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May 25, 2016 | The Justifying

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.


Derek lives in Ottawa, thinks the dawn of T2 means house prices there will stop rusting (more civil servants coming) and believes this blog is tragic. At least we agree on one thing.

“I understand that my thinking below runs counter to your theme of housing being BAD, but take a quick look at the numbers,” he says, turning out to be yet another person who badly needs to justify what he’s already done.

“I live in Ottawa and we just bought a 4-Bed, 3-Bath suburban house (around 2,200 sq ft) for around $475K.  To rent the same place would be around $2,200.  So by buying (we paid cash), we will be saving around $26K in rent per year.  Take off $4,500 for taxes and perhaps $5,000 per year maintenance and an extra $500 for insurance and the net savings work out to $16K per year.  So we are basically getting a tax-free 3.3% yield on our money by buying (plus any appreciation- if that happens).  I understand that is not a great return, but as a diversifier (the house will be less than 20% of our net worth), why not?”

For the record, real estate ain’t bad. If it was, I wouldn’t own any. I do. But what it bad is concentrating your net worth in a single asset. Especially one whose value depends on cheap money and HGTV house lust, both of which are now running on fumes. If Derek’s numbers are correct, it sounds like he can afford a house and it makes sense. I just hope he’s not a senior Policy Analyst for the Department of Finance.

First, you can lease an almost-new suburban in an Ottawa burb for $1,600 these days. In fact, rents have been going down. (Here’s one. ) That means the price-to-rent ratio is about 25, even for an “affordable” sub-$500,000 pile. And remember the formula:

  • Price-to-rent ratio of 15 or less – buy the sucker. You’ll save money.
  • Price-to-rent ratio of 16 to 20 – you’ll be money ahead renting.
  • Price-to-rent ratio above 21 – your landlord is a benevolent deity. Or an idiot. Or a realtor with an A7.

And what of Derek’s ‘proof’ that he is actually making a decent ROI by spending $475,000 (no financing) to own a house he could have rented for $19,200 a year? Hmm. Well, property tax, maintenance, insurance, renos and such aside, if he’d invested $475,000 and received a modest 6% return the cash flow would be $2,375 a month. That means (a) his portfolio pays the rent, (b) he keeps his $475,000 liquid and (c) lives in the same house.

In other words, in a market like Ottawa where prices are not hockey-sticking (and never will) there seems to be no financial argument for tying up even a modest half-million bucks on a pile of bricks (actually for that you get metal siding and fake stucco). If the goal is financial independence and the accumulation of wealth, real estate’s no longer a good play, now that we’ve reached the end of the road for ultra-low interest rates. Of course, this ignores the powerful nesting instinct so many people succumb to, or the irrational logic your mom taught you that owning beats renting. It doesn’t.

Well, here’s some news from the Bank of Canada that Derek should also contemplate. As you probably know, the bank did not drop its key interest rate today. In fact, markets now believe this will never happen again. Two months ago the odds of a rate drop some time before the end of 2016 were 40%. Now they’re now heading for single digits. Meanwhile the odds of a US rate hike are traveling hard in the other direction – roughly 60% by summer and 80% by autumn.

Some key language changed in the central bank’s communication this morning. It has long warned about what debt-snorfling piggies we’ve become, but in polite terms – saying household vulnerabilities were ‘edging’ higher. Now they have simply ‘moved higher’. That may not seem to be relevant, but Donald Trump wasn’t either until three months ago. In fact the bank is singling out family debt and cash-flow issues just as a new survey finds a whopping 37% of people are occasionally ‘falling short’ on monthly bill-paying. But has that stopped them from buying trophy houses? Nah.

So we’re at the bottom of the rate curve. Banker dudes know full well any cut would only make those piggies and vulnerabilities fatter, blowing more air into the YVR and GTA gasbags, leading to a landing we’d never forget. Without a doubt the Bank of Canada will resist the upward rate pressure coming from the US for as long as possible, but at the risk of trashing the dollar and goosing inflation. Inevitably, it will move. But long before that, mortgage rates will have reacted. Look for that process to start in weeks.

As always, buy a house if you want.

But don’t use a blog to tell us how smart you are. That’s pathetic

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May 25th, 2016

Posted In: The Greater Fool

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