Entries from May 2011 ↓

What happens you buys a $442,000 house with $433,000 in financing? Well, here’s Jim and Vesha. I told you about them a month ago. “Thought your readers might want an update,” Jim wrote me last night. And we do. We love drama.

The kids, who make 130K between them, drank the Kool-Aid and bought a semi in Victoria with 5% down three years ago. After 30 mortgage payments they realized the house was consuming them. “We weren’t saving a dime,” he says. Worse, the place wasn’t rising in value and the mortgage wasn’t being reduced. Real estate prison. So they listed back in February, at $475,000, pissing off the neighbours who found it too cheap.

But buyers found it too dear. Three price cuts later the house was at $449,000.  “We are starting to get worried,” they said a month ago, “ some of my friends in similar situations are worried too – but most of the idiots out there still seem to think prices are rising.”

So, here’s the rest of the story:

“After more than 100 days we finally sold, to a 25 year old hottie newbie realtor. Purchase price you ask? $442,500 – the exact same amount we paid for the half-duplex just under 3 years ago. So for the meantime we are taking a step back and moving into a suite in a brand new home our friends own for about half the monthly cost allowing us to put away $1200/mo. On one hand when I click on HGTV it feels rather depressing, but on the other, knowing we can pay cash to go to Maui in November for our one year anniversary while still saving oodles of cash feels pretty good.

“Well lesson learnt, had we taken all the money we kicked into this place over and above rental costs over the last three years I bet we would’ve had at least $70,000 to show for ourselves now.  Our exodus from ownership is actually quite liberating, now we can just pick up and do what we want for a bit, wait till things cool down, build up some savings and security and eventually build our own modest shack at reasonable prices with a realistic plan in place for the future.

“The real irony though, well that was the stabbing two doors down on Saturday night, but shhhh don’t tell the buyers!”

This couple that lost three years because of a house. They walk away with far less than they put down, and during the intervening time, occupancy costs far outstripped what they might have paid in rent for the same place. They gambled big – using extreme leverage in the hopes of scoring a capital gain – and were lucky to exit without major losses. Chances are the people just listing their homes now will have less luck.

Buying that semi was not a rational, logical, deliberated decision. Jim and Vesha, like most young house hornies, were egged on by peer pressure, family, media and government. They prove once again that in anything but frothy, bubbly, irrational markets (which never last), home ownership is a losing gig. People who think they are ‘buying’ anything with 5% down have way too many hormones. Instead, it’s a trap. It’s why banks always win.

One theme here over the past three years is the wisdom of investing in liquid assets instead of illiquid houses. Not only would it have taken 15 minutes to sell ETFs, bonds, stocks or preferreds –  instead of 100 days – but the returns inside a balanced portfolio are more certain.

Actually, an economist at the US Fed just proved it. His research paper debunked the notion of houses building wealth better than  investing, showing that half the time it’s the opposite. Said Jordan Rappaport: “For many households in many years, renting and investing the saved cash flow has built more wealth than homeownership.”

Interesting, stocks have outperformed real estate in the US consistently since 1980 – and that even included the subprime bubble years. As Jim and Vesha just learned (and many more are about to), there’s been no money to be made during Canada’s current bubble when you have a ginormous debt hanging over your head. Five/35 is a cruel hoax.

Of course, this is about to slip from being amusing to abusing. With real estate now entering a decline phase, it means tens of thousands of other young couples will surely come to the same conclusion. Renting wins. All booms end badly. Bubbles burst.

Just to underscore this, I hope you noticed the latest news from the south. American house prices are (on national average) back to 2002 levels. They’ve fallen 33.1% from this time five years ago. Still falling. Homeownership has dropped from 69% to 66% and is expected to hit 63% – where it was fifty years ago.

Here’s the thing: it’s not that Americans can’t afford a house. Hell, they’ve never been cheaper in terms of income. But people don’t want them. Demand has withered. If the object is financial security, then housing can be a death spiral. That’s now obvious.

Jim and Vesha may have lost three years. But millions in America burned a whole decade. Legions here continue.

We are so foolish.

F before the election: “By choosing to act in the best interests of our country, we can ensure a bright future for our children and grandchildren.” F after the election: “I am quite worried.”

