Is It Time to Buy?

Before we get into this post, I just want to thank the readers who contacted me about the comment verification plug-in failing. I've installed a new verification plug-in that seems to work well and is easier to read than the last one. Comments are back!

Canadians love housing! For nearly two decades now, housing has been the economic story in Canada. Thousands of us have become fantastically rich on paper as prices of tiny lots and chipboard went to the moon.

Of course ridiculous amounts of leverage helped. Prices have only about doubled in the past 10 years, but at a 19:1 leverage ratio the gains on equity appear enormous!

The real estate pushers got really rich! With billions of dollars of housing changing hands each year and 4-5% of that for grabs in sales commissions, these folks have made hay.

When times are good, thanks in large part to horrible government policy, the pushers celebrate the rising "natural" condition of the market.

When prices begin to fall, thanks again in part to horrible government policy, these same middlemen furiously point fingers.

An Update on the Market

Well, at the end of summer 2018, prices and sales volumes are falling in nearly every major Canadian housing market. Things are not looking good at all for sellers or people who extended themselves to buy real estate.

Toronto and Vancouver, the two big Canadian market movers, have seen a massive sales collapse in their single family markets. Sales=to=listings ratios have exploded. We are now in what the pushers call a "buyers market". But that doesn't mean it's time to buy!

Prices are slowly falling alongside, but the real reckoning hasn't started yet. The condition of these big markets reminds me of the Prairie markets back in 2015. Eyes have not been opened yet.

For example, the largest Prairie markets, Calgary and Edmonton are continuing their multi-year price slide across the board. The slide began with low volume and isolated good deals, particularly in the condo space. But it has spread and the price concessions are growing rapidly.

Although the house pumper MLS numbers seem to paint a rosier picture, units in my townhouse complex are selling for almost 20% lower than their brand new price seven years ago! Single family houses in Edmonton that sold for $500,000 ten years ago are now selling for $400,000.

Factors Driving Real Estate Prices

As I've stated before on this blog, house prices are primarily the result of interest rates and household income. With a dose of consumer optimism or pessimism to extend the market one way or another.

Household income needs to expand over time to see an increase in house prices beyond the normal rate of inflation (1-3% per year). In the short term, a fall in interest rates can expand borrowing capacity leading to higher prices while a rise in interest rates leads to price compression.

If the Canadian real estate markets were solely dependent on household incomes, the price of a house would be around $290,000 today. That's if Canadian households spent 20% of their income on mortgage costs (the historical long-term average).

Higher income regions like Toronto, Calgary, and Edmonton would see higher house prices. Same goes for areas that appeal to high net worth individuals, certain areas in southern B.C. for example.

However, it does not explain an national average house price of $630,000. These insane valuations are not economically justifiable in our current circumstance.

No region of Canada is even remotely comparable to the world's higher priced regions like Hong Kong, New York, San Francisco, Singapore, or London.

These are the finance, culture, and industry capitals of the world, filled with millionaires and billionaires who can afford expensive homes. And they are not millionaires just because their houses have increased in value, I'm talking real financial assets with the representative income.

Where Things Are Going

Our house price explosion is purely due to a combination very ominous factors. Record household debt and leverage ratios, extremely relaxed borrowing standards for over ten years, reckless government policy support, and a population that is convinced housing is a get-rich scheme rather than a roof over your head.

These big, long-duration parties come with nasty hangovers, and don't be fooled: no party lasts forever.

Over the past few years an untold number of Canadian families have taken on mortgages of $500,000 or more. The monthly payments are approaching $2,700 at today's best discounted rates. As rates creep up over 4% (yes, it seems to be happening), those payments will balloon over $3,000 a month.

Did I forget to mention, that is after-tax money. If you are earning in the 40% tax bracket, you need to earn a gross income of $5,000 just to pay the mortgage.

Those who took on these monster mortgages when the 5-year fixed rate was less than 2.5% will be shocked when they renew at the end of their terms. They will have a choice of paying at least $500 more per month for the same mortgage, or, if they are lucky, refinance and stretch out the term to keep the payments low.

