a big 2005 paper, the one that estimates user cost. They use the 2.5% figure to estimate that. There's another empirical paper that looks at multi-family investment properties, commercial and multi-family properties in the US. 2016 paper, but Carrie and Geltner, they find overall average depreciation of 1.5% per year. And their estimates range from 1.82% for properties of new buildings, 1.12 for properties with 50-year-old buildings. Now those are net of maintenance. So like maintenance has been added back to that to reduce how much the buildings were depreciating which means to find our maintenance and depreciation cost we would have to add maintenance back. So they don't do that in this paper but they do note that the end grief, which the real estate index records suggest that nearly 20% of property net operating income is typically reinvested in maintenance and upgrades. So all those figures come in. - This is of the building value of the home purchase value. - Well, so it's technically the building value and that would be the ideal way to do this, especially in places like Vancouver and Toronto where the land is an increasingly large portion of the value of a home. I don't make that adjustment because I don't have good data on relative land and building costs. And a lot of these papers don't. A lot of these papers say you just use 2.5% or whatever of the property value, acknowledging that there's a little bit of a bias in there. - And I guess with things like townhouses or condos where there's very little if any land value to what you're actually buying, right? And you're paying like stratifies which essentially cover a lot of the maintenance and depreciation costs anyway. But I guess the percentage of like a strata cost would be probably in line with the total home purchase price. Probably 2.5% of the home purchase price or as a single family residence like you said in Vancouver. Like my property I think is maybe 25% of the value of it is the building itself in the rest of the land. So you'd have to look really locally at the type of building, like the type of dwelling and geographically at the differences. - Yeah, so we are looking at apartments here. And I agree that stratifies or condofes would cover a lot of the costs that we're talking about. But you could also have stuff like a building reserve declining relative to future maintenance costs over time which will eventually show up as a special assessment. So these costs can show up a lot of different ways or in resale value because you've got an older building relative to newer buildings that are going up. Statistics Canada uses 1.5% of the building value. They're explicit about that for depreciation, for homeowners when they're calculating how much costs to live in a home. And then they also have an estimate for maintenance. Combining those two together comes out to about 2.1% of the building value. That's what Statistics Canada's using. But you look across all these studies and stats can. And it's like somewhere between 2% and 3% of the property value maybe more technically the building value is a reasonable assumption. So we use 2.5% in our model. And then we do some sensitivity around what if it was higher or lower. We use a 25 year mortgage, 20% down payment, five year fixed rate, and we get mortgage data from the Bank of Canada and Statistics Canada. We use advanced mortgage rates, which is like the rates on actual advanced mortgages. So I think the mortgages have actually been issued by banks, what are the average rates on those? When the data are available, but they're not available for the full period, when they're not available, we use posted rates, which tend to be much higher, minus 1.95%, which is the average difference between posted and advanced rates over the full sample. And the property tax ban, actually note on that, we're still working on getting some property tax data 'cause it's like literally calling municipalities and saying, hey, your website only has property tax records back to 2018, can you send us back to 2004? So Hamza and PWOs, I'm working on that. So I've got detailed data for a bunch of the areas we're talking about, rougher data for some, but I don't think that the results are gonna change much once we get them updated to the actual values. Like it's kinda close enough right now, but just not quite perfect, just as a note. Okay, so the main results, it's mixed, which is interesting, because my prior going is that only would dominate. The ending wealth, renting beats owning in seven of the 12 metropolitan areas. And I looked at Toronto Montreal, Vancouver Calgary, Edmonton Ottawa, Winnipeg, Quebec City, Hamilton, Kitchener, Waterloo, Victoria, and Halifax. Owning wins in Toronto, Vancouver Calgary, Edmonton, and Waterloo, and renting comes out in. - Even Edmonton, hey, that's interesting. - Edmonton was a really interesting one, because the price returns and Edmonton over this period were not good, but rents were really high. So really shows you've got to look at both of those factors to see who was better off. Rents were really high relative to the cost of owning. If I take the simple average of all of those areas, the ending network difference favors renting by about $15,000 at the end of the sample. So not huge, which is what you'd expect if there's an equilibrium of housing costs. - Winnipeg was the best place to be a renter, not an owner over that period, is that right? Just, I'm just looking at the notes that you posted here. - Yeah, okay, just making sure I'm reading the data. - In terms of the wealth accumulation. - Yeah, I point that out specifically, 'cause there's a guy I talked to almost daily on Twitter, who's like a huge landlord in Winnipeg. And I hope he's listening, and he just loves Winnipeg real estate and just talks about how good he's done in Winnipeg real estate over the past like 20 years versus global stock market. I've always been skeptical that that's necessarily true. And I think a lot of this just comes down to anecdotes and he's not tracking the data correctly. And so I just wanted to very specifically call out that Winnipeg was actually the worst metropolitan area that you looked at for being an owner versus a renter over that time frame. If you're listening, gotcha. - He