The fall (and rise) of the Real Estate Market

In these ever interesting times, I find it fascinating to watch the goings on in the real estate market. Over the past several months (if not years) there have been lots of pundits and moon lighting real estate “experts” predicting the collapse of the Canadian real estate market. In particularly in the two hottest Canadian markets Toronto and Vancouver.

In July the finance minister Jim Flaherty yet again changed the laws around government backed mortgages (think CMHC) yet again. These changes were designed to cool the market a little bit and help slow the decent many Canadians are taking down the debt highway. They will work in my opinion but not necessarily quite the way people expect.

As I wrote about previously http://chuckbrady.ca/?p=143 the Canadian real estate market in many ways is quite predictable. (yes I know stuff happens which can temporarily through it for a loop) Despite the high profile of some real estate investors, most purchases (96%) are home owners looking for a place to live. These buys generally do not really care what the sticker price of a property is, they simply pay attention to the monthly payment, aka “what can I afford”.

One of the most high profile changes made by Flaherty was to move the maximum amortization period (only on government backed mortgages) down to 25 years from 30 where it was before. This little move has the same effect as a 10% price reduction to the market. Let me explain:

In June, Joe and Sally home buyers go to their bank looking for a mortgage approval to go house shopping with and Mr. Banker says ok you can spend up to $1800 per month. Based on average prevailing rates of 3.5% at the time and an amortization of 30 years Joe and Sally could go out and spend $400,000 (monthly payment comes in at $1790). Come July the changes are announced, Joe and Sally still make the same amount of money so Mr. Banker says they can still spend the same each month ($1790) but since the amortization period is now 25 years they can only spend $358,600. This equates to a price reduction of a little more than 10%.

This makes the government happier as now Joe and Sally are building in more of an equity buffer each month and not going quite so fast down the debt highway. Though now Joe and Sally look at what is available to them to purchase and they do not quite like what they see so they sit on the sidelines and watch. As more customers begin to sit out for a while the market quietly adjusts down to what people are able and willing to spend.

The simple fact is that since 96% of the real estate market is home owners, they will dictate what the prices are. Over time the market has to adjust accordingly. Nothing happens over night and there are events which can temporarily through the market off course but the fundamentals always return.

So yes, the market is going down probably in the ballpark of 10% but no it is not the end of the world. It really means very little at the end of the day. As interest rates slowly begin to climb (it is not an if but a when, though possibly not till 2014) the rising rates will have a similar effect on the market but it will make very little difference if you buy today or wait a year. If you of the belief you should wait to buy because you think the prices are going to fall, all you are really doing is losing a year of building equity. Sure maybe you can wait two more years and save 10% on the purchase price. Over time the money you saved on the price will be eaten up by the added interest you will be paying. Find something you love and can afford and just get on with it already.

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