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For the past couple of years, the Canadian housing market has been that perfect kind of emotional money puzzle that will drive almost anyone bonkers: is real estate too hot to buy into? Or is it too hot not to buy into? What if the recent interest rate hikes do more than just slow things down and the whole market collapses? It’s a lot to think through – maybe so much that you don’t want to try to think it through at all.
Let’s start by quantifying the craziness. In mid-May, the Canadian Real Estate Association announced that the average sale price for existing homes across the country was $746,000. While that’s actually down 12.6% from the prior month — thanks mostly to the interest rate bumps and resulting higher mortgage rates bestowed upon us by Tiff and friends at the Bank of Canada — it’s still 7.4% higher than a year ago. On one hand, that increase is netting a windfall for sellers. On the other, the concept of home ownership is getting more and more far-fetched for ordinary Canadians — especially if mortgage rates continue to rise without an offsetting fall in home prices.
So what in God’s name are folks without trust funds or questionable golden parachutes (a year’s salary for one day!?) supposed to do? We talked to three Canadians who are currently considering entering or reentering the frothy housing market. Then, after learning a bit about their goals and financial situations, we called in the expert: Wealthsimple’s own Damir Alnsour, Manager on the Portfolio Management team.
Although Damir can’t hand out sub-3% mortgages or guarantee that a new condo isn’t actually 60% caulk, he can at least share information that’ll help these three people make the best decision possible for them. And since his wisdom applies to the real estate market overall, we’re pretty confident it can help you, too.
Issue #1: Is it better to buy what you can afford now, or wait until you can afford the house you really want?
Potential buyer: Frida, 27, Toronto
“Right now I’m living at home with my parents and saving up to buy something. I’ve been thinking I want to buy a condo in the next 2-3 years, but eventually I really want to own a house. When I look at the prices of houses on the market, though, it’s so expensive I’ve started to wonder if the idea is even realistic for me in Toronto. I’m not really sure what to do. Do I try to buy a condo now, rent until I can afford to buy a house, or just forget buying altogether?”
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There’s a saying you may have heard: get on the property ladder. Instead of waiting for the perfect place, buy something that’s close enough — something that meets your current needs, reflects your current budget and financial circumstances, and maybe offers some wiggle room for kids, pets, or any other changes you’re envisioning over the next few years.
Owning a smaller home than you eventually want to be in helps you in two ways. The first is that it forces you to save money. With most mortgages, a portion of each payment is always going toward your principal, which means the longer you own that starter condo or townhouse, the more equity you will accrue. And that equity can eventually be put toward a down payment on a larger home.
The second major benefit of stepping onto a rung — any rung — of the property ladder is that it’s a great hedge against real estate price movements over time. The equity in your starter home will go up and down in value alongside your forever home — assuming that the properties are in a similar location and exposed to the same market forces. If prices fall, you may lose some equity, but the relative stability of property as an investment should help you escape the worst of a broader downturn. If prices rise, your home’s value will rise in step with that of your future home, helping to keep you moving toward your goals instead of watching them rise farther out of reach.
Issue #2: Should I try to time the housing market?
Potential buyer: Emily, 32, Ottawa
“After growing up in Vancouver and going to school in Toronto, I moved to Ottawa in 2016 for a job with the federal government. I feel super fortunate: in terms of stability, there’s nothing better. I’m not paycheck to paycheck, and I have a good pension. I can even forecast how much I’ll be earning in five years based on collective agreements.
“My hope is to buy something here in Ottawa — preferably a house or a townhouse, as opposed to a condo. I know I’m looking at the $700,000 or $800,000 range, which is a LOT for me. My fear is that I’m buying at the highest possible point. The last thing I want is to be the last person who jumps into the market. How do I know if it’s a good time to buy? At what point do I just pull the trigger on something?”
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While we would love to announce the launch of the Wealthsimple Crystal Ball ™, any attempt to predict the future is a fool’s errand. That’s especially true today, when financial uncertainty feels like it’s at an all-time high. That’s why, instead of trying to figure out the right timing for the market, it’s better to figure out the right timing for you. So if you like a home and you plan on living in it for a while — at least five years, but the longer you’re there, the more chance you have to ride out any market downturns — your biggest concern should be whether or not you can afford it.
It sounds like you’re pretty confident in your budget, but it’s worth double-checking. One of the biggest mistakes people make in buying a home is confusing the maximum amount they can borrow with the maximum amount they can afford. If you buy based on what you can borrow, you risk ending up house poor — with so much of your money tied up in your home that you can’t afford to do anything else.
To determine what you can afford, take your total household monthly income after taxes, then subtract any fixed expenses (groceries, your water bill, etc.), your discretionary expenses (fancy dinners, your Vitamin Water bill, etc.), and how much money you need to save every month to pay for goals like an upcoming wedding, your kid’s college tuition, or retirement. Anything left over is the maximum you can spend on a monthly mortgage, property taxes, insurance, and maintenance fees. If that number isn’t sufficient to buy the home you want, it’s not the right time to make the purchase.
If the numbers don’t add up for you now, you’ll either need to save more towards a down payment so you can borrow less, or compromise on the size and/or the location of the home you’re looking to buy. Most likely it’s a combination of the two: bringing down your costs while raising the amount you have at your disposal — and seeing where they meet.
Issue #3: Over a ten-year period, is it better to rent or own?
Potential buyer: Jo, 38, Edmonton
“I was raised thinking that renting was throwing your money away, and owning was keeping money for yourself. I bought my first place at 19, and I’ve been a homeowner ever since. Until recently.
“After a recent breakup I sold my last house to my ex, and for the first time in my life I’m renting. I’m literally sitting here with equity from owning a home, renting month to month, and wondering what to do. When I rent, I have to worry only about that monthly payment. There’s no lawn to deal with, no repairs. But I just can’t shake the idea that I’m wasting my money. What do you think?”
Folks often compare the cost of monthly rent versus the cost of a monthly mortgage payment, and that’s where they stop. But to run an accurate comparison, you’ll want to compare what we call the total unrecoverable cost of renting versus the total unrecoverable cost of owning.
Figuring out your unrecoverable costs for renting is pretty easy: just add your rent, tenant’s insurance, and monthly utilities. Ownership is trickier, though. You start by adding up the interest component of your mortgage payment, condo fees or property maintenance costs, property tax, owner’s insurance, utilities, land transfer tax, realtor fees, and all those transactional costs that get tacked on at your closing. And then you have to make a few assumptions — big ones, like the direction of the market and the rate of inflation. But the biggest assumption, by far, is the opportunity cost of putting your down payment in a home instead of in the stock market or another investment.
Fortunately, the Financial Market’s Authority of Quebec provides a really good calculator here. (You’ll want to fill both the “Buying a home” tab and the “Renting” tab at the top and then take a look at the summary thereafter. I’d also play around with the assumptions just to see how small changes can have large impacts.)
The biggest advice I’d give is to stop thinking buying is always the right way. It depends on the person. And the market. And so many other things. Homeownership may get you equity and let you paint the living room without asking for permission, but renting means not worrying about the costs of repairs and being able to move much more easily when you get a new job or need a new neighbour. And by investing the money you’d otherwise spend on buying a house, you can sometimes achieve returns that leave you as well off as or even better off than a homeowner over the long run. (Check out “The Wealthy Renter” by Alex Avery.) It’s just as much a question of preferences as a question of numbers.
Alex W. Palmer is a writer based in Washington, D.C.
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