Thursday, June 18, 2009

Your home: the investment you think it is?

Note: edited on June 19 to fix formula, H/T to Just Janice and NanHousing in comments for corrections, added two future assumptions below

Many people consider their home to be their primary investment. There are a number of financial and other reasons for long term home ownership including:
  • "fixed" cost of shelter
  • pride
  • perception of security
  • historical market value growth
But is your home the investment you might think it is? The classic definition of investment goes something like this: you take something you have today (money) and create something with it (business, consumer good, income producing asset) to cause a return on investment. Simply put, a return on investment (ROI) is calculated as gain from investment minus investment cost divided by investment cost.

For example: you give me $1 (cost) I agree to give you back $1.10 in 1 year (gain) = $0.10/$1 = 10%.

There are a number of factors that go into determining the quality of an investment, not the least of which are:
  • ROI rate
  • liquidity
  • risk of capital loss
  • ROI factors (interest, dividend, yield, capital gain etc)
Usually, the higher the risk, the bigger the gain or loss. Stable, liquid investments historically offer low rates of ROI as a trade off for security of initial capital. If the only source of ROI achieved by a particular investment is capital gains, the investment is usually labeled speculative.

Clearly, a home you own can fit the classic definition of investment. There are two classic ways to achieve ROI in your house: growth of its market value over time concluded with a transaction and rental income (no transaction necessary).

Here's the wrinkle: most people today see this as the calculation that makes the home they've owned over the past 7 years such a great investment: sale price ($500K) minus purchase price ($250K) divided by purchase price = 100% over the ownership period or 10.4% annually.

What happens when you calculate the real--and keep in mind this formula is very rough--ROI as: sale price ($500K) minus [down payment ($12.5K) + interest paid ($72K) + principle paid ($11.5K) + taxes paid ($14K) + maintenance paid ($17.5K) + sales costs paid ($20K) + mortgage balance repayment ($228.5K)] = $124K/$24K = 516%.

The above formula doesn't account for inflation of 2%-3% per year and guesstimates the interest, maintenance and taxes (conservatively).

There are costs associated with "investing" in a house. The over-simplified model of ROI used by the media and the real estate industry typically ignores those costs. Even my simplified model formula doesn't include all of the myriad extra costs that homeowners pay that renters don't. Ignoring the costs associated with home ownership clouds the true ROI, even in so-called boom times like we've just experienced. If housing only stays flat year-over-year for the next several years, ROI diminishes then disappears as time goes on. Here's a couple of examples (ownership costs * = sum of above list):

Buy today, flat market for 5 years
Purchase price = $500K
Down payment = $25K
Principle payments = $31.5K
Sale price = $500K
Ownership costs* = $601K
ROI = loss of $101K or -178%

Buy today, falling market for 5 years
Purchase price = $500K
Down payment = $25K
Principle payments = $31.5K
Sale price = $450K (10% loss over 5 years or approx. 2%/year)
Ownership costs* = $601K
ROI = loss of $151K or -267%

Assumes a 5 year 30 year amortization mortgage at 4.5%.


Ryan said...

A lot of people don't know what investing means. They say "investing" when they mean "speculating".

Traditionally, owning your home has been a good investment because it is cheaper than renting over the long term. Rent goes up with inflation, while the portion of your mortgage payment going toward interest goes down over time. You get a return on your investment in the sense that shelter is a necessary expense, and your cost for shelter is lowered.

However, in the recent market buying has not been cheaper, and thus real estate has not been a good investment. The realtors and the sheeple then changed their definition of "good investment" to mean expected price appreciation, unsupported by fundamentals or historical data.

That's not investing, that's speculating. People have been speculating on real estate (and winning) while calling it investing for so long here that some people have forgotten the true definition of the word. They have such short memories that they think real estate always goes up because it has been going up for five years. Unfortunately, the market's definition of what the market "always" does goes back further than that.

Vic said...

That is why many will get burnt in the coming year as the profits don't materialize. Their expectations of making money, and it not just being a home, will overrule when they get sick of paying twice or more what they were paying for rent. After all the novelty of the new furniture etc wears off then reality sinks in. Toss in any employment problems and the mortgage payments and the stress pressures appear.

I have been lucky to make cash on all 3 homes I have owned but knew any potential profits were years down the road not by the following spring. It is part of our new culture and pressure young couples have when they see their friends getting in because grandma opened up the bank early for them. How can they refuse the easy money from parents and the bank if their jobs are even halfways safe ?

Just Janice said...

Hate to be a bit of a pain in the but here but the calculation is off, just a bit because of the leverage involved.

The original homeowner bought the house for $250,000. Let's assume he bought for 5% down ($12,500) plus property transfer taxes, etc. He also paid a mortgage (for ease of calculation, we'll assume that the mortgage amount after closing costs, etc. was $240,000). At 5% and 25 year term the mortgage payments are $1395 per month. At the end of 5 years, this person will have paid down the mortgage to $214,418. He will have also paid $83,700 in mortgage payments. So the total investment (ignoring property taxes and maintenance) would have been $96,200 over the five years. If he sells and gets $500,000 for his house he will realize ($500,000 - $214,418 (mortgage owing) - $20,000 (realtor and legal fees)) = $265,582. So the return on investment is 276%...give or take.

But that only works in a rising market. If it's flat or falling you get screwed fast. If 5 years pass and there is no price appreciation, the ROI would be $250,000 (sale price) - $214,418 (mortgage owing) - $15,000 (realtor and legal) = $20,582 (money in jeans). For which this chump would have paid $96,200. Put in $96,200 and get out $20,582...way to get ahead!! Over 5 years, this buyer's down payment for then next place is just $8,000 more than it was to begin with.

This is why RE investment in a flat market does not make sense...unless of course the mortgage is less than what the cost of renting would have been, as you must live somewhere (which in Victoria is just not the case)...

HouseHuntVictoria said...

