Wednesday, July 6, 2011

Interest rates: buy low or buy high?

Only when the tide goes out do you discover who's been swimming naked ~ Warren Buffet
There's a conventional wisdom thought in the real estate world that buying a home during times of low interest rates is a good thing. This is very true at the beginning of cycles, but nothing could be farther from the truth at the end of cycles. Back in 2000-2001, when the Victoria real estate market started heating up after the doldrums of the 1990s, we watched interest rates drop over 3% seemingly overnight. If you'd bought a house then, you've likely done exceptionally well in the housing market (especially if you've stayed in it and not lost money to transaction costs). Average reported prices have grown at over 9.6% per year, or almost a full 3% per year higher than the previous 23 year history of appreciation in the Victoria market (1978-2001). See the correlation? 

Reid, way back in 2009, wrote this informative post about interest rate effects on valuations. It contained this simple graphic illustrating the interest rate effects on mortgage affordability:


Let's assume for a minute that the average Victoria first time buyers have an annual income of $100,000. They all have a minimum down payment of some varying degree, but let's say they all have to be CMHC insured. We'll work with the lowest common denominator of 5% down to keep these calculations simple.

At current discounted 5-year interest rates, this household get's qualified for a mortgage that looks something like this:


If mortgage rates rise 2%, like they did between 2004 and 2006, then this same household will be looking at a far different story:

These folks are likely shopping for a single family home, preferring to be in the Saaniches, but perhaps settling in the West Shore when they see the differences their money can buy. Very few of these folks will be thinking to themselves, if I can't find a house I like, I'll just buy a condo. A few might consider, or even purchase, a townhouse. But the fine folks looking to live downtown in the new highrises aren't out shopping for fixer uppers in Marigold. These are different markets altogether.  

Affordability plays a huge role in real estate prices. Average households with average incomes, by and large, are out shopping for the average house. They could, relatively, easily get it in 2001-2004. During the period 2004-2007 it became far more difficult for a variety of reasons, interest rates being one of them. Then in 2007, mortgage product innovation (extended amortizations and no down payments) coupled with drastic interest rate reductions in late 2008 and early 2009 coupled to pour gas on the fire of what was then a quickly falling market. 

There are no policy options left: the government's move to curtail extended amortization and no skin in the game mortgages (#fail), signals the death of these choices and fixed-term interest rates can't get any lower. Which leaves us where we are today: record high prices, coupled with record low interest rates, and some of the most unaffordable housing options in Victoria's history. 

If you do fit the mold of the above household, choose to buy today at your max, and interest rates rise 2% in the next five years, you could be perilously close to being underwater in your home should prices track affordability over the same time frame, which they mostly have over the past 33 year history in Victoria.  

53 comments:

Just Janice said...

I think we're sitting safely on the sidelines again - due to CMHC rules and a self-employed DH - we don't have the income (in CMHC's eyes) neccessary to buy the kind of place we want to buy (5 bedroom, 3 bathroom - in Fairfield/Oak Bay or within a 20 minute commute with all kinds of land that is not a series of endless to-do projects). Our options were to increase the downpayment (it'll take time as we paid of all our debts) or get a co-signor (thanks, but no-thanks).

I generally agree that now is likely the worse time in the history of the Victoria real estate market to buy a house. It might be a 'buyer's market' but the VREB can keep it.

As an aside Beach looks like it'll go for about $1.068M and needs about $70k to finish to occupancy.

Just Janice said...

In terms of interest rates - we're in bizarre territory. The Bank of Canada's primary goal is to keep inflation in check (ie. not to sustain the housing market). Inflation has been running a bit on the high side. The Bank of Canada will raise interest rates.

Unless you hold a variable mortgage or were planning on going variable - this might mean fiddlesticks to you as fixed mortgage rates are determined in the bond-market.

IMO it's entirely plausible for Canada to find itself in a high-interest rate environment, with high levels of unemployment and wide-spread house price deflation. There's an elephant in the room.

Reid said...

