When I was a child, in the late Palaeolithic age, my high school principal father made ten grand a year. He had four kids, a wife at home, a dog and two cars. And a cottage. The two-storey house they bought in Toronto in the 1950s cost $18,000, or 1.8 times the household income.
The last house to sell on that same street went for $849,000. Even if those who bought it have an income of $180,000 – twice the Toronto average – the house would cost 4.7 times earnings. That’s slightly above the level at which the US real estate market collapsed in 2006.
How can people afford such homes? Or the $1.2 million plain-vanilla digs in Vancouver I mentioned yesterday – the one with 20 competing offers earlier this week?
Because they can finance it, of course, on the most generous, debt-friendly terms in human history. To buy the $849,000 home requires only 5% down ($43,000), and then a monthly payment of just $3,000 (5-year VRM, 35-year am). That means any bank will give you such a whopper mortgage with an income of about $120,000. It also means the house then costs 7 times household earnings.
See what I mean? That old house of mine can still be purchased by a high school principal. But this time it comes with a price that’s been wildly inflated by the ability to borrow your brains out, unprecedented leverage, and a debt that will probably never be repaid.
Oh yeah, and danger. Should a five-year mortgage swell from the current 2.85% back to the historic norm of 8.2% (and it will in the next few years), monthly payments just about double, even with a dumb 35-year amortization. (By the way, at that rate a homeowner would pay $64,000 per year in interest and only retire $4,000 in debt. This, kids, is why you do not want a 35er.)
Unparalleled access to debt at unheard-of rates and on astonishing terms through irresponsible banks is largely at fault for obscene house prices. And the pornographers at HGTV. This has resulted in a homeownership rate of almost 70% in Canada, about the highest in world, which continues to climb as the US rate free falls. It also means we now have $1 trillion in mortgages. You have to admit that a thousand billion in loans spread across nine million families is one mama of a burden.
One other thing this price/debt spiral has yielded is a lot of poor people.
They don’t know it yet. But they will.
Seven in ten of us have no corporate pensions. Sixty per cent have no money saved. Just five in ten have RRSPs. And while more have tax-free savings accounts set up, 80% of the money in them is in savings yielding less than the inflation rate. Can you say pooched?
Not a day goes by that I don’t talk in depth with people who own all kinds of stuff, but have no actual money. They may have houses and equity, but no liquidity. And the majority carry big debts at low interest rates which they are just servicing, not retiring. These are all employed, middle-class families with above-average incomes and that mysterious sense of entitlement, now ubiquitous. What they’ll retire on is a mystery to me. Where they plan to find the wads of cash to college-educate their kids is also unknown. But the first thing they all wanna do is buy the biggest, bejesus house they can finance.
I thought of this when reviewing the latest stats on incomes. Only 1% of us make over $169,000, and now researchers are flummoxed that in the past ten years a third of all income growth has gone to these top 246,000 Canadians. Said one of them: “You can’t keep growing an underclass that plays by all the rules, gets a better education, works more and doesn’t get ahead.”
Of course not. The ‘underclass’ is busy watching Property Virgins, then buying houses they can’t afford with money they don’t have, taking on debts they’ll never repay, ending up without enough liquid assets to finance their lives.
So back to my father. He sucked at money, too. But his epoch saved him. Economic growth, continuous wage gains, a defined benefit pension and inflation rescued his generation from itself. That turned real estate in a winning asset class, even when mortgage rates were multiples of those now.
Today, when growth is gone, inflation flirts with deflation, pensions are extinct and incomes languish, it’s only the soma of cheap and free credit sustaining the illusion of wealth.
This doesn’t end well.