Rational Thought Not a Factor in Home Purchases

By The Canadian Press

Referencing RBC Study.

TORONTO - Recent first-time homebuyers say they felt pressure to enter the market as they contended with jitters about rising home prices and higher mortgage rates.

The Bank of Montreal says as many as one-third of respondents in a homebuyers survey believe their expectation that housing prices would increase, and interest rates would soar, left an impression on their decision to make a purchase in the short term.

"There's definitely a sense of urgency among home buyers," said Lynne Kilpatrick, senior vice-president of personal banking at BMO.

"While we encourage Canadians to pursue their home ownership dreams we recognize it's easy to get caught up in the emotions of the purchase and this can lead to stretching one's budget too thin."

The results come as Royal Bank released its own homeownership survey on Wednesday which showed that a majority of Canadians expect to see higher mortgage rates over the next year.
RBC's annual homeownership survey said 64 per cent of Canadians expect high rates, with about the same number of mortgage holders concerned about higher rates.

Economists expect the Bank of Canada to raise interest rates by between half a percentage point and a full point over several months beginning this summer to fight inflationary pressures in the economy.

With many Canadians taking on larger and larger mortgage debt in expensive markets across the country, higher rates could create financial problems for some homeowners.

In the Royal Bank survey, three-quarters, or 73 per cent of homeowners, feel strongly that homebuyers need to think ahead to ensure they will still be able to make their mortgage payment if rates rise.

The bank says six-in-10 mortgage holders say they have taken advantage of current low interest rates to pay more principal on their loans.

Eighteen per cent of homeowners say they've made a lump sum payment on their mortgage and 16 per cent have doubled their payment to reduce their principal.

While 84 per cent of mortgage holders believe they are doing an excellent or good job of paying down their mortgage, 49 per cent say their mortgage is larger than they thought it would be at this stage in their life.

Marcia Moffat, RBC's head of home equity financing, says the best advice for homeowners is to review their mortgage holdings with a financial adviser to position themselves for any changes.
BMO's senior economist Sal Guatieri added that a cooler housing market is "just around the corner."

Greater Vancouver Price / Rent Ratio

House prices in Greater Vancouver are overpriced and consequently the rental yield on properties is very low. The chart above (click to enlarge) shows the long term detached house price adjusted for inflation, the inflation adjusted rents for a 3 bedroom apartment and the price to rent ratio for the benchmark detached family home (I used a multiplier of 2 on the 3 bedroom apartment rent to represent the benchmark detached rent).

The price to rent ratio is at all time highs by a long shot with monthly rent representing 1/300th of the purchase price of a home. In some cases the ratio is much worse.


Any analysis of price vs rent would be ignorant if it did not account of the cost of capital, which is represented here by the five year mortgage rate. Mortgage rates were extremely high in the early 1980s and prices were also very high so the mortgage payment to rent ratio was extreme. It peaked in the third quarter of 1981 at 3.5 times equivalent rent to purchase the same property. In the current cycle we peaked at 2 times rent for equivalent properties. Clearly affordability was worse for a brief time in late 1980 through early 1982 compared to today.

The risk today is of course the prices themselves but the risk of mortgage rates rising is an additional risk that mortgage renewers must keep in mind. Would they be able to absorb an unexpected drop in house prices of 20% combined with a rate increase of 2-3%? Variable rate mortgage holders are in for just such a surprise over the next couple years. Fixed rate mortgage holders may dodge the bullet on the rate increase but the price decreases may leave them feeling a little trapped, especially if the payee loses his or her job.

Bank Raises Rates on Variable Rate Mortgages

LORI MCLEOD, Globe and Mail Update, October 6, 2008 at 8:46 PM EDT

The latest victims of the growing financial crisis could be the standard discount available to consumers on variable mortgages, and home equity loans at prime.

In a move expected to be followed by other banks, all of which have been stung by higher funding costs, TD Canada Trust is raising rates on both types of loans, effective Oct. 7.

Rates on these products will rise to 5.75 per cent, a percentage point above the prime rate. Only last week, TD eliminated the discount on its variable rate mortgages, offering them at the prime rate of 4.75 per cent. During the housing boom of the past several years, consumers could often get their bank to drop the rate by half or even up to a full percentage point.

