Is home ownership getting out of your reach?

I had plenty of opportunity to buy a house in Calgary before the market exploded, and I kick myself on a regular basis. I'm not sure why home ownership seemed so scary, especially now when I'm paying twice as much.

Humans are hilariously short sighted when it comes to investing over the long term...we have a tendency to remember recent events and extrapolate from them rather than study the long term trends associated with our investments. What matters when assessing the "value" of real estate are several important ratios: price/earnings (or price to rental income), avg home cost/avg salary and the % of regional salary required to service costs associated with owning a home. Right now in Canada, all of these ratio's are through the roof with respect to history. To bet on them continuing to rise faster than inflation is to make a bet that households are going to be willing to devote an even greater % of their already stretched budgets to own homes and that real estate investors are going to be willing to stomach heavy cash flow losses in order to make money on a capital gain etc. Of course...this is all possible because the "price" of real estate is simply a function of supply and demand. If humans continue to believe that the price will go through the roof if they don't get in now (based on their narrow view of the past ten years) prices will continue to increase in the short term, however the big question is this: what happens when all of the baby boomers are looking to flood the market with 1 million dollar homes that they hope young budding households will pick up off their shoulders?

Throughout history, investors "valued" an investment intelligently based on what portion of cash flow they would have access to ie "yield". Homes intended for personal use were never viewed as "investments" because they didn't produce cash, they absorbed it ie they were liabilities. Stocks that didn't pay dividends looked suspicious and based solely on artificial value. It seems as though philosophies have gradually changed and speculation in the personal real estate market, but unfortunately philosophies can shift but the fundamentals of economics do not. If a 20% swing occurs in the opposite direction it will wipe out the entire life savings of many recent buyers that are overleveraged and even put them underwater. This can change the "recent memory" of those looking to purchase personal homes from mania to absolute fear of losing their shirts. This will drive prices even lower. That is when all young people of our generation should look to buy up as much money as possible while they were hoarding away money while renting: "be fearful when everyone is greedy, and be greedy when everyone else is fearful".

Think real estate can't be unstable...look at the USA...think this can' happen in Canada? Look at the early 80's to early 90's rather than 2001-2011.

Canada, and especially the Greater Vancouver Area are way overdue for a major housing "correction". If you think that the bursting of the US housing bubble was alarming, you just wait, you ain't seen nothing yet. Millions of Canadians and overseas investors will lose virtually all of their assets when the upcoming housing bubble arrives.

I think that there are 2 rules that apply to residential real estate. The first is that (for most people) houses are primarily a place to live...one of life's basic necessities so it's not really an option to go without one. And since it is our dearest asset we have a natural tendency to want the best one we can afford. Renting really only makes sense for those who can't afford to own or those who have portable lifestyles.

The second rule is that housing prices (as Rob alludes to above) are simply a function of supply and demand. And demand is greater the more desirable something is...that's why an apartment in Vancouver costs more than one in Toronto or Calgary...or Flin Flon.

So it still makes sense for most people to buy a home and to buy one in as desirable a city as possible. OK, so maybe we can't all afford to buy a place in Manhatten, Paris or Vancouver (aka "Vanhatten") but if you have a "normal" job you can probably afford to live in Toronto, Edmonton or Calgary. There is nothing wrong with those cities and they are probably decent investments.

Well Rob you are partially right. You do identify many of the drivers but you missed the most critical. The prime interest rate.

This has a tremendous impact on real estate prices. Simple math says that a 400K house at 10% interest will cost more over time than a 600K house at 4%. So people like you indicate that the housing market is overheated and due for collapse when prices go from 400K to 600K but you fail to mention the cost of borrowing has fallen from 10% to 4% making that house cost about the same amount as before.

So when you are looking at house prices also take a chart and calculate house price "cost" with the factor of interest rate changes in there. You will see a much more consistent trend with the last 5 years not being anything special.

As for the actual question no home ownership certainly isn't out of my reach. I'm 32 and I have a really nice 1600sq foot bungalow on a nice sized lot. I also have a condo in a nearby resort area for weekend use. These were my goals early in life and I have worked toward them and been successful.

Basically my philosphy runs that anybody can own their own home. If you haven't managed it you need only look in the mirror for the reason why as there are an absolute amazing amount of opporunities in this world. Make the hard choices early in life and you will be repaid 10X later in life. Take it easy in the beginning and you will fight for every day thereafter. Its really that simple.

Sorry Western,

Prime interest rate has absolutely nothing to do with the PE ratio, and the % of salary required to service a house...if these #'s are at all time highs the only thing that means is that if it rolls up slightly, even more people are going to be in trouble. Low interest rates don't mean that housing is priced correctly at a higher number, think about it...if you are going to buy a car and the dealer offers you a lower interest rate, are you going to be willing to spend more on the car? The reason why prices increase while interest rates are low is because it draws more people into the housing market and increases demand.

I agree with Rob 100%.