Just Janice,

Educate me a bit here please. I understand you're calculating the ROI based on the "investment" of the down payment. I over simplified by assuming a short time frame and not basing the math on the down payment. If we extended the time frame out to the life of mortgage (say 25 years) this drastically changes your math and mine right?

Say I bought in 1982 and sold in 2007?

1982 = $150K
2007 = $500K
Interest paid (8% avg rate) = $193,446

so ROI will = $500K - $150K - $193K - $20K = $137,000/$150,000 = 9% over 25 years or 0.36% annually. Taxes, maintenance and other ownership costs actually have you losing money in this scenario right?

But if you hold at this stage, your real ROI is calculated in terms of the monthly net savings from eliminating the mortgage payment right?

NanHousing said...


137/150 = 91% and is 2.5% over the 25 year term.

Also, something doubling over 7 years increases 10.5% each year and not 14%.

I think these examples are good to look at if someone is simply buying a house as a pure investment and not living in it or renting it out. It would simply go unused

There are many variables such as buying vs renting costs and if the place is being rented out.

HouseHuntVictoria said...

I see my math needs remedial work. Thanks for the corrections.

Inglishmagor said...
This comment has been removed by the author.
Inglishmagor said...

JustJanice has a very good point. The stories and desire to buy into real estate aren't just the idea of doubling your money over 20 years. It's the idea that you can pay 2,500 per month for 2 years, then flip the place for double your buy in.

With the idea that any house will be up 30% in 2 years leads to the idea the more house you can squeeze into the more profit on the sale. The oddest part of this is that I don't think a lot of people were actually purchasing to do this. The accepted knowledge that you could sell at a huge profit was enough of an incentive to not worry about personal affordability.

With the prices staying up for so long it reached a point where people really don't think they are stretching anymore. It just became normal for a home to be worth a lot. With the bulk of Canadians wealth tied to their home, there are only two options going forward. Return housing prices to be affordable to the average wage (hurting home owners). Or inflate the money supply until wages make current prices affordable (hurting savers).

From a firm belief that the price of a home must be tied to the wage of a family, this market has been a gamble for the last 3 to 4 years. As mentioned above, yes people have made out. But logically the risk is larger than the reward. Unless of course the government constantly reshuffles the rules to your benefit. Again how long can you bet on that unknowable factor?

Just Janice said...

I calculated the ROI purely based on the money that the buyer put in...and I assumed a 5 year flip with the kind of insane conditions that have prevailed over the last 5 years. The conditions we've been seeing aren't the result of somebody buying a house and committing to be there for 25 years. The conditions we're seeing is a result of leveraging downpayments to the max and then repeating the performance.

Right now, it's almost become cultural. The way to get ahead has been to buy as much house as you can as soon as you can with as little down as you can and then move up as soon as you can get a bigger house with a bigger mortgage with more room for gain. But again keeping the actual skin in the game to a minimum, and 'investing the profits' elsewhere. It's been a situation where people have put equity growth on steroids, and has generated both a housing bubble and a stock bubble and only now is the damage being seen.

The wake up call isn't going to be pretty. Politically, it's a time bomb. With 68% of Canadians owning a home (note - that it's probably a much higher share of 'voting' Canadians) that's a lot of political sway. So unless the decline can be blamed on some force beyond government control, and beyond government rescue - there will be political blood to be paid.

On a policy front, the trick will be finding some solution that harms the fewest voting members of the population. It won't be the right answer, but it'll be the answer with the least amount of political carnage. It'll probably prolong the hurt and delay a return to sanity.

The right answer would return economic stability and sustainability to the system. This means a world where people spend some money on housing, but have enough money to spend some money on everything else as well. It's also a world with fewer construction jobs but more other jobs, and probably a little less homelessness.

Just Janice said...

My calculation also included all mortgage payments over the term of the investment.

The math definitely changes depending on what costs you include or exclude. However, I would say the basic is that the "investment made" is equal to:

Downpayment + mortgage payments over the term + property taxes + maintenance

The profit is equal to:
Sale Price - Investment Made

The Return on investment is equal to:

Profit/Investment Made

Leverage really does change the game, and makes everything much more complicated and risky. Imagine what the market would be like if to buy a house you had to commit to remain 'invested' in the house for 5 year term if there was a mortgage on it...and you could borrow no more than 4 times your annual household income....

Just Janice said...

Actually making tenure changes to CMHC insured mortgages might be a politically 'low-risk' strategy to begin to return the market to normalcy...

By requiring a person to stay invested in a house at least X years (with a penalty of 50% of the capital gain needing to be paid in tax if they don't)....that would so change things...

You could call it the 'Real Estate Speculators Tax' would give the market a REST...

HouseHuntVictoria said...

Just Janice,

Thanks. I appreciate the clarification and see exactly where I made incorrect assumptions in my formula.

U think changes to market value of homes will be politically disastrous for any executive to make. If you were to introduce a 5 year minimum tenure, market values would decline, possibly slowly, but decline they would right? With the bulk of the boomers having tied up the majority of their "money" in their homes, would they not see this as an attack on their ability to retire?

I think we'll see more liberalism introduced into the mortgage marketplace before we see a retrenchment to a more conservative lending structure.

HouseHuntVictoria said...

U should have been I above.

HouseHuntVictoria said...

Re-worked the math on the front:

If total investment = down payment + mortgage principle payments, that greatly inflates the ROI in my formula. This seems off to me.

Just Janice said...

Like I said - the policies offered will be 'politically correct', but not correct from an economic or fundamental standpoint. Crisis has a way of changing that though.

There's an 'inconvenient truth' to be had, and until it is fully detailed, change will be slow and hard to do. The inconvenient truth, is that looking for a convenient get rich quick scheme was easier than methodically saving for retirement and that that same get rich quick scheme has hooched a whole generation of Canadians who did not drink deeply of the Kool-aid and now find themselves trading off having a kid or two kids or three kids for being able to afford a house. After all, who really wants to work for their money, when really thier money is supposed to work for them and who needs a home, when what you really need is an 'investment'. I'm sure it's the same phenomenon that happend in the 20's, and its part of the reason why the 80 year olds of today are the way they are. On the upside, the kids in pampers today, might just might have the where with all and the courage to put some of their self-interests aside for the interests of the society as a whole.