“While TD Canada Trust has endeavoured to not pass on the increases in rates to its consumers, this change reflects steadily increasing costs of funds in the current economic environment,” the bank said in a statement.

The percentage point increase raises the term interest cost on a $250,000 variable rate mortgage by $12,247.22 over five years, according to Royal Bank of Canada's online mortgage calculator. The difference is based on a 25-year amortization, a variable rate mortgage with a five-year term and bi-weekly payments. On that basis, the bi-weekly payment amount rises to $725.90 from $657.83.

The credit crisis and economic uncertainty have caused banks to stockpile their cash. That's driving up their short-term cost of borrowing from one another, and means margins on variable rate mortgage products are shrinking.

Rates on fixed-term mortgages went up last week too, as banks have passed on fewer of their savings from falling bond yields to consumers to consumers.

“The deterioration of global credit markets is beginning to squeeze the ability of even the strongest of financial institutions to raise longer-term funds, which could limit the provision of longer-term credit in Canada to businesses and households,” federal Finance Minister Jim Flaherty said in a statement Monday.

“Hopefully this isn't a permanent shift, but a short-term reaction to conditions the likes of which we really haven't seen before,” said Gary Siegle, regional manager at mortgage broker Invis.

With a discount, some customers can still get five-year, fixed-rate mortgages at 5.55 per cent, meaning a bi-weekly payment of $707.66 on a $250,000 mortgage amortized over 25 years. This means those looking for peace of mind in the current market turmoil aren't paying a premium to lock in, Mr. Siegle said.

Vancouver Real Estate Bubble Uberpost

It has been awhile since I've put everything together in a complete picture for us to formulate an informed view on our local real estate market. This is a long post but well worth it.

First some history:

Average home prices have catapulted into the stratosphere recently.


The price of a benchmark condominium in Greater Vancouver has risen 111.5% in the past five years to a disgustingly unaffordable $377,579.

The price of a benchmark townhouse in Greater Vancouver has risen 100.8% in the past five years to a sickeningly unreachable $456,941.

The price of a benchmark single family home in Greater Vancouver has risen 95.5% in the past five years to nauseatingly excessive $730,399.

Even adjusted for inflation we are far above any historical norm.

What this means is that the average family can’t afford to buy a first home or upgrade since the income required to fund this purchase via a mortgage is double or triple what they make.

Now our current house prices wouldn't be a problem if people were earning more money but they aren't. Average incomes have not increased to the extent necessary to afford the average home.

This wouldn't be all that concerning on its own either if rents were rising but the crux of the matter is that the income yield or rent from real estate in the Vancouver area has not increased to the extent necessary to justify today's high prices.

Many observers point to low interest rates to justify current real estate prices but this does not explain our current situation either. If interest rates were low enough to justify current prices then we should see a similarity between mortgage payments and rents but we see a wide disparity between the two at this point in time. In fact we would have to go back to the heyday of 1981 and 18% interest rates for the mortgage payment to rent ratio to be as high as it is today.

Many people see the current building boom and assume we have high population growth which, if it were true, would partially explain the huge run up in prices but it is just not true as population growth has not been high by historic standards.

Granted, we have had population growth (in 1000s of persons) and all of these people do need to live somewhere. We did go through a period of time in the late 1990s and early 2000s when developers were not building a lot of new homes because there wasn't a lot of profit in it and demand seemed low but that changed quickly as interest rates declined dramatically after the tech bubble crash and 9/11. Subsequently, people went out house shopping in droves causing a shortage of supply in our local market.

We do live in a mostly free market economy and supply demand economic equations really come into play when we are discussing price movement of commodities such as real estate. When development companies are able to make a profit selling a home they will do so and the higher the profit earned they will consequently build even more homes. Logically, this would suggest that we shouldn't have a problem at all with prices because supply and demand should quickly come into balance but this is not so.