still could have done fine though, right? If he's a leveraged landlord, if you look at the rental yields were still pretty high, the capital return was not the highest by any means, but it wasn't terrible. I have about 2%, 1.85% real annualized over the period. And then rental yields were high enough that if you're a landlord and your costs aren't too high, it's probably not bad. Okay, so looking at those two factors, like high rents relative to the cost of owning and low realized real estate returns, make owning look worse relative to renting. But in other cases, high rents and high realized real estate returns make renters disadvantage relative to owners. Either one can sway the outcome. You don't have to have both. So the Edmonton example I thought was pretty interesting where price returns were pretty low, but rents were relatively high. On average, 6.5% of the property value in rent was paid by Edmonton renters, which is I think the highest, that's the highest of all the places that I looked at. So keeping in mind that we're comparing the total cost of owning each one. So in the case of the Edmonton renter, they just didn't have much money to save. Like they saved their down payment, but then their monthly savings was minimal. And then auto was another interesting one where price returns were kinda high, 2.68% real, but rents were pretty moderate. So renters actually come out ahead there. The biggest advantage for owners was in kitchen or waterloo. They had really high price growth and kinda higher rents. And for renters like you know, did Mark was a Winnipeg which had lower price growth and moderately high, but not too high rents. And the rental growth wasn't too crazy. I was surprised by Victoria. Price growth was super strong there, but rents were really low. But then Vancouver had even lower rents, but price returns were higher, which gave owners the advantage there. So it was really hard to predict like, you know, this place did better. You have to know the relationship between the relative cost of renting and owning and the returns on the assets over the period. And even within that period there was like you said, multiple sub periods that would be really interesting to look at right like in Vancouver. As you pointed out, I think from 2015 on, things just went absolutely banana. Like I was looking at Vancouver rents, like maybe six or eight months ago. 'Cause I used to live in Vancouver and we moved to Squamish like five years ago. I was like, I wonder what rents are doing in Vancouver and wow, like it's unbelievably expensive to rent in Vancouver now. Yeah, that is, but I'm very expensive to buy a home in Vancouver too. - For sure. - Yeah. - But yeah, so there was somewhat of an inflection point around 2015 where rents and prices just kind of started to go up like crazy. I didn't look at the full comparison over that sub period. One thing that is worth mentioning actually, I don't have my notes, but in Calgary and Edmonton, there's this big spike in prices early in the sample and then a big drop. And so if you bought at the beginning of the sample, you kind of were insulated from that. But if you bought at the peak, I think it was like 2007 or something. Calgary and Edmonton had this really big bump up in prices that then dropped down. If you bought then, the owners look better in the full period. But if you bought then, renters would have come out way. I don't know what that is. Idiot's an incredible timing risk or something. - That's why I mentioned Edmonton being interesting 'cause I think prices there have barely if only recently eclipsed their previous peak, which I think to your point was like somewhere between 2007, 2009 or something like that. - Yeah, I do have that chart. They have come back at least in nominal terms from that previous peak. Maybe not in real terms though. So investment fees super important. I had the 0.25% baseline assumption, but over the sample period 2005 to 2024, people were paying way more than 0.25% in fees. Like there's probably 2.5% on average. In 2022, it was 1.76% on average, largely driven by active mutual funds. If I bump the fee up to 1.76%, renting trails owning in 10 of the 12 areas. So it matters a lot. And realistically, I mean, this is an interesting point where like in reality, like we're talking about this model, in reality, Canadians over this period were probably better off owning the renting because they were getting hosed on investment fees. - Even if they weren't too, they were, you know, good luck maintaining 100% equity portfolio over that period with discipline. That would have been extremely difficult to do. - I agree. - Honestly, doing this analysis like, it shows that renting comes out ahead in the way that the model is set up. But going through it has made me probably more likely to tell people that they should just own their home. - There's a lot of caveats to get renting out ahead. And it's not that you're biased, right? It's just that a lot of these caveats down as you point out, like are difficult to actually achieve. Like the discipline that it requires to save every dollar between the ownership and rental costs. And sitting on your hands through events like 2008 and COVID and everything, like not making those mistakes, much harder to fire sell your home in 2009 than it would be to fire sell your portfolio, right? - Yeah, that's actually a really interesting point because I have made this argument with clients before is that people will panic sell stocks. Nobody panic sells homes. In fact, they do the opposite. If you own a home and housing prices plunge, I mean, almost everybody says it doesn't matter because it only makes a difference when I'm ready to sell. And I'm just gonna hold on to it. Well, it would be great if you applied that same discipline to stocks, but people don't. On the savings efficiency, 100% is the base assumption where owning comes out ahead in five areas out of the 12. I had 90% savings efficiency. That's saving 90% of the available cost difference between renting and owning. It's seven out of the 12 areas. So we bumped up from five owning being better to seven. And then if I drop that down to 80% savings efficiency, 10 out of 12 areas, you're better off owning than renting. So I mean, to your