And if they still allowed 40 year amortizations as they did 15 months ago the $518k that someone could borrow at 3.6% in the posted example would have increased to about $620k. At 5.6% and 30 years (todays maximum) it is $412k or more than $200k less. If and once discounted five year rates get into the 5.5% to 6% range that is my estimate of what you see SFH home prices drop. Add in a bunch of foreclsoures and it could be worse.

bullwhip29 said...

I wouldn't assume that the current interest rate environment is about to change dramatically anytime soon. Things in the US are not improving, so many/all of the stimulative measures currently in place will remain as is for the foreseeable future. Think Japan, folks. That being said, zero interest rates didn't work there anyway. Prices still fell, people stopped spending etc. despite the massive amounts of personal saving that the Japanese had (unlike the average citizens of this generation). Personally, I think Carney is full of hot air. He has been warning us that changes are coming imminently (meanwhile months, years...go by without any action). Bottomline, Cda and the US are attached at the hip. We go as they go. If Carney was bold enough to break from the pack and do the "right" thing, he would also deep six the Cdn economy in the process. By not doing anything he is simply delaying the inevitable.

Just Jack said...

So what do investors think of the current market. By investor, I don't mean the person renting out part of their home, but the ones who look at the property on its income producing potential.

A recent sale of a purpose built four suite building just sold for $730,000. The property generated $4,900 a month or $58,800 per annum. Thats a monthly rental factor of 149 or a gross rent multiplier of 12.4

And the four suiter previously sold in September 2001 for $400,000. That's an 83% increase over the last decade.

Meanwhile the median price of a home in the core municipalities went from $237,500 to $609,500 or up 157%

Do you think, the investor knows something we don't? If investors are the leading edge of the market, they seem to be factoring in a decline of close to 30% in today's core district prices.

As for new housing in Langford. The bloom has come off the Rose, as prices have rolled back to the first quarter of 2007. Such as the re-sale home on Wild Berry that sold in March 2007 for $441,000 and sold this week for $450,000.

I wonder if someone sold back in 2007, invested their money and rented a similar home, would they be better off today than someone still making payments to the bank?

My spider senses say - yes.

HouseHuntVictoria said...

Do you think, the investor knows something we don't? If investors are the leading edge of the market, they seem to be factoring in a decline of close to 30% in today's core district prices.

Apart from a brief period of two years or so during the last decade investors for the most part have been required to have some of their own skin in the game. They (typically) can't get access to funds at the banks like the average owner-occupier can, and therefore the market for true revenue generating properties like your example hasn't been impacted to the same degree by interest rates and speculation.

Just Jack said...

Which would help explain the drop in the volume of home sales too. As the demand for revenue properties has declined sharply with the recent changes in CMHC guidelines.

So it may no longer be home owner versus house investor/speculator bidding against each other driving the prices up.

Interestingly though, if the demand by home owners shriveled up, then it would take a 30% drop in prices to stimulate the investors to buy back into the market.

Robert Reynolds - HMR Insurance said...

Revenue properties are akin to other investments like bonds or stocks. When an investor buys a revenue property they are looking at totally different metrics to a SFH buyer.

Investors are looking for the best rate of return for the lowest perceived risk. For most RE investors this is a return of 6-8% after expenses. Rents and purchase price determine this return. Rents are what they are, there isn't a lot you can do to influence them. So the one metric to focus on is the purchase price.

Using the example above with $58,800 of income and a price of $730,000 that is a gross return of 8.05%. Deduct from that, interest payments, property taxes, maintenance, insurance, heat and electric, vacancies, etc.

Net rate of return is probably 5%-ish (depending on financing, if it is heavily mortgaged it could be cashflow negative). Which is the bottom end of the investment scale. $730,000 is about as expensive as this property can get based on its income. If the return was worse, the investor would simply turn to something more secure and less effort like long bonds.

Just Jack said...

The investor should almost always be the lowest bidder for a property. Of course when human emotions come into play and/or the investor is unskilled that could change. Especially when the novice investor is no longer looking just at cash flow, but market appreciation as well. Which may actually put them into the speculator field.

Nevertheless, if sale volume continues to decline and inventory increases, its the investor that would come to the rescue of the marketplace. But prices would have to be a third less than today.

