When this week started indigent visitors to this pathetic blog roasted me for saying Canadian house prices would decline by 15%, then go limp. Too little!, they cried. As the week ended, hoary posters raked me for saying financial investors can earn 6% income. Too much!, they wailed. So I’ve decided to put everyone out of their misery. I’m taking the weekend off. Deal with it.
This, of course, doesn’t mean I am backing down. I’m just tired of trying to get the same message through to people who wear Depends on their heads. Maybe it’s the times, or perhaps my apocalyptic personality, but the air around here is thick with mistrust, misconception and revenge. Seems a core group of people are more interested in seeing others toppled than in helping themselves. They want HouseAgeddon, leading to crashing bank towers and blood on Bay Street. It ain’t gonna happen.
But I won’t get into this. I’m on strike.
In fact, I’ll purposefully fail to mention that the International Monetary Fund now backs me up. The world body said this week Canadian house prices are overvalued by 10%, and a correction even of that size would be a major economic event, cutting consumer spending and dropping the GDP half a point.
“Adverse macroeconomic shocks, such as a faltering global environment and declining commodity prices, could result in significant job losses, tighter lending standards, and declines in house prices, triggering a protracted period of weak private consumption as households reduce their debt. The effects on economic growth could be exacerbated by weaker external demand and slowing construction activity,” they said.
What does this mean? Simply that it won’t take a 50% plunge in real estate values to wash consequences over millions of families. Rather, a correction of 10% would be more a catalyst than a conclusion, paving the way for years of crappy markets, falling values and gaping opportunities for investors with the stones to buy.
In fact, the IMF says if house prices do plop by 15% (my guess) at the same time commodity prices weaken, the economy could contract by 2.5% over two years. And remember, it was a 2.6% pullback in 2009 that cost America fourteen million jobs. As a result, Canada is being urged to mandate higher downpayments and adopt far tighter mortgage regs.
Those people who want house prices to drop by half, so they can buy one, might as well hope for heart disease so they can avoid retirement planning. But I’ll refrain from commenting on this moronic view, since I’m legally withdrawing my services.
In fact, I’ll also be refusing to discuss the lame comments from people who think getting 6% on their money must involve selling dope or hiring Bernie Madoff. It’s hard to underestimate the subliminal impact of TNL@TB, and the way we’ve been conditioned to see anything not offered by the thinly-trained suit at the local branch as drenched with risk.
The irony is people who refuse to buy a piece of the bank (in terms of equity, bonds or preferreds) think nothing of putting all their money in the bank. They actually believe if one of the Big Five keeled over the Canada Deposit Insurance Corporation would make them whole again. Worse, they feel that by avoiding risk and stuffing cash into do-nothing GICs or the vacuity of the Orange Guy’s shorts they’ll be secure even when returns are negative after taxes or inflation.
Of course, the greatest risk is not losing money, but running out of it. A lesson few learn. Until they run out.
As a consequence of my boycott of this blog, I will therefore not be discussing the massive advantages of yield-producing assets, such as preferreds, REITs and trusts. Nor will I refer to a new report by Macquarie Research listing 50 of these suckers and their yields (Bell Aliant 6.7%, Artis REIT 7.8%, Crombie REIT 6.6%, Inter Pipeline Fund 5.8%, Retrocom REIT 8.7%, BMO or CIBC 5.0%). I won’t detail the benefits of collecting dividends, claiming the dividend tax credit, and paying 80% less tax than on a GIC.
It just won’t happen. I give up. You’re on your own.
My traditional Amazonian Christmas is on.
Days ago I was hooped for dising horny young people. Like there are other kinds. If anyone’s turned into debt piggies these days, I mused, it’s the virgin buyers who treat mortgages with more amusement than horror. After all, if you need to sign up for a fat one to get a sweet house, well, where’s the pen, dude?
Fact is, first-time buyers are probably more responsible for jacking house prices in the last five years than any other single group. And while Americans under the age of 35 have decided renting’s cool and owning sucks, in Canada our lusty little nuts haven’t fallen far from the Boomer tree.
Why are young couples so aroused by real estate? Beats me. But let’s try to help Stefan and Brianna work through it. Yesterday, they sent this:
We’ve been following your blog for a little while now and decided to ask you for a piece of advice since you are after all an expert in this field. We’re in our 20′s (not married yet). We both have very solid jobs.