point, then it really highlights the importance of discipline and 80% like, but the lot. It's probably more than most people are saving. That's why that term forced savings is used all the time because it's very good description of what it's like to own a home, right? People don't elect not to make mortgage payments, but they sure as heck elect not to save in a given month. And so, especially in an emergency too, right? Like the last thing you will stop paying is your mortgage. And the first thing you will stop paying is your savings plan, right? Your own total opposite ends of that decision matrix. The main is cost assumption, which I mentioned is often contentious. So the base case again is five areas owning was better at 2%, seven out of 12 areas favor owning, and at 3%, which is still within the range of sort of the academic recommendations for what to use here, only three areas favor owning. So that assumption about how much you're going to spend and maintain your home, and how much will it depreciate over time is super important. At 2.2%, I just looked at kind of where's the break even in terms of the number of areas at 2.2% six out of the 12 areas, still favor owners. That's an interesting number two though, right? Because it's pegged to the value of the home, you said, whereas if you own literally the same structure in a expensive market versus an inexpensive market, presumably the maintenance costs are going to be pretty similar in dollar terms, but the percentages are going to be thrown way off based on that, right? Like, home maintenance isn't more expensive in Vancouver than it is in Winnipeg. I don't think. But the same house would have a very different price in those two markets. Yeah, yeah, that's definitely true. We talked about that then, I think a few weeks back, when you were first starting to look at this, and I was trying to wrap my head around the maintenance cost issue, and Dan, that's the exact thing that I was stuck on is if I took my house and lifted it up and put it in a rural place in Manitoba, the cost would be 30% of what it is here. And Squamish was a percentage, it wouldn't make sense, which is why I think, and again, I know that that is hard to find, but the maintenance costs as a percentage of the building value probably makes more sense, right? 'Cause if I transpose my house into rural Manitoba, the building cost presumably doesn't change that much. It's the land value cost that's going to be reduced significantly, but as a percentage and as a dollar value, the maintenance versus the building cost likely doesn't change in those two locations. Yeah, but the data's impossible to get on that. It's like, right? Yeah, yeah, not so easy to get the data. And keep in mind, it's maintenance and depreciation, not just the explicit maintenance costs. How much less does a building appreciate in one area versus another based on the building being slightly owner or less well maintained? And that may make more sense, where an older place in Vancouver would sell for proportionally less. Does that make sense? I don't know. I don't know, there's a place in downtown Vancouver. There's like one single family house, like in downtown Vancouver. And they just refuse to sell. And I just, when I drive by it sometimes, I'm like, that thing must be worth $100 million now. Because it's the only single family house. Like, there's towers everywhere. And it's just one little house, I think. They're just whole note, right? I don't know why. Maybe it's just principle at this point, but I wonder what it's worth. Or I wonder what developers have offered them. That's a good example where the building's probably worth, like nothing. Yeah, basically. The location is everything. Yeah. Yeah. This is a quick addendum to the discussion on maintenance costs. I'm recording this the day after we recorded the rest of the episode. I really wanted to get this in because I think it's important. Mark and Dan made the valid point that maintenance costs in, for example, Vancouver are not going to be twice as high or whatever the number is as maintenance costs in, say, Winnipeg or Edmonton, just because prices in Vancouver are higher. And so we had talked about different ways to account for that, like looking at maintenance costs as a proportion of the building value. In any case, I wanted to figure out a better way to model it. So I split out maintenance and depreciation. I'm now applying depreciation to the eventual sale value of the building. And then I've got maintenance as a separate cost. Figuring out what to use for a maintenance cost is tricky, but I realize a pretty good source is just looking at condo fees. They're called maintenance fees for a reason, 'cause they're a large part of the cost of maintaining a condo building. So what I did is, for each city that we're looking at, historical data for, I went and pulled 12 current real estate listings. There's nothing magic about 12. That's the number of listings that Realtor.ca shows on a page. At least that's the standard number of listings. So I opened up Realtor.ca, went to each city, pulled the first 12 listings that I saw. I took out duplicates and stuff like that. I recorded the price and the monthly condo fees for all 12 of them and then I took the average. I made sure that the average listing price was close to the final month benchmark price for that city in the model. And then I used the average of the maintenance fees as the cost of maintenance, plus 10%. I added 10% because condo fees are not 100% of maintenance costs. So I've got 110% of that average condo maintenance fee figure as the final month maintenance cost in the model. And then I reduced that through time. I deflate it through time using the inflation rate of the home maintenance and repairs index in the CPI for each province. It's reported at the provincial level, not the municipal level by Statistics Canada. So that's what I used. The effect is for lower price cities like for Edmonton and for Winnipeg. Maintenance costs as a percentage of property prices went up a lot. And then for higher price cities like for Vancouver and Victoria proportionally, maintenance costs went down. In dollar terms, they're now more consistent across all the different cities. In Toronto, I think maintenance