Vic said...

Garth's current post is a classic.

BC(Before Crash)

"No doubt in my mind that BC real estate is sitting on a fault line and ready for the big one. When it takes 70% of disposable income for the average Vancouver family to carry the average home, you know delusion has replaced logic."

Reid said...

HHV, although I have not studied your new numbers it is a fact that you can make huge returns on real estate if you only put down 5% and markets are rising 10%-15% per year. It is all about leverage, but what people totally miss is that you can also lose huge amounts if market values drop and this can and will have big implications for both over levered owners as well as society in general.

Although a "speculator" may think they are only risking 5% when they make their levered real estate investment but they are legally on the hook for everything that may be lost (including real estate commissions to get rid of the property) if the investment goes bad. There only option out is to declare bankruptcy otherwise pay up.

It has been a long time in BC since we had a real drop in real estate prices, so people just ignore this option and look to how much “money” other have made over the past few years and jump into a financial disaster.

Roger said...

HHV & Just Janice,

The problem with "quick" ROI calculations on real estate is they make a number of assumptions which can lead to significant errors in the result.

In particular, they omit the time value of money. A dollar spent today is not the same as one received 5 years from now. (See Wiki - ROI) One needs to make some prediction of inflation in order to do the calculations. Spreadsheet programs have built in functions which will calculate the present value (PV) or future value (FV) of a series of cash flows (i.e down payment, mortgage payments, taxes, maintenance, rental income etc.).

The second factor that needs to be considered is how the property is used. If the property was rented during the time it was owned there would be a series of rental payments that would have a positive impact on the ROI. If the owner lives in the property the ROI drops but there is a personal benefit because rent is not paid somewhere else.

In a nutshell you need to build a spreadsheet or use one of the online tools in order to get meaningful answers.

Just Janice said...

In a low inflation environment - the time value of money is pretty minor. It matters when inflation is high...but not so much when inflation is low. CPI has been around 2% for many years now, and right now we're actually facing the prospect of slight deflation.

My point being that unless the time horizon is long, doing a present value calculation when all you're really wanting to do is an example for illustrative purposes, complicates things without adding (much) value.

This is why I don't do a Net Present Value in this example- the time horizons are short, inflation is low, and the illustration would remain largely unchanged.

The point about leverage and risk, and trying to explain why things are going to get ugly is more important in my opinion.

HouseHuntVictoria said...


Agreed. After messing around with this stuff for 24 hours I'm ready to toss it out the window. I completely understand why no one in the industry wants to have this discussion with the average buyer... we just won't get it, and it's highly unlikely anyone in the industry dealing with the average buyer does either.

Helen said...

HHV "getting it" should be just the kind of thing this blog can help us with, so I hope you don't toss finding a methodology for ROI entirely "out the window". I know it's not the only lens, or perhaps even 'best' lens to evaluate home ownership, but it does provide an important aspect of the decision I think. (besides people will accuse us of just 'not liking the potential answer' unless we hunt this one down).

I also think we all understand that leverage cuts both ways, and that the goal for a would-be homeowner is to find ways to mitigate exposure to risk that leverage creates (e.g. only buying what one can truly afford so that they can ride out decreases in value), while also enabling conditions where the potentially significant rewards of leverage can be realized.

I guess the one thing I would say about leverage as it pertains to home-ownership is that I would never borrow $400k to make a play in equities (or god forbid, commodities). However, provided I've done my homework and I can reasonably afford to keep up payments, with a house, my exposure to risk is minimized since I would still be able to live in it.

Finally, one consideration on ROI that I didn't see mentioned, perhaps because it is too obvious, is that if you are patient, and apply that leverage on buying a house for $400k next year instead of $480k today, your ultimate ROI looks even sweeter.

Roger said...

Here is an online Canadian rent vs. buy tool that is very useful. It takes into account inflation, property taxes, CMHC insurance, investment return, rent, sales commission etc. However, maintenance is not included in the calculations. Press the view report button for a complete breakdown of how the calculations are done.

Rent vs. Buy Tool..

I have prepared a number of illustrative examples based on a 500K house purchase with a minimal 5% down payment. Inflation was assumed to at the mid-range of the BOC target of 2.5%. Mortgage interest was at 6.2% which is the 18 year historical average.

This example shows that with an annual house appreciation of 2.5% it takes 13 years to break even with renting.

This example shows that with an annual house appreciation of 3.5% it takes 5.8 years to break even with renting.

But what happens if houses do not keep up with inflation and only appreciate at 2% per year?. In this case it takes 22.1 years to break even with renting.

I encourage folks to experiment with this tool. You can see that results are quite sensitive to even small changes in inflation, mortgage and investment return rates.

jesse said...

Including financing in doing an ROI calculation confuses things. If the property is not a good investment by purchasing it with 100% cash, it can never be a good investment (ex speculation) by including financing. Banks don't give away money for free.

The one that always gets people is not factoring in depreciation.

Consider why large corporations are not investing in residential housing in BC. It's because the returns suck. If you look at the cap rates they need, based upon REIT investments in other parts of the world, a condo should have a cap rate around 10%, detached perhaps a bit less depending upon the area.

Dealing with ROI and financing muddles things when trying to look at the big picture

Roger said...

In my previous examples I did not include maintenance in the examples although it is a possible input. How much is a reasonable figure? If the house is fairly new I think $2400 per year is pretty conservative. This takes into account annual landscaping, painting, appliance repair etc.

In the example above (with no maintenance costs) if the house appreciated at 3.5% it will take 5.8 years to break even with renting.

If we add in the $200 per month maintenance it takes 8.7 years as shown here. If the place needs $400 a month maintenance it takes 18.4 years.

Roger said...

Some of the readers might be wondering about all those buyers getting 3.8%, 35 year amortization loans on pre-approval. Will they be able to sell in five years and be ahead of the renter?

