it’s all consumption.
If you own a home, have run the above math, and really want to improve your financial position, you could look at selling your house, finding cheaper accommodation, and, instead of consuming the savings, re-invest the proceeds of the sale in other investments, like the Dividend Aristocrats Index. Then you could re-invest the dividends from your income-producing investments, creating even further personal wealth!
Now for the second thing you can do with your monthly housing cost number:
Take your total gross monthly income (before taxes) and add to it the implicit rent you calculated earlier. That was the number you calculated by multiplying the value of your house by 0.95 (95 percent) and again by 0.04 (4 percent). This is your gross monthly income, including the rent you are paying yourself to live in your house.
Now take your total monthly housing cost (including property taxes, utilities, insurance, and maintenance) and divide it by your total gross monthly income plus the implicit rent you are paying yourself.
This is how much of your total income you are spending on your housing. I like to think of this number as the amount of money a person spends on consuming housing. It is consumption because every component we’ve included in this calculation is a rent — meaning there is no residual value.
CMHC suggests you spend no more than 32 percent of your gross, pre-tax income on your housing costs. CMHC’s gross income doesn’t include implicit rent in either your gross income or your housing costs. I think that’s because the measure is designed to determine whether a person can make the monthly payments required to stay current on their mortgage.
However, the test we just calculated does ask you to include the implied rent you are paying. In doing so, it is designed to show you how much you are spending of all the possible income you could be earning on housing. It is also designed to make you question, once you know that number, whether you want to be spending as much of your income on housing as you are.
Figuring out how much of your income you’re spending on housing is so much simpler for renters, and I think that’s one of the reasons renters usually don’t get in over their heads with housing costs. For renters, take your rent, plus any utilities you pay, and divide it by your gross monthly income to determine how much of your total income you’re paying on housing.
Now both renters and owners have their numbers.
If the number you calculated is over 50 percent, you should probably spend some time looking into whether the housing you are spending so much on is really as important to you as the percentage of your income it is consuming. You could very well find that there are lots of other things you might prefer to spend your money on.
If the number is between 32 and 50 percent, then you are above the upper limit of what CMHC recommends you should be spending on your housing. That might be fine with you, if you really like the home you have and don’t want to move. But it might also mean there are some significant savings you could find by moving to less expensive housing.
If you are under 32 percent, congratulations! You have made housing decisions that have you spending less than the maximum recommended amount, according to CMHC. This puts you on the safe side of disastrous, in terms of consuming housing you can afford. As we’ll discuss later on, if you want to build wealth, there are much better things to spend your money on than housing. Minimizing consumption of housing is crucial to building wealth.
This chapter has had quite a bit of math, and I know not everyone loves math. I don’t even love math. But it’s an important tool. The key idea of this chapter is that, just because homeowners aren’t paying rent to a landlord, it doesn’t mean they aren’t paying rent. They just pay rent to themselves. And when you pay rent to yourself, it’s easy to lose track of how much rent you are paying, and you might end up over-consuming housing.
If you’re still having trouble with the idea of implicit rent or are dismissing it as “interesting in theory, but not a real cost,” you should know that it’s not just me who recognizes implicit rent as a real cost. If you live in Switzerland and you own your home, you have to pay taxes on the implied rent you are receiving, as the owner of the house, paid to you, from you, the tenant in the house. Fortunately for Swiss taxpayers, they also get to deduct all of the costs of the house, including mortgage interest, from that implicit rent income they receive from themselves.
CHAPTER 5
The Canadian Housing Market
Canada is a nation of homeowners, for the most part, with just 30 percent of households being renters. House prices have been rising rapidly in recent years, which means a lot of these homeowners have seen the value of their homes rise, lifting their net worth. However, we also know something else has been happening that a lot of these homeowners probably haven’t noticed: Their rent has been going up. And up a lot!
Just because 70 percent of Canadians own their own home doesn’t mean 70 percent of Canadians don’t pay rent. What it does mean is that the vast majority of that 70 percent probably has no idea how much their rent has gone up in recent years, instead focusing on how much more their home is worth.
Everyone needs to live somewhere. Canadians still need to live in apartments, townhouses, semi-detached houses, and single-family homes. But Canadians don’t need to own.
However, more Canadians own their homes today than at any point in history — and this is true despite the fact that prices have risen considerably over the last few decades, to such a degree that many experts think Canada’s housing market is significantly overvalued. Why has home ownership been rising? Government programs encouraging home ownership are part of the answer. But I think a big reason for rising home ownership rates is that it has been a winning strategy. As I just noted, house prices have been rising sharply for a long time. And everyone who has owned has made out like a bandit! (Or so says the common wisdom.)
Source: Canadian Real Estate Association (CREA).
The good news is that Canadian homeowners have seen the value of their homes rise, creating significant wealth. The bad news is that house prices are high. If you haven’t heard, not only are Canada’s rising house prices seen as expensive by Canadians, but a good number of experts from around the world have voiced concern about our house prices.
Robert Shiller, co-creator of the S&P/Case-Shiller U.S. National Home Price Index, Nobel laureate, and Yale economist, began calling for a correction in Canadian house prices in 2011.
Goldman Sachs warned of an overheated Canadian housing market in 2013 and 2014.
Some of the others who have expressed concern about inflated prices in Canada’s housing market include the following:
The International Monetary Fund (IMF) — 2013, 2014
Paul Krugman, Nobel prize–winning economist, City University of New York economist (2013)
Pimco, the world’s largest bond fund manager, with $1.4 trillion under management (2014)
Deutsche Bank’s chief economist, Torsten Slok (2015)
Fitch Ratings, the global credit ratings and research company (2014)
The Organization for Economic Co-operation and Development (OECD)
