New rules of personal finance: Spending

Real estate isn’t just a place to live…

A home is now an integral part of your financial plan but it wasn’t always this way. According to the Canadian Real Estate Association data, the average Canadian home cost just $76,534 in 1984. It rose to $226,604 by 2004 and currently sits at $442,264, a stunning 478% increase in just three decades.

“At one point, a home was considered a place to live,” says Talbot Stevens, author of The Smart Debt Coach. “It wasn’t part of the investment decision.” But with rapidly increasing housing prices, our attitude toward real estate has changed.

“Real estate is clearly very important,” says CIBC deputy chief economist Benjamin Tal. “Many people are using the valuation of their house as a forced savings plan, but there are negative implications to this strategy.”

Like most assets, housing is subject to market conditions and investor sentiment. But CFP Vicki Campbell with Ottawa-based financial planning firm Ryan Lamontagne points out: “it’s also not like any other investment.” It’s one part investment, one part forced savings plan and one part necessity. (We all need a place to live). “To make a smart housing decision, you need to look at the overall financial picture.” And in this new era of slow growth and low interest rates, the golden rule is still diversification, explains Ayana Forward, CFP, also with Ryan Lamontagne. “You don’t want all your money tied up in a home, leaving you little left over for savings.”

Yet, according to a recent report by HSBC, 48% of working-age Canadians either haven’t started or stopped saving for retirement. And 20% felt that selling their home would help to make up their shortfall.

“There’s this idea that you have to get in before the train leaves the station,” says Stevens. Combine this with two stock market crashes since 2000, and it’s easy to see why property is so tempting. We fail to recognize that record low rates helped to inflate home prices, making “a reliance on housing unwise,” says Tal.

Forget the 30% rule

Don’t spend more than 30% of your income on shelter costs. It’s a popular rule but it’s also “an arbitrary number,” says associate professor of urban affairs at Virginia Tech, David Bieri. “It creates more distortions than it actually solves.” A more practical rule to follow? Try the “residual income” approach: The amount of income left over after all personal debts and expenses, including shelter costs, have been paid. Those with higher incomes will have higher residual incomes so they can afford to pay more in housing costs. It’s also why families with two incomes and no kids can spend more on housing then families with children, for whom more income will go to child-related costs, such as clothing and daycare.

Renting is now the smart choice

Deciding whether or not a house is a good investment comes down to good, old-fashioned budget analysis, says Vicki Campbell, certified financial planner with Ryan Lamontagne. “Decades ago, people bought a house without planning. Now, the move has to be weighed against the costs and the trade-offs.” And sometimes it just makes more sense to rent and invest the savings. It’s a decision faced by many millennials, particularly those drawn to Vancouver and Toronto—where 25% of Canada’s jobs are currently found. In Toronto the average rent for a downtown condo is about $1,700, while the average resale value of that same condo hovers just above $375,000. Factor in the monthly maintenance fees and the cost to own can add $200 or more per month. Rent, invest the extra, and in 10 years you could save $31,300 (assuming a 5% annual return and no change in rental rates).

Busted: Timing the market

“Timing the real estate market is never wise,” explains Ted Rechtshaffen, president and CEO of TriDelta Financial. He explains that when buying a home, “it’s not about the home price, but the mortgage rate.” If you can afford to pay the mortgage now—and you can still afford to pay the mortgage five years from now, after rates have risen, then you can afford to buy the home. For today’s home buyer that means calculating whether or not you can afford monthly payments for your dream home at rates of 4% or 5% or even 6%.