Many are buying older homes needing work. Lets use $300 per month maintenance to get the place in shape. The renter's investment returns will be lower than historical averages over the next five years so I will use 4.5% after tax (i.e. bank preferred shares)

It turns out that the buyer needs to see the house appreciate by 2.1% per year to reach a break even selling price of 555K. Calculations here

Now I bet HHV is saying that he would rent at much less than 2K while he waits to buy. He will save the difference. If the rent were $1500 then the house would need to appreciate by 3.4% annually to 591K before buying would have been a better option. Calculations here

Roger said...


You raise a good point about the impact of financing in the rent vs. buy tradeoffs.

What happens if we ay cash for the property instead of financing?

3.8% Mortgage takes 2.1% house appreciation to break even. in 5 years

No financing takes 1.9% house appreciation to break even in 5.3 years

HouseHuntVictoria said...


The TD Mortgage mutual fund has returned an average of 8.2% since 1975 (inception). If I use that as my tool, and assume housing tracks inflation henceforth, I get this. You estimated that housing in Victoria over the long term returns inflation plus 2.7% right?

jesse said...

"3.8% Mortgage takes 2.1% house appreciation to break even. in 5 years"

So basically you are claiming you make money by leveraging? I would consider adding in opportunity cost; the bank needs to make a profit by renting out its money. In is case it does so by taking a share of your profits.

Reid said...

Interesting quote from Sal Guatieri (Economist) in one of the economic report I get.

"Although household debt relative to income is still
significantly lower in Canada than in the U.S. or Britain, it continues to mount unlike in
those countries or in the Eurozone. Canadians continue to belly-up to the debt bar, with
ultra-low rates driving an all-day happy hour. There’s no doubt that record-low mortgage
rates have juiced Canada’s housing market. In fact, declining mortgage rates have
accounted for three-quarters of the improvement in housing affordability since 2007’s
peak, with minor assists from lower house prices and higher incomes. Because of the
upturn in house prices, affordability fell in May. Though it’s still close to long-run norms, it
could retrace a good part of last year’s improvement should mortgage rates return to
average levels of the past decade (about two to three percentage points above current
levels). Despite the modest correction, house prices remain lofty at 5.8-times household
income versus an average 4.7 (though that’s down from 6.4 at the peak). This is not to say
that Canadian housing markets or consumers are heading straight for a U.S./U.K.-style
crash. But it’s worth remembering that the further house prices go up and the longer
household finances get stretched, the greater the risk of a painful correction. Anyone who
doubts that should talk to an American or British homeowner."

Vic said...

" In fact, declining mortgage rates have accounted for three-quarters of the improvement in housing affordability since 2007’s

And Vancouver affordability index declined from 80% to 70% so everyone back in the pool. This insane acceptance of what is afforfable is the problem here. The MSM wants to keep the boat going til the Olympics,notice their shift from the crash stories a mere 6 weeks ago to now nothing but "now is the time" stories. Once we get a correction in the stock markets ,which can be anytime from now til fall, then we shall see how much "pent up demand" there is.

One other item, they said on Global the other day when discussing housing that 1000 people a month move to Surrey. If this is so, then where is all the job growth to support this with unemployment growing ? They are also implying that all 1000 are buying a house which is totally misleading.

Roger said...

HHV said:

You estimated that housing in Victoria over the long term returns inflation plus 2.7% right?..

I think you might be referring to my historical price graph - click here..

Prices did cycle around inflation + 2.7% until 2004 and then prices departed from this pattern. Reduced down payment requirements, increased amortizations and lower interest rates have been the driving factors. Throw in RE industry and MSM hype as well.

I leave it to the readers to figure out what happens next.

Just Jack said...

So, you have been priced out of homes forever.

And now condominiums and townhouses are too expensive.

Feeling disheartened?

Your "home owner" friends look down on you as a bitter renter.

Well, say hello to the manufactured home!

Here are some median prices for manufactured homes in Victoria

Year Median
2001-2002 $58,500
2002-2003 $69,250
2003-2004 $90,450
2004-2005 $100,750
2005-2006 $102,500
2007-2008 $147,500
2008-2009 $145,000

Change "Trailer Trash" to "Trailer Cash" and start moving up the property ladder to that double wide.

HouseHuntVictoria said...

But Just Jack, they truly aren't making any more trailer park land!

mr4am said...

In other news, realtors were wrong after all. They ARE making more land! 50 cities worth!

Roger said...

You will not see an article like this in the Victoria Times Hollowness.

Globe and Mail - ‘Irresistible' rates drive Canada's recovery..

In the midst of recession, the average national price of Canadian resale homes hit a record level in May. In just 12 months the national real estate market seems to have stumbled and picked itself up again. But those eager to join the bidding wars are being warned that the sudden rebound may not last.

mr4am said...

The MSM, reporting on the Victoria/Vancouver housing recovery due to temporary historic record low interest rates, government stimulus, threats of quantitative easing and seasonal real estate upward swings... and a lot of ignorance.


Just Janice said...

"The Times Hollowness"
That's such a great nick name. Unfortunately it rings true. If I want true analysis and debate on some important issue, I am currently forced to look towards the US (mainly the New York Times)...most Canadian outlets are wanting in this arena.

What's sad is we have just as many issues that merit debate and exploration:
1. Housing Affordability and Homelesness.
2. Health Care
3. Child Care and Education
4. Mental Health and Addictions
5. Legal Matters

And countless others. The thing that gets my goat, is even the fluff of the hollowness is somewhat down letting. Mommy 9-1-1 should really be called Parenting 9-1-1 as it's not just mommies who face dilemmas (step-parents, fathers, grandparents, etc.).

The editorials are occasionally entertaining...but there could be so much more meat to the bones. I suppose the Tyee isn't bad...

Roger said...

Affordability and interest rates..

How much mortgage can a homeowner carry? A good reference site on this topic is Lending Max. Here are some terms you need to know (from Lending Max).