The problem is that real estate product takes from 6 to 24 months to produce and the time lag is substantial as people, after all, do need a roof over their head. This lag produces another effect - speculation - savvy speculators perceive shortage in the marketplace and act quickly to take advantage of the obvious price implications of shortage by buying any available units. This competition for housing causes prices to rise very quickly. This also causes a feedback loop and sends a signal to developers indicating that there is even more demand and so they build even more units. This feedback loop causes further effects such as skilled labour shortages and escalating construction costs as other people become aware and want to take advantage of the perceived shortage. People now feel the prices are justified because of these higher costs.

All the while the loop increases until we have exhausted all demand and the feedback loop that made everyone feel we were in a boom ends and it is replaced by a vicious circle of increasing developer inventory, speculators who cannot sell the homes they speculated on, decreasing construction input costs as competition becomes fierce, and increasing unemployment which further exacerbates the problem. We are nearing this exhaustion point as the number of units under construction in the Vancouver Census Metropolitan Area is way higher than justified by our population and many projects have completed or are scheduled to complete in the next 12 - 24 months.

Anecdotes abound of Realtors, mortgage brokers, and wanna-be Donald Trumps picking up 4, 8, or 12 housing units before they are even completed so they can sell at a profit when the building is finished. The problem is that this will cause the vicious circle mentioned above and prices will decrease as all demand is exhausted and the supply burgeons with newly completed inventory and desperate speculators.

The prospects are bleak for Vancouver real estate as there are very few potential buyers out there, population growth is low, average incomes are below urban Canadian averages and we have a housing inventory that is projected to increase dramatically in the next 12 - 24 months. Stay tuned and grab some popcorn since this is going to get real interesting.

BC Mortgage Statistics

I had a look at the Canadian Bankers Association data on mortgages since 1990 and thought I'd compare it to housing prices. I suppose this data shouldn't shock anyone but I thought I'd post it anyway for discussion. The data seems to indicate that arrears on mortgages, that is those mortgages that are at least 90 days late on payments, increase substantially when house prices have fallen. Conversely, mortgage arrears are low when house prices are rising.

This makes sense logically as home prices rise, refinancing options are plentiful to all mortgage holders who run into trouble making payments. When house prices are stagnant or falling the mortgage holder has very few options and may or may not have equity to draw on to cushion the loss of payment making ability.

As home prices fall, look for a significant upswing in the percentage of mortgages in arrears. Even a subdued decrease in home prices could unfortunately put the screws to a lot of mortgage holders - witness the mid-90s as an example.

Price to Rent Ratio Stinks in Vancouver

Well another loverly day in the blissful paradise that is Vancouver. Warm, balmy tempuratures in the low single digits, liquid sunshine of different varieties and over 8 hours of wonderfully cloud-filtered daylight. The weather must be one of the reasons for the real estate prices being higher here than anywhere else in North America. Really, California or Florida, give me a break . . . all they have is sun, sun, sun and hot, hot, hot. Who wants that!?!?! (um - don't answer that - me - thats who!)

Let's look at the Price / Rent ratio in our splendid and worthwhile village, er, I mean Metropolis of Vancouver. The average price / rent ratio over the data period has been 19.9 and currently sits at an all time high of over 27 as of June 2007.


Now let's look at Price / Rent ratio in other loverly places where sadly for them it doesn't rain as much. How would you get mould to grow if it doesn't rain? How would building envelope specialists be employed in these sunny climes? Notice anything about most of the more pricey real estate markets in the US? (hint - the earth orbits it and clouds block our view of it in Vancouver 300 days a year)



Vancouver clearly has nothing to worry about with its cost of living because quite obviously this is such a desireable place to live and nothing like Honolulu or San Diego or Miami. Smart people (or amazingly rich and stupid people) will pay anything to experience the bone-chilling warmth of Vancouver in November (and December and January and February) with short and wet days and dreary and soaking nights.

Price / Rent ratio be damned. What is the point of all these silly numbers anyway? Afterall how can you measure the cost of our amazing climate and mouldy buildings? Priceless I say.

Gosh - I am so sick of this self-absorbed city.

Canadians in Hock

Tip of the hat to reader '/dev/null' for forwarding this news story. Credit card debt is obviously a major problem for many Canadians. It is hard for me to comprehend how much revolving debt many people have and they don't even realize that they are enslaving themselves to the cheap crap they bought on the card.

