Entries from July 2009 ↓

Sure thing


Yours in Vancouver for $699,000. Listing.

On the same day Imperial Oil recorded a $1 billion profit plunge and StatsCan said a third of all employers were still laying off, the recession was declared dead.

That was the word from the Conference Board, and economists at Scotiabank. This, despite 64,000 payroll jobs disappearing in the latest reporting period, and a $1 billion bailout of Air Canada, a quarter of that being tax money.

To put it mildly, the data’s conflicting.

If you believe establishment forecasters, then the nightmare of failed businesses, vaporized earnings, unemployment and insecurity is ending.

If you observe the real economy, then not so much. But maybe misery is just a lagging indicator.

The exception, as we have noted with great interest here, is housing. In fact, a Canwest story which moved on the wire Thursday claimed boldly that house prices in both Canada and the US had stabilized – an omen of good fortune.

“With the housing market stabilizing…this cycle will end, and could even be followed by a cycle of growth: would-be homeowners who wouldn’t buy into a declining market could rush to pick up today’s bargains, driving prices and luring still more buyers to keep the upward cycle going…”

And so it goes. US home prices may be sitting 20% lower than they were a year ago (which was 15% lower than the year before), and 19 million American homes may currently be vacant, but the media spin is irrefutable: Rush and buy. A new upward cycle is starting.

Regular visitors will know my reasons for believing this will not happen. Won’t bore you with it all again. But what’s striking about today’s real estate market is the casino nature. Once again, a speculative fever has gripped society in which authority figures (muckamuck economists, the prime minister, realtors with cufflinks, Canwest) can pretty much condone, if not welcome, actions which look a lot like gambling.

Like I said, the data speaks for itself. And it’s speaking golden retriever. There is absolutely no clarity on whether life will get better or worse for the average family in this country anytime soon. If rates rise, the loonie soars, oil spikes or crashes, swine flu turns into a neo-plague or some nutbar blows up the federal building in Chicago, people taking on piles of debt right now could seriously regret it.

But, hey, free country. That’s their choice. If they think this is Japan, and rates will stay at 0% for a decade, no prob. Amoritize yourself silly. If they think house prices can rise by 5% a year for the next decade, putting the average Toronto home at $648,000, then believe that, too,

However, crunch this: If the typical Toronto home does hit $648,000 (and realtors claim an annual 5% appreciation rate is ‘normal’), and if mortgage rates return to their 20-year average of 8%, then to buy it with 10% down ($65,000 in cash, plus another for $18,100 in land transfer tax, plus closing costs) will mean mortgage payments of $4,500. Add in a grand a month for property tax and monthlies, and that ends up being a cash flow drain of $5,500. To afford that average house, according to CMHC guidelines would require an income of $17,000 a month – or $204,000 a year.

So, yeah, makes sense to me. Average family income up 300% in the next ten years. Why not? Let’s party.

_ _ _

Dear Garth: I am a 100% down, 25 year amort case.  Here’s the scenario:
Age 31
Combined income – $110k a year
Wife’s (28) RRSPs – $0
My RRSPs – Approx $12k and contributing regularly
Mortgage = $289k
House value = approx $340k if we sold today
Term = 5 yr @ 5.08% (3 yrs remaining) approx $1650 a month
Credit line = $36k @3.8% (moving, renos etc)

Question is, we have virtually no spending power so the debt is moving at a snails pace and if we go with an extreme budget we may be able to pay it off in about 5 years. But that leaves no room for savings, a life or an emergency. What do you recommend?  Do we sell, do we stay and pay it off in 5 years and then start with RRSPs?  How do we strengthen our financial situation?

This fool needs some guidance. — Dave

Dave: You’ve owned for two years, nothing down, and you’ve made $51,000 in equity advance, right? Fantastic! Real estate really works.

Of course, for that you borrowed $36,000 on a LOC for moving costs and renovations, leaving a net gain of $15,000.