GDS RATIO (Gross Debt Service Ratio): The percentage of gross annual income required to cover payments associated with housing. Payments include mortgage principal, interest, property taxes and sometimes include secondary financing, heating, condominium fees or pad rent.

TDS RATIO (Total debt service ratio): The percentage of gross annual income required to cover payments associated with housing and all other debts and obligations, such as car loans and credit cards.

Lets take a look at a Victoria family with 100K of gross income and a 40K down payment. Assume annual property taxes (after homeowner grant) of $2400 and annual heating costs of $1200. Credit card and car payments are $670 per month. With a mortgage payment of $2370 the GDS is .32 and the TDS is .40 so they are at the maximums.

Here is the maximum 35 year, 5 year fixed mortgage they can carry at various interest rates:

3.7% - 560K
4.2% - 524K
4.7% - 491K
5.2% - 461K
5.7% - 434K
6.2% - 410K

Readers will note that the mortgage to income ratio drops from 5.6x to 4.1x income as rates go from 3.7% to 6.2% (18 year historical average). It is also obvious that when renewing in five years, at higher interest rates, their GDS and TDS will be way over the limits and will be "mortgage poor". This will mean they will have to renew with their current lender because no one else will accept them.

Some economists have said affordability will not erode because incomes will rise as the economy improves and will offset higher interest rates. Here is the household income necessary to obtain a 560K mortgage at various interest rates using a GDS of .32 and a TDS of .40

3.7% - 100K
4.2% - 106K
4.7% - 113K
5.2% - 119K
5.7% - 126K
6.2% - 133K

You can clearly see that required income goes up by 5-6% for every .5% increase in fixed mortgage rates. In the last three weeks five year fixed rates have jumped from 3.7% to 4.2%. Affordability has become worse (5.6x to 5.24x) because incomes did not increase. But buyers still believe that houses will go up. How can prices increase when affordability gets worse?

There is only one way prices will go after interest rates increase - DOWN.

Art Vandelay said...

Roger, good post.

The big intangible that the logical people on this blog don't explicitly account for? Government intervention.

If 2/3 of Canadians have skin in the home-owning game, governments will find ways to bail them out at the expense of savers.

It's not fair. But that's an historical trend I'd bet my life will continue.

Art Vandelay said...

Roger, good post.

The big intangible that the logical people on this blog don't explicitly account for? Government intervention.

If 2/3 of Canadians have skin in the home-owning game, governments will find ways to bail them out at the expense of savers.

It's not fair. But that's an historical trend I'd bet my life will continue.

HouseHuntVictoria said...


What does bailout for homeowners look like in the face of higher inflation?

Do you really think the government will do something to prevent house values dropping 15%-20% that would hurt the greater economy? I don't.

Roger said...


I have heard the government bailout comment from several people. Here is my two cents worth...

When housing crashed in Toronto in the eighties it took ten years for prices to recover. Prices dropped 26% in Victoria after the 1981 peak and did not recover until 1988. Prices took a big tumble in Vancouver after the 1995 peak and took eight years to recover.

In all these cases the government did nothing. One has to remember that the bubbliest cities in Canada are Victoria and Vancouver. The rest of the country has experienced moderate price increases in comparison. Does anyone really think the federal or provincial government will do anything for BC?

And even if they tried it would be futile. Washington has tried to shore up housing in the US but it just keeps getting worse. When your mortgage is bigger than what the house is worth you eventually bail. And when the market crashes buyers are only interested when prices are at vulture levels.

But for now the sellers and agents are having a great party. The recent mortgage rate hikes means they ran out of ice for the koolaid. By fall the band will have gone home and the party will be over.

Just Janice said...

The difference between this bubble and most other bubbles - is that previous RE bubbles were highly localized. This bubble is wide spread, Vic and Van may be the most bubbly, but there are several other Canadian cities that are also bubbly when compared to historical norms and rents. The exception would be maybe Quebec, and maybe some maritime provinces.

It's what makes this a policy nightmare - do something to correct it and hooch a substantial number of voters, or bail-it-out and hooch the economy and future generations. There is no easy fix.

Policies that would bring long-run stability to the housing market:
1. Tenure rules, if you own a home and flip it within 2 or 3 years face a substantial tax hit on your capital gains.
2. Increased down-payment requirements (10% at a minimum).
3. Multiple-of-income maximum rule for CMHC insurance (no more than 4X household income).
4. Banks don't get an automatic bailout when mortgagees default, there should be some penalty to an institution making what is likely to become a 'bad loan'. Perhaps they should lose 10-20% of the amount as an 'insurance deductible'.
5. Maximum 30 year terms.
6. Increased incentives to build purpose built rental units. This would increase competition from reasonable substitutes to owning.

PainInThe said...

As far as government bailouts... just where are they going to get the money when tax revenues go into the toilet when real estate, the economic sector, and consumerism all tank?

Look at California for a look at our future. Of course we don't have their illegal immigration problem, and we've got quite the underground economy going here on the West Coast, but that isn't enough to stave off the inevitable forever.

Roger said...

Just Janice,

You made a number of sound, common sense proposals. Unfortunately there is no common sense at CMHC or in the Federal government when it comes to housing policy.

HouseHuntVictoria said...

Let me play devil's advocate for a second. Why would anyone accept a government placing limits on criteria for home ownership? Wouldn't eliminating the CMHC all together provide a more rigid structure than what's been proposed here? Why not force the banks to underwrite their own loans to would-be homeowners? That will have more "natural" effect on the market than a tenure tax or a minimum down payment scheme.

Don't get me wrong, I'm not suggesting this is the way to go, but if there is so much faith in our banks to do the right thing, then we should get out of the way and let them. They can use their math skills to determine what is fair value and worthy credit risk.

As long as we continue to protect the banks with tax payer cash, I don't think there will be any public pressure to do anything other than make it easier for more people to buy a home.

Economists at the banks have been "worried" about affordability for years, but the loan givers there have the fall back of knowing that CMHC insured loans are limited in their risk, so there is no market incentive for banks to refuse them.

jazzgate said...

