By Adrian Spitters and Win Wachsmann. The mainstream media is doing an excellent job of supporting the real estate market. Glowing reports of low mortgage rates and high demand. Pages and pages of new home listings of all shapes and sizes.
Professional pictures of stunning homes with granite and marble and nine-foot ceilings. Eye candy and the latest shiny object syndrome induce gullible and not-so-financially savvy new home buyers (or upgraders) to drop that down payment and join the ranks of the upwardly mobile.
Hold it! Can those stories of high demand be true? If not, can the papers really afford to sing a song of sadness and annoy their major advertisers?
Declining prices and sales numbers over the last several months have been buried in the data and have yet to reach the front pages of the newspapers. But efforts by the media and the real estate boards to spin and fluff the data are failing. People are examining the numbers put out by the real estate boards and noticing that their interpretation is suspect.
But aren’t home prices rising? Yes in some cases, in some areas, but sales numbers on the whole are decreasing and the number of available buyers is dropping dramatically. Listings are also declining as more homeowners realize that they may not get the prices they expected in the overheated markets. Its only a matter of time before overall prices begin their decline.
So what are some of the reasons not to buy at this time?
- Interest rates are low! House prices rose as interest rates fell and amortization rates went from 25 to 30 and finally 40 years (before they were brought back down to 35 years). The government is now contemplating reducing amortization rates back to 25 years. What would happen to a mortgage payment if interest rates were to double in the next five years? House prices would fall because a fixed monthly payment covers a smaller mortgage at a higher interest rate. Since interest rates can only go up, prices MUST come down.
- Leverage is a double-edged sword! Leverage means using only a small amount of the final price as a down payment and financing the balance as debt to amplify gain. A 10% down payment will increase in value if the house price goes up. On the other hand, if the house value goes down 10%, one loses 100% of his money on paper. If forced to sell, his losses escalate as he loses 10% and is also forced to pay all the real estate transaction, closing, and legal costs. A market where predictions from bank economists indicate a 2% annual gain (less than inflation) over the next few years is not a good market in which to buy. The risks are too high.
- Many houses are priced too high! Governments and financial institutions suggest that a safe mortgage is a maximum of 3 times the buyers annual income with a 20% down payment. So a $75,000 annual salary could buy a $270-$300,000 home if the down payment is around $50,000. How many people can afford a $950,000 bungalow in Vancouver on a $75,000 or even $100,000 salary?
- It’s cheaper to rent than own! In many areas, rent is still only 3-5% of purchase prices. A rent of $2000 would easily get you a home that is valued at $450,000. With a down payment of $50,000, the monthly mortgage costs at 3% would be almost $2,400 plus taxes. If interest rates rise to 5%, the monthly mortgage cost rises to $2,800 plus taxes.
- Boomers are retiring! There are 9 million Canadian Boomers and the oldest are 67. Only 20% of Canadian Boomers have savings of $250,000 or more; about a third have less than $100,000. And thats to fund a lifespan that is getting longer. Many have zero retirement savings. Their only retirement money is the equity in their house, so they must sell they need the money. As more and more Boomers realize its time to sell, prices will be driven down even further.
- The housing bubble was not driven by supply and demand! Builders have overbuilt anticipating the same rate of home buying as in the past ten years. There is less demand now that the Baby Boomers are retiring and selling. Current homes are too expensive for many new home buyers. Prices in the housing market are a function of interest rates and amortization rates. Banks have been lending on interest rates and overstated income levels knowing that they can push losses onto the government through CMHC.
- Condo vacancy is very high. Builders have overbuilt and investors have bought in to condos on the promise of ever-increasing prices. The result thousands of vacant condos in Vancouver and Toronto. When the carrying costs get too high and the losses mount, those units will be dumped. Condo prices will drop and the domino effect will lower single family home prices as well.
So what should you do?
If you are a renter, you are paying less to live in an identical house to a buyer. Every month you rent, you can save extra money to invest and will be able to accumulate wealth many times faster than a home owner (especially in the years to come when real estate flat lines or declines). As cities are forced to increase their taxes to pay for services, home owners may not be able to afford property taxes. A falling housing market and increases in mortgage rates may put many home owners under water. Home owners will find their once liquid asset turning into a major liability.
How can I secure my future?
- If you are retiring, have a healthy retirement fund and be debt free, then a declining real estate market may not bother you. Stay in your home and dont sell. In a few years the market will come back and you will be able to cash out. Trying to time the market rarely works, even for the experts.
- If you are retiring, or have retired and are planning to downsize, NOW may be the best time to do it. Buyers are still willing to pay top dollar. How long till hungry buyers begin to wait on the sideline for prices to drop?
- If you are still working and are doing well, hold on! Are you well on your way to paying off your mortgage? Have you taken a balanced approach to home ownership? Are you funding your retirement and will you be debt free by the time you retire? Do you have enough money to retire comfortably and maintain your current lifestyle? Will a decline in or possibly flat-line in home prices for the next decade be OK? Then, do not risk what you are doing by trying to time the market. Better experts have tried and lost millions.
- Then there’s the homeowner who faces monstrous challenges. Too much money owing on real estate. Carrying too much credit card or consumer debt. Little or no retirement funds and planning to join the Freedom 75 plan. Downsizing to a more affordable home or selling to pay off all those debts and renting may be the right course of action for you now. The market wont be this good for a few years to come.
- If you are a first time buyer, save like crazy. Be ready to have cash on hand to buy those marvelous deals that will start to pop up everywhere as the markets decline.
What can a wise person do? Your decision is specific to your own circumstances. A Certified Financial Planner will review your situation. Theyll present a plan to show you whether you are on track or show you what adjustments you need to make to make sure you keep money in the bank.
It may cost a little, but it will give you peace of mind. The best decision you can make is an informed decision.
By Adrian Spitters, FSCI, CFP, FMA
As a Certified Financial Planner (CFP), Adrian Spitters offers financial advice that focuses on investments, retirement, business succession, estate and tax planning in cooperation with his clients own legal and accounting professionals.
He can be found at www.theretiringboomer.ca
Win Wachsmann is an author, journalist, syndicated columnist, filmmaker and businessman who makes his home in the Fraser Valley of British Columbia. His articles and columns can be found in some of the finest offline and online magazines, journals and media properties.
He can be reached at email@example.com.