A virgin's lament: 'Looking at hell-holes'

Hi Garth,
I was just introduced to your blog after receiving a note from my landlord to check you out. I recently let him know that my wife and I are interested in buying a home over the next few months and that we’d likely be moving out before the end of the year. He quickly introduced me to your blog and explained how right now real-estate agents are regularly pressuring him to sell his home, promising ridiculous pots of gold at the end of the buyer’s rainbow.

After reading a few of your articles and reflecting on my experience in this market so far, I know that it’s not a great time to be a buyer. We’re in no financial rush to buy, other than sitting on a pretty big down payment and putting $22,000 towards rent on an annual basis (which is extremely frustrating). Since starting our search, we’ve looked at hell-holes asking for $440K and incredible properties listed the same and selling for 150K over. It’s like we don’t know what anything is actually worth any more.

I’m a commerce grad, and I have studied economics long enough to know that demand is far outweighing supply right now in Toronto, which is obviously affecting prices. I know the HST and interest rate conditions have caused an increase in the total number of buyers. So I guess after that long preamble I have three questions for you.

1. As a new buyer, how do you judge what a fair price to pay for a home in Toronto is any more?

2. What do you expect in the short term once interest rates rise and the HST goes into effect?

3. Is it just stupid to buy right now? And if so, how long do we need to suck it up and keep renting?

Any guidance would be much appreciated. I’m sure you get a ton of questions on a regular basis, so I understand if you don’t have time to get back to me. I look forward to more great posts now that I’ve discovered your blog. It’s going straight to my RSS reader. – Alex

Well, Alex, I have posted your note to me because we love new virgins here @ Greater Fool. Naiveté is so refreshing. And to find one with a principled landlord is even more unique. So, welcome. Addiction has its rewards.

You best point is, “we don’t know what anything is actually worth anymore.” This defines a market which has strayed from fundamentals into hormones. People want houses so badly that they pay almost anything for them, which imbues real estate with such value that it makes others want it even more.

This madness is fueled by dirt-cheap money, which many newbies totally fail to recognize. Because a mortgage is, oh, 2% today, that becomes the norm for first-time buyers, who base their entire budgeting process on a number which is extreme, and about to swell like a horny blowfish. These emergency rates, combined with 5% downpayments, 35-year amortizations and banks willing to lend to people with no money since the government is backing them, have created the situation you now face.

Half-million-dollar skanky dives. Greedy sellers who even don’t bother rinsing curlies out of the sink before a showing. Real estate agents who collect commission for showing up. And a disconnect from reality for a commerce grad like you.

But, Alex, there is hope. This will not last. So let me get to your questions:

(1) A fair price for a house is what people can afford. That seems to be somewhere around four times income today with these cheap rates. With normalized mortgage costs, fair value is probably a little less. The media income in T.O, is about $77K, so the average house should cost $308,000. The average now, however, is $431,500 – a $123,000 premium. Yes, Alex baby, this means the market is overvalued by 28%

(2) What comes next? Well, my view is that 2010 will be a tipping point. The combination of rising interest rates this summer with the HST, more job losses (check out Siemens), government cutbacks and buyer fatigue will start the process. Sales volumes will fall even as prices rise, then both will decline together – starting a process which will probably last for years.

(3) Stupid to buy now? Yeah, Rahim Jaffer stupid. Your LL may like cashing your rent cheques, but he’s actually saving you from your own self-destructive juices. Wait as long as you can. All of this year, for sure. And a good chunk of 2011, too. You may end up with a higher mortgage rate, but a far smaller loan. A smart boy like you would get that.

So, Alex, we welcome you to this oasis of contrarianism. Drink deeply, son.

And don’t mind the dogs. They always do that to a new leg.