Entries from November 2009 ↓

Welcome home!

In a magic place.. near a ditch & an enchanted ramp...

RC

...349 square feet for $180,000

Hot on the heels of realtors bashing each other and throwing elbows over a new condo development in mid-town Toronto comes more evidence dark forces have taken over the GTA. It’s called River City.

The ‘river’ in question is a channelized concrete ditch full of dead water called the Don. And in a crook of roadway, where the six-lane divided Don Valley Parkway leaps skyward to join the elevated Gardiner Expressway, on acres which sat for decades as an industrial wasteland, will rise River City.  I will let you imagine.

One feature of this oasis of five buildings and 6,000 suites to be built over the next three years, is a four-acre park. But not just any park – this is the world’s first park built under highway ramps. Yes, under the Richmond-Adelaide ramps, which are choked with rush hour traffic and form one of the main arteries into The Big Smoke, will be bucolic bocci courts, children’s playgrounds and all the pigeons you’ll ever want to meet.

In any case, prices start around $180,000, (lucky buyers to be selected by lottery) for which you can get the 349-square-foot beauty above. No bedroom, No closets. No space. But a balcony with a lovely view of a ditch and bumpers. Better units are available in the $500,000 range. Enjoy kids. This is the big time.

RCC

Letter of the day:

My name is Jamie from Sherwood Park, AB. Your posting on Nov. 27 really hit home. You came up with a hypothetical scenario whereby a guy loses 120 G’s on a bad housing guess. I can tell you, this actually does happen. Although not to the same extent, I did get burned by the housing bubble just like you described.

What’s worth noting is that at 22 years old and just finishing school I too was told that you couldn’t lose with housing. I purchased a starter home in Sherwood Park in Oct. 2006 at $310k. After stumbling onto your blog in Jan. 2009, I sold this past May for $305k. Just a modest decline in principle $5000, I quickly realized that this was the worst “investment” I ever made. The criminal realtors and crazy closing cost to break my 5 down/25am 5.19% mortgage was a real shock.

This is just another real example you can use to back up your statement that the low-down payment crowd can only win if prices continue to rise. If their bet is wrong, it’s worth noting that the downside risk can cost you REAL DOLLARS as I lost $30 G’s on just a 1.6% correction. That money could have gone a long way towards the debt incurred during my education. Anyways here’s my stats, in a format that you posted today.

Thank god I got out when I did and I won’t be purchasing again until I have at least 25% down. Thanks for your advice

Purchase Price (Oct 2006)  — $310,000
Closing Costs (CMHC, etc)  — $8000
5% Down Payment — $15,500
Total Cash In — $23,500
Mortgage Debt — $302,500

Selling price (1.6% decline) — $305,000
Commission (7/3) + Legal –14,150
Net Proceeds — $290,850
Less Mortgage Penalty (IRD) — $7,850
Less Mortgage Principle — $289,000
Less Cash In — $23,500

Net Loss — $29,500
Loss as % of cash invested — 125%

Cheque required to close sale (paid May 2009) — $6,000

Soft landing

soft landing1

As I was working on my new book this week I ran a few numbers. The inspiration came from this blog. Actually a few bloggers have been included in the text. But I will not reveal who. Paparazzi being what they are these days.

The argument put forward by several is that, yeah, houses are probably overvalued and, yep, the market will correct. But they do not foresee any large dump of America-style epic proportions – such as the 50% drop in Miami condos or the 70% plunge in two-storey suburbans in Phoenix or southern California.

Instead, they like to contemplate a 10% or 15% decline to ‘more normal’ levels, which they  believe will then remain in place for a number of years. The rationale behind this soft landing is a conviction interest rates will stay frozen at current levels from here to the horizon. This is a comforting scenario to many homeowners for obvious reasons. Then they don’t look like financial idiots for buying in 2008 or 2009.

But I disagree. That gentle-decline scenario is not going to happen.

Nonetheless, if we did have a 15% decline and prices went into a long-term holding pattern, what might a recent buyer expect? As mentioned here the other day, a majority of new purchasers have been  getting in with 5/35 mortgages. This means any kind of correction would be hard to stomach, since the only rational reason for a 35-year am and a weensy down is the certainty of a bull housing market to cover up your mistake.

So, let’s imagine you are one of the legions of people who have bought a first home in an idyllic wonderland like Mississauga, for $528,000 with 5% down.

Chart 1

Now let’s suppose the housing market declines in late 2010 when the Bank of Canada starts raising interest rates, Dubai sinks into the sea under its own debt weight, unemployment continues to rise, Obama is handed his shorts in the US mid-terms, the HST clicks in and the reality dawns on folks the economy is entering into a few years of stagnant, side-sliding ennui. In that case, a 15% drop in market prices might well occur. Suddenly our homeowner realizes he owes more in mortgage debt than he owns in house.

So, is selling an option? Let’s look:

Chart 2

In other words, for this guy to unload the house, he’d have to show up on closing day with a cheque for $82,440. And, of course, he’d have lost almost $120,000 on the deal itself – not to mention a couple of years of mortgage payments and all that stuff he bought for the new home. That would be a loss on invested capital in excess of 300%.

Now I hear some blog dogs yelping, ‘So what G? Why wouldn’t he just keep the house and wait for better days?’

Absolutely. That’s an option. But not a long-term one if the scenario of multiple years of slow growth unfolds. For all that time, while house prices remain below bubble levels, this guy is feeding a mortgage worth more than his home. Every month it is a drain on wealth, cash flow and manhood (hey, it’s a guy thing). I’m betting than a significant number of recent first-timers will freak at that, and bail. Personal bankruptcy rates will rise as a result. And house prices will decline further.

But, as I said, I don’t expect that to happen.

Instead, markets that rise exponentially tend to decline in the same fashion. The longer current conditions last, the higher prices go, the more elbows raised in anger at condo offerings, the more denial, the more bidding wars and the more time emergency interest rates are in effect, the more reactive will be the consequences.

Unless, of course, it’s different this time. But it hasn’t been yet.