"Tenure rules, if you own a home and flip it within 2 or 3 years face a substantial tax hit on your capital gains..."
Excellent concept and a good solution. I wonder how many 'investors' are currently seeking the next capital gains loop hole in case this one is plugged.

Just Jack said...

Accountability and Responsibility

It comes down to the originators of the loans - the mortgage brokers.

These are the people that should be in the gunsights of consumer protectionism.

However, when you have CMHC encouraging eroneous business practises by the lack of enforcement of their own regulations then you have a market that rewards the corrupt and penalizes honest people.

When honest families are out bid on houses by those people, with the aid of broker have falsified their income and debts and by this very fact have driven the prices of homes upwards.

When due dilegence has been illiminated for the sake of speed and commissions. As the case of CMHC when it developed its own computer programme to access a properties worth, rather than an independent appraisal, and then CMHC gives this programme to the brokers to input the data to have the loan approved in minutes. A practise, that again pushes house prices upwards.

This has lead to a mortgage market that is dependent on a steady stream of new mortgages. If the market slows and begins to retract, then the system fails. As those people who have over bought can no longer use their home as an ATM machine. This was the case in the USA and this is route Canada will follow. The only difference is that Canadian politicians will have been able to give themselves time to liquidate their holdings at a high price.

Roger said...

Let's take a further look at what happens to today's buyer in 5 years.

Today - Household income of 100K and a mortgage of 560K as detailed in example above. (35 year amortization, five year fixed @3.7%, $2371 monthly payments)
GDS @ .32 and TDS @.40 which are maximum CMHC levels.

Now five years later inflation has taken hold. Let's assume salaries expenses and debts have increased by 15%. Interest rates are back at historical levels and are 6.2% for a five year fixed term. After 5 years the homeowner's principal has been reduced and the outstanding balance is now 517K. The new monthly payment for a five year fixed with 30 year term is $3139. The GDS is now .365 and the TDS is .445..

This means that nearly 45 cents out of every pre-tax dollar is going to property taxes heat, mortgage and debt payments. If the 115K household income is split evenly between spouses (best case assumption) 23 cents of income is also going to income taxes, CPP and EI. What is left of the 115K income for all other expenses and savings is 37K.

Whether that is enough to cover expenses, savings and plan for retirement will be discussed in other posts.

Reid said...

Great comments over the weekend. You are now getting to the core of what is driving prices so high:
- legislation and policy (35yr amortization, 5% down, no cap on borrowing and 3.65% 5 yr mortgage rates) that has allowed/encourgaged people to borrow far too much
- buyers who do not possess the knowledge to fully understand the risks they are taking in securing 5.5x mortgage debt loans relative to income levels
- buyer who actually believe real estate today is a good investment

When I buy a stock I typically base my decision on whether I think the company will generate higher future cash flows as cash flow and cash flow expectations drive stock prices. You would think a buyer puting down $500k plus on a house would try to understand what will drive the value of their investment.

So what drives house prices in Victoria. It is called affordabilty (as the market is driven from the bottom) and we have seen a classic case of increased affordability over the past three months as five year mortgage rates hit their lowest level ever. Outside of price what drives affordability:
- income growth
- lower mortgage rates (i.e. higher borrowing capacities)
- longer amortization periods

So if you really think houses will increase over the next five years you have to believe that income levels will rise and/or the governments will extend amortization periods again as five year mortgage rates are not going to get below 3.65% again unless we really enter a depression.

In my opinion Jim Flaherty will go down as the worst Finance Minister in Canadian history because he has allowed Canadian lending practices to mimic those offered in the US five years ago. Although we do not offer "sub-prime" mortgages, they are in essence the same; low teaser rates and high borrowing levels relative to borrowers capacity. We all know rates will rise and the resets are going to kill people. Problem is that although Greenspan was able to claim he could never have foreseen the impact of his policies, Flaherty will not be able to make this claim.

If this government was prudent they would have capped mortgage borrowing to 4.0 or 4.5 times family income levels, but they did not as they wanted to stimulate the economy.

Once the Liberals get back in power they will blame the mess on Flaherty.

HouseHuntVictoria said...

Reid, the first round of liberalization of mortgage products began under the Liberal government of Paul Martin. CHMC is operated at arms length of government and they'd been lobbying the Fed's to loosen the restrictions it placed on CMHC so as to allow CMHC to respond to what it called "consumer pressure." This isn't meant to be a defense of Flaherty, who goodness knows has shown a capacity to only do the wrong thing.

IMHO, it really wouldn't matter who is/was in power; the pressure to be seen to be "doing something" to increase home ownership through manufactured affordability was too strong. Home ownership is the single biggest driving force of north american consumerism. Without it, the conditions to create credit wouldn't exist.

Bubble 'n Fizz(le) said...

Policies that would bring long-run stability to the housing market:

1. Tenure rules, if you own a home and flip it within 2 or 3 years face a substantial tax hit on your capital gains.:

2. Increased down-payment requirements (10% at a minimum).:

3. Multiple-of-income maximum rule for CMHC insurance (no more than 4X household income).:

4. Banks don't get an automatic bailout when mortgagees default, there should be some penalty to an institution making what is likely to become a 'bad loan'. Perhaps they should lose 10-20% of the amount as an 'insurance deductible'.:

5. Maximum 30 year terms.:

6. Increased incentives to build purpose built rental units. This would increase competition from reasonable substitutes to owning.

It's not surprising that the bitter renters eventually arrive at mean-spirited policy proposals along the lines of "I can't afford to buy a house so the government should make it more difficult for anyone else." Let me address your socialist suggestions individually.

1. So if working class Joe has to relocate after a year you'll punish him? Oh, I forgot, only rich bastards buy houses so screw them!

2. Suppose the buyer has other collateral or income that makes the loan sound at a lower down payment? Oh, I forgot, only rich bastards buy houses so screw them! Also, why stop at minimum 10% down? Get rid of the RRSP down payment while you're at it.

