- the source for market opinions


March 26, 2017 | The Plot

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.

Welcome to the Greater Fool, saving one young butt after another, while reminding everyone else that the fool who comes after is the greater fool. Like Aaron. “Started reading your blog a month ago and I’m a big fan,” he says, little suspecting what happens when you write me for advice.

“I’m a 26 year old in Toronto who makes about 30K a year. I moved back home 18 months ago to save overhead, and now I have about 50K in savings. My parents however just sold their home and are moving into a 2 bedroom Condo, with a nice chunk of change left over they’ve offered to help me with.

“I’m not an investor, I’m not following the trend, I don’t have FOMO, I just need a place to live. I had hoped to put a down payment on a place, which my Dad will give a hand with co-signing mortgage and rounding out my down payment. The alternative is to rent, but the place I moved out of 18 month ago paying $900 is now $1800. And basically the city’s rent is even higher than buying. Everyone in real estate says get in now, prices are gonna get up to NY levels, but I take your points arguing against this and yes they are biased.

“So, in my situation, given everything you say re: not buying now/just chill, should I really feel too bad about getting into market on a 1 bedroom unit between 400-425K as opposed to throwing away half my savings on a 1 year lease at almost 2k a month on same sized unit? My logic was even a 5% loss/correction is equal to what I throw away on rent instead of building equity, no?”

No, Aaron. Let’s examine why.

First, I hope it’s not lost on you that your parents sold the family real estate, pocketed big bucks, downsized and left you homeless. So if they’re smart enough to cash out of property in these insane times, why are you hot to jump in? There’s no economic argument right now to justify buying a place in Toronto, especially a condo when tens of thousands are under construction. And, no, Toronto is not New York – which is the financial capital of the world. GTA has Drake, and the Leafs.

So with a one-bedroom apartment renting for $1,800 (you can find tons for less) is it really cheaper to buy for $425,000? Would you be further ahead even if prices corrected a little? Let’s see.

Buying that place with a 10% down payment requires $42,500 in cash, leaving a $383,500 mortgage and a $11,900 CMHC insurance premium (typically added to the borrowed amount). So, $395,000 from the bank. At the current three-year rate (2.59%), that costs $1,790 a month. Wohoo! Cheaper than rent!

But wait. There are condo fees, which would be about $400 a month on this unit, plus property tax of about $250. That comes to $2,440 – and you really should factor in the cost of the deposit, because if the $42,500 were invested for a 6.5% return it would yield $250. The true cost of ownership, then, is $2,690 every few weeks. It’s a $990-per-month premium over the average Kijiji Toronto one-bedder rent, at $1,700.

Over three years, Aaron, you’d pay an extra $35,640 to be an owner rather than a renter. Sucks.

But, I hear the realtors, specuvestors, amateur realtors and Brad Lamb cry, owners pay down principal with each monthly cheque. So even if you have to spend almost a grand extra a month to live, you’re building equity!

This is true. Over three years the loan is reduced by $35,100 – down to $387,300 – or almost exactly the extra amount sucked up away by ownership costs. So, where does this leave us?

The argument that owning is cheaper than renting in Toronto (or almost anywhere else) is false. There’s more money ‘thrown away’ by purchasing than renting – evident once the math’s correctly done and the hormones are washed away. But what happens to little Aaron, whose parents obviously don’t like him, if condo prices rise or fall?

Hmm. Well, if the unit is miraculously worth 10% more at the end of his three-year mortgage commitment, that would net him $467,500. From that he needs to pay the outstanding loan ($387,500), plus realtor sales commission ($23,375). And he must deduct his downpayment from the proceeds ($42,500) because that’s just getting his old money back. Then there’s the legal costs involved in buying and selling ($3,000 or more). And HST on the commission ($3,050). So the final profit is: $8,075 – the ultimate payback for spending almost $1,000 a month more than he needed to in order to occupy the same space.

But what if prices decline 10% (a likely scenario over the next three years for overbuilt condos). Now the sale price would be $382,500, less than the $387,500 owed to the bank. Aaron would have to pay $19,125 in commission and $2,500 in HST, and deduct his down payment of $42,500, resulting in a financial loss of $69,125. And just imagine what a 12%, 15% or 20% correction would mean.

As a renter Aaron has no market risk. The landlord carries that. He has no risk that interest rates will be substantially higher when he has to renew. He hasn’t taken the risk of concentrating all of his net worth in a single asset. If some numbnuts moves in next door, or above, Aaron can give his notice and move. If he lands a better job in Vancouver or Atlanta, he can go. And he has no financial obligation to his parents, who threw him under the bus anyway.

In short, why would a 26-year-old ever want a deed, a mortgage, a property tax bill or a chain? What am I missing? Besides, making $30,000 he doesn’t even qualify to borrow almost four hundred grand – too much risk. Unless Daddy cuts a cheque.

See, Aaron, it’s a plot. Run.

STAY INFORMED! Receive our Weekly Recap of thought provoking articles, podcasts, and radio delivered to your inbox for FREE! Sign up here for the Weekly Recap.

March 26th, 2017

Posted In: The Greater Fool

Post a Comment:

Your email address will not be published. Required fields are marked *

All Comments are moderated before appearing on the site


This site uses Akismet to reduce spam. Learn how your comment data is processed.