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August 19, 2017 | The Math of Paying Too Much

Danielle Park

Portfolio Manager and President of Venable Park Investment Counsel ( Ms Park is a financial analyst, attorney, finance author and regular guest on North American media. She is also the author of the best-selling myth-busting book "Juggling Dynamite: An insider's wisdom on money management, markets and wealth that lasts," and a popular daily financial blog:

This past spring Canadian realty prices leapt to a fevered peak that was far beyond historical norms of affordability or investment valuations in many areas.  Since then prices have weakened pretty much all over and many are in shock.  See:  Toronto home buyers and sellers try to stay afloat in a rocky market:

“…buyers who purchased in the spring have become spooked by the decline in prices in the past few months. Tales of buyer’s remorse are common. Some buyers are trying to back out of deals or renegotiate. Mr. Rocca understands the predicament; he has clients who purchased a bungalow on a very good street with the intention of selling it again for a profit.

“They paid a big buck,” he says. “They paid $1.9-million. Now, that bungalow’s worth $1.6-million. It’s scary.”

Scary? Let’s do some math.  If a buyer were funded enough to possess a conventional 20% down payment on 1.9 million, they needed 380K down and a mortgage of $1.520m to close.  Five months later, a price decline of just over 15% has evaporated 79% of their notional equity, reducing it to 80K while still owing a mortgage of 1.520 million.  And that’s if they did not borrow some of the down payment from relatives or other revolving credit.

And we have hardly even started into this mean reversion process.  After leaping 40 or so percent between December 2016 and April 2017 to an average price of $1.455 million in the GTA, and giving back most of that since, average sale prices in the greater Toronto area in July were still $1.177m and some 12k higher than at the start of 2017.  Year over year, many prices are not even negative yet.

But for the majority of households who were already paying more than 50% of their disposable income just to keep the roof over their heads, a 15 to 20% price decline is not manageable and has already wiped out their equity or put them in a position of owing more than the house is now worth.  This makes refinancing or locking in to fixed rate mortgages very challenging already even without further price corrections or higher interest rates.

This is the math of paying too much.  Whether it’s for investment securities, real estate or anything else that is supposed to hold value or appreciate over time.  The price we pay locks in our return experience for years thereafter.  A great many people are going to learn this lesson the hard way yet again in the months and years ahead.

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August 19th, 2017

Posted In: Juggling Dynamite

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