3. Suppose the buyer has other collateral that makes the loan sound at a lower ratio? Oh, I forgot, only rich bastards buy houses so screw them!

4. Banks (and their shareholders) are already penalized for taking excessive risk. If the market requires a 20% deductible on insurance losses, the market will take it. Oh, I forgot, the banks are rich so screw them!

5. See (2) and (3)

6. Here we get to the crux of the conundrum for bitter renters. You want state controls over market forces AND cheap, plentiful rental accomodation. Yeah, rent controls sure did the trick everywhere they were applied. Not.

HouseHuntVictoria said...

Month-to-date Victoria Real Estate Board Stats: New sales: 648, new listings: 1049, total active listings: 3792 (via Tim Ayres)

mr4am said...

I think you just made the bear's case even more obvious... you shouldn't have to be rich to own a house; however, you should have significant savings and not be loaded with debt up to your eyeballs.

Your retorts are a tad immature. How about sticking to making remarks backed up by logic and investigative analysis?

HouseHuntVictoria said...


How do you reconcile making sweeping generalized statements about "bitter renters" (who I can only assume is directed at anyone on this blog who doesn't own) based on the commentary of a single participant?

There is a wide variety of opinion to be found here. If you can't engage without baseless smearing perhaps it's because you have nothing relevant to offer?

omc said...

I wouldn't bother with B&F, he/she has been shown to be a liar and a loony. I doubt that he/she (to be referred to as "it" to avoid confusion due to multiple personalities) can even separate the lies it has told from the truth.

I would call what we are up to is ensuring our families future and ignoring the propaganda. I offered before to you as a challenge you slunk away from; I am sure my family out earns yours by at least a factor of 2 and we can afford to buy a house easilly in any neighbourhood. We won't because it is a terrible time to buy.

Roger said...

I thought readers might enjoy a good laugh this morning. We often think buyers and agents in Victoria are delusional with statements like "everyone in the world wants to live here".

I was raised in Saskatoon which the Tragically Hip called the "Paris of the Prairies" in their song Wheat Kings. Looks like the good folks of Wakaw, a small town north of Saskatoon, have been listening to this song and drinking KoolAid. The Star Phoenix reports Canal project in Wakaw delayed..

The $200-million canal development that was to transform Wakaw into a resort community comparable to Banff is still on hold due to the struggling national economy, the town's mayor said Friday.

The proposal would see a one-kilometre canal to link the town to nearby Wakaw Lake and the subsequent development of housing, a hotel-spa-convention centre, marina and golf course

The resort development will be able to draw on a substantial part of the provincial population and is also expected to attract visitors and buyers from out of province.

Just Janice said...

B & F -
You're statements cause me to chuckle. The current structure of the market has turned Real Estate into a Ponzi scheme at a system level. The only source of RE growth in value is as a direct result of finding and enabling ever greater numbers of people to assume a suffocating amount of debt, so that the last person can make out like a bandit, even without having added any true value to the property. It works great for those who got in early, (the minority) perhaps at a time when the market had a more 'balanced' structure, but ultimately it hurst those at the base. So you are essentially advocating that the Ponzi scheme be allowed to continue, so those at the bottom of the pyramid can be crushed while giving everything to those in the middle and top end of the pyramid.

We need policies that preserve houses as homes first and reinforce sound personal finances and encourage real economic growth. Imagine if a person could buy a home, and have enough money left over, to save for retirement (perhaps by making real investments that actually create value), and enjoy the brief time they are on this planet by consuming things other than housing (vacations, entertainment, food, education, etc.).

If anything the monthly cost of a mortgage should be (in a 'balanced' and appropriately functioning market), slightly less than rent to compensate for the risk of owning property.

The market is broken, it needs to be fixed, the status quo is unsustainable and harming the rest of the economy.

Reid said...

HHV, I realize the liberalization was started under the Liberals, but what these politicans typcially say when it comes to legislation is that "no one could have ever envisioned this current environment" when we drafted the legislation. I hear it all the time with pension legislation in particular.

So the fact that these extraordinarily low interest rates would allow average Canadian's to borrow upwards of six times their income in mortgage debt I am sure was never "envisioned" when they went to 35 and 40 year mortgages, but here we are. My issue with Flaherty is that he helped pushed the interest rates down and should have recognized the problem this created with respect to borrowing capacity and subsequently limited family borrowing to some reasonable level. Things just get way out of control once you get too close to 0% interest rates and he should understand this. But in placing such limits, it would have stalled the current mini housing boom.

HouseHuntVictoria said...

Reid totally agreed. I understand the need for some kind of intervention in the housing market, but the push back that you'd get in the capital markets as a result would be incredible.

The soft integration of the housing market with the capital and equities market is a phenomenon that i don't think anyone has a complete understanding of either the effects or the solution to the negative effects.

I think policy makers are looking at it as the benefits outweigh the risks. Until we see a drastic correction in Canada, one that causes the gov't to have to bailout CMHC, we won't see a substantial policy shift. I'm not sure I see that kind of crash happening here in this cycle.

Metaldwarf said...

Holy crap, I agree with Bubble N' Fizzle! unclean unclean

I am against regulation for the sake of regulation. Though I am also against bailouts and get out of jail free cards.

If I am a banker and I want to loan money to risky individuals so be it. If I loose money because the risky loans default, I go out of business. No bailouts. If my neighbor is more conservative and makes only good loans he stays in business.

If I am a 5/35/5.5 and I can find a bank which will give me a NINJA loan wicked! When I spend 70% of my income on my mortgage and I can only afford to eat cat food, sucks to be me. No tax breaks, incentives or emergency financing.

A free market economy is self regulating. It will blow some bubbles, some people will get burned, some businesses will die. All of those who get burned made poor decisions. The vast majority will enjoy more competition, better service, better products and lower prices. By introducing a bunch of regulation we add the Greenspan Effect, one change causes another, and another and another... the ultimate effect we cannot see or predict.

Long rant short, if people want to make poor decisions let them. We are all grown ups and can make our own decisions. Also, being grown ups we should have to live with the consequences of our actions.