costs actually went up relative to the proportional model because I guess I hope this isn't just sample bias from the random 12 that I picked, but it seems like condo fees in Toronto are relatively high. Another interesting one was Montreal where condo fees are actually pretty low. So I think maintenance cost there went down. Overall, directly the results didn't change much. Victoria is the only one that flipped from being advantageous for renters to being advantageous for owners over the sample period. And it wasn't by much. It wasn't by much when it was advantageous for renters and it's not advantageous for owners by much now. The average ending net worth difference went from favoring renters by $15,000 to favoring renters by $22,000. So pretty immaterial overall. I think that that commentary from Dan and Mark was valid to the point that it was eating me up inside and I had to improve the model, which I've done. And then I felt guilty leaving listeners hanging for a couple of weeks. So I'm hoping that adding this into the episode makes the overall discussion that much more useful. I also look at mortgage down payments and advertising. So 25 years is kind of a typical amortization used by Canadians at a 15 year amortization. So that means you've got higher payments and less debt, owning a home, only beats renting in three of the areas and renter wealth exceeds owner wealth by $78,000 on average. So that assumption makes a big difference. And a 35 year amortization, which would require a 20% down payment, which is what we're modeling anyway, owning beats renting in six areas and owner wealth exceeds renter wealth by just over $15,000. So that's an interesting finding here saying, it's not really an argument for paying off your mortgage more quickly, is it? - No, no, it's not. Yeah, it's the opposite for sure. Which, you know, most people would think common sense pay off your mortgage as soon as you can afford to do it, but the leverage is clearly working to your advantage here. - Yep, and a lot of people point this out when I talk about renting versus owning a home, people say, well, you can't get a mortgage as a renter, like mortgages are amazing. And they don't necessarily make owning better, but you can see from that short example there that the mortgage definitely has an effect. Down payment's matter too. So 50% down payment renters come out ahead in nine out of 12 areas, and renter wealth exceeds owner by $59,000. And then at a 5% down payment, the kind of baseline result holds with renters coming out ahead in seven areas, but the average wealth advantage drops to just under $12,000, which is lower than the base case. So again, same thing where leverage is good for homeowners, at least over this period. So in line with at least those two past studies that we mentioned, we found in our analysis that renting and owning were both perfectly reasonable approaches for paying for housing in Canada over the period 2005 to 2024. There was no clear dominant approach, even with house price appreciation being kind of crazy and rent inflation being kind of crazy in Canada, especially in the second half of the period. I think it suggests that renting is a reasonable option to pay for housing, but as we already talked about, I think it also highlights the importance of discipline, which a lot of people don't have, and low investment fees, which a lot of people don't pay, which kind of makes owning look pretty good. It's like what that 2007 UBC paper said that like, renting looks pretty good in our model, but it takes a lot of stuff to happen or to go, people have to do the right things at the right times, not panic sell, pay low fees, be disciplined with their saving. And if any one of those things falls apart, it makes a big, big difference to the outcome. So like I mentioned earlier, I think going through this analysis made, we even though it showed that renting comes out ahead in the model, I think it actually shows that in a lot of ways owning is a pretty sensible decision for a lot of people. Renting is a viable option though. If someone wants to rent and can be disciplined and will have low fees and so on and so forth, I think that's great. This shows that you can be successful as a renter, but for the average person, I don't know, owning is probably pretty compelling. - I think that's a great takeaway from it, which is not that, oh, the model shows that renting is preferable. It's that the model clearly demonstrates that the idea that renting is throwing money away is just simply not true unless you assume you're inclined to throw your money away, right? In other words, yes, lots of us struggle with discipline and pay high investment fees and et cetera, but for those of us who don't, renting is a perfectly viable option and to suggest that you're going to end up further behind if you choose that method is just simply not true unless a whole bunch of other things are also biasing that. - Yeah, it's less of a mathematical decision than a behavior one it sounds like, right? So you shouldn't approach necessarily this problem as a math problem. - That's an interesting question too, and I have no idea if there's any data on this, but do we know whether as a group renters are happier than homeowners or the reverse? Because I can certainly see it in both ways and I've been both, there's something about renting that is extremely liberating, that you never have to worry about, you know, the leaky basement and the other things that keep homeowners awake at night, but there's also great pride of ownership, satisfaction. So it can work in both ways, but I don't know in aggregate whether we know which group is happier. - Yeah, there is a bunch of research on that actually. I just wrote an article on this for the Globe and Mail. There's even one paper that looks specifically at Canadian Data, it's a 2021 paper from a guy that I think Thompson Rivers University. Overall, I think the evidence kind of shows that owners are not happier than renters. They're not less happy, but it's pretty neutral. The Canadian paper specifically showed that owners at lower income levels are less happy. Mortgage debt makes people less happy. So even in some samples where homeownership makes people more satisfied with their housing, the