This is what happened to the "leaky" condos. A prospective purchaser for home ownership couldn't get inexpensive mortgage financing. However, investors were able to use their unimpaired properties as collateral for the loan. However, the purchase price had to be low enough, to give the investor a return on their equity. That meant condominiums that had been selling for $150,000 had to drop down to $25,000 or $50,000 to cover the remediation costs and provide a reasonable return. It was the investor that stepped in to stop the slide of prices going any further.

Dave said...

Others have said that inventories on their PCS have been dropping. I don't see it on mine. Up to a month ago I was staying flat at 160 for a couple months, Today I just hit 190 listings.
SFH-saanich west, highlands,view royal min 2bd, 300K-1,000K

Dave#1

Leo S said...

@Dave That was me, and I take it back. Looks like it was a temporary blip. Still rising.

Just Jack said...

The only area that I can say for sure that listings have decreased is Oak Bay. There are about 88 listings and 3 months of inventory in Oak Bay.

Oak Bay is not my thing, so I don't keep a good watch on it.

jesse said...

@RR I agree with you on the investment property front. There are enough landlords operating in the amateur market to tell me where prices are headed. See "consumer surplus".

Alexandrahere said...

Marko: What would a realistic selling price be for MLS 294093 at 202-2340 Oak Bay Ave? It is a 2 bed, 2bath co-op? I understand they are much harder to attain a mortgage on. What are the ins and outs of purchasing a private co-op? Thanks

Just Jack said...

The difficulty with lending on co-operatives is that there is no title to the individual property. You are purchasing shares in the corporation which comprises the entire complex. So you might be buying 30,000 shares out of 400,000 in a $3,000,000 property. And transfer of these shares are restricted.

If you default in your mortgage payment the bank has no title to your unit to take back. That makes foreclosing on a co-op very difficult and the banks will want additional collateral or a co-signor. Most banks will not even process this kind of loan and I believe CMHC will not insure the mortgage.

That leaves you with private financing which can be expensive or buying all cash. And that negatively affects the value of the property relative to a strata titled complex.

Co-op's do not see the same kind of appreciation in the market as strata condominiums. For example here are the last four sales in the this Oak Bay complex of the identical unit as 202 but on the floors above.

#402 bought Sept 1992 - $195,000
#402 bought Sept 1995 - $215,000
#202 bought Sept 2003 - $225,000
#302 bought April 2005 - $289,000

And #202 currently listed $296,000

Meanwhile prices for strata titled condominiums have more than doubled since 1995 from a median price of $133,000 to today's $305,000.

The chances are good, that you may be the only offer on this property.

But if you are sure that this is the last home you will ever own. That you will never be able to tap into the equity with traditional bank financing and your heirs may have a problem selling in the future. A co-op is an inexpensive alternative to the traditional strata ownership.

Would I buy one. Yup, if I were in my 70's.

Didn't mean to steal your thunder Marko. I found out most of this two weeks ago while riding my bike in Oak Bay and stopped to talk to little old lady that owned one of the co-ops.

patriotz said...

JJ you've given an excellent example of why price increases for condos (or SFH) have been simply due to easy credit, not to an increase in fundamental demand, by comparing to co-ops which have much more restrictive financing.

Which means that condos have a lot more price downside going forward.

Not to say that co-ops are a good buy at today's prices though. I wouldn't pay more than 100x rent for a condo and would pay less for a co-op. You really don't own either of them, it's just that condos present a better illusion that you do.

Just Jack said...

There are other things that are keeping the price of the co-op down too. Such as not being able to rent the suite out. That you have to be 55 years and older. That the maintenance is fee is a whopping $527 a month. And you're buying into a 42 year old building that may have some expensive repairs coming up.

And you need to be approved by the co-op to live there. Even Richard Nixon was refused, when he tried to buy into a co-op in New York. I doubt that will happen - but bring cookies to the meeting anyway.

And along the same lines, but not as restrictive as the above are float homes in the inner harbor. If I were 20 something with a ton of ill gotten gain from flipping pre-built condos, I would waste one of my bank rolls on one of these. - No lawns to cut and my commuter vehicle would be a cigarette boat. Getting to Vancouver and Seattle would take about the same time as getting to Sooke.

a simple man said...