Already a few years ago, deep-diving economists were raising alarm bells about borrowing. There are more than 1.8 million households with monthly mortgage payments exceeding 20% of their net household income. This group has an average savings rate of -13% of their household income.

The evidence suggests at least hundreds of thousands of households across Canada are perpetually dipping into household equity, or accumulating other debt. Canada might not be the U.S.A., but it turns out people are behaving the same here as the Americans in the 2006-2008 period.

I believe many who already stretched themselves farther than they should have will be forced to sell. If I'm correct, we may be looking at an American-style downward spiral right here in Canada... where no Canadian thought it could ever happen.

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We Moved! And Renting Still Beats Buying

Edited Photo. Source:

Check out our new house! A few months ago I outlined some of my own goals for the coming years. I like to practice what I preach, so we've downsized again.

It's our second move in as many years. I'm admittedly a bit tired of moving at this point, so I locked in a longer-term lease.

Once again, we got rid of a lot of crap in the moving process and would say we are well on our way to minimalism. There are very few things left in our possession which we have not actually used or received meaningful benefit from in the past year.

Our first house was a massive. We bought a fixer-upper a few years ago, did a complete renovation, and eventually sold it for next to zero profit—even in a slightly rising house market. That house was a 1970s split entry with 2,000+ sq.ft. finished area. I estimate our wage rate on all the hours of work we put into the renovations was about $10 per hour. Pitiful considering I'm a journeyman carpenter...

A year ago we moved to a still-too-large-for-us duplex which we rented. (Our first experience renting). It was not ideal and didn't help our vehicle costs or other life costs. But it did get me switched on to the ease of renting. I would estimate that house was approximately 1,500 sq.ft. of finished space plus a full unfinished basement.

Just a few weeks ago, with the help of a few friends, we downsized once again into a 2 bedroom, 2 bath row-house. This place is around 1,100 sq.ft. finished area with a double car garage. The size is just about perfect for us, especially considering we live in a city with 6 months of winter. We spend a fair amount of time indoors during those cold months!

A Financial Evaluation

As shared in a post a long time back, in my former rental duplex I was better off renting than owning by a whopping $400 a month. Twenty-five years down the road, I could reasonably expect to be $250,000 wealthier renting that duplex vs. plunging into ownership.

Once again, I did some calculations before deciding to rent our new townhouse. Ownership is always an option, so it should be considered.

Let's do some Moose Math to figure this one out.


Purchase Price: $320,000
Downpayment: $64,000
Mortgage @ 3%: $1,210/month
Exterior Maintenance/Condo Fee: $280/month
Interior Maintenance Est: $100/month
Insurance: $75/month
Property Tax: $190/month
Total Ownership Cost:  $1,855 during mortgage, or $645 after mortgage is paid off


Rental Fee: $1,550/month
Insurance: $25/month
Total Rental Cost: $1,575

Required Savings: $1,575 (rent) - $645 (ongoing ownership costs) = $930 x 12 months x 25x Rule = $279,000 Savings Requirement
Downpayment Future Value: $64,000 (1.06^25) = $274,700
Compound Interest on Monthly Difference: $1,855 - $1,575 = $280 [(1.005^300)-1)/0.005] = $194,000
Total Future Value in 25 Years for Renting: $468,700

Simply put, in this evaluation I could choose between fulling owning a mortgage free $320,000 townhouse in 25 years, or having a $468,700 investment account. (All in today's dollars).

Naturally we chose renting once again. I firmly believe most renters who invest will be better off than homeowners in the coming decades.

I'll also mention that our former home equity has grown substantially in the past year of renting. At this point the investment gains alone will pay for several years of rent fees.

Based on my math, our former home equity has grown to the point where it will easily cover the net rent costs (Rent Fee - Ongoing Ownership Costs) for the rest of our lives using a 25x Rule.