Growing credit debt is crushing Canadians: study
Updated Tue. Nov. 13 2007 8:46 AM ET CTV.ca News Staff

A new study of Canadians' credit debt finds that a whopping 25 per cent owe between $10,000 and $40,000, and 28 per cent don't even know the interest rate they pay on their main credit card.

The report by Credit Canada and Capitol One was timed for release during their Credit Education Week, and is designed to raise awareness of good financial management.

Laurie Campbell, of Credit Canada, said the numbers -- which don't factor in mortgage debt -- were surprisingly high.

"The numbers are quite startling, even I was quite surprised, but nevertheless, this is truly what we're seeing," Campbell told CTV's Canada AM.

"Savings rates at an all-time low and debt rates at an all-time high so this financial literacy week in my opinion is long overdue."

The study, which questioned 4,000 respondents about their personal credit debt practices, found a disconnect between Canadians' debt levels and retirement plans.

When asked about their total outstanding debt from credit sources and loans, respondents said the following (figures don't include mortgage debt):

$0 -- 16 per cent
$10,001 to $20,000 -- 13 per cent
$20,001 to $40,000 -- 12 per cent
$100,001 to $200,000 -- 9 per cent
$300,001 to $500,000 -- 1 per cent

Two per cent of Canadians said they had six credit cards; while six per cent had five credit cards; 12 per cent had four cards; while the majority, 25 per cent, had two credit cards.

Twenty-two per cent of Canadians said they had only one credit card.

When it came to the average balances people said they carried on their credit cards, 36 per cent said their monthly balance was $0 because they paid off their credit card each month.

Eleven per cent said their monthly balance was between $1,001 and $2,500, 9 per cent had a balance of between $2,501 and $5,000 while 1 per cent had the highest monthly balance of between $20,001 and $30,000.

When asked how their credit card habits could be best described:

50 per cent said they pay their credit card off in full every month.
37 per cent said they pay the minimum requirement each month
10 per cent said they do not have a credit card.
3 per cent said they sometimes/often miss the minimum required payment.

"Certainly what happens with a lot of people is they look at their statement, they see a minimum payment, and say that's what I have to pay and unfortunately they don't look further to find out what the implications of only paying the minimum payment are," Campbell said.

When it came to budgeting, 53 per cent said they have no budget. Another 31 per cent said they have a budget and stick to it, and 16 per cent said they have a budget but rarely stick to it.

When asked when they thought they would be able to retire, respondents said the following:

13 per cent -- never
3 per cent -- between 71 and 76
24 per cent -- between 56 and 60
29 per cent -- between 61 and 65
14 per cent -- between 66 and 70

"The majority of people expect to be able to retire at 60 or 65," Campbell said.

"I don't know how they expect to retire if they're not saving, so there's a real dichotomy between the way people see their future and the way they're handling their money."

When asked what their top concern was regarding credit and debt management, 26 per cent said they worried about not being able to deal with unexpected emergencies.

Campbell said the goal of Credit Education Week is to raise awareness among Canadians about credit debt and how to deal with it, through providing free advice and online resources.

While a strong Canadian dollar has lulled many Canadians into a sense of financial security, people must be cautious, she said.

"People are very optimistic which is a very wonderful thing but you also have to plan for your future and think about where you're spending your money and put your goals in place, that's the most important thing."

Mortgage Payments are BIG and TD Economics is smoking something!

Well I thought it was about time to revisit how much the average Vancouver area home buyer must earn to afford to purchase different types of fairly average accomodations. This calculator assumes a 32% ratio for all housing costs - this has typically been the criteria for CMHC backed mortgages in Canada. Click on the chart to enlarge it.





It is shocking to me to consider that a household must earn nearly $60,000 per year in order to afford the average condo in the Fraser Valley. That is even with an insane 40 year amortization mortgage. And I thought condos were supposed to be affordable for first time buyers and low income earners - phsssssh - so passe - only high income earners, loan application liars and ever-so-prescient real estate speculators can afford the basic condominium now. My former condo was affordable when I bought it but it sure wasn't when I sold it.