If you sell for $340,000 you’ll have commission of $13,600 (at 4%) to pay, plus GST of $680,  and legals of $500. That makes your capital gain $720. Oh wait – forgot the penalty for crashing your mortgage three months early. The standard three-month penalty is $4,950.

Bummer, Dave. Here, try the slots.

Update: Economy lays an egg in May

The inevitable

human nature1

Over the last three weeks I’ve tried to explain in reasonable terms why real estate is overvalued in Canada, and will correct. That should happen concurrently with interest rates rising. There is no doubt both will occur.

I have also published a number of emails from people asking for my opinion on their own housebuying aspirations and their unique circumstances. Now I will make a few final points.

Most people, it seems, migrate to this blog because they are homeless, rather than students of the economy or investors looking to build wealth. By ‘homeless,’ I mean they lust to own real estate (and usually rent nice digs) and were first attracted to me since I seemed to be an oracle foretelling a housing crash. Now some of them doubt my mystical powers (join my wife).

Hey, there are perfectly valid reasons for wanting to own a home, and the letters I’ve shared with you show how irresistible they can be. Many people equate real estate ownership with stability. They just wouldn’t consider having a kid without buying a house. Others fear renting, thinking they might be forced to move in a few years (even though most homeowners now move every 3.5 years). Some are convinced rent is wasted cash flow, even though paying the interest on a mortgage is equal. And others just have an overwhelming need to nest, to have a place they can paint chartreuse or nail plywood butterflies on the garage.

Can’t argue with that stuff. It’s in the genes.

But for those who buy because they believe it’s a smart financial move, a good investment, a wise use of capital or who swear housing is an essentially undervalued asset retaining the potential for large capital gains, well, get over it.

Here is my message:

There’s a rally going on with real estate at the moment, as there is on the TSX. In both instances, it’s a bear market event. This is a rare opportunity to get out, while there are enough fools around, desperate to get in.

To reiterate a couple of key reasons why this is so:

  • The current buoyant housing market is the artificial creation of central bankers who are pulling your strings. If interest rates were not suppressed, there would be a housing glut with few buyers and falling values. The policy makers took rates to the lowest point ever because they knew without an aphrodisiac, you would not get hot and bothered and expose your chequebook. It was crass and manipulative, but it obviously worked.
  • So, with a home-buying binge with rising prices and multiple offers having been stimulated in the middle of a recession, nobody should be under the illusion it will last. Interest rates will be rising because of many factors, including a massive need for capital by governments now with bottomless deficits to finance. As countries compete for capital, the price of it goes up. Add to that the inflationary aspects of public spending, rising energy prices and a recovering global economy over the next few years, and rates will likely double.
  • This dramatic increase in mortgage rates – from, say, 4% to 8% – impacts house prices, since a home is worth what someone can afford to pay for it. Today, at 4%, a $500,000 home might be ‘affordable’ since $450,000 in financing costs $2,300 a month. But if mortgage rates rise to 8%, then $2,300 a month finances only $300,000 – which suggests the market value of that home should be closer to $350,000.

This underscores a basic rule I have always held out as irrefutable: When the average family can no longer afford the average house, the market corrects.

There is no doubt interest rates will rise over the next few years, and substantially (this is worth reading). Buyers today have a far greater threat facing them than simply not being able to afford higher mortgage payments upon renewal. The real risk is declining valuations pushing them into negative equity and turning their emotional nests into wealth traps.

Finally, what about the argument that rising inflation – also inevitable in years of recovery – will lift real estate values as it did over the past 30 years?

Well, it’s bogus. Three decades ago, house prices were advancing from a low point when affordability was exceptionally high. Today real estate in major cities is at, or near, its historic peak. More importantly, in the Seventies and Eighties, the largest group in the population, the Boomers, were having families and setting off a real estate boom. Today those Boomers are on the verge of history’s greatest property dump.

Don’t know about you, but I see only one outcome. And it has claws.