February 3, 2019 | Just Watch

Dick and Jane (not their real names) want to buy a SFH in 416. It costs $1,145,892 (the average). With land transfer tax, but not counting other closing costs, the actual price is $1,184,677.

D&J have no choice but to cough up a 20% downpayment, since no lender will provide them with CMHC insurance on the mortgage amount. If default coverage was available, they could get away with 95% financing. But for almost seven years now there’s been a million-dollar cap, imposed by Ottawa. That made sense in 2012, when the same house was changing hands for $728,800.

So these guys need to have $230,000 in cash, plus another $39,000 for closing taxes in order to buy, with a mortgage exceeding $900,000. Monthly payments will be about $4,700. Adding in property tax, heating costs and insurance brings that to $5,700. The allowable GDS (gross debt service) ratio is 35%, so Dick & Jane must earn $170,000 to pull this off.

That’s seven times the national median income, and just twenty grand below the threshold for being in the top 1% of all individual earners. And, sadly, $1.1 million currently doesn’t buy prestige in Toronto. Here’s a semi in that price range:

This is why personal finances are in terrible shape and household debt sits at record levels. As one of Ryan’s fancy charts yesterday demonstrated, there’s a near-perfect correlation between the growth in house prices and family indebtedness. Our house lust plus low interest rates have delivered outsized risk. So, things will be changing.

But, sadly, not for the better.

First, politicians are poised to try and reflate housing prices which are now in corrective mode in most markets. This Milkbone-loving blog has already told you about Alberta’s Jason Kenney cozying to realtors and vowing to trash the stress test. There will be more. We’ve also predicted the governing Libs may be using the budget or the election campaign this year to (a) bring back 30-year mortgages, (b) cap or modify the stress test and (c) remove the $1 million ceiling that make D&J produce a 20% downpayment. The combination of a higher price point and longer amortization would let this couple buy the same place with a smaller down and a similar monthly. But, yes, their debt would be over a million and interest charges greater.

Why are elected officials so keen goose housing less than two years after governments declared a real estate emergency, amid FOMO and 30% price hikes?

To get elected and stay elected. Duh. Voters crave homes and since prices haven’t tumbled substantially, politicians seem willing to give up and once again make credit easier to get. For these guys ‘long-term’ means after lunch. Pathetic.

Second, the economy will be slowing and Canadian public policy has allowed real estate to swell to about a quarter of the entire GDP. It’s no surprise the expansionary years will be winding down – something central banks have been signalling. The Fed’s message last week was clear. The interest rate tightening will be over before long. Corporate profits which roared past 20% last year will be just a quarter or a third of that in 2019. Debt servicing costs have mushroomed, but in Canada wages are actually less than inflation. China is leading global growth a bit lower, while the Trump trade war and that absurd government shutdown have taken a toll on expansion. This is the tenth year of advance after the GFC. It’s only reasonable there’s a pause coming.

(I will explain soon how financial portfolios should prepare.)

In any economic slump, no matter how shallow, Canadian real estate will be disproportionately impacted. Given static incomes and sticky house prices, buyers have been using oodles of credit, so even as the pace of sales slows, mortgage indebtedness continues to rise. Add to this an increase in unemployment, a drop in oil prices as global demand for commodities slows and a sluggish, protectionist US economy, and suddenly spending $1.14 million for half a house with a quarter-million-dollar downpayment and seven-figure debt doesn’t look like such a hot idea.

How did Canadian politicians fight the 2008-9 global financial crisis? Right. By making it easier to buy real estate. It worked – even as families became less diversified and more burdened than ever before. And how do you think Ottawa will try to counter the next slow patch? Uh-huh. Just watch.

Garth Turner February 3rd, 2019

Posted In: The Greater Fool

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