Wednesday, April 09, 2008

Real estate in Canada

I read with interest the recent Canadian Press article on housing in Canada. It shows that housing prices have increased by too much in recent years. The inevitable result of this is that prices are now set to either stagnate or tumble.

I was surprised to find the Greater Fool site. I can't believe someone prominent is finally publicly telling the truth about real estate in Canada. Thank you Garth Turner, always a straight shooter from the old Mulroney days.

Typically the media like the Halifax Comical Herald just publish breathless articles bragging that house prices have doubled in the last 7 years. Of course the realtor they quote tells you that it's not yet too late to get in on housing if you haven't been suckered in yet.

Tell me, have wages doubled in the last 7 years? Has the economy doubled? Have rents doubled? No, No and No!

Who can possibly buy these houses? Housing prices have risen in a way detached from the underlying economy. As evidenced by the appearance of 40 year mortgages, no money down mortgages, and cashback mortgages we have predictably reached a point where increases in house prices have made the average house unaffordable for the average buyer.

After years of growing at an unsustainable rate, housing prices are set to stagnate or tumble until wages and the economy can catch up. The no down, cashback, 40 year mortgage is Canada's version of subprime. The people taking out these mortgages cannot afford the houses and will be unable (or just unwilling) to service the massive debt they have foolishly saddled themselves with.

It's too bad about housing really. Historically the ability to get a respectable house in a respectable neighborhood for an affordable price that left enough money over to actually live was the foundation of the middle class.

That's no longer the case today. People are overstretched financially. In the past the way to make money from buying a house was by getting an affordable house and having enough left over to get other investments and when the house was paid off you would have that too.

The dirty secret of Canada's middle class is that most people can't afford their lives. Look at the record debt levels reported in the CP article. What happens is that people overpay for houses too far from where they work. Then they get killed on gas money driving two vehicles all over everywhere. Because they spend more than they make they end up with high consumer debt in credit cards and line of credit.

What then happens is they refinance their consumer debt onto their mortgage. While they get short term relief from creditors by doing this they also wipe out their home equity and whatever paper wealth they accumulated. Some people refinance their debts onto their mortgage multiple times and even reset their mortgage term back to 25 years after paying it down for several years.

I don't have the exact numbers, but just talking to people it seems a lot of people quietly admit they have refinanced their personal debt onto their mortgage at least once. The question really is who hasn't refinanced their mortgage into a higher amount than it was originally. Buying a house is only financially sensible if you can pay it off in 25 years or less. Refinancing a mortgage to a higher amount or longer term destroys any financial reason to purchase a house.

Up until now the banks have been willing to let people refinance their debts onto their mortgage because as long as the houses increased in value the bank felt the loan was secured in case of default. However if the economy falters at all, or when housing prices start to stagnate and tumble it will be like in the US. The banks will not be willing to refinance because the loan amount is larger than the value of the house backing it. Then there will be real trouble and a spike in foreclosures, which will accelerate the price declines to proper levels.

A realtor, banker, broker, inspector, CMHC employee, city tax collector, builder, lawyer or anyone else who makes a living suckering people into buying houses will say the renter is throwing money out the window. Many people who overpaid for the house they occupy while they pay off the bank who owns it will insist on the same thing. Bet let's look at that.

If you take out a 40 year mortgage you are throwing money out the window.

If you purchase a house in a neighborhood where you could rent an equivalent house in the same neighbourhood for less than half the mortgage cost you are throwing money out the window.

If you spend hundreds of dollars a month servicing consumer debt you are throwing money out the window.

If you refinance your debts onto your mortgage you are throwing money out the window.

If you spend $300-$400 or more per month on gas money you are throwing money out the window.

If you buy a house and then have to move and sell it at a large loss shortly after you are throwing money out the window.

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