Housing market has peaked, says Royal LePage.

"In many of Canada’s regional markets, we saw house prices appreciate at a significantly faster rate than wages and salaries, and this trend cannot continue indefinitely,"

Alexandrahere said...

Thanks people for your input re co-op's. The one in Oak Bay is indeed intriguing in that it has three beds and two full baths and is over 1500 sq. ft.

The taxes are also included in the co-op fees.

I wonder how this particular 1969ish co-op got started. Would it have been a bunch of "rich" investors getting together and building these huge and then luxurious units? Or would it have been purposely built as an apartment block and then turned into this "new" co-op idea?

Makes you wonder why they, the co-op members don't turn this ideally situated building into individual strata units. True, it would cost a bit, however they would get well over 200K more for each unit especially if they did some minor remodeling.

Reid said...

@Patriotz - "I wouldn't pay more than 100x rent for a condo and would pay less for a co-op."

100x rent gives you a 12% gross return which at today's interest rates would very profitable. If interest rates were 10%, the cash flow from the investment would be negligible or negative.

Does your 100x rent price benchmark vary at all with interest rates?

Just Jack said...

From what I understand the concept of individually titled condominiums (stratas) didn't exist until the early 1970's. Before that, the complexes were co-ops or leaseholds (you own your suite, but the land is owned by someone else).

You also find buildings that were originally rental apartments that have been converted to strata titled suites.

Yet, I have never heard of a co-op being converted to a strata? Maybe the building has to be brought up to current building codes if it were to be converted or the difficulty in getting all of the shareholders to agree.

Maybe in the future, you'll find developers, insurance companies or union funds buying options to purchase in these old co-op's. And nukeing the building thirty years from now.

SilverSurfer said...

Licensed alternative realtor services now have access to post flat fee and other variant listings into MLS.


"The fight for real estate commissions is about to heat up, as two of the industry's biggest agitators join forces in an attempt to steal market share from the country's 100,000 real estate agents.

Propertyguys.com Inc., a company that helps people sell their own homes, will merge with flat-fee brokerage Realtysellers Real Estate Inc. The deal that will make it easier for those who want to handle their own transactions get their properties on the popular Realtor.ca website, which provides the online listings for an estimated 90 per cent of the country's home sales.

The two companies decided to merge after the Competition Bureau and Canadian Real Estate Association changed the rules to allow flat-fee listings to appear on the Multiple Listing Service, if they are posted by a licensed brokerage. Previously, anyone who had a listing on the MLS had to employ an agent to handle every component of a transaction, whether they wanted those services or not, normally for a fee of 4 to 5 per cent of the sale price of a home. At an average price of At an average price of $376,817 that means a commission of up to $18,840."

Just Jack said...

So how are those Pender Island Waterfront acreage properties doing?

This is certainly a limited market. If you're lucky enough to own one of these properties - you should also hope to be lucky enough to sell it. As the prices for this limited market have rolled back to 2005 levels.

Such as the one on Pirates road that was bought March 2005 for $1,400,000 and sold this week for $1,475,000.

The outer fringe properties, to me, are interesting properties to watch. They illustrate how far prices can roll back. Of course, Victoria and Oak Bay should be in greater demand than Pender Island. It may be a stretch to conceive that if demand dropped off to where we have 18 months, like Pender, of inventory our prices could be back to 2005 levels as well.

Yet, Sooke is running 16.5 months of inventory today.

Back in March of 2005 (6 years ago) our prices were 35% lower than they are today.

JMJ said...
This comment has been removed by the author.
Marko said...

I went to the new 21 story Bayview building opening today....

All Promontory Homes Feature:

8'10'' foot ceilings.
Roller blinds
1 secured parking stall
1 secured storage locker
All Prices Include net HST

Studio - 468 sq/ft priced from $219,000
One Bedroom - 531 sq/ft priced from $259,900
Two Bedroom - 731 sq/ft priced from $362,900
Two Bed + Den - 1178 sq/ft priced from $569,000

I was excited when I saw the studio price and parking including but the layout is really poor in my opinion. Also the exposure of the studios is not great either.

