Housing: Rent or Buy (Part 1)

Over the next few weeks, I want to wade carefully into the soul-sucking, downpayment-scrape togethering, real estate and mortgage guy preached, parent endorsed, all holy and reverent, the undisputable, hallowed deity of all Canadian cross-generational horniness: The God of Real Estate.

Coming into 2017, across many parts of Canada except Toronto, we are finally seeing a tapering off of the real estate frenzy. This is after an almost relentless climb in housing prices since the mid-1980s. In 1985 the average house in Canada cost about $78,000; after adjusting for inflation, that translates to $156,000 today. But instead, the average house in Canada now costs more than $475,000. 3 times the inflation-adjusted 1985 number! That's because houses are a proven great investment, their not making more land, and because everyone wants to move to Canada, right?

What Is Housing?

Housing, at its most reasonable level, should be nothing more than a comfortable roof over your head: a place to feel safe, raise a family, be at home, and enjoy. Instead, through careful marketing and with the help of other factors, housing is now widely viewed as a bulletproof investment, and even more dangerous—a status symbol.

Throw in the latest matte finish non-porous fake stone countertops, exotic wide plank hand-scraped hardwood floors, and stainless steel smudge proof brushed finish HGTV advertised star contractor endorsed appliances. What was once a comfortable abode has turned into a wise, equity growing, investment eyes of your peers. The bigger, the better—always.

That massive mortgage carried by many Canadians who live in these polished castles is conveniently ignored because it has been perceptually twisted into "good debt" or necessary debt.

The Reality Check

As a nerdy numbers guy, I feel very scared for my house-horny young Canadian friends. While no one can say anything with certainty, we might be close to the top of the biggest real estate bubble in modern history. Regardless of all the marketable factors and excuses for high-priced real estate, I believe for the most part they are a complete fallacy and time will show reason right.

When it comes to real estate valuations only two numbers matter: household income and interest rates. Over the long term, real estate values cannot deviate from the limitations of these two numbers because they govern purchasing power. Average house prices will not go up if household incomes don't go up. Average house prices will not go up if interest rates don't go down.

Household Income

The median gross household income in Canada right now is about $80,000. Among the provinces, Alberta is the highest at over $100,000 and New Brunswick is the lowest at $70,000. Most of the others are in the mid-to-high $70,000s. At an $80,000 income, the typical Canadian family can afford a max monthly housing cost of around $2,000. (Keep in mind, this leaves practically nothing for savings after other living costs.) Take away your property tax and heating costs and you're left with around $1,650 for your mortgage payment.

At current all-time low interest rates of around 2.5%, your max mortgage amount will be around $375,000 provided you don't need CMHC insurance. To buy the average house in Canada today, a family would need a downpayment of $100,000 to avoid CMHC. That's a considerable sum of money that must come from mysterious places when you take into account BMO found more than half of Canadians have less than $10,000 in the bank.

After adjusting for inflation, the average Canadian household income has barely climbed since about 1985, so we know that household income growth is not the main driver of exponentially higher house prices. What about interest rates?

Come back for Part 2...

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