We are looking into buying a brand new house in Mississauga for approximately $550k. We are planning long term. The downpayment would cover 20% or $110 000 which would leave us with about $440,000 mortgage. After all the calculations and monthly deductions we would end up with approximately $2000 buffer each month.
We know that the market will correct a bit but believe that we are on a level where we would be fine even with the correction. What do you think we should do? Should we buy or not?
Of course, this is a very unusual case. Kids with cash. These twentysomethings, through work or generous families, have a mega-downpayment compared to the cab fare most couples use to leverage real estate. With 20% down a house should be a no-brainer, right?
Maybe not. For example, young buyers have to plan for the end of cheap money, with mortgage rates likely doubling over the next five years. But let’s not factor that in, to be generous. More immediate is a correction in housing prices after a 13-year run which landed us in history’s deepest pile of debt. Any kids buying now must understand they’re jumping in at the top, and risk having to endure a much weaker market.
So let’s assume Stefan and Brianna buy that perfect new house in the distant burbs for $550,000. With closing costs, of course, the price swells to $561,000 (actually a bit more, but it’s always a good rule of thumb to add 2% to the purchase price to close the deal). With a fat $110,000 to put down (and no mortgage insurance needed), their new debt would be $451,000.
With a mortgage of that size borrowed by virgins, the only sane action is to get a five-year fixed loan, which these days is about 4% at most major lenders. And if they do this in 2012, chances are they’ll be forced into a 25-year amortization, since I’m hearing the next federal budget will murder thirty-year loans. So, the monthly payment would be $2,394, not including any occupancy overhead.
Now let’s say the market corrects in the next year by 15%, taking the value of the house down to $467,500. So what?, cry Stefan and Brianna. We ain’t selling.
Good thing. Because if they did (not counting in selling costs or mortgage break penalty), their $110,000 in equity would dwindle to less than $17,000 – giving them a stunning 85% loss on their original investment. And you thought the stock market was risky…
So let’s say they stay in the love nest in this most romantic of Canadian cities for a full five years, and then decide to sell (long enough to get married, bummed and divorced). During those sixty months, Stefan and Brianna would pay $85,876 in interest charges for the privilege of borrowing the mortgage principal. Property taxes would be at least $25,000, while insurance and feathering would add a minimum of ten grand. Dumping the place triggers an average commission of 5%, plus legals and moving, for total selling costs of almost $31,000.
Now let’s assume the value of the house has been fully restored to what they paid – $550,000. After 60 mortgage payments (of $144,000 of which $85,876 was interest), they’d still owe $393,212. The sale proceeds (minus the mortgage and selling costs) would then be $129,913. Whoo-hoo, a profit!
Er. Nope. Remember that $110,000 of that was the original downpayment, which reduces the profit to $19,913. But if the $110,000 had been invested (at a modest 6%) for five years instead of sitting in the house, it would have earned $37,204, which must be considered opportunity cost. Therefore Stefan and Brianna would have actually lost $17,291, even though they sold for as much as they paid.
Now I hear the unemployed realtors on this blog grumbling about me fudging the numbers because S&B would have needed to rent a place if they didn’t buy. Quite true.
The actual cost of them owning this house for five years (finance charges, taxes and maintenance) was $179,000, or almost $3,000 a month. And at the end of it they got their deposit back plus $19,913, reducing the monthly cost to $2,651.
And what does it cost to rent a half-million-dollar house with five bedrooms and three bathrooms in the outer western GTA wasteland? Like this one? Hmmm. Two thousand five hundred a month. But wait. If the $110,000 they’d used as a downpayment was invested (at 6%), the $37,204 in returns would offset rent. So to make a fairer comparison, their occupancy costs would fall to $1,879 a month over five years.
See, kids?
Even if there’s no housing correction and your mortgage payments don’t rise; even if you don’t build a deck or cheat and get divorced; renting’s cheaper than owning. You have freedom and mobility. You trade debt for investment income. You avoid systemic, interest rate and economic risk. You can move to pursue a career, change houses when you get bored and piss off the neighbours with impunity.
Or you can buy, and turn into your parents.
Tough choice.