fact that they have mortgage debt kind of neutralizes the effect on their overall life satisfaction. What else was there? One study showed that female homeowners specifically, which is a sample they were looking at, are less happy and it's largely due to time use where they spend less time on active leisure activities and more time on housework. And then negatively impacts their overall happiness. There's a bunch of papers on this, though. It's a super interesting topic 'cause that's one of the criticisms that I get when I talk about and keeping in mind that we're just saying what we just said, that renting's not stupid. But I'll say that and people are like, yeah, but renting is miserable. Like renters are so unhappy and they're always worried about their landlord coming into the bathroom when they're showering. I'm like, what? No, I've rented, it's not that bad. But anyway, a bunch of research on this and it's kind of, I would say fairly neutral in terms of happiness with maybe a slight tilt toward owners being a little bit less happy because of their time use constraints. - And then down just anecdotally when I was a renter, I felt the same sort of liberation. And I think it's easy to say that in hindsight now is a homeowner and it's not that obvious when you're a renter. I think it's a grass that's always greener type of situation where you wanna be an owner and then you become an owner and you're like, man, renting was really easy. And I could pick up and move and there's a flip side to that, right? But there is a lot of psychological benefits or stress related benefits to renting in my anecdotal experience. - Yeah, and it really comes down to, I think if you're gonna talk about happiness that comes from a home ownership, the presumption is you bought a home that you like and that you can comfortably afford because if you bought too much house which was incredibly common over the last decade or so, that's not a recipe for happiness. That is a recipe for stress for a sure. So I think most people who can buy house and comfortably make that mortgage payment, it's great. But if you're stretched every single month and you're constantly worried if interest rates go up, I'm gonna be in big trouble. That is not a recipe for pride of ownership. And some of this is just so outside of your control too, we love our neighborhood and a lot of it's 'cause we have two young kids, we have a single family house and kind of a cul-de-sac type of area. And there's like 20 other kids within 100 houses. And so on any given day, especially in the summer, my son can just open the door, go outside, there's 10 kids to play with. And we didn't necessarily know that before we moved here. You can't knock on people's door and say what's your family like? We wanna move into the neighborhood. But if a bunch of those neighbors moved or if that wasn't the case, I bet our happiness with this location would be less. And so a lot of that just comes down to luck, right? Or they were gonna build a development right through the forest next to our house, which we didn't know about until about two years after we moved into this house. So they were gonna punch like a gas line through not quite our backyard, but like 100 meters from our backyard in the forest. And so there was uproar about it and it ended up falling through, but had they gone through with that, that's just bad luck that would have led to a reduction in happiness for us for sure. - Hmm, interesting. I've always surveyed the neighbors, whether renting or buying, I've gone around and knocked on the doors and they're like, "Hey, you would." - You're mad in the air. - You wouldn't be here. - What do you think the neighborhood always got good information from doing that? We actually had something similar, where we bought our house. There's a massive forest kind of in our backyard called the Hundred Acre Wood. It's like literally a hundred acres of just forest with a bunch of beautiful hiking trails. And the developers were about to buy it. And so a bunch of people in the area raised money through a charitable organization, which we ended up donating a bunch to. And I just kind of thought, what? This is going to be part of the cost of buying our house because we want to maintain the forest. And so the community group ended up buying the forest. So now it's a conservation land. Pretty cool. - Oh, very cool. Pretty good. But like your point, it could have worked out differently where that became a massive housing development, which is like, we moved out here to not be near that. - Yeah, and it can affect the prices too, right? Like, values of homes here might have gone down as a result because they were less desirable if they'd done that and I don't know. - Yeah. - One of the thing Mark, you mentioned how renters, imagine they'll be happier as homeowners and then they look back and kind of think while renting was pretty good. There is one paper that I looked at for that happiness thing using German data and it found that people, they show that a home ownership does make people more satisfied with their lives a little bit, but they dramatically overestimate how much happier they're going to be. So it does make them a bit happier, but not nearly as happy as they expected when they made the decision to buy a home. - Like, most things that we think we'll make us happy. - Yeah. Yeah, so it does link it to extrinsic motivations. So people in the study who are more extrinsically motivated had the worst bias in terms of overestimating how happy they would be when they bought home anyway. Okay, so let's move on to the topic Dan has here, which is economists are predicting, this is a client question that we've paraphrased, but it's a great question and Dan's got a great answer. Economists are predicting more rate cuts in the near future. Should we switch into longer term bonds to take advantage of falling interest rates? - Yeah, it is a really good question. It's one that we get a lot and I can remember years ago when we were in the opposite situation where everybody expected interest rates to rise. We got the inverse question, which is again, perfectly reasonable. So let's start by acknowledging that central banks do sometimes telegraph their next moves, right? I mean, they try