Which kinda begs the question. Should you be worried, too?

Well of course you should, but not on the macro-economic level that keeps F up at night fretting over Basel 3, international settlements, capital reserves and how to keep hair stuck on the bald spot. Yeah, I know we face giant issues. Europe is committing financial suicide again, led by those fun-loving Greeks, now busy cleaning out their banks. The US faces a debt apocalypse and yet the biggest news this past weekend was Sarah Palin on the back of a Harley. Oil is mired over a hundred bucks and that quick little war in Libya is turning into a mess. Even Canada has dropped hundreds of bombs there, each one costing the same as a bungalow in Winnipeg.

The world’s a sea of risk. Of course F is a wreck. Does he keep on spending and fuel the debt crisis, or go all Mennonite on us? Find out next Monday.

But this blog is not about stuff you can’t control. That’s what Lady Gaga, Navy Seals and the Royal Family are for.

Instead we focus here on micro-economics, which these days almost always leads us back to house porn. The reality is, when it comes to family finances, people in this country have never been so exposed to this one asset, which currently sits at nose-bleed height. That’s odd enough, given high unemployment and swampy wages, but it’s all the most astounding since we refuse to believe we’re like any other humans.

Like the Irish. They had a real estate bubble, too. A mama of a gasbag, with Belfast bloating up to look like a green Vancouver. That hit its zenith three and a half years ago, at which time a guy named Jonathan Davis shocked the media, and was called an idiot, for predicting a collapse in prices of 50%.

So what happened? As of last month, Irish house values are down 47%.

“The house price bubble has been the biggest economic disaster for Northern Ireland, yet everyone was saying it was a good thing,” Davis says. “The prices to earnings were way beyond extremes, the borrowings were way beyond extremes, the investment speculation was way beyond extremes.” Sound, ah, familiar?

Of course, when the house bubble inevitably deflated (as all bubbles do), lots of Irish dudes who bought expensive houses with tons of borrowed money suddenly got nailed. They felt poorer. They stopped spending money on consumer stuff. The economy tanked. And you might have heard that Ireland went bankrupt and had to be bailed out – all just a few years after people were writing books about the ‘Celtic Tiger.’ Unemployment is 14.6%. And this may be just the start, since the average Belfast home has lost more value in the past 12 months (11%) than those in staggering America (8.2%).

But that’s Ireland, the Canuckistan house pumpers cry. This is Maple! We’re different. And so was Britain, the US, Spain, France, Portugal, Japan and (soon) Australia and China. In fact, there’s never been a real estate boom that did not turn into dust. The only constants have been human stupidity and denial.

Anyway, Ferenc could care less.

He writes:

Hi Garth, I love your blog and read it a lot! Does it ever really matter if you lose or win money on a house you live in (i.e., it’s not for investment purposes) because when you sell it and buy a new house, the price of the next house will be proportional to the market at that time. For example if I bought a house 5 years ago for 250k and today it’s worth 500k, I wouldn’t be able to get a house that is twice as big now because all of the house prices have gone up by 50% (hypothetical). Similarly, if I lose money on a house all of the other houses will have gone down as well. So I’ve lost dollar amounts, but I didn’t lose what I can afford for my next purchase.

What do you think of this kind of reasoning? Am I off my rocker and just trying to justify buying a house in a market that I think is going down?

Uh-huh. Bad logic, Ferenc baby. There’s no safe way to catch a falling knife.

Of course, it might not matter so much what house prices did if the average family could afford to buy the average house. If real estate cost two or three times what the typical income amounted to. If a couple could manage to put down, say 25% of the asking price. Or the government didn’t need to subsidize the banks because nine of ten borrowers were high-risk.

But that’s not this world. So today almost all purchasers are forced to put almost all of their net worth into one asset on one street. No pretending a house is just a home any more, Ferenc. It’s a savings plan, an investment plan, a kids’ education plan and a retirement plan. When the housing storm hits, and it always does, a huge amount of net worth can be blown away, leaving only debt standing — erect, silent and as sad as chimneys in Joplin.

So buy if you want. But understand the odds.

F is worried. And he knows why.