Where did the buyers go?

It's no secret a significant number of buyers have left the Victoria real estate market. The usual suspects want you to believe it has to do with uncertainty caused by factors like the HST having brought buyers forward earlier this year or is now making them sit on the sidelines until the referendum is held in just under a year's time. There may be some very limited truth to that, but I think there's a more simpler explanation to be found.

A regular reader and sometimes contributor (Reid) in the past once postulated that the availability of credit was the primary driver of prices. I'm inclined to agree with him.

Sales really began to suck, volume-wise, at around the same time that the Federal Government reigned in CMHC's ability to approve mortgage insurance applications. The single biggest change announced, in my opinion anyway, was the rate at which new applicants would have to qualify: the five-year posted rate. They don't have to take this rate, but the five-year-posted rate, in most cases, is what determines the total amount of money a lender will make available to someone needing an insured mortgage product.

Let's have a look at an example: in this case, it's a mythical Victoria couple, early thirties, one child, if any, looking to buy their first home and wanting to purchase a house, not a condo. They may settle on a town home, albeit reluctantly. They're both working, but still in the early stages of their careers and report earnings that are about average for Victorians: $80,000 per year. Through hard work and sacrifice, they've managed to clear off their student/twenty-something debts and save $20,000 in RRSPs they plan to use for their down payment. They've got decent credit and they're confident their bank would work with them to get them into a home.

Prior to April 17, 2010, this couple, let's call them the Smiths, could walk into their bank and make application for a mortgage. They'd likely have their mortgage account manager show them something like this:

They could get a bit more money if they took a variable rate mortgage, but with fixed rates at ridiculously low levels, they're willing to trade a bit on the interest side for the peace of mind of a low fixed rate for the first five years of their home-owning lives.

The Smiths head out shopping. They're underwhelmed to say the least. They knew houses were expensive in Victoria, but they thought they'd be able to find something small in a quiet neighbourhood close to a school for Sally or Steve. Instead the best they could find was this 1500 square foot home on a busy street:

Their REALTOR® cautioned them: although the market was changing, the impending mortgage insurance rule changes would mean they may not be able to find a house like this in their new price range if they waited too long. The Smiths, not completely comfortable with a buying decision at the time, chose to wait and seek a better property. After three, then four months of waiting, seeking and disappointment, their mortgage pre-approval lapsed so they had to head back to their mortgage account manager to find out they now qualify for this, if they use anything less than a five-year fixed rate term (see update below):

 

Even though they can still lock-in a fixed rate over a shorter term or use a variable rate for less than 3.5%, the Smiths will see almost $100,000 of mortgage disappear off their qualification if they make that decision. And now they're doubly disappointed because when they go out shopping, this 1300 square foot home with the busiest highway in the city at the end of its driveway is literally all they can find:

And so they give up over the short-term. They've been renting a decent condo apartment down in the Cook Street Village neighbourhood for a couple of years at just over $1000 per month so they decide to stay put for the time being. The Smiths agree to keep working with the REALTOR® to find a home, knowing that slowly prices are starting to come down and maybe in a year's time they'll have saved another $10,000 and gained another $5,000 in income and perhaps a few more $460,000 homes like they saw in April 2010 will be closer to $400,000 in late 2011. 

Their REALTOR® keeps sending them links to homes, mostly new condos in the Westshore he thinks may peak their interest, but every time the Smiths crunch the numbers they keep saying to themselves, "why would we pay an extra $800 to a $1000 per month to essentially live in a place like we already do but out in Langford instead of within a 15 minute walk to our jobs?"  

UPDATE: Tim Ayres, local REALTOR® points out in the comments that the Smiths would still be able to qualify for their original mortgage amount if they took out a five-year term fixed rate mortgage. In cases where the Smiths want to use a variable rate, or less than 5 years as the term, the second scenario would apply.