On the day Barack Obama went to Vegas a TV reporter stuck his mic in the face of a guy in the crowd. “It’s tough on my generation,” the boomer said. “We were always told a house was the safest possible thing to put money into. Now I’m looking at retirement. And it was a lie.”
Another day. More millions and billions trying to breathe life back into an asset which has destroyed the American middle class. The average US house price has fallen by just 17% – but that was a big enough financial bomb to blow up the richest economy in the world. Why? When the fuse of inflated prices was lit, families had run up the greatest debt load in history, betting big that real estate would always rise.
This should have more Canadians on the edge of their seats, with the little fuzzies on the back of their necks vibrating. Those people who pooh-pooh a “US-style’ house collapse as being improbable, impossible and imbecilic in this country invariably paint it as a 70% free fall of the kind which hit hoods in Phoenix and Vegas. But equally destructive has been a 16% decline in Seattle, a 13% drop in Boston or a 15% slide in New York and San Francisco – all wealthy, vibrant cities with million-dollar fixer-uppers.
In those cities, as in Toronto, Calgary or Vancouver, credit was easy, money cheap and lenders accommodating, five years ago. People were able to secure properties with little or nothing down using perps like Eddie, the subject of yesterday’s post. So, sans equity, house prices didn’t have to fall far to destroy their finances. Because most people put most of their net worth into one asset – a house – a decline of even 15% was enough to ripple through the entire economy.
Today one in four families is under water. That’s why Obama went to Vegas. Another bailout – this time a plan to let people who owe more on their mortgages than their homes are worth refinance their loans to get a lower rate and cheaper payments. “This will save me a few hundred bucks a month,” another guy told the media. “But what problem does it solve?”
None. Because Mr. Market is bigger even than Washington. An estimated $2 trillion in federal money has not resuscitated real estate – the most of emotional of assets. Without love, it croaks.
I mention this because 9% isn’t all that far away from 17%. A new report by the pointy heads who work for National Bank Financial says that if mortgage rates rise by 1% to 1.5%, housing prices will decline that much. Indebted households can’t absorb more debt charges, unless incomes start shooting higher. And guess what the odds are of that?
Now, in fairness, the bank figures this will not happen until 2013, which seems a tad rosy. That optimism stems from a belief mortgage rates will stay close to current levels for about a year, before trending higher, thanks to a lousy economy. That presumably means Canadians will continue to pile on debt buying houses – at least in the places where urban mass delusion is so popular.
Some people come to this blog and have a tantrum when I break the news house prices in Kitsilano or Leaside won’t be falling by half. This is as childish as bank economists who dismiss a potential 15% price correction because it’s not ‘US-style.’
Actually, it is.
One of the worst things you could have done in 2011 was buy a house in a bidding war in the GTA or the Lower Mainland, in Winnipeg or Saskatoon. One of the best things would have been loading up on bank stocks or an exchange-traded fund pacing the TSX or the S&P seven weeks ago. We’ve just had another great example of how smart investors do the opposite of what their mothers-in-law urge.
It’s all about risk. Remember, risk rises and falls with price. In the polar opposite of what most folks think, assets falling in price represent value while those spiraling higher grow more dangerous. This is augmented when the suitors are using borrowed money, destined to be paid back at greater cost.
You may not think a lot of Americans. Being prejudiced, most Canadians don’t. Too bad. We have much to learn. There, but for the grace of a few basis points, go we.
James was minding his own business, walking out of his Kitchener apartment, when he flipped the door shut and saw a sign on the outside saying “RENT NOTICE.” Disconcerting, because, as James says, “this is a controlled access building so whomever put up the flyers almost certainly trespassed to do so.” And was there an issue with his rent?
Nah. More a problem with a dude called Eddie, the Zero Downpayment Guy.
I’ve written about bottom-feeders before, but no-money-down realtors and mortgage brokers appear to be getting more numerous and more aggressive. They target renters, of course, using misleading claims, myths, distortions and outright fabrications to turn house lust into a commission. In most cases their clients end up paying far more a month to live in virtually the same place they rented, but now with a staggering debt, and an interest rate they cannot control.
Why is no-money real estate spreading like a virus? And why do people who don’t have savings or investments think they can ‘buy’ a house? The second question answers the first. This is the age of entitlement. Everybody can have everything. Newlyweds expect better homes than their parents ever enjoyed. Young couples expect careers, babies, real estate and travel. Buyers expect granite, stainless, hardwood and fat shower heads. And people without money expect houses.
And they can. Thanks to Eddie. I’m sure he scuttles into many lives.
But while selling houses to people without money may not be illegal or even (in the world of real estate agents) unprofessional, is it ethical to use arguments like these?
Says Eddie: “It is by far better to buy a house today with Zero Downpayment than to wait until you can save for a downpayment.” That’s right, kids. Having actual savings of, say, $20,000 to put against a house costing $400,000 is so 2007. That’s because we all know waiting for good stuff to happen to you or achieving through work and sacrifice is for losers. Besides, as Eddie says, it hardly makes any difference to monthly payments anyway if you have money or not.
And he’s right. When the major banks will actually give you a cash payment for borrowing money, why bother saving it yourself? Of course what Eddie does not divulge is that borrowing $400,000 at, say 3% with a 30-year amortization, a no-money-down buyer would pay $1,686 a month (plus CHMC insurance, property taxes, condo fees and insurance). In the first year, that’s $20,237 – and the mortgage amount owing would still be $397,935. The total monthly for an 800-foot condo would be over $2,200, when it could be rented for $1,600. So the owner pays an extra $7,000 a year to end up with $2,000 in equity. (By the way, at 5%, Eddie – or an agent like him would have made $20,000 on the deal.)
But wait! Eddie knows how to deal with this embarrassing math thingy.
He says: “It takes a long time for most people to save 5% or more, by that time prices have gone up about 10%. A $200,000 house today will likely cost $220,000 the following year and the interest rate may not be as low as today’s rate.” In fact, this guy states on his site, without qualification, “prices go up about 10% yearly.” That means your $400,000 condo is soon worth $440,000, so losing $5,000 a year in cash flow is no big deal. In fact, in just 10 years your unit will have a value of $1,037,496! Why wouldn’t everyone do this? And unlike acquiring, say, an iPad, you don’t need cash.
But what if Garth Turner is correct, interest rates zip higher over the next five years and you have to renew that 3% mortgage at 6% in 2015? Then payments on the $362,712 remaining debt would jump to $2,400, for a total monthly of more about $3,000 – or almost twice what the renter pays. What if you lost your job? Or went to India for spiritual renewal? Or just defaulted?
No sweat, says The Ed: “When you default on your mortgage, you will have the option to sell your house at a profit (prices go up about 10% yearly ) and keep what’s left over. All the equity you built on the property is money you get to keep.” And at that point in 2015, of course (because of the Eddie 10% Rule), the condo is worth $644,204. You get to keep $281,492!
Sigh.
Can you now understand why nine out of ten new mortgage borrowers opt for 5% down, or less, with 30-year amortizations? Why they always add closing costs on to the principal? Why they happily borrow some or all of any down payment? Why the banks allow them to? Even give them the money?
And can you see why this will not end well?
Eddie Tavares may be a smart marketing guy. He got James’ attention. He got mine. He’s acting within the bounds of his profession. No regulator has shut down his web presence. His employer, Century 21 Millennium, must condone. Its master franchisor, Century 21 Canada, and its president, Don Lawby, host this under their corporate banner. I know Don, actually. A Regina boy. It’s a surprise and a disappointment such things take place on his watch.
Suddenly in the autumn air, there’s a whiff of Phoenix, circa 2005.
