Entries from September 2012 ↓

In 1990 banks were charging 15% for a variable-rate mortgage, while five-year home loans were 14%. The real estate market was tanking, as you might expect. The only way many people could sell their houses was to offer buyers a deal on financing.

I mention this for two reasons. First, interest rates will rise again and when they do current home prices will be crushed. Fifteen per cent loans are not in the cards, but it won’t take much to start breaking arms. Look at the serious impact F’s squishing of 30-year loans has had – and that was the equivalent of just a 0.9% rate hike.

Second, there was some discussion on this miserable blog last weekend about VTBs – vendor take-back mortgages – and how they’re a no-brainer way to sell your house, suck cash flow from the borrower, and take virtually no risk. One poster posed this question: “We are selling our home in Richmond Hill. What are the potential benefits and concerns of holding the mortgage?”

That elicited this response from another: “Private lenders are lending to those the banks reject lending to every day and for far better returns than anything Garth has ever suggested here. If the buyer is willing to put x amount of dollars of his own money into the purchase – anywhere from 5 to 10 percent of the purchase price and you can get him to go a 1st mortgage on 70% (with you) and let them find a broker who can arrange a second for the difference, then you move out with 30% of the purchase price in cash in your pocket while holding a 1st mortgage doable at 8.5 -9% – You will be way ahead in the game with a grand monthly income being generated from your Richmond Hill property. More than enough income there to rent a place with for yourself – and with a load of cash to boot with your bulk principle secure.”

So, let’s throw a little light on this subject. A VTB means the seller becomes a lender. Instead of pocketing the sale price of the home, you might receive only the down payment and forgo the principal in return for amortized monthly payments. Yup, just like a bank. But unlike a bank, you can’t get CMHC insurance on a high-ratio VTB (for 80% of more of the sale price), so if the buyer walks, you’re likely screwed (more on this in a moment).

A VTB is a legal obligation, so it has to be properly executed by a lawyer and registered against the deed. This costs money. You also want to ensure the buyer gives you not only a signature on the document, but a personal guarantee. It might also be wise to ask for a child as security.

On first blush, this may look like a good deal. Sell the house. Get 20% in cash. Take back a mortgage and enjoy a monthly payment with a fat interest rate. Get the property back if the dude walks. If you have a house with no mortgage, isn’t this a way of turning it into a cash-flow machine?

Not so fast. Like loaning money to ‘mortgage syndicates’ or ‘mortgage pools’ – both popular these days among people hungry for yield – this is a great way of making money disappear in a real estate correction. There’s a reason VTBs have typically been an instrument of despair – accepted by sellers who absolutely have to get out, and can’t get a buyer any other way. So, taking back a first mortgage is a rare thing. Normally a seller will assist only with the financing gap between what a buyer might have arranged from the bank and what they have as a down payment. That might be 5% or maybe 10% of the sale price, and still there’s huge risk involved, since in the case of non-payment you have no real security.

Does that mean letting someone buy your home with a deposit only, and you holding a mortgage secured against the property, is relatively riskless?

Hardly. First, if you can digest or breathe you can still get a mortgage in Canada, and at prime or less if it’s a variable-rate loan. That suggests anyone incapable of being bank-approved is homeless for a reason, like they have no money, a hideous credit history, or served time for grand larceny. Do you really want a relationship?

Second, if they stop paying it doesn’t mean you change the locks and move back in, keeping the down payment. Legally it’s not your house any more. You don’t own the deed. And the only way of getting it back is to begin power of sale proceedings (or, in some provinces, foreclosure). This means you need a lawyer (who needs a retainer), courts, and time. The guy you ‘sold’ to continues to live in the house, and by making a payment at any time during the long process, can set the legal clock back to zero.

Finally, why would any purchaser agree to pay 9% for a mortgage on your house, or about three times the going rate, if they actually intended on making payments for the entire three- or five-year term? Would you? What if they borrowed the down payment as well as your VTB, intend to live there for a year of non-payments, then depart? Under power-of-sale rules the property has to go on the open market and find a buyer at market prices. If you take less, the dude you sold to – who didn’t pay – can sue you.