I think I'll pass on this one for now and see what the Era and Modrain have to offer....

Just Jack said...

I think there is a problem with the pricing. The price for a studio is quite good but the bigger units are way off. They need someone, like you Marko, to revise the prices.

Watching and waiting said...
This comment has been removed by the author.
Watching and waiting said...

well another 10k price drop at 1627 Hybury Pl down to $699k (beat that St. Ann house) . My scientific prediction came to fruition: "by July 8 it will drop another 10k" - I think I'll buy a lottery ticket ...

Mindset said...

Ok, time for a quick rant.

I just read a few sentences in an article that I thought were unbelievable; "Economists suspect that prices will drop off when interest rates rise, further putting pressure on affordability.", and "We expect price gains to moderate considerably in the latter half of 2011", and "the picture is still not pretty, but much less alarming" (Author Sunny Freeman, the Canadian Press).

...Further putting pressure on afforability? Moderate considerably? Not pretty but much less alarming?

- Affordability relieves pressure.
- Since when is anything moderate 'considerable'?
- Last time I checked, when something is alarming, it's serious.

Are these journalists formally trained in using oxymorons to sound like they are really saying something important, without ever really saying anything at all?

It's no wonder they don't allow comments.

patriotz said...

"Does your 100x rent price benchmark vary at all with interest rates?"

No, because you can't lock in the interest rate at purchase time over the lifetime of the property.

Pretty obvious to me but apparently not to a lot of people.

Just Jack said...

?

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

Any opinions on the Duval in Royal Oak?

Mindset: I agree with your rant, I think you're pretty spot on when you say that they're trained to say something without actually saying anything at all. However, point #2 I disagree with.

mod·er·ate
verb \ˈmä-də-ˌrāt\
transitive verb
1
: to lessen the intensity or extremeness of
To apply the adverb "considerably" to that makes sense to me.

a simple man said...

from the TC business section today:

The average selling price of a detached bungalow in Greater Victoria has dropped nearly five per cent in the last year, according to a Royal LePage survey of house prices.

With inventory rising in all housing categories and reduced sales activity, the average selling price of a detached bungalow in the second quarter of 2011 fell 4.8 per cent year-over-year to $495,000, the survey said.

Just Jack said...

Some of us may be confused about the Royal Lepage Survey. Specifically when there is such a massive difference in the average prices between the local real estate board and the Royal LePage Survey.

What Royal LePage has done is used a benchmark house and compared how that benchmark house has increased or decreased between say June of 2010 and June, 2011.

A benchmark house would be something like the average price of a home built between 1975 to 1995 having between 1,500 to 2,500 finished square feet on a 6,000 to 8,000 square foot lot.

Its a good way of tracking prices - in Vancouver.

But not in Victoria. There just isn't enough sales of benchmark homes. Vancouver has oodles and oodles of standard lots, set out on grid pattern on flat land. The homes are built to the maximum floor area. Its a highly uniform and mostly boring market of "Vancouver Specials".

Imagine the style of housing and lots in Gordon Head but twenty times larger - thats Vancouver.

Victoria is a mixed bag of house styles, house sizes, age, lot size and views. If Royal LePage published the sample size, for Victoria, used to derive the estimate, people would discredit the results as being to few sales.

At this point in our market, the volume of sales is so, so low that benchmarking, averages and medians are inconsistent and we can see gigantic swings in these numbers. Which is exactly what you would expect at the end of the market cycle as the market becomes shallow and dysfunctional.

So, over the next little while, I would take any survey or statistic with a big dose of salt. Especially any stat that uses averages.

You might even find that the real estate board will find it necessary to discredit how they publish their own statistics as being misleading as the average plummets.

The fun is just about to begin as one source tries to discredit another source.

Me, I'm sticking to re-sales of the same house and how prices are rolling back. Some of you may not like it, but (in my world) it's the most accurate.

a simple man said...

JJ - I really appreciate your method - it should be the standard for reporting, but it is not. Ideally, I would like to see the stats reported as they are, along with medians, SD's ect to get a sense of chnages over the short term (within a yr) as well as JJ's method for chnages over longer terms.

Alexandrahere said...

