Entries from March 2008 ↓

Of VRMs and seller’s remorse

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Mr. Turner;
First let me say thank you for the insightful web site and I fully intend to purchase your book, Greater Fool. The subject matter is most interesting. I do have a question regarding my personal situation.

I have a variable interest rate mortgage (prime + 2%) that is short term (6 months). My mortgage is 170,000.00 and the value of my end unit townhouse is about $220,000. I have no intention of selling to buy the 4000 foot monster home.

With the Bank of Canada still cutting the prime lending rate, is it a good idea to have a short term variable interest rate mortgage or should I lock in for a few years? I like the short term variable because over the past fourteen years of being a home owner, I have consistently obtained lower interest rates on the short term mortgages as opposed to locking in for five or more years.

Your thoughts?
Thank you, Wesley

You are right on the money, and my advice to everyone with a mortgage right now it to go variable. The Bank of Canada has absolutely no choice but to drop rates given the impending impact of the US recession on Ontario and Quebec, and the collapse in investor and consumer confidence. Of course, lower rates are no long term solution to anything profound, since they just encourage more borrowing and more debt – which got us all into this mess following Nine Eleven.

In any case, Wesley, hang in there with a short-term VRM. You will see interest charges slide – an ideal time to maintain your monthly mortgage payment, and be eating into the principal at a deadly rate.

Hi Garth,
am feeling a quite a bit of sellers remorse. I sold my property in March 2006. Thinking it was the peak and I had some personal family issues to overcome. I used some of the money to invest in stocks… even still the housing market went beyond my expectations. though my cash increased 50 k these 2 years, Housing has gone up at least 100 k. Am I crazy to think about buying into the market now. Things just keep going up and up. I bought your book and read most of it ..throughout history Houses have gone up and down …when it does? how much..? No one knows. It is very frustrating. I ‘m the only one in my family that does own property.

Please advise
thanks.
Careful and a little crazy

Why be remorseful when you sold, presumably at a profit, when you have made $50,000 on your cash investments, when you have no mortgage debt, and when real estate values are set to decline? Get real, pal – this is a great time for you to think about re-entering the market, but not yet!

The Canadian housing decline is just beginning and although we should not expect the same 30% price dump that has hit California and Florida, Detroit and Phoenix, there in Vancouver you should certainly be anticipating a 10-15% correction, or possibly much more in some condo developments.

Play your cards right, and your family will think you are a genius. Then you can rub it in.

Hi Garth, would like your opinion re “holding costs” on property which has reasonable expectation of GAIN (no rental revenue, while holding). Assuming that interest and other costs are in fact deductible (CRA has not as yet changed the wording to my knowledge):
Would costs are deductible from other-source income as they accrue or are paid out OR should they be part of the adjustment to cost base upon disposal?

Here another possible twist: Does above hold true, even if the eventual disposal (a) results in a loss even before cost adjustment? (b) the adjustment would create the cap loss?

Should you not have a definitive answer to this, just let me know so and I will dig further.
Thanks for your attention to this!
Harold, Mississauga

Harold, you are delusional. There is no way the CRA is going to let you deduct the carrying costs of property which is not providing income. You are on your own here, gambling your money for the potential of a taxable capital gain on a property which is not throwing off any cash flow. Suck it up. Why expect the taxpayers to bail you out on the costs of owning a property you think will rise in value? Sheesh.

The boom goes bust

bus.jpg Get on the foreclosure bus, here.

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How different is the Canadian experience from the conditions that caused the US housing meltdown? Not enough.

By Garth Turner, Ottawa Citizen Special
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Imagine listing your home for sale, but there are no buyers. You drop the price. Again. And again. The house across the street’s now for sale. And the one two doors down, plus a dozen others in a two-block radius. Nothing’s selling, and every time one home is reduced, all are affected. This property used to represent wealth. Now it’s a wealth trap. Most of what you have is here, and with each day passed, it diminishes.

Imagine your first home – a dream in granite and stainless. You bought it from the region’s largest builder, for 1.5 per cent down – enough to cover closing costs – and mortgaged the rest. Months later, the economy turns abruptly. Your spouse loses his job and the monthly payments – mortgage, taxes, utilities – are crushing. You decide to sell, but the realtor tells you the market’s also turned. Your mortgage is now slightly greater than the value of the home. After paying commission, you’ll have no house, no equity, and still owe the bank more than $20,000. How could this have happened?

