Thursday, December 27, 2007

NEWSFLASH: It's not 1992

There is an article in the Edmonton Journal titled Buy sooner rather than later. The writer was bold enough to buy a townhouse in Edmonton for $55,000 in 1992 and uses this example to make the case for first time buyers to get on the property ladder.
Regardless of the boom and the city you live in, buying your first home is always tough.
However, In the 1990s buying a home in Edmonton was easier. And if you waited a year or so it was no big deal. Below is a chart of % after tax household income dedicated to mortgage payment from RBC Housing Affordability study. Note how all property types are currently less affordable now than at any other time in the chart range.

This number takes into account wages and interest rates so it is a good picture of relative difficulty of getting into the market. It assumes a 25% down payment which is much more difficult to get now because of the appreciation of the last few years. The author of the article was prudent enough to save $10,000 or 18% down payment in 1992 and gives the following advice:

Buy what you can afford: I know you might think it's tough in this market but don't push yourself to the limit.

Too many people are stretching amortization periods and putting down very small down payments.

The cheapest 2 bdrm townhouse in west Edmonton is currently about $200,000. An equivalent 18% down payment today is $36,000. How is it possible to buy sooner rather than later and save up that kind of money? To illustrate see the following average price chart for Edmonton showing both nominal and inflation adjusted prices. A certain percentage down payment will be proportional to the nominal amount and its relative size in terms of buying power would be proportional to the inflation adjust series.

Bottom line is the article is simply not applicable in 2007 Edmonton.


Radley77 said...

I also have a problem with the statement "Fortunately, they tend to go up more than they go down and that's why, long term, it is better to own than rent."

I found this article incredibly interesting long term trends in real estate prices.

"Between 1628 and 1973 (the period of Eichholtz's original study), real property values on the Herengracht — adjusted for inflation — went up a mere 0.2 percent per year, worse than the stingiest bank savings account. As Shiller wrote in his analysis of the Herengracht index, "Real home prices did roughly double, but took nearly 350 years to do so."

So, it's important for people to realize that house prices will likely appreciate at roughly 3% over the long term. Benjamin Tal senior economist at CIBC has also made statements that allude to appreciation at roughly 3% year.

The reporter of the article has neglected to consider offsetting rental yields over the period of the amortization.

Here is a rent vs. buy calculator:

Under many circumstances, even after 30 years more wealth can be accrued by renting and investing the difference than owning.

This is due to an extremely high price to earnings ratio.


People need to consider rental yields, NOT just price appreciation when determining how much to purchase a house for.

Radley77 said...

It's also interesting how 1990 was a peak in house prices and 1997 was a trough and how that compares against affordability. A peak in house prices corresponds to a peak in affordability.

The following graph is Calgary house prices but Edmonton/Calgary house prices are closely coupled so the relation between affordability conditions and house prices is still relevant.

It is also worthwhile to note that affordability conditions are significantly worse than the last peak in real estate prices.

Anonymous said...

Have you ever thought of doing a YouTube video? ;)

Anonymous said...

Good post!

Simply unsustainable RE in Alberta.

Anonymous said...

When I purchased my first Home in 1985 I paid $75,000 with 10% down and my income that year was $40,000 to buy a house was less than my gross income for two years, which was very affordable. Now my income is $75,000 and the same house would cost around $300,000 thats four times my gross income, add on to that the other costs such as vehicles, fuel, groceries and utilities that have sky rocketed, its easy to see why its tough for first time buyers and affordability is becoming an issue.

Anonymous said...

Right now there is a real estate shill out there on YouTube looking for an even greater fool...

Anonymous said...

I liked how they slipped in Housing Affordability and Diversified Economy in there for reasons to get in. Someone should inform this guy that mortgage interest isn't tax-deductible in Canada. I assume by bolding this statement in his video, he thinks otherwise. And sorry but what's with the Eminem soundtrack? Is that suppose to induce added credibility? Just sad.

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