Entries from November 2011 ↓

Honesty

Pay attention. There’ll be a test later.

What does the average family in Toronto earn in a year? $96,040.

How much does the average home cost in the GTA? $481,548.

What portion of pre-tax household income is needed to own a house in Toronto? 52.1%

And what’s that called? ‘Affordable.’ Actually, this exactly how Royal Bank economist Craig Wright puts it in RBC’s latest study: “Housing affordability levels are quite good… and will pose little threat to overall housing demand.” In fact, adds the bank, even though house prices went up, jobs went down and household income atrophied in the last few months, owning a home in this desperate country just got ‘slightly more affordable.’

What does this mean? Are houses really getting easier to own? (If so, time for this pathetic blog to get bombed and go for a long, final Harley ride in the snow.)

First, here’s the way the bank determined this affordablility thing:

Our standard RBC Housing Affordability Measure captures the proportion of median pre-tax household income required to service the cost of a mortgage on an existing housing unit at going market prices, including principal and interest, property taxes and utilities; the modified measureused here includes the cost of servicing a mortgage, but excludes property taxes and utilities due to data constraint in the smaller CMAs. This measure is based on a 25% down payment, a 25-year mortgage loan at a five-year fixed rate and is estimated on a quarterly basis. The higher the measure, the more difficult it is to afford a house.

But wait. The average downpayment in Canada these days ain’t 25% – it’s actually one third that amount. So the average mortgage for a new buyer is more like 93% of a property’s value, not the 75% used here. And because of the higher assumed downpayment, the bank’s numbers do not include the cost of mortgage insurance, which almost all buyers add to the principal (and end up paying it three times over). Mitigating that a little is the use of a 25-year amortization, because nine out of 10 new mortgages today are lifers – the full thirty – which brings the monthly down a tad.

In any case, after paying tax on an income of $96,040, the average Toronto family would have $70,708 left. But wait, the RBC study calculated the cost of owning a house in pre-tax dollars. So, 52.1% of that is $50,036. And when we suck that amount from the money the family actually bring in, the difference is $20,672. This is $1,722 a month.

From this we need to deduct house and car insurance (I’ll estimate $3,000 total over a year), car payments and gas ($9,600) and food for a family of three ($6,000). That leaves $39 a week for clothing, medical expenses, vacations, entertainment, cable and net, Timmy’s and RBC bank service charges. And I forgot booze, stimulants and leopard print panties, which are obviously necessary in such a situation.

This is affordable? And let’s remember the study takes place in a Beaver Cleaver world where everyone has $100,000 to plop down on a home, where property taxes don’t go up (unlike Toronto), furnaces don’t croak, kids don’t covet Xboxes, dogs don’t need vets, nobody takes trips, mom knits your underwear and makes a great pine needle casserole, and you have absolutely no future need for savings, investments, retirement plans or a TFSA.

This, of course, describes the actual existence of the average RBC economist. You can spot them on Bay Street, walking funny.

In short, the bank should be ashamed of itself for publishing such crap. The media which ran the ‘Houses more affordable, study says’ headlines should be even more ashamed. We can excuse (sort of) RBC for wanting to keep its mortgage business robust, but not the reporters, paid to be our filters. Every young couple encouraged to buy into this – one of the most dangerous housing markets of a generation – by the bank’s words is being deceived, misled and failed. I expect more from the guys in the gold tower.

Finally, for comic relief, the same economists say it takes 90.6% of the average pre-tax income in Vancouver to carry a house.  That’s $75,315 a year. Sadly, the after-tax income of Van families is (on average) is $64,162. Add in food, a kid and a car and that household’s under water by $29,753. This is why BC has a negative savings rate and why Vancouver’s doomed.

Average Van house: $622,955

Average Van income: $83,130

RBC: Priceless.

Rough choices

For some reason, Trev and Anna started reading this blog after they bought a house in Vancouver. “We paid $1 million,” he says, “for a place near Main Street.” Sadly, it was unrenovated, so they must spend $150,000 to make it livable. “We plan to stay here 10 years,” Trev adds, “and we were fortunate enough to put down 50% (but perhaps that was a mistake after reading your blog).