What I noticed about the Royal LePage survey is the difference between the average selling price of a bungalow $495K and the average selling price of a two storey home at $477K Most bungalows were built in the 1920s thru to the 1960s and most two storey homes here were built from 1970 on. Bungalows being the entire living area on the main floor with a partial in-ground basement, and two stories in the 70's & 80's having a ground level entrance (later usually finished), and the living area all on the top (main) level; and lastly two stories built in the 90's & 2000's having a mix but mostly the main living area at the ground level entry & the bedrooms on the top level. So, if the bungalows have the larger sale prices, then the homes built pre 1970 are going for an average of $18,000 more than those built post 1970. Of course the majority of bungalows are located in the four core municipalities.

Mindset said...

I stand corrected in term use Fudiciary.

But it's more of the word trickery I was eluding to, when a statement is made 'that price gains are going to moderate considerably', are prices still going up, staying flat, going down? Where is the information in the statement?

I get really sick of 'information' where it feels like something is being said, but if you take time to examine it, it says a big fat nothing at all.

in·for·ma·tion
Noun
: Facts provided or learned about something or someone

news
Noun
: Newly received or noteworthy information, esp. about recent or important events

Mindset said...

Oh, one more important definition.

prop·a·gan·da
Noun

: Information, esp. of a biased or misleading nature, used to promote or publicize a particular political cause or point of view.

: The dissemination of such information as a political strategy

Fiduciary said...

Mindset: I read that statement as saying "the foot is coming off the gas pedal" with prices. They'll still go up, just not as highly.

I think most readers of this blog, seeing the VREB press releases can agree that they fit much more in the category of propaganda than news. The facts in them are slim and the "analysis" is extremely self-serving. Plus it never helps to have to read a sentence three times to get what they're actually trying to say. I think it's deliberate on their part. When they say "It's a great time to buy" it's clear and simple. Whenever they give bad news, they spin it so much that it's near-impossible to understand.

Leo S said...

when a statement is made 'that price gains are going to moderate considerably', are prices still going up, staying flat, going down? Where is the information in the statement?

They are saying it will continue to go up but at a slower pace. The "considerably" implies a strong reduction in appreciation rate. However I don't think you can interpret that as "prices will go down" unless you assume that price gains can be negative

Fiduciary said...

For any math types, the second derivative flipped from being positive to negative. :)

a simple man said...

but most importantly, the mainstream media is now reporting real estate agencies stating that the market is dropping.

This will play hard into buyer and seller psychology, which may be one of the most important factors of all (greed to panic).

Mindset said...

Fair enough. I'll accept that my general point was made and leave the bad example to die a quick and timely death.

An entire article of this 'stuff' does tend to put one in a state of general confusion, even when an individual sentence holds up on its own as proper english.

Marko said...

http://www.youtube.com/watch?v=Rb8Gzx4bqs4

Leo S said...

An entire article of this 'stuff' does tend to put one in a state of general confusion, even when an individual sentence holds up on its own as proper english.

True. Weasel words are endemic. It allows the media to say anything and nothing at the same time. We need a national journalistic standard banning/strongly discouraging weasel words, similar to what Wikipedia does. If a story can't be written without them, it shouldn't be a story.

Mindset said...

Hi Marko,

Here's Garths post and the blog articles as debate context.

http://tinyurl.com/5w8jph7

Just Jack said...

Watching that video, with the mortgage guy, hurt my brain. It's Friday - I need Vodka.

snev said...

I see that 976 Dunsmuir in Esquimalt has a sold sign- anyone know what it sold for? For a while, it was the cheapest SFH available.

thanks,

Marko said...

Sold price still has not been entered.

Marko

Marko said...

Monday, July 11, 2011 8:00am:

MTD July
2011 2010
Net Unconditional Sales: 140 527
New Listings: 407 1,119
Active Listings: 4,756 4,477

Please Note

•Left Column: stats so far this month
•Right Column: stats for the entire month from last year

a simple man said...

thanks Marko - 140 sales - seems slow out there. Listings still coming hard.

loanmodifications said...

Loan modification programs have been designed to help a home owner repay their mortgage at a lower rate and avoid foreclosure.

loan modification program california