Gulp, you sound like a Real Estate Broker.

Western guy, I am sure you have a stable income. Good for you. You will be able to survive when the interest rate goes up, but most people who have bought the house between January 2008 to June 30, 2012, will loose their shirt.

Western guy, please send me an email on December 31, 2012.

No offense to anyone personally. Accept my apology, if I offended anyone.

All the best.

Hasan Abedi
hasan_abedi@hotmail.com

Ok, lets apply some math to this to let you guys see the point. Lets assume 10 year mortgages that you can lock the entire time (I know thats a stretch in Canada but it simplifies the math a little to highlite the point). Also lets say you & your wife make combined incomes of a 100K a year

1. Interest is 10%, house costs 200K so your PE ratio is 2. The monthly payment is $2,643 (thx excel).

2. Interest is now 4%, same house now costs 250K so your PE ratio has increased to 2.5. The monthly payment has fallen though to $2,531.

I agree the PE ratio and interest rate don't correlate. By your logic the increasing PE ratio in the examples above should make the house less affordable but instead it has become more affordable due to the interest rate change. Basically your model is flawed and is leading to poor decisions.

One thing you don't take into account Rob is that I am a proponent of fixed mortgages, not floating (especially at the beginning of a mortgage). A little off topic but I also carry a very large amount of debt (think low 7 figures) as I expect inflation to hit hard in the near future (Canada probably won't raise interest much as the US reslumps causing our economy to overheat) so I have quickly come to realize that a floating position would quickly destroy me. Also people have come to love floating over the last 20 years when interest fell from 20% to 3%. What are the odds its going to fall on an equal scale over the next 20 years? Its much more likely to rise or at least stay even.

So Rob take into account when all of "your" ratios are sky high that they are being evened out by the "super" low interest rate we are experiencing and are likely to experience for a decently long period to come. Basically housing in "most" of the country is business as usual. I can't speak to Vancouver as there are outside influences there that could change due to non economic factors (poltical etc).

Happily financial math easily proves my point.

Hi Western,

One huge problem with your calculation and your philosophy...you are assuming that every increase in price related to the interest rate was due to consumers willing to spend more on a home due to lower interest rates. Wrong...it is related to increased demand (think about the car example above). The reason why this is a problem is because you are doing your calculation as though people entering the house market are rationally treating it as though it is a simple arbitrage opportunity and creating a perfect balance everywhere. Thats great that you can do simple math and obviously taut yourself as a self professed genius of personal finance because you are having a good run (aren't we all in our own minds), however you are controlling the variables to prove your point. Using your examples are going to keep the % of income required to service the debt constant, and the PE ratios within historical norms....you should have clued into this problem with your assumption by recognizing that they are at all time highs because people haven't been rationally entering an arbitrage situation, housing prices have increased due to increasing demand...not arbitrage, and they have clearly overshot the mark. When demand drops....look out.

BTW, quit hijacking this post to tell the world how financially successful you've been, it takes away from the meat of your message and makes you look like a twit.

I agree with Rob 100%.
I don't know if Rob and Western Guy are catching this yet. You are arguing two different points.
Western Guy, try to look at this from a different point of view then purely financial.
Most people don't think from a purely financial view, even though they should learn much more about their finances then they do.
Rob, thanks a bunch for your quote at the end. I will be greedy when others are fearful.

@ western guy

Hahaha, I wonder who you work for?

I quote you: "Lets assume 10 year mortgages that you can lock the entire time (I know thats a stretch in Canada but it simplifies the math a little to highlite the point)".

10 year mortgages?!?!... Lock the entire time?!?!... hahaha

I also love how you contradict yourself in your longest paragraph, and then conclude with the phrase: "Happily financial math easily proves my point". Hahaha - didn't you just also type that people "love" floating rates, and that such a rate would destroy you? Who are you working for?

Don't you see that your math and your logic makes you out to be a "sub-prime" cheerleader. You are touting all the fallacies that people assumed were correct in the USA which led to their housing debacle. You basically say "buy now; while you still have the financial beer-goggles on! Who cares if rates wont stay this low forever".

It is no secret that when interest rates go up, they're going way up.

So you see, cheerleading a Canadian housing crisis makes little sense. Perhaps you should take fact finding trip out of the west.

Hmmm. Who to respond to first.

Clear and focused:
I said I am a proponent of fixed mortgages. Go look it up in a dictionary if you don't get the meaning. So no I don't contradict myself. Yes in Canada you can lock in for 10 years (TDs rate today is 5.24% before even negotiating and in the US and elsewhere you can lock-in for up to 25 years). The US got into trouble by selling people houses at a low intial interest rate where the mortgage rate would reset for the last 1-2 years at a higher rate. People only had to qualify to afford the low interest rate and not the reseting rate later (which would often literally double the payment). Basically backloading mortgage costs. We don't do this in Canada so we won't get the kind of bubble they did. Yes Canada's housing could bubble but I expect inflation will wipe that issue out.

