I have $75,000 in total savings and I want to invest it in a single stock. I feel so bullish about this stock, I’m going to take my money and use it to secure a loan for $700,000 at 3%, which I will also put into the investment. This represents a 9.3x leverage and I feel really good about it because historically this investment has done very well. I’m going to have to spend an additional $10,000 per year in fees, but I think this investment is worth it.
I’m in it for the long haul.
If you think borrowing 10x your money to invest in a single stock is insane, you’re right.
But it’s exactly what buying a house in Calgary, Alberta is. If someone told you they wanted to borrow 10x their money to dump nearly a million dollars into a single stock, you’d think they were gunning for bankruptcy. It doesn’t matter if that stock is Apple or General Electric, being “all-in” with your money + the bank’s in a single investment is stupid. Yet we do it all the time with houses.
I’m already familiar with, and therefore desensitized to, house prices in my city. Most of the homes I would consider for permanent residence cost about $1 million. When I find a house on Realtor.ca in a neighborhood I adore priced at $850,000, I quickly fire off an email to my husband-to-be. “Look at this one!” I coo, “At only $850K, it’s such a steal. Maybe we should go to the open house?”
Living in a city with outrageous house prices does wacky things to your brain. The numbers become normalized to the point that you can no longer process them rationally. If a mortgage affordability calculator tells you that you can afford a $1.2 million dollar home, you’ll prudently set your search criteria at a max of $900,000.
“I’m so frugal,” you think, “I’m searching 25% below my maximum purchase price, I’ll never be house poor like those idiots that buy the maximum they can afford”.
When you see a house priced at $700,000 or $800,000, you feel like your bargain-bin shopping. What’s more, when it appears to need any sort of work from appliance update in the kitchen to landscaping of the front yard, you think, “that’s ok, that’s why it’s priced so low. We can definitely upgrade those next year”. When you wade into the $600,000 homes and they look like condemned haunted houses, you can’t help but feel even more secure in your decision.
This gem still $599,900. I'm serious.
— Money After Graduation Inc. (@moneyaftergrad) March 6, 2015
Who wants to buy this for $625,000?
— Money After Graduation Inc. (@moneyaftergrad) March 6, 2015
It’s still a really dumb decision.
It’s taken a few seasons of House Hunters for me to really grasp the rest of North America is not like this. I’ve seen people buy 4 bedrom, 2,500 sq ft homes for $250,000 and complain that it’s at the upper end of your budget. In some states people set budgets of $150,000 and have the nerve to whine that their realtor hasn’t shown them anything with a double-sinks in the master bath. In Calgary, $150,000 will get you a mobile home.
Yes, in a trailer park.
In the personal finance blogosphere, home ownership is the holy grail. Nothing quite says has-their-financial-shit-together like charming bungalow with an attached garage. “I won’t throw money away by renting!”, they exclaim, “You can either pay your mortgage or your landlord’s!”
People are typically ignorant or bad at math. Usually both.
Renting is always a sound financial decision in an overheated housing market. In a city like mine, it is significantly cheaper to rent than buy, but very very few people will actually work out the math.
The 2-bedroom, 2-bathroom downtown condo my fiancé and I currently occupy would retail for about $435,000. If you put 20% down (that’s $87,000), you’ll end up with a mortgage payment of $1,592 financed at 2.69%.
With heated underground parking and other amenities (honestly we have an amazing condo board), condo fees are probably around $500, possibly more. Add in property taxes and you’re paying $2,250+ per month to live here. Our rent is only $1,750/mo.
We use our extra $500 per month for savings and investments. The $87,000 down-payment we haven’t dumped into a house is collecting interest and dividends in our accounts. We’re sitting on it and waiting.
$87,000 invested at 5% with $500/mo in contributions will grow to almost $98,000 in only 1 year — a gain of $11,000.
In 1 year of home ownership, with $87,000 down and a $1,592 mortgage payment, you will have paid down only $9,916 of the principal (and $9,188 in interest on the mortgage!).
If the value of your home decreases even 1%, you’re even worse off. And yes, the house prices in Calgary are decreasing. More on that later.
Our landlords own this property outright. They bought it more than 10 years ago when it was priced at something less insane. Now it’s a pure income property for them, which is cool. Except property taxes and condo fees keep rising (but they graciously did not increase our rent). It’s a good play if they sell now, but they didn’t. We just signed a lease for another year.
If I were a property owner in Calgary right now, I’d put my home up for sale and take the money and run.
The Deutsche Bank says the Canadian housing market is as much as 60% overvalued, but most Canadians don’t give a shit because they don’t know what the Deutsche Bank is or why that assessment matters. Closer to home the Bank of Canada says the housing market is only a modest 20% overvalued, but everyone plugs their ears and la-la-las when this is said too.
When it comes to condos, Canada’s heading towards a glut, which is another thing almost no one seems to be aware of. Words of warning are primarily for cities like Toronto and Montreal, but overall there’s condo overbuilding across the country.
Furthermore, Canadians like debt. Albertans like debt the most, and they’ve borrowed a shit-ton of money to buy their dream homes in Stampede City.
But there’s more than that. Most prime property is still recovering from the 2013 flood, which damaged a significant amount of property in Calgary’s core. And for the past year, oil has been falling. Maybe that doesn’t mean much to you, except bewilderment that the price of gas doesn’t follow, but oil is Calgary’s lifeblood. Since the price has plummeted, there’s been a number of layoffs. Then more layoffs. The numbers are worse than they appear in the papers, because those only record terminations of full-time employees, but there are tens of thousands of contractors whose contracts simply weren’t renewed. They have mortgage payments, too. Mortgage payments that they will still have to meet, even jobless and without income.
Calgary house prices have only dipped slightly in response to the market fall. Maybe everyone’s in denial. Maybe everyone’s still holding up while they collect unemployment insurance, but things will probably get ugly when that runs out. Uglier still when all the debt they’ve taken on is also maxed out. Or maybe not. Maybe we’ll keep nourishing the Canadian dream, making it true by buying-in.
High house prices are a self-fulfilling prophecy: buying “before the market goes up” sustains these prices.
If you tell everyone that home ownership is a milestone, that it’s a financially sound decision, that it’s worth stretching yourself thin, they’ll buy in. And that will keep prices high. But there is a limit. We don’t think there is, but there is. House prices cannot go up forever, and the truth we must all accept is that the major gains have already happened. Our parents profited off real estate, not us. So it’s no wonder your mom & dad are trying to help you buy your first home: they think it’s the best investment you’ll ever make. It’s probably not.
For now, I’m a happy rich renter.