Mortgage Slaves

by Mr. Cheap

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Toronto Life had an excellent article some time back on mortgage slaves. The Canadian Capitalist has linked to this article before, and I think its an excellent question: is it worthwhile being house poor?

My ex-girlfriend and I discussed buying a place together a few times, and her feeling was always that to live in the areas she’d want to live in, it would cost so much to pay for housing that her quality of life would dramatically shrink. She felt that renting in a decent area, then having extra cash to enjoy life made sense. Now that the real estate market seems to be changing, her perspective seems to make more and more sense.

In a wild market where property prices keep going up and up, it seems to make a lot of sense to stretch the budget to the breaking point, buy the most expensive house you can find and reap the benefits of appreciation. This strategy requires that the party keep going. If prices plateau (or drop) and you’re having trouble making payments, life gets a lot less pleasant in a hurry.

I’ve been reading Garth Turners “Greater Fool” at Indigo when I have time to kill, and he makes an interesting case that we’re coming to the peak (or just past it) of a real estate bubble. Of course, he’s been saying this since 2006, so I’m not sure *HOW* much credit he should get when we actually hit a crash.

When housing grows away from affordability, its dangerous territory. Consider Japan’s real estate boom and bust. Consider Toronto’s condo crash in the 80′s. Consider the US’s current sub-prime crisis. A money article from 1992 sounds like something people might be asking right now in the US. We’ve been here before, and we’ll be here again. I suspects its a continuous cycle of people viewing their homes primarily as shelter, then over time they increasingly view them as investments, until there’s a crash and the family home becomes viewed as shelter again.

I was predicting to anyone who would listen that the Toronto market was going to die once the property transfer tax went into effect. My rationale was that it would heat up demand in the end of 2007 to beat the tax, everyone thinking of buying would buy, then 2008 would be an immediate slump. I’ve been apologizing to people I made this prediction to, as the the media kept reporting that the market was still doing well in 2008.

Then they said there wasn’t as much sales volume in Toronto real estate because of bad weather (riiggghhht). Since then they’re saying that high end properties are dropping in price, and sales volume is going down, but prices are still high (which, supposedly, dropping sales volume is the first step of a real estate decline). When I’m out walking around these days, there seem to be A LOT of properties for sale.

Anyone shopping for Toronto real estate right now, I’d strongly recommend holding off for a couple of months. I have a feeling prices will be dropping soon.

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{ 25 comments… read them below or add one }

1 Four Pillars

I have a strong feeling prices will be dropping soon.

Maybe you can do a follow up article in a few months?? :)

Regarding the transfer tax – I agree that in theory, it should affect the sale prices once it came into effect but a 2% (max) tax is not going to cause a major price correction.

Mike

2 guinness416

It’s boggling me that property is swooning everywhere at once. I’m getting emails from friends/family in the states and Ireland freaking out about house prices, now I gotta worry about TO? (Not that I can afford to live in Dublin yet anyway).

I have to say, I didn’t think the transfer tax would affect the market too much. I mean, look at the people in the TL article. If you’re spending hundreds of thousands + plus closing costs + moving + CMHC insurance, does it really factor in that much? But you know, that’s probably one reason I’m not an economist.

3 Canadian Capitalist

Thanks for the link. The funny thing is people are likely to jump in right away if prices are going up, not wanting to be left out and hold off on buying when prices are falling, hoping to buy it for less in the future.

4 squawkfox

Houses are extremely emotional. People will defend their housing decisions till the end…even if they are mortgage slaves feasting on Ramen. When a person falls emotionally for a house, the 2% transfer tax is not likely a concern or a consideration.

5 Kyle

I do view my current condo as an investment but only because that was the plan to begin with: I was going to live there for 2 or 3 years, then buy another in a nicer area and rent out my old one for a year or two, then sell so I can get the gains tax free. Of course, if prices are flat I will probably live in my current condo for another year or so. The value of the capital gains exemption disappears if there are no gains to begin with and I have a decent place to live in the meantime. I win either way.

6 Mr. Cheap

I guess I wasn’t clear about what I meant, it wasn’t that the price is 2% higher that I felt would kill demand, its that all the people thinking about buying would try to buy before the tax went into effect, then there wouldn’t be many potential buyers left.

Say you were thinking about buying a horse in the next year (you love to ride, or you want to make glue or whatever). You read a report that a new tax is coming in that will take effect in 3 months that will increase the price of horses by 2%. You know you want to buy a horse, so why not buy it before the tax takes effect and save some money? A lot of horse buyers do this, then for the rest of the year hardly anyone is shopping for horses (because all the people on the fence bought to beat the tax). If someone has a horse to sell, they’re going to have a hard time finding a buyer, because all the people who were thinking about getting one, bought early in the year to beat the tax.

That’s what I was predicting would happen with the transfer tax. I was pretty convinced I was wrong, but I’m starting to think I may have been right (and people are just doing their best to hide the housing slump).

Feel free to refer back to this post in 2 months (so we’ll call it June 14th) and tell me if I’m a genius or an idiot! :-)

7 Mr. Cheap

Kyle: Please check with an accountant about your strategy. My understanding is that you need to get a valuation for the property when you START renting it out, then pay the capital gains on any increase to this amount when you sell.

8 NeverStopBuying.com

Mr. Cheap

heard from an accountant friend, I think there is a clause (loophole?) to claim PR on a rental property within 2~3 yrs (for converted-to-rental PR), and therefore avoid capital gains

me being no accountant, is conservative on the RE investing side

9 Four Pillars

Cheap – I see what you mean.

Yes, I had assumed there would be a ‘flurry’ of housing activity to beat the tax.

Ironically I thought some people would end up over paying for their house (by more than 2%) in order to save on the tax….