to keep tight lit, but I think we can all agree that the consensus is the next few interest rate moves are likely to be down rather than up. So let's unpack the concept a little bit. I think it's important to start with just a reminder of two important ideas here. And the first one is that bond prices and yields are inversely related. So I always ask people, just think of it like a seesaw if yields go up, prices go down, if prices go down, yields go up, and we know that when interest rates rise, bonds will lose value. I mean, we don't have to go back too far, 2021, 2022, brutal years for bonds in a rising interest rate environment. And it's of course the opposite. So if we expect interest rates to fall, then we would hope or we would expect bond prices to rise. So the second part of this, though, is that bonds with longer terms are generally more sensitive to interest rate movements than those with shorter terms. So they're likely to rise in value more sharply in response to declining interest rates. And that's why our listener is asking if it makes sense to move to longer bonds in this kind of environment because you would expect that if rates do go down, the longer bonds will outperform short-term bonds over that period. Now, I don't want to get too technical, but I think it is useful to talk about a concept in fixed income called duration. Guration is a measure of how sensitive a bond or a portfolio of bonds is to changes in interest rates. And the actual calculation, unless your bend is very hard to do, but the good news is you don't have to do the calculation because it can be boiled down to a single number that is easily distilled. You can just go on the website of any bond fund and it will have the duration expressed. So let's use an example here that always helps. So let's look at the BMO aggregate bond index ETF to ticker his Zag, very common, broad market bond fund. It holds bonds of all maturities and it's got about 30% in long bonds with terms between 10 and 30 years and the average for the whole portfolio is right around 10 years. And if you go on this ETF's webpage, you can learn that the fund has a duration of 7.3. So what that means is that if interest rates were to fall by one percentage point, you should expect the ETF's price to increase by 7.3%. Okay, now let's compare that to the BMO's short-term bond ETF. The ticker is ZSB. That one is bonds only from one to five years maturity. The average is about three years, so quite a bit less than Zag. And this fund has a duration of 2.7. So if interest rates were to fall by one percentage point, then you would expect the ETF to rise in price by about 2.7%. So when you see that, you can see why it's tempting to want to shift your bonds from shorter term to longer term because if interest rates go down, those long term or technically long duration bonds should be expected to outperform. But now this is where we get into the problem because duration, it's a very useful concept when we're talking about bonds and fixed income, but it's theoretical, right? Because it describes what would happen if all interest rates moved up or down by the same amount, what we would call a parallel shift. So in other words, let's imagine the yield on two year, five year, 10 year, 20 year bonds, would all need to rise or fall by the same amount in order for that duration number to work. So in other words, if all interest rates fell by 1%, then you would see that 7.3% bump in a fund like Zag. Now, there are periods when rates will generally move in the same direction, but it's never that tidy. There's no period where all interest rates are going to move in parallel by the same magnitude, right? Now, sometimes we will see short term rates will move and longer term rates don't. Sometimes they both move in the same direction, but not to the same degree. And occasionally you will even see short term rates move in one direction and long term rates move in the opposite direction. So duration, unfortunately, as interesting as it is as a concept, it doesn't really have much predictive power when it comes to diversified bond funds that hold a mix of maturities, there's just too many variables. And that really is the key lesson here. And that is, it's misleading to talk about the Bank of Canada raising or lowering interest rates plural, because they don't really have control over all interest rates. They really only directly control the shortest of short term rates, what they call the overnight raise, the rate that banks use when they lend to each other. And that rate is very important because it directly affects what you're going to pay on your variable rate mortgage, your line of credit, but it really does not directly affect the yield on 5, 10, 20 year bonds, right? There's some influence for sure, but it's not control. So I thought it would be helpful to have a real world example, because as I was saying earlier, I remember getting this opposite question back when we were in an environment where everyone expected that rates were going to go up. So let's go back to 2017. The Bank of Canada had indicated that rate increases were going to be on the horizon. So at that time, this is like summer 2017, the overnight rate was only 0.5%, and it had been stuck there for two years. And you guys probably remember this, right? For roughly 10 years, people said interest rates up nowhere to go, but up. And eventually they were right. And everyone was expecting that rates would go up. And so people were asking, well, maybe we should move from long bonds to short bonds, because if rates go up, those longer term bonds are going to get hit hard, and the short term bonds are going to perform. Well, as it turned out, the forecast were bang on. The Bank of Canada did raise the overnight rate. In fact, it raised it four times in the next 12 months. So it went up from 0.5% to 1.5%. And what happened? Well, there was these four well-publicized rate increases. We all saw them coming, and bond funds with longer terms actually outperformed. It was the exact opposite of what people predicted. And the reason, again, is that the Bank of Canada does not control those longer term rates. And what happened at the time was that the rates on long-term bonds barely moved, but the rates on short-term