HouseHuntVictoria said...


Works in theory but not in practice. Not a single "conservative" government has acted in this way ever. The public pressure to protect people from the consequences of their poor decisions has proved overwhelming.

I'm all for free markets and limited intervention in practice, but when the intervention occurs as a reaction I'd rather see a shift to proactive intervention--usually results in better decisions no?

Metaldwarf said...


Proactive intervention is better than reactionary for sure.

Many of the suggested regulations put forward would limit consumer choice, I don't like being told what I can and cannot do, especially by the Govt.

As Bubble N' Fizzle suggested, I don't want my rights curtailed by someone else who thinks it is in my best interest. Feel free to make your own choices, just please don't make mine for me.

HouseHuntVictoria said...


So should we eliminate CMHC altogether? That would force banks to be responsible for own decisions and would likely end up in 20% (or higher) minimum downs and higher interest rates to compensate for added risk.

You'd see markets react very negatively to this, both stock and housing, and further wealth erosion. Do you think there is any realistic chance that any government of any party would actually implement something like this?

Reid said...

There has been lots of intervention by governments over the past twenty years, but when it comes to housing it has all been to increase affordability. Not that many years ago when I first bought a house you needed 20% down and most banks demanded 25% down. You could not extend amortizations beyond 25 years and those were the rules we all lived with. Most buyers were forced to save up front and this was a very important lesson which is missing today. It is really hard to save money and it takes a change in behaviour to do accomplish it.

Now our regulations allow you to basically buy with nothing down and borrow six times your income. Then you say the individual can decide, but lets face it most individuals are financially illiterate. The LONG term cost of these policies on Canadian society will be huge. Forget about the whining when mortgage rates rise, what about the retired who forgot to put anything aside during their working years, who will bail them out.

HouseHuntVictoria said...


If history is to be any guide, the answer is the previous generation: except they're broke too and worse spenders/savers than their parents, or so it would seem.

Metaldwarf said...

lets look at the opposite scenario

Policies that would bring long-run stability to the housing market:

1. Tenure rules, if you own a home and flip it within 2 or 3 years face a substantial tax hit on your capital gains. No tenure rules means more developers more competition, lower margins and lower prices. People paying less taxes on productive work is always a good thing.

2. Increased down-payment requirements (10% at a minimum).:
No down-payment, riskier loans, higher interest charged, higher monthly payments, lower purchasing power, results in lower prices.

3. Multiple-of-income maximum rule for CMHC insurance (no more than 4X household income).: Banks will only loan so much, a natural equilibrium will be found, it might even be 4x income, the equilibrium will benefit the most possible people

4. Banks don't get an automatic bailout when mortgagees default, there should be some penalty to an institution making what is likely to become a 'bad loan'. Perhaps they should lose 10-20% of the amount as an 'insurance deductible'.: With no CHMC, banks will flee from risk, only very credit worthy people with will secure loans at all, only those people with large down-payments will get the best rates. Fewer buyers, less demand, lower prices. This instantly negates points 2&3

5. Maximum 30 year terms.:
So the bank becomes your landlord, 99 year mortgages are born, you never actually own your home, eventually an equilibrium will be reached where more interest payments negates the benefit of the longer amortization. This will probably also help the developers to create more housing, reducing their costs, and thereby margins, so housing should be cheaper since it costs developers less in financing. Point 4 also reduces the number of people that might qualify for this type of loan.

6. Increased incentives to build purpose built rental units. This would increase competition from reasonable substitutes to owning.
: If no one is building rental units there must be a reason for it. Interest only mortgages will make rental units more attractive to build, see point 5. If condos still make more financial sense then rents either need to go up, or condo prices down. Rents are tied to wages, and wages aren't going to change dramatically. If condos become completely unaffordable, more people are forced to rent, increasing demand and prices of rentals, eventually it will start to make sense to build rentals as condos are not selling. Rental prices will find an equilibrium as demand and supply equalize. If rents get high enough to equal buying a condo, what benefit would there be to renting? rental prices have to stay substantially below the cost of buying or no one would rent.

In all circumstances it looks like the opposite of what you suggest provides more options, more creativity, and more benefits to more people. If I am not one of the segments of society that directly benefits the most, so be it. It just means I obviously need to work harder to get to a level where I can benefit. Maybe I am too risk adverse, maybe I don't have good enough credit, maybe my income is too low.

Don't get me wrong, I want to buy a house, but I refuse to mortgage myself to death. I also refuse to use a 35 year mortgage, the market as a whole seems happy to take those risks, good for them, because I don't want to play their game I have to settle for either renting, buying a cheaper property, or earning more money.

Metaldwarf said...

HouseHuntVictoria said...


So should we eliminate CMHC altogether? That would force banks to be responsible for own decisions and would likely end up in 20% (or higher) minimum downs and higher interest rates to compensate for added risk.

You'd see markets react very negatively to this, both stock and housing, and further wealth erosion. Do you think there is any realistic chance that any government of any party would actually implement something like this?

As you said the effects would be devastating. But man housing would get really cheap really fast!

Which is what we all want right?

Of course only those with excellent credit and the ability to save a large down-payment would be able to buy regardless of how cheap things got.

As Reid said above the banks would regulate themselves. 25% down-payments would be the norm, total debt service ratios would be imposed by the lender. the pool of potential buyers would dry up, there would be frantic sellers trying to unload before they lose all their equity as prices plummet. It would be easily as bad as the last 3 years in the states, but would happen overnight, probably worse.

Which just goes to show how out of whack we are. If we have that far to fall, I think something must be very wrong.

And no, I don't expect it will ever happen.

Just Janice said...

Ah MetalDwarf -
If only the evidence of what has happend didn't contradict you oh so badly....
If the market is not to be free completely (and there are good reasons why Banks have rules - see Great Depression), then they must be governed with prudent policy. The policy in place is not prudent, and unfortunately somebody else's bad decisions get paid for in some way, and unfortunately it seems to be indirectly by the public at large.