Go to the CMHC site and do the calculation for your situation. Tell us what you find. Is rent cheaper than the monthly payment? By how much? Or if you already own your home, would you be able to afford to buy it today with your current income if you had to.


UPDATE:

In the category - what are you smoking - another bank releases a milque-toast economic report on how Canada's housing market is undergoing a soft landing. I'd like to see the TD Economics department relocated to downtown Vancouver and we could see those poor economists struggle under the burden of a crushing mortgage payment double what they pay in Toronto for a similar property. Here are the comments about the Vancouver market that defy logic:


Vancouver – A balanced market within sight


Existing home prices are expected to post a 12% gain from last year. TD Economics forecasts that this softening in price growth will continue into 2008, where the yearly average resale home price gain is expected to come in at 7%. Okay brilliant TD economist, how much did wages rise or interest rates fall? Wages were up approx. 3% and interest rates rose thus making houses more unaffordable than ever. How exactly will we sustain another 7% rise in prices?

What lies beneath this outlook? We have profit goals as a bank for next year and the profits hinge on us reaching our lending goals so we were reluctant to release the real analysis that we did because we wanted to keep our job. Oops . . . I mean . . . First, a higher number of existing homes listed for sale. This dampens new home demand and helps ease relative demand pressures for existing homes. As more homeowners look to lock in price gains from recent years, listings are expected to continue feeding supply more than enough to meet demand.

The second main driver behind our forecast for softer price growth lies on the demand side: affordability. Not only is affordability poor on a level basis, it has been deteriorating significantly in the last couple of years. Hmmmm . . . . really - you don't say!? Typical mortgage carrying costs for a median-priced home in Vancouver required close to 10 percentage points more of the median market household income in 2006 than it did a year earlier. I guess no more food for junior and we are going to have to drive that old Honda for another 10 years. As the lagged effect of this significant deterioration works through the system, it will continue to dampen demand going forward.

Whereas sales might increase at most 2-3% from last year, new listings are expected to increase by twice as much in per cent terms. After exhibiting the characteristics of a strong seller’s market since the turn of the decade, Vancouver’s market is heading back towards more balanced conditions (see textbox for discussion of overall market balance measure). Indeed, the demand-supply ratio for Vancouver’s housing market is inching towards the balanced market range of 0.4-0.6. So how exactly will demand (sales) going to increase when you just said it would decrease? I don't understand.

On the new home market front, housing starts continue to downshift after having peaked in 2004. However, the number of starts should remain lofty throughout the forecast horizon. A lean inventory of completed but unabsorbed units, along with high construction costs, have helped continue an upward trend in new home price growth that is six years long and still running. Extrapolation at its finest - prices have gone up so they will continue to go up. Brilliant!

Residential construction continues to face challenges like a shortage of skilled trades, high land prices, and increasing competition for resources from the non-residential sector. This is illustrated by the recent increase in building permits that has not been accompanied by rising starts to match. In other words, builders have purchased permits, but have not broken ground. Unless sufficient resources can be made available to catch up with building intentions, this is likely to put continued upward pressure on new home prices and to further erode an already strained new home affordability. This is why framers and guys who pour concrete without high school education make more money than well educated financial planners who manage millions of dollars of other people's money! I'm not bitter!

In terms of resale home price growth, Vancouver was the first western market to cool from its peak of 20%. Thankfully, the easing from such a break-neck pace of growth is proceeding gradually. Demand remains well supported by a pace of job creation that only Alberta has been able to outmatch. But Vancouver’s job market is also less vulnerable to downside risks tied to the volatile resources sector, and employment growth is expected to outpace the Canadian average by 2.5 times. Therefore, we are expecting the market to remain relatively tight. But as the supply of homes continues to grow, while demand softens as a result of eroding affordability, price growth should head back down towards a more sustainable pace. Yes we have robust employment in Starbucks baristas, retail, tourism, and yes, of course, construction employment. All of which are low paid, non-house-affording jobs except for the construction employment. And how exactly is our employment not directly tied to the volatile resource sector? Isn't the BC economy 'resource based' like cutting trees and digging up rocks?


TD Economics - you get the mohican what are you smoking award - hooray.