I'm going to revisit a purchase plan on a SFH. I'm going to use an MLS listing that has sold, but I think we'll see more of these types of sales situations so it may be indicative. Or it may not be.
Here it is: MLS# 231005. Original asking was $419,900, it sold after 108 days for $371,000. I picked this one on purpose; if we went after a house we'd be looking for a "motivated seller" so this fit.
Anyway, here's our particular economic situation with it: 5% down, 25 year amortization, 5.85% locked-in over 5 years. It looks like this:
We'll pay bi-weekly rapid. We won't overpay our mortgage because we prefer to max out our RRSP contributions. Any disposable income left over will go into other investment products, not the mortgage. You can debate the intelligence of that, but at relatively cheap money (5.85%), paying down the mortgage isn't huge on our priority list. We anticipate feeling comfortable in this house in this neighbourhood for 5 years.
Growth continues as it trends right now, roughly 6%/year.
Current value (actual): $371,000.
Future value at 5 years (assumed): $496,481.
Mortgage principle paydown: $36,000 (approximate)
Total approximate (possible?) equity at sale time: $160,000 ish.
Now of course you're thinking, $160K, no wonder everyone's getting rich off real estate! It's not that simple though. We have all sorts of other considerations here: taxes, interest, maintenance, months of vacancies etc. Here's the thing: we can afford the monthly payments on this. We can do so without sacrificing our savings, but the days of eating out would be done.
The rental income on the suite (1-bed) we'd calculate at $800/month. That's the high side of the rental market, but it's in a convenient location, we'd clean the place up and replace anything needed. We pay close to that now, so we anticipate being able to have that kind of income come in. That income would go directly towards maintenance of the house and property taxes. Our tax bracket wouldn't change, so our taxes would be based on an additional $9600 to our income, which we can eliminate by maxing out our RRSP contributions--we both have ample room from our years in college and low-income employment. The room is there for five years.
So why wouldn't we do this? It looks like a no brainer on paper. Even for a boisterous bear like me.
What if we changed the assumptions to something like this:
We experience a moderate correction of 6%/year. I don't think even an ardent bull could argue that this is well in the realm of normal possibility and is fairly indicative of the 94-2001 correction which witnessed just modest price reductions. When compounded though, those modest corrections can hurt.
Current value (actual): $371,000.
Future sales value at 5 years (assumed): $245,519.
Mortgage principle paydown: $36,000 (approximate).
Approximate loss: $89,481.
Again we've used the rental income to cover taxes and maintenance as a simplistic way to remove those variables out of this complicated analysis. Regardless. When the market increases, you obviously come out ahead. But when the market decreases, you really do get hurt if you have to sell.
If you don't have to sell, you may find yourself living in a place with negative amortization, so you can't go get a HELOC and renovate to make it more comfortable.
It's this possibility that keeps us out of entering into this kind of scenario. It is just too much risk. That 6% decline over 5 years is a compounded 30% correction. That could very well be a reality. It could be less, it could be more, it could be faster, it could be slower. Even if we halved that assumption to 3%, that would still be a $30K loss all things considered. That's my master's degree I want to do over the next few years. That's approximately one-third of our income. That's a lot of money. Did I say a lot?
All signs point to a slowdown in both sales and growth. All signs point towards a looming economic downturn. Dodge is calling on the government to let the market correct the debt crisis, which means some pain is predicted, including raising interest rates. The federal government is trying hard to orchestrate their own defeat because come October 2009's scheduled election there is a highly likely scenario of a less-rosy economic (dare I say recession?) situation.
And this analysis is why we will rent for at least another 6 months. Unless we buy, gulp, a condo; which we'll run over tomorrow.