bonds went up. And so it was short-term bonds that got hit harder. So I looked at this, actually, I have a friend, Kevin Prince, over at BMO ETF. He's a good source for things like this. And he sent me some data of interest rates going back 25 years. And you could look over that period for periods of time where the yield curve was flat or inverted. So that means that short-term rates and long-term rates were either very similar. Or you even had some periods, which we've had very recently, where short-term rates were higher than long-term rates. It's not a normal environment. One would expect that over time that curve would normalize. And the longer term bonds would move to a place where their yields were higher. And what happened was, if you look back during all those periods, when the yield curve did normalize, it was not because long-term rates went up. It was because short-term rates went down. And so, in other words, if you expect short-term rates to go down, it would be reasonable to expect that long-term bonds could stay the same. At least historically, that's been the case. And so, when our listener says more rate cuts are going to happen in the future, he's probably right about that. That isn't what we're arguing here. But just because the bank of Canada's lowering its own key policy rate, it doesn't necessarily follow that yields on longer-term bonds will also come down. And therefore, the long-term bonds are not necessarily likely to outperform even though that seems like a logical place to go. So, I do think it's worth talking a little bit. And I'm interested in your opinion on this too, guys, is that, OK, if we acknowledge that the central bank can influence, but not directly control long-term bond rates, what else affects those bond yields? It seems to be its market factors. It's expectations. It's people think interest rates are going to go up or down. And so, therefore, they do. Their concerns about inflation, concerns about market volatility and safe havens that bonds might offer. So, these kinds of things are market-driven. And as always, if you believe markets are mostly efficient, that stuff is probably already baked in. I mean, the way I like to put it, if everyone is expecting short-term rates to fall, the bond market knows that. And then the longer-term rates have probably already fallen because of that expectation. So, there's no opportunity here to exploit something that's already widely known. Yeah, I think a lot of people don't realize how big and liquid bond markets are either, right? We talk about stocks as they're exciting in their flashy. And bonds, maybe people think they're easier to exploit because they're just less sexy, right? Like, who cares about bonds? So, maybe there's pricing and efficiencies there. But the bond markets are absolutely massive. They're super, super liquid. They're super competitive, so to your point, then, if something like that is widely available to the point where I can literally just go on the fact sheet of the ETF and find out what the duration is. Like, it's right in your face. There's probably not an arbitrage opportunity available there. Yeah. And if you want to talk about market efficiencies, I don't think there's any more efficient market than liquid bonds, right? Because their pricing is mathematical. I mean, obviously, it is affected by markets, end up in and things like this. But duration and these sorts of things are just math. If interest rates do go up, the bond will be adjusted by a known amount, right? And so there's much less room, certainly, for a retail investor. There's zero room to exploit mispricings of bonds, right? Totally. I think another really interesting point just on the Bank of Canada idea and should we be responding to what we think they're going to do. Pharma has said, possibly in our podcast, but for sure, we're including in a paper that the Fed, not the Bank of Canada, but that the Fed follows the market, doesn't lead the market. So when the Fed's changing rates, it's doing so in response to the market, it's not telling the market what to do. So I think that further strength is at the point that you're making there. It's very tempting. I always say to people, like, if you know something is coming, and we don't know rate cuts are coming, but I think we can have a fairly high level of confidence about that. And if that's the case, there's no opportunity to exploit it. I wish it was that simple, but it's very similar to stocks when people will talk about sort of good company equals good stock. This company is likely to make a lot of money in the future, therefore, it's a good stock to buy. I wish it was that simple, but alas, it is not. And so I think that take home here is stop trying to adjust your portfolio based on forecasts because the market has already incorporated all of these into the prices. And so your job then as an investor, when you're building a fixed income portfolio is match it to your risk tolerance and to your time horizon. And longer term bonds versus shorter term bonds, those are important decisions. If you're holding your bonds in an RSP, you don't plan to make withdrawals for 10 or more years, include a fund that has longer term bonds. If you are retired and you're drawing down your portfolio now and you would prefer less volatility in your fixed income, hold shorter term bonds. Just don't try to switch back and forth because that's where you run into trouble and build a portfolio that makes sense for you in your situation, not for what you think the market conditions are going to be. - Timeless advice, great stuff, Dan. - Awesome. - Great question from your reader or client. - Yeah, all right. Should we go into the after show? - Let's go to the after show. (upbeat music) - We're here, we're here. How many people listen to the after show now? I think, Cameron, so there's four people now? - I thought we were up to six. - We're up to six. Incredible girl. - 50% increase. Five years of doing this, we were up to six after show listeners and incredible work. Much to be talked about. I want to give a shout out to the Financial Planning Association of Canada. So this is a relatively new organization founded in, I want to say, 2020, 2021, somewhere in that neighborhood. And it's really kind