The longer I have walked this earth, enthralling women, the more I’ve learned about hot markets. They don’t wither or wilt, or end with a whimper. They blow up.
Take, for example, what’s happening in the US. Six years into a real estate implosion, it just gets worse. The home ownership rate’s plunged to a 15-year low. Guru Robert Shiller says things probably won’t rebound for a generation. “I am sad to say this,” he adds. There are 18.5 million empty houses and it looks like six million more families will lose their homes over the next five years. Every week local media run realtor-fed stories of a renaissance. Each week, they are wrong. Prices fall still.
The lie of a nation is that Canada escaped. We won’t. And our fate will likely begin with death by condo.
Sharon shows well how we never learn. “I really appreciate your blog,” she says. “It’s definitely sobering.” Maybe so. But she’s still corked.
“I live in Vancouver and own a condo in the heart of downtown. Bought it for $515K and only seen a slight increase in value in two years. Quite depressing… If what you say is true about a 30% reduction, I would indeed lose almost all the equity I have which is made up of my down payment and two years of mortgage payments.
“Is it a stupid idea to buy another property, maybe sub-500 sq ft for roughly $280K to rent out, with a 20% down payment and a locked in 3.29% 5-year fixed rate? With rate and market adjustments to come, if I am not borrowing 95% (though still 80% debt), am I in the same risk category? Or should I just wait until 2015 to snatch something up when prices are?”
See what I mean? Even somebody whose real estate has made nothing, who accepts she could be completely wiped out, and could live in the same place for half the cost as a renter, can’t leave the cult. Despite being at risk, Sharon’s possessed. Real estate is likely the only asset class she knows, and now – like hundreds of thousands of others – she’s falling for the myth that buying a rental condo is anything other than financial suicide.
In Toronto these days, it’s epidemic. With 23,000 new condo units hitting the market in 2012 (and twice that number in the pipeline) an estimated 80% will be sold to flippers, speckers and virgin landlords. Similar numbers preceded the US real estate meltdown, when average Americans flocked to investment properties, fueling their avarice with borrowed money, egged on by developers, hustlers, floggers and property pushers who dangled mythic, riskless profits.
Kinda like Calgary. Circa now.
6th and Tenth is a honking big tower of concrete boxes being developed and marketed by Toronto’s roi-des-condos, Brad Lamb, the baldy, Rolls Royce Phantom-driving, HGTV-starring, imperious urban legend. His journey from condo salesguy working out of a little Harbourfront real estate storefront to purveyor of trendoid digs for the Vespa-riding crowd has earned him fame and millions.
So Calgary’s now being Lambed. The ad at the top of this post shows you how the unsuspecting can be sucked into investing at the wrong time, for the wrong reason. Buying a single condo now as an ‘investment’ is a lot like lining up for Nortel a $120 a pop or gold at $1,900 a single ounce.
So, is purchasing a $230,000, one-bedroom apartment across the tracks from downtown Calgary the ticket to a 282% return on your investment?
Here’s the math: Put $57,500 down, mortgage at 3.5% and with condo fees and taxes the monthly is $1,151. Rent it, says Lamb, for $1,450 and you end up with positive cash flow of $298, or $3,585 a year. Add in the $4,410 in mortgage principal paid annually, and you have “total annual cash flow” of $7,995, for a “rate of return of 13.9%.”
Hell, who doesn’t want to make almost 14%?
Trouble is, mortgage repayment is not cash flow, nor would any accountant label it as a return on capital. So that drops the return on the $57,500 invested to 6.2%, assuming the condo is never empty. And this is 100% taxable as income, which sucks. In contrast, just sticking the down payment money in bank preferred shares paying only 5% and claiming the dividend tax credit would give a better after-tax return. And no risk.
But this is just the start. The ad also says “rental condos provide large capital gains” – in this case, the condo will have a “value after 4% annual appreciation for 10 years” of $340,000. So the “return on equity” is now 192%. Add to this $52,817 in mortgage repayment after 10 years (assuming a 3.5% mortgage for a whole decade), and the “total cash gain” is $162,217, or a 282% return on equity.
If this developer were selling a stock, mutual fund or any other regulated financial asset, this ad would be the end of him. He guarantees future capital gains. He fibs about cash flow. He ignores interest risk and market risk. And nowhere a word of caution on the use of 75% leverage to buy an asset a modest correction could destroy.
But we all know what will happen. 6th and Tenth will sell out. People will use this math to justify property lust, and step off a cliff into a void they see not.
This is why things will not settle quietly. And might explain the fence.