Now imagine if we had a real estate correction (which we will), and the property declines to be worth less than the financing you hold. You have no house, no cash flow and (probably) no buyer. Oh yeah, and legal bills.

The moral? Never take advice from a stupid blog.

On one side of a glossy white sheet is the headline, “Is the condo market headed for a correction?” On the other, the pitch, “Get expert advice and protect your investment. Call Craig Emond.”

That mailer was mass-delivered to thousands of condos in central Toronto by a guy many believe is a marketing genius when it comes to getting virgins to buy concrete boxes. In fact, Egmond boasts that he’s flogged over 1,000 condos over the past decade which, when you figure it out, is two deals a week. This is to condominiums what Justin Bieber is to puberty.

Craig’s done TV, too. Five years ago he blazed in an episode of Brad Lamb’s star-crossed HGTV epic series “Big City Broker,” when flogging for the condo king. (“Story line: Meanwhile, sales rep Craig Emond is finally about to move out of the shoebox condo he’s been sharing with his wife Susan and into a 2500-square-foot, one-of-a-kind apartment.’)

His specialty? Finding “value properties that have consistently made phenomenal profits for his clients.” In other words, Mr. Emond likes speculation and sees real estate not so much as shelter as a tradable commodity. Which is fine, and makes more sense than filling your garage with silver bars. But it’s telling that the master of marketing – now vp of Model Suites Realty – has now decided that fear sells. It can sure get his phone ringing with potential listings, from former virgins now freaked that their gossamer threads of equity are about to be snapped.

Fear’s in, actually.

After three long years of insatiable greed – fed by cheap mortgage rates, shameless bankers and herd instinct – people are scared again. Of course most Canadians were always terrified by the stock market (unless tasty little bits of it were sold off, disguised as mutual funds) but this is deeper. Real estate has been the forever fall-back position, so when news gathers than a correction might occur, it’s life-altering. Especially if that’s where all your money is.

Nobody is more exposed to this than young, recent buyers of downtown condos in any major city. Overwhelmingly they are first-timers who used extreme leverage and have average equity of less than 5%. None of them bought with the slightest thought the value of their units would do anything but increase. This is because everybody misled them. The real estate brokers and agents, the developer and salesperson, the mortgage lady at the bank and their parents.

Thousands are about to have a horrible experience, and many are waking to that fact. And while selling into a falling market when you have no virtually no equity guarantees big losses, this is what humans do. They get blinded and buy things at their most expensive, then panic and dump them when they fall. Mr. Emond doubtlessly knows that. Fear sells.

Meanwhile in the troubled West, some of my recent words have not gone down well. A media column this week referenced my belief Vancouver prices could fall by 40% before they hit bottom a year or three from now, then spelled out the consequences. Local developer, consultant, newspaper columnist and builder Michael Geller, who thinks 40% is impossible, said, “if we had a 20% drop in home prices, a lot of people would suddenly be under water. In other words, they would owe more on their house or condo than it’s worth.”

Geller also lays on the fear, saying a house price plunge of even half my recommended dosage would trounce consumer spending, cutting sales of cars and clothing and killing off the home reno business. And how about those poor retirees in their million-dollar houses?

“Then there is the real issue of people planning on using the equity in their home to help them in their retirement years. A one million dollar home on Vancouver’s eastside that suddenly plummets to $600 or $800K would have a huge impact on the future income of retirees. This would likely delay the retirement plans of thousands of Vancouverites whilst reducing the number of job openings and promotion opportunities for younger workers.”

Yes, those same young people who have been goaded into $400,000 condos with nothing down or are permanently shut out of the housing market. And here’s some even worse logic: “As we’ve seen in many American cities, housing may have suddenly become affordable, but that has been accompanied by a declining economy. Regardless of whom you believe, one thing is abundantly clear. If Turner’s predictions are correct, there will be plenty of negative fallout for both homeowners and prospective purchasers alike. We should therefore be careful what we wish for!”

Of course, it is possible to have a healthy city where houses don’t cost seven figures. Where families are not required to spend 70% of their income on shelter. Where debt’s actually paid off, so people have money to buy cars and save for retirement. Where you don’t need others living in your basement. Where kids aren’t taught that being adult means being mortgaged. And where rock star realtors don’t traffic in doubt.

I think we have lost our way.