of a grassroots organization still at this point, but we're gaining a lot of steam. And this is what I would consider to be the home for anybody who takes this career path seriously as a profession. And when I say career path, I mean, financial planning. It was founded by some incredible planners. The caliber of members that are involved in this is just blows my mind. In my opinion, some of the smartest people in financial planning and tax planning and estate planning and retirement planning in this country are not only members, but they are active members of, F PAC, the Financial Planning Association of Canada. There's a forum that you get access to as a member. And that forum alone is absolutely priceless. Like, if you have a financial planning question as a practitioner, and it's a real safe space, and you can just go in that forum and say, like, hey, how does this work? And you will get answers from the brightest people in this country within minutes. It's an unbelievable resource and had something like this existed when I was just getting started. It would have accelerated my learning, my knowledge, and likely my career path by at least a decade. So I want to give a shout out to anybody who's listening who's a Canadian financial planner who wants to join F PAC absolutely without consideration. Reach out to me if you want to talk to about it, if you want to talk more and learn more about it. Ben, I think you're a member as well. The other cool thing is they just launched a student tier for membership and $30 annually for any student of either a financial planning designation, like if you're studying to be a QAFP or certified financial planner or any sort of financial planning designation, or if you're a student of an undergraduate program that is finance adjacent, right? So business or economics or finance. Basically, if you're looking at a career in finance and you want to be part of this, it's $30 a year, absolutely a no-brainer to join. I agree. So important for planners to have that kind of community. I mean, we have a tight group here at PWO, but a lot of us kind of go in with the same mindset, I think, and we can learn a lot from each other. But sometimes it's very useful to just have a completely different perspective from people who work with a different client base, too, right? Like that's one of the things that you definitely notice when you train as a financial planner. A lot of it is based, I think, on let's called and sort of middle-income modest net worth people. And we don't necessarily get a lot of opportunity to work with people in those situations if we have a minimum portfolio size, for example, how often are we dealing with people who are in a lot of debt or struggling with cash flow? Like, most of them would not be clients if they were in that situation. And so working with people who have different set of experiences, you get a much different philosophy and sometimes specific strategies that maybe we wouldn't have encountered as often. - Yep, it's a great point. I think in this industry, it's very easy to become siloed and it's a very top-down industry. So like, there's advisors, I know they've been doing this for 30 years that can't kind of break out of the molds that they were trained in from their mentors. So to your point then, being exposed to different ways of doing things, people with different experiences in the industry is huge. And I will say, your network in this industry is really, really important. And developing a network of other like-minded professionals gives you not only more opportunities, but also a bit of a kind of a social safety net and some respects, right, like just myself from posting online for the past few years. And Dan, I'm sure this is the same and Ben, you're the same. We're relatively well-known, I think, at least in Canada in the financial planning space. And so that creates a lot of safety for us, right? Like, if Cameron said, you know what, I'm firing all three of you guys tomorrow, we're probably gonna be okay. Like, we know enough people, we have, I think, the respect of our colleagues and we could probably find something to occupy our time. And so networking with other professionals and gaining a bit of a reputation through groups like the Financial Planning Association of Canada is really, really important. And the earlier in your career, you do that the better. So if you're a student for 30 bucks a year, again, no brainer. - Yep, I agree with all that super interesting discussion. I did want to mention that we're looking to add more people to the rational reminder community moderation team. It's a volunteer role. All the moderators that are in there now are people who are just, like, immersed in the community. I mean, like, people who literally read every post, which is nuts, but they do it. And I think the moderation in the community is one of the things that makes it special. And moderation from people who are really engaged in the community. But as the community grows and there's more and more activity, the moderation team has kind of voiced that they need help. So if you're in the rational reminder community and enjoying it in there, there's a post I think that Angelica pinned that you can fill out a form. Yeah, so if anyone's interested, we would appreciate the help. There is a meetup in Ottawa, September 25th at 5 p.m. at Beyond the Pale, a rational reminder meetup. So I expect a bunch of listeners to come. Last time we had, I don't know, 30 people that came out, I think. And it was just great. It's always interesting to meet people in real life that listen to the podcast and their part of that community. Mark, you'll be there. - I will be there. - Mustache and full effect. I'm not shaving until after that meetup. That's my target mustache release date. - Yeah, so hopefully we get to see lots of people out there. - I thought you were going to say, hopefully we get to see your mustache. And I was like, "Yeah, you will." - Well, it sounds like we will. You just keep it up. - You don't have to keep a choice. It's coming. - Okay, I don't have anything else for the after show or anything else for you guys. - I don't think so. - All right, let's wrap it up then. Great episode. Thanks for listening. (upbeat music) (upbeat music)