Investing the downpayment and rent cash flow difference is a key factor here. The fact that house prices are absurdly high in many parts of Canada just makes this an easier win for renters.

Of course, some would say that I'm discounting the outsized historical return of housing, forgetting the leveraged return aspect of homeownership, or just that stocks are "riskier" than houses.

Well let's dig into some of these commonly held beliefs.

Housing Historical Return

Housing in Canada has been on a tear since the 1980s. You shouldn't be surprised about this. But don't kid yourself, it's not a coincidence and it's not a "new normal".

In the past decades, interest rates on mortgages have dropped from 20% to just 2.5%. This has made the cost of borrowing for housing cheaper. Yet, as a percentage of our income, we are spending more on our housing now than we did back then.

In the 1980s, the typical Canadian family spent 20% of their gross household income on mortgage payments. Today that number is more than 26% of gross income. Considering nearly 30% of our incomes get sucked up in income taxes, this is huge!

Lower interest costs plus higher spending as a portion of income means a huge boost in the value of the underlying asset—your house. This can give the illusion that housing is a good investment. But most economists disagree.

It's more likely that we've hit the "max" amount of our household budget that can be spent on mortgage costs and we've also hit the realistic low of mortgage rates. I believe house prices are only likely to go down relative to income from this point.

Already there is substantial evidence the Toronto market is collapsing. From a price peak early this spring, detached house prices have fallen as much as 20%! There's a lot of home equity being wiped out there.

Pretty much everyone who bought a house in the GTA in the past year is in a negative return situation after selling costs now. As our country's largest market by far, this can set the trend for the whole country.

Over very long periods of time, it's generally accepted that housing returns are comparable to the inflation rate. This is expected since inflation rates and wage rates go hand-in-hand.

Leveraged Returns

Housing in Canada is a highly leveraged asset. With at least $1.35 Trillion in mortgage debt alone—nearly the size of Canada's entire economic output in one year—it's apparent that houses and debt go hand in hand.

High leverage can make gains seem great, but losses really really hurt. When buying with a 5% downpayment, your leverage ratio is 19:1 (you borrow $19 for every $1 you put in). This means you realize a magnified gain or loss compared to the base asset.

To put this into realer numbers, take a $500,000 house and you put down 5% ($25,000). If the price of the house goes up 10%, your return on equity is actually 200%. If the house price goes down 10%, your return on equity is -200%. Closing costs not included. A -100% return means your equity is gone, more than that means you owe more than the asset is worth.

In housing, because of the structure of mortgage pay down, your leverage ratio declines over time. This means that a 10% gain in house prices during the first year after purchasing looks a hell of a lot better than a 10% gain 20 years after purchasing. Likewise, a 10% loss in value is much more damaging in the first years after homeownership.

One way to maintain leverage rates at a reasonable 65%, diversify your assets with some real investments, and be on the right side of the tax equation is to use the Smith Manoeuvre.

It's important to remember that leverage works both ways. It looks really smart when your asset goes up in value, but should be avoided when prices are flat or going down. A lot of investors who appear very successful in rising markets get wiped out by taking on too much leverage.

Risk In Housing

Risk can be measured in many ways. One method is to evaluate loss. In the U.S., during their housing crash of 2006-2012, house prices collapsed nearly 40% nationwide.

In the most overheated housing markets of Florida, California, Nevada, and Arizona, house prices fell as much as 70%. That would be devastating, but it's not out of the realm of possibility. What happened before can happen again. A 70% skid would see detached Toronto homes under $500,000 in the future.

A passive stock-bond portfolio can see a drop up to 50%. If you invest following the Dual Momentum strategy, your max loss is about 20%. Depending on your indicators and limits use, your max loss with trading rules can be less than that still.

The worst market conditions in history during the Great Depression, and not even globally diversified, saw a 70% drop in U.S. stocks.

In my view, housing is roughly as risky as a properly invested stock portfolio. Don't over-leverage, don't assume its not risky just because it's a roof over your head, and certainly don't believe housing prices never suffer from severe corrections.

Comments & Questions

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