Rob:
No. I am pointing out your basis for your conclusions is missing a key factor. You claim all your indicators are at all time highs and therefore conclude that housing is in a bubble but you won't consider that interest is at an all-time low and is the direct cause of your high ratios. From my example its obvious that PE doesn't reflect house affordability. I showed PE going from 2 to 2.5 and yet the house was less expensive to purchase. Im not correlating that low interest causing house prices to rise (I didn't say that anywhere), I am correlating that low interest makes homes less expensive to buy. Also the market does arbitrage this quite effectively as houses are bought by the highest bidder. If interest rates are cut in half banks will approve all people for higher amounts (because the payments are the same) which means people will be able to pay more which will increase the market price. Ceteris paribus the increase in market price doesn't mean the house is less afforable.

All my life I have had conversations with chicken little's like you claiming that the sky is about to fall. If I had listened to any of you I wouldn't have anything right now. I am certain eventually one of you will be right but by then I will be so far ahead that a 20-30% loss will still put me miles ahead of the person who has never risked anything. If anything in this world I would be hedging inflation because it could really rip in the next 2-3 years (which means betting the exact opposite of what you propose).

Lastly what are the consequences of our positions if they are wrong. Say we have a circa 1986 housing bubble crash (about the worst we have had in 50 years). Housing prices took until 1993 to recover. So I sit tight for 7 years and you buy a house 15% cheaper (yay for you lol) . On the flip side of extremes say we get a circa 1981 inflation spike (18%). I will be a millionaire several times over and you will probably never afford the house you want ever. Seems you risk a fair bit more than me on your side and I have much more to gain.

A word from an recent retiree. I have been a renter all my life. At age 65 I decided to become a first time home buyer. I could not afford market rents on my retirement, fixed income. However, I could afford the current mortgage rates (varialble) and it turns out I have more disposable income as an owner vs renter. I am building equity and as the thrust is to keep seniors in their home as long as possible,, I feel given my good health, that this could be for quite some time. I enjoy a beautiful (to me) home in a popular vacation area in Ontario. I couldn't be happier or more blessed. Yes, rates will rise and I may have to sell for a variety of reasons. I will never regret this risk takingr at retirement. I have my forest retreat that I have dreamed about since childhood. Sometimes, not matter how bizarre, it is time to take the plunge and simply go for it.

However, in saying that I advise you make it part of your financial plan and not simply an emotional buy.

@ Western Guy,

1) You have absolutely no idea what a PE ratio is with respect to housing as you didn't mention rental income in your original equation. I guess you are talking about salary to servicing a mortgage? You have created a nice scenario, however the key figure that proves you wrong that I used (which is exactly why I avoided your mistaken impression of what a PE ratio is) is the percentage of salary required to servicing housing costs...which is at an all time high!

2) The reality is here is that you don't care about this debate, you aren't even paying attention. This is obvious because...When did you buy and take on all of this debt? It was at least three years ago no? Would you do the exact same thing right now in Vancouver or Toronto if you were just starting out? The point I am trying to make is that I, nor you, would be taking out a $950,000 mortgage on a $1,000,000 home in Toronto or Vancouver tomorrow, that would be stupid. You are changing the scenario to one where you use debt as a key driver to leverage net worth at key opportunities that arise. You (as well as myself) leveraged yourself to a large degree three years ago at the beginning of the recession when everyone was scared silly and the market temporarily flipped from a seller's market to a buyer's market, which is also what I talked about earlier. You are taking every point anyone makes and are trying to manipulate it into a way that allows you to brag about how smart you were and how rich you have become as a result. You didn't necessarily make a bad move and it fits within my original scenario....if you want nothing more than a pat on the back here you go: "Western Guy, you are such a genius, and so rich and on the right path, and are doing everything correctly"...do you feel better about yourself now?

Every point Rob has made is very true. However, a low interest rate has caused more people to consider owning instead of renting. More importantly, it is very human-like to want things the neighbor has. Because of this low-interest environment, I am convinced many homeowners have moved up to more expensive homes by not having higher mortgage payments. Those who could not afford higher payments , probably locked in for 5-7 years. That was their insurance policy to future rising rates Their decision was merely to have a nicer abode for 1/2 a decade and hope rates will stay the same. While this is not likely, they will address that obstacle at the end of their term.

I can't predict the future, but I do not suspect our rates will go much higher. Maybe 1.5% more in the next 2-3 years. Our Can $ is simply too high vs. the Americans. Higher interest rates will make the dollar go higher and affect our exports. The government does not want this imbalance. They say the U.S. inflation will go much higher because of all the money they had to print. Not so. The political will in the U.S. is to pay down the debt which will not create jobs and keep inflation low. The U.S. economy will be stagnant and our exports will not increase.
The only way our inflation is going up? If we can secure more free trade with Brazil, India & China to increase our exports abroad. That will create profits with companies which Unions will demand higher wages thus creating inflation. Then all bets are off!