So, what else will you have besides a house and mortgage?

“We’ve set aside an RESP for our kid maxed out to the level the government will contribute. I have a limited partnership investment of $50,000 which is projected to provide us with a 7% return. Our combined income at the moment is 120k per year. The house has a separate suite which will provide us $900 per month income. If times get tough then we can rent a spare bedroom to a student for $700. So, we will have $50k after renovations to invest which from what I have read on your blog may be best invested in a TSFA. Also should we seriously consider selling the house when the renovations are complete, rent for a while and then re-invest? The concern after reading your blog is that we will be house rich. If we are planning on staying there for 10 years does this still apply?”

The scorecard: $1.15 million house, $500,000 mortgage and $100,000 in liquid assets (half of it in an LP, which is probably completely illiquid). Net worth is $750,000, of which 87% is in a single asset, the house, and $50,000 is tied up. You spent almost 10 times your income to buy and reno the place, which is absurd. You can only afford to live there, it sounds, if you share the house with other people. And renting out a bedroom to a student? Is this why you spent a million bucks?

So, your questions: sell when renovated, rent then buy again? Or stay?

The best move would have been to discover this pathetic site months ago. Not only did you pay property transfer tax of $18,000 when you bought the place, but it’ll cost another $40,000 in commission (plus HST) to sell – almost $60,000, which means a year after the purchase you need $1.2 million to break even (adding in mortgage and property tax payments, but not the mortgage break fee).

Is that a reasonable assumption, given the market, the economy, and the state of Canadian house horniness?

Not a chance.

Look no further than the recent numbers. Wages and salaries have fallen below inflation, which means people have less actual money to spend. Mortgage debt and lines of credit have exploded. Families have never owed this much, so  imagine what happens when interest rates recover. More jobs are being lost than created. Governments are deeply in hock, which means austerity and less spending. China’s property bubble is deflating fast, while the US economy sputters and Obama may lose his job to a Mormon protectionist.

Why should real estate rise in value in an environment like that? As I’ve pointed, there’s nothing supporting house prices in Vancouver (or Toronto, or piteous Calgary) but new buckets of debt. There are myriad examples of what happens to real estate when jobs wilt and wages sag. They get slaughtered.

But is it different in Van these days?

Nope.  Sales in November will be below those of last year by about 10%. Average prices are declining, and will be off about 7% from the peak. According to my realtor buddies, “there have been two inflection points this year. The first was in late Spring when listings took off and the second was in mid-October when momentum in sales shifted down.” Anyone trying to sell a property in the last three weeks knows this well. Crickets.

The first half of this year was hot, the second half will show a dramatic cooling. Tons of sellers have given up, and will flood the market with renewed listings in the Spring. Says one broker (who wishes to remain anon): “The market will come off the rails in Vancouver next year.   We’re seeing some China buying reductions but there will always be some Chinese money, however smart money does not chase a falling asset no matter how much they want their kids to go to the “best Schools”. Give me a break – they are not so great that Vancouver is better at education than other cities, that losing 500K is not noticed. Spring will be a disaster out west – as soon as the mainstream media pick up on this – it may self-perpetuate.”

The real question, Trev and Anna, is how much equity do you want to lose? You can try to flip now, and lose a hundred or so; dump it reno’d, and lose two hundred or more; or hang on for three years and lose a ton. Ten years? With endless luck and horseshoes departing your rear end, it might be worth what you paid.

Now, are there lessons here for those fortunate enough not to own Vancouver real estate?

You bet. The implosion there will vibrate the nation. In hindsight, it will seem so patently obvious we screwed up. That we thought the laws of economics no longer applied to Canada. That assets could rise in value just because we wanted them to. That debt had no consequence.

People like Trev and Anna have a stark choice. Live in their mistake, watching equity hemorrhage and listen to their boarders grunt through the walls and the joists. Or admit stupidity, sell, and eat an immediate loss.

Of course, the second option’s the best. With half a million tucked away they can let investments pay their rent, escape the realty storm, and buy a better house in a few years with less debt.

Only hubris stands in the way.