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.