have shown a regular pattern of increasing dividends over the past five years and have market capitalizations (the value of all the shares of the company) of at least $300 million. In short, the index is designed to provide investors with a conservative portfolio of defensive, income-producing stocks. Over the past ten years, this index has provided an annual total return of about 7 percent (yield plus appreciation of value), and the current yield on this index is about 4 percent: $850,000 × 0.04 = $34,000 ÷ 12 = $2,833.33 per month.
Now remember, what we’ve calculated in the three previous examples — mortgage interest on 100 percent of the value of a home, the value of a home invested at a 4.5-percent yield, and the value of a home invested at a 4-percent yield — has just been the implicit rent or opportunity cost of a home. The total cost of “rent” for a home also includes maintenance, utilities, insurance, and other items.
Another way to look at the cost of an owned home without a mortgage would be to find a home for rent nearby and use the asking rent as an estimate. Depending on where the home is and how nice it is, the amount a home rents for could be a lot more than the implicit rents we calculated, in part because the rent a landlord charges is supposed to cover not only the interest but also maintenance, property taxes, and insurance, among other things.
So for our $850,000-house example, we found implicit rent was somewhere between $2,125.00 per month and $3,187.50 per month, to which we would add: 1) maintenance costs (2 to 5 percent of the value of the home annually, or $1,416.66 to $3,541.66 per month); 2) property taxes (usually 0.5 to 1.5 percent per year, or $354.16 to $1,062.50 per month); and 3) insurance and other costs.
At a minimum, in today’s very low interest rate environment, an $850,000 home in Canada costs between about $4,000 and $8,000 per month to occupy. Regardless of the approach, those are big numbers. And those are the actual costs of occupying a home, whether you own the home or you don’t.
Attention Homeowners!
Before we wrap up this discussion, let’s do one more thing. If you happen to own a home with no mortgage, or just a small mortgage remaining, let’s calculate how much you are paying in rent, see what else you can do with that rent, and see whether you are over-consuming housing.
Take your house value and multiply it by 0.95, to reflect the transaction costs of selling your house. This is how much you could walk away with if you sold your house.
Take that number and multiply it by the Dividend Aristocrats yield (http://ca.spindices.com/indices/strategy/sp-tsx-canadian-dividend- aristocrats-index), and divide by twelve to get your implicit monthly rent. A good conservative and rough estimate, if you can’t find the current yield, would be 4 percent.
Add to that number all of the other “rents” you pay (monthly costs of property taxes at 0.5 to 1.5 percent per year, depending on what city you live in; estimate of maintenance cost at 2 to 5 percent per year; plus utilities, insurance, and any other regular expenses related to your house).
This is what you are spending to live in your house, on a monthly basis.
Now that you know that number, there are two things you can do with it. First, spend a bit of time comparing that number to the costs of other housing options you would consider. They could be nearby single-family houses, rental apartments, condominiums (for rent or sale), or even housing in another location.
If the amount of money you’re spending to live in your home on a monthly basis is significantly more than what your other housing options are, spend a bit more time thinking about what you would do with the extra money you would save by selling your house and moving to less expensive housing. If you were to save $1,000 per month, you could spend that money on four $3,000 vacations a year. Or you could take classes on something you’ve always wanted to learn about. Don’t be shy — think of the most fantastic thing you could spend money on, and you could probably figure out how to pay for it with the sale proceeds of your home!
It might sound reckless to suggest selling your house to spend money on other things you enjoy, but what we’re actually looking at is how much money you are spending on “consuming” the housing you are living in. Whether you spend that money on continuing to live in your house or on cars, antiques, or sporting events, 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