Far-fetched? Hardly. For millions of middle-class Americans, this is a reality as housing values collapse in the first nation-wide housing meltdown since the Depression. In some markets, prices have crashed 30 per cent. In Phoenix, there are more than 20,000 new homes, vacant, unsold and unwanted. In suburban Detroit, million-dollar properties can’t fetch buyers at $300,000. Downtown, prices plunged in the first two months of 2008 by 54 per cent, to a median of $22,000.

In Florida and California, homeowners establish web sites to try and sell their homes. Three million American families now have mortgages larger than their home values. Comfortable upper middle-class families with six-figure homes find their wealth evaporated as their properties languish on the market. So many foreclosed homes are for sale, it’s estimated prices will not recover for years. In fact, a recent Credit Suisse report says prices must fall another 40 per cent in Miami and 26 per cent in Los Angeles before they become affordable.

The real estate disaster now in full flower to our south is a fascinating, gripping spectacle. It’s time we looked closely. Because, one way or another, it’s coming here.

Canadians, strangely, believe this country’s immune from the housing contagion sweeping America. The myth results from three powerful forces. Denial tops the list, no doubt the result of having more than 80 per cent of our net worth in one asset, the family home. Add to that the excellent communications job done by the real estate lobby — mortgage-lending bank economists and the CEOs of real estate marketing companies — who claim home values will rise forever. Finally, our belief the Americans screwed up by giving subprime mortgages to unworthy people so they could buy unaffordable homes.

But this is not so. In researching my book, Greater Fool, I was reminded again of why all booms end badly. The inflating real estate market to the south became unsustainable when average prices exceeded the ability of average families to buy homes. This inflation in turn was the result of policy decisions made after 9/11 which gave America (and Canada) the lowest interest rates in a generation. Debt was cheap, and volatile stock markets represented unacceptable risk. So, real estate became the asset of choice.

If you have any doubt, watch a few past episodes of Flip This House. It’s good real estate pornography.

Prices roared to new levels and to sustain the fire, mortgage lending practices went lax. No-money-down deals were common, and home loans with discounted rates were extended to buyers who now qualified, as the bar for home ownership fell. This all made sense while the market advanced, since growing home equity gave even dodgy buyers new money to use for refinancing loans as the introductory ones matured.

But as interest rates increased, the American economy softened and realization spread that real estate was overvalued, the bubble burst – and with a vengeance.

So, how different is the Canadian experience? Not enough.

In the period between 2000 and the market crash in 2006, U.S. home prices increased 74 per cent, while household income rose by just 15 per cent. In Canada, real estate prices jumped 70 per cent by the end of 2007, with family incomes ahead 14 per cent.

In other words, we’ve seen an almost identical pattern of real estate excess – familiar to anyone caught in a bidding war, or staring in disbelief at a new MLS listing. The average home in Toronto is now over $400,000, while in Vancouver it tops $700,000. Last year homes in Saskatoon raced ahead more than 50 per cent in value. A young couple in suburban Toronto with a $450,000 price limit ended up buying a $700,000 home after losing 16 competing bids.

And the Canadian response to this affordability crisis? It’s called the 40-year mortgage, which lowers monthly payments by extending the amortization 15 years beyond the traditional quarter-century and, in the process, grossly inflates the total debt to be repaid. In other words, this loan (now accounting for over 40 per cent of all new borrowings) allows people to buy homes they would not otherwise afford.

Meanwhile, down payments have become almost optional. One of Ottawa’s largest new home builders routinely allows young couples to move in by paying just closing costs, and financing the other 98.5 per cent of the purchase price. With virtually no equity in the home and substantial carrying charges, any market downturn means they owe more than they actually own.

So, how exactly do American subprimes differ from Canadian 40-year mortgages? How are mortgage lenders here more prudent when they allow appraisals based on postal codes, rather than actual home inspections? Why should Canadian real estate values, as inflated now as were those to the south two years ago, hold when our families are no better off? As a global economic slowdown and an American recession take hold, what impenetrable barrier is wrapped around this country?

Meanwhile, what about the future? Won’t nine million house-rich and pension-challenged boomers be forced to dump billions in real estate over the coming decade? Won’t runaway energy costs and the uncertainty of climate change breed a popular taste for smaller, more efficient, more urban housing, rendering four-bedroom, three-car-garage suburban palaces unsaleable?

Most of all, won’t those who understand what’s clearly coming, and sell now, rejoice that they found a greater fool?

Garth Turner is the MP for Halton, Ontario. Greater Fool: The Troubled Future of Real Estate is his eighth book, published by Key Porter Books. www.GreaterFool.ca

© The Ottawa Citizen 2008