10 telly

Mr. Cheap is correct. Kyle’s idea to buy a 2nd property, rent out the 1st, and then later sell the 1st won’t fly. You can only have one PR and that would be his 2nd property (the one he’d be living in) so the sale of his 1st would initiate capital gains (we’re in this process now). Again, this is assuming there are capital gains to be had in that year or two…

Being a landlord isn’t fun. It’s even less fun when you’re waiting around for capital gains that may not materialize!

As I’ve said before, I’ve never been a fan of purchasing or converting a property to a rental as a capital gains investment, especially so in the current market. Buy for cash flow. The burden of being a landlord is much harder without it.

11 Garth Turner

‘Reading my book at Indigo’? What kind of a cheapskate are you?

Buy it!

Regards,
Garth

12 Kyle

Telly, are you sure? I’ve had friends and family do this before. UNLESS they’ve changed the law, you only have to have had it as your primary residence 2 of the last 5 years to claim the capital gains exclusion. It doesn’t have to be your current primary residence. I know somebody who did it with 2 separate properties in the same he had converted to rentals. Has there been a change in this law recently?

13 Four Pillars

Keep in mind that Kyle lives in the US, so the rules are different for him.

Their PR capital gains is a bit easier to get (I think).

14 Kyle

Yes, I live in the US. I guess I should specify that every time I comment so as not to confuse everybody. I just talked to my friend who’s a CPA and he told me it still flies this side of the border.

15 Four Pillars

Garth – I think you should provide Mr. Cheap with a review copy of your book. If nothing else it will save him the 28 trips to Indigo to read it.

Mike

16 telly

Ahhh…thanks for clarifying! If I’m not mistaken, there is a cap on capital gains exclusions on principal residences in the US (whereas i don’t believe we have any in Canada) so that may explain why this is allowed in the US.

Just to be sure though, I asked some pretty knowledgable folks over at the Canadian Business forums and it appears we may have a similar exclusion in Canada (however, it appears to be pretty restrictive).

Just goes to show, there are some things I don’t know. ;)

17 ThickenMyWallet

Its hard to say that all of Toronto real estate will go down. Some areas will always maintain their values while others will not.

The PR exemption can be used as Kyle described in Canada with the formula being:

A- (AxB/C)

A= capital gains
B = # of years after acquisition property was PR +1
C= # of years ending after taxation year during which property was owned.

18 Halton Resident

Isnt nice to know that the MP for Halton is more interested in bashing the government and shilling his own book instead of looking out for the needs of his constituents.

Dont bother reading the book. Its crap.

19 Mr. Cheap

Garth: Thanks for dropping by, its great to have the author here! I’m Mr. Cheap so you’re going to have a tough time getting me to buy (maybe I’ll put my name on the reserve list for it at the library though ;-) )

Mike: I agree on both points. I also thought people might overpay trying to beat the tax. I also think Garth should send me a review copy.

TMW: Sorry, I didn’t mean to imply the drop would be uniform. One of the things I love about low priced real estate (like my condo) is they supposedly weather downturns in the market better (its more comparable to rent I guess).

Halton Resident: Glad you could join us to anonymously bash your MP. Here at Four Pillars we’ve always prided ourselves on being at the center of Halton politics.

Telly, Kyle, NSB: Very interesting that things work differently in the states. That seems like a heck of a loophole…

20 Quietrose

Mike– great comment. It was LOL funny! :)

21 Four Pillars

Thanks Q.

Cheap – Maybe we can work the word “Halton” into our blog name??

22 jrochest

One quick point about the original article — for all the distress being expressed, most of the buyers profiled bought well within a reasonable budget. They AREN’T house poor!

I can’t guestimate the first couple’s salary, so I won’t speak to them. But the assistant professor & lobbyist (who intended to go to law school) probably make something like 140,000-150,000 per year: he’s at York , where salaries start in the 90-100 thousand range, and she’s got to be able to bring in at least 50 grand a year: even in law school she’ll get a stipend of close to 30,000. They bought for 381, which means that they paid 2.54 times their salaries. If they are living only on his salary and she’s not paying anything towards the cost, they’re still at 3.81 times their income. Tough, but do-able.

The lesbian couple who bought in Roncesvalles paid 262,000 on a salary that’s probably about 100 – 120 thousand a year. They should be okay too: the baby would make it tough, as would the layoffs. But they should be just fine, according to the most conservative estimates.

The gay couple who bought for 470,000 would have a salary close to the first couple: I’m assuming 150,000. They’re in a tougher situation, but they are still only paying 3.13 times their income. Plus they had a downpayment, and they have no other debt.

As others on this thread have pointed out, what’s killing them is the assumption that they have to gut-and-retrofit the house to HGTV standards the minute they moved in. I’m sure the places were shabby and hellish ugly. But you can live with shabby and hellish ugly, and most first time buyers do. Paint does wonders.

The article is also amusing because it’s obvious how the author (whom I’ve met, a nice woman) did her research: she talked to people she knew and/or went to school with. This is why all the couples fall in the same demographic, and all work in media or academia.

The people who are really struggling are the families with 50,000 a year incomes who are trying to buy a 250,000 house.

23 jrochest

Sorry, just realized I posted to the wrong thread…

24 Four Pillars

jrochest – I think this is the right thread.

You are bang on with your analysis – if they can hold off on the top level renos then that will help their financial situation.
The other factor is that maybe the couples thought they could buy an expensive house and still have lots of money left over for vacations etc. Reality sucks sometimes.

Mike

25 Mr. Cheap

jrochest – I agree with Mike, very good analysis. I think people who complain about being house-poor often resent giving up luxuries. As you say, its possible to afford the houses people are buying these days (perhaps they go from being rich to normal rather than to poor ;-).

Holding off on renos until they can afford it is totally the way to go.

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