Entries from June 2017 ↓

The slither

Joe’s back. He asked us last week if he should keep his rock-bottom variable rate mortgage in place, or lock in. The rate (1.9%) was so silly-cheap it made sense to hang on, for the reasons explained. But he’s not convinced.

“CIBC offered me 3 years locked in at 2.29% if I want to switch to a fixed,” he says now, “or 4 years at 2.34%. Should I take one of those deals and run? Appreciate the insight.“ Well, Joe, if you’re going to write to a dodgy blog every week at ask the same question, then nail it down. And if you want another 12 months of serenity for an extra five lousy basis points, go for four.


Well, I guess rate anxiety is about to mount for everyone, after the events of Wednesday. The Canadian dollar rocketed a full cent higher and government bond yields swelled after our central bankers left no doubt what comes next. The market’s now giving 65-70% odds that the first (of several) rate hikes will take place on July 12th – way higher than the 39% probability given the event just a day earlier.

Why is this happening?

Simply, the era of emergency interest rates – here, in the US and around the world – is coming to an end. Yeah, it’s taken nine years to recover from the biggest, baddest, fugliest financial crisis since the 1930s, but central bankers think it’s time they turned off the tap to cheap money. The economy is strong enough to withstand it, they say. Besides, when it’s too easy to borrow, people borrow too much. Household debt’s off the charts and an ocean of liquidity has created asset bubbles – none bigger, scarier or more stuffed with risk than Canadian residential real estate.

Bank of Canada boss Stephen Poloz and one of his sidekicks (Lynn Patterson) were as clear as central bankers ever get when facing the media this week.

“Rates are of course extraordinarily low,” Poloz said, taking about how the bank slashed in 2015. “It does look as though those cuts have done their job… certainly we need to be at least considering that whole situation now that the excess capacity is being used up steadily.” Added Lynn: “Two years later, it is our view that these cuts have helped facilitate the economy’s adjustment to the oil price shock and that the economic drag from lower prices is largely behind us.”

Markets reacted fast. Bond prices lower, yields fatter. Dollar up. Preferreds popping. Now the eggheads at Bank of Montreal Economics think Poloz will add a quarter point in mid-July and another in January. That may not sound like a lot, but those two moves alone will double the Bank of Canada rate from 0.5% to a full 1%. It’ll add half a point to lines of credit, taking them from (in general) 3.2% to 3.7%, tack 50 basis points onto variable rate mortgages, while increasing the prime at chartered banks to 3%.

Scotiabank now goes one better. Rates will move three times, it says, in July, October and January.

And that’s just the start. Meanwhile the Fed has jumped US rates three times in six months, has one more increase on deck for later this year (confirmed yesterday) and three more planned for 2018. The Bank of England is also, despite Brexit and a broken government, anxious to raise rates, while the spend-happy European Central Bank is considering ending its massive stimulus.

Of course, the cost of money will not spike, surge or spiral higher. No drama. Instead, it’ll just slither up until one day three years from now you’re shocked at how that old 2.5% mortgage you’re renewing turned into one costing 4% or even 5%. Meanwhile the inverse relationship between the cost of money and the value of real estate will do some crazy things to urban housing markets. It’s inevitable. The reason crap houses now cost a million is not due to shadowy Chinese dudes, but rather because your daughter can borrow ten times her entry-level salary for less than 3%.

In order to get us back from the edge of deflationary disaster in 2008, that’s what guys like Poloz did. They knew the risk of creating an asset bubble was there, but the threat of a depression was worse. So they rolled the dice. It worked. We survived. And now, reality.

For the first time in seven years, there will be an increase. Maybe in July, maybe later. But get used to the idea. More will follow. Given what some real estate markets are already doing, the outcome will be predictable.

In some hoods, we’re there already.

Months of inventory start to pile up

Source: Realosophy

The obvious

Stan and Mary are 62 and 58 respectively, live in a paid-for house he figures is worth $1.1 million, have crappy defined-contribution pensions and want desperately to retire. Or quit and find something else. “Got to be more to life that this,” says a guy who’s worked 23 years in the automotive parts business. (She’s clerking for an office full of real estate lawyers, and sees the writing on the wall. “Way less busy now.”)

Like most, they’ve shoveled the bulk of their net worth into the house, have scrawny, malnourished TFSAs and inadequate amounts in their pension plans – maybe $150,000 between them. But no debt. That makes them financial rock stars, compared to their adult kids. (“Boy,” he reflects, “are they ever screwed…”)

They want to sell the house, downsize and tell their bosses to shove it. Here’s the plan: buy a two-bedroom condo for about $650,000, invest the rest and live large. Then they talked to me. Big mistake, I said. Let’s do the math.

So, ditch the house. That’s a no-brainer, since their pensions plus CPP/OAS will hardly support a good retirement lifestyle in the big city they love. Besides, the place needs serious work over the next few years – the basement’s original, the roof sucks, Mary hates the kitchen and the furnace has a bad ‘tude. Property taxes are eight grand a year now and seem to keep rising. It’s all a drag – besides, there’s a big pile of money sitting there doing nothing.

Selling today (as opposed to three months ago) may yield a million, if they’re lucky enough to snare a buyer this summer. After paying 5% commission, that leaves $950,000. So now, downsize to a nice two-bedroom condo, or rent one?

If they purchase, and find something for $650,000, they’ll have to shell out $19,000 in double land transfer tax in the 416 along with the purchase price (because no bank is going to give them a mortgage as they enter retirement). Now there’s $280,000 left.

If that’s placed in a balanced, globally-diversified portfolio of low-cost ETFs with 60% in growth assets (equities and REITs) and 40% in fixed income (corporate bonds and preferreds, mostly), they should expect about 6% after any management fee (figure 1%, tax-deductible). The income generated from that would be $1,400 a month, mostly untaxed since it’s structured as return of capital payments. But, sadly, condo fees ($500), property tax and insurance amount to about $900 a month, leaving just $500 to party with.

Is renting a better option?

The full house proceeds of $950,000 similarly invested would produce (at 6%) about $57,000 a year, or $4,750 per month. Rent for a two-bedder (a nice one) in that hood is $3,000, and comes with no property tax bills, no monthly fees, cheap insurance and no special assessments. So, if the entire rent were paid for out of the investment returns, it would leave $1,750 a month for living, or actually grow the nestegg by more than $20,000 a year.

There’s also a strong argument that S&M would actually have more financial security by not buying – and likely more emotional stability, as well. After all, their investments would pay the rent, add to their wealth, and they’d still have almost $1 million in liquid wealth – accessible any time if their circumstances changed, if health costs materialized or they wanted to travel like upscale bourgeoisie nomads for five years.

And what of the risks involved with both scenarios? Each contain downside. Investment portfolios fluctuate in value month-to-month, and some people worry about that. But over time returns have been consistent. And while a rerun of 2008 is unlikely, even that storm passed relatively quickly for people with this kind of portfolio – a 20% dip for a year, then a strong recovery.

There’s a good argument real estate now carries greater risk. Asset values are at record highs while interest rates sit at record lows. As that relationship changes, property values will probably decline and along with them liquidity. Could Stan and Mary could get out if they needed the cash? A 20% decline (totally possible) would wipe away more than $130,000 in net worth – with none of the loss deductible. Ouch.

Meanwhile condo fees could increase. So could property values. There could be a special assessment to repair a salt-riddled parking garage, install new elevators or replacement windows. All of this would affect the property value, and none of it could they control.

How’s this even a contest?

It isn’t. Buying is emotional. Renting is logical. The real nut these kids now face is selling.