Saturday, October 31, 2009

Buy vs Rent

The following comparison will illustrate how the low interest rates are reducing payments enough to compete with the rental market. Under more reasonable financing terms mortgage costs are not terribly out of line with the rental market. With more creative financing it is easy to see why sales are currently strong.

First consider this 1716 sqft house in South Edmonton for $374,900

Looking on craigslist for rentals in Edmonton I found the following.

The 1680 sqft house is the closest match. The advertised price is $1500 but after a few months the price increases to $1700.

1680 Square Foot Beautiful house in Edmonton's most popular newly developed community called Ellerslie crossing. The house location is seconds walk from ETS bus stop and kids school buses. Close to all amenities. Its next to South Edmonton Common, Anthony Henday, Calgary Trail and Whitemud. The lake is visible from the bonus room....Starting rent of $1500.00 will increase by $50 on December ($1550), January ($1600), February ($1650) and will get fixed at $1700.00 from March, 2010 onwards.

Comparing full asking price and rent results in a ratio of 220. That is fairly high even though it is from one of the more reasonable priced houses on the MLS (there was only one rental to choose from in the neighboorhood).

Looking at the price vs. rent things are a little closer.

Assuming full asking price, 10% down, 2% CMHC premium, 4% 5-year fixed rate and 25 year am.
$1814/month. $674 of which is principal.

There is a premium here, especially when taxes and maintenance are included. However, after 5 years the balance will be $300,255.

A buyer under these terms will end up paying a moderate premium and pay down some of the principal over 5 years. Meh. Not terribly exciting.

However if a buyer chooses a more risky mortgage a more interesting comparison appears.

Full asking price, 10% down, 2.4% CMHC premium, 2.25% variable and 35-year amortization.
$1192/month. $543 is principal (the first month, at least)

So for $1192/month + taxes + maintenance a buyer can move out of an apartment into a house and become a homeowner. The problem of course is not considering the interest costs for the entire duration of the loan and the effect of this stimulus on the asset price itself. Is this a bubble? Are current buyers the greater fools by recklessly overpaying for houses due to blind faith in future appreciation? Not entirely. Buyers may be incorrectly assessing the risk of future financing costs and not accounting for the asset inflation caused by low rates. This is a more subtle mispricing as opposed to a bubble and due to this I expect a less dramatic unwinding.

The type of financing above is an artificial boost to the housing market. What about the rental market? Low interest rates and creative loans reduce demand for rentals as the monthly payments attract people towards becoming homeowners. While rents have been falling partially due to the weak economy, I think another reason is from these financing terms. If/when these financing terms become less attractive the rental market may gain strength.

But its Halloween so we have to consider we may be in a deflationary depression where everything is toast.

Friday, October 23, 2009

Policy advice for Mr. Carney

Dear Mr. Carney,

Today you made the following statements regarding the Canadian housing market:

"We expect prudence from lenders," he said. "We expect, and we have confidence in, prudence from Canadians. We remind people that borrowing is for the period you are going to borrow, not just for the moment you take out the loan."

That is a concise statement and echoes what many people have been saying for some time. However this appears to be a case of CYA so in 2011 you can say "hey, look! I told people to be prudent", while still allowing the heightened demand for housing contribute to precious green shoots.

You don't need to remind borrowers of anything. All that needs to be done is for CMHC to require qualifying income to be set for more normal interest rates. If CMHC ensured that borrowers could handle more normal rates that would limit the downside if/when rates increase. For example it would be more reasonable if CMHC required a qualifying rate of 6% to insure these mortgages.

Obviously people are qualifying and depending on super low interest rates. This has been going on for awhile. Consider the quote from the July 2nd article First time buyer like low rates:

What really helped? The 2.75-percent interest rate they were offered. It ultimately allowed them to move from a $1,800-a-month apartment into their own home.

“But we don’t have a lot of [wiggle] room,” Morettie said. “We can go up to four percent, but then we’re done.”


craigslist rental sample

The price to rent ratio remains elevated in Calgary and Edmonton. I suspect this is due to an irrational negative attitude toward renting in Alberta and very low interest rates. However, I do think that some part of the price difference between Alberta and the US is a real difference between the cost to rent (and build). Its simply more expensive to rent in Calgary and Edmonton than Phoenix and because of this prices should be comparatively higher.

Consider this selection of craigslist rental ads for $1250.


$1250 / 2br - Apartment For Rent at

Two -2- Bedroom, apartment condo , approx 900 sq ft with a nice sized west facing balcony in a 3 yr old west end elevatored building is available immediately. The suite comes complete with fridge, stove, dishwasher, washer and dryer.

The suite also features underground parking.

The unit is on the top floor so there will be no noise from above.

Heat and Water are included in the rent.

The master suite has a walk in closet and full 4 pce bathroom. The second bedroom has a large closet with sliding mirror doors. The second bathroom is next to the second bedroom and is a full 4 pce bathroom and also houses the upright washer and dryer.

The suite also has a full storage room and linen/storage closet.

The kitchen, with ample counter and cupboard space, is open onto the living/dining room and comes with an island.

The suite is located in an area that is close to schools, YMCA, parks, shopping, dining,transit , just south of the Whitemud and just west of 170 st.

Lease duration is negotiable but preference is given to a 1 yr lease.


$1250 / 2br - Stylish 2 Bedroom Upper Suite in Killarney (Killarney / Inner City)

Beautiful and bright 2 bedroom upper suite in the desirable inner-city community of Killarney. Minutes from Downtown, Marda Loop and Mount Royal College. Located on a quiet tree lined street conveniently nestled just several blocks from 26th Avenue and 17th Avenue transit corridors. Close to Westbrook and Westhills shopping centres; Killarney pool; parks, and University of Calgary with easy access to Crowchild Trail and Glenmore Trail.

Crisp, clean, open concept suite with laminate and tile flooring and a brand new renovated bathroom. Features a private balcony, high ceilings and in-suite laundry. Street parking (a two car insulated garage is also available).

No smoking or pets. Please call for more information and to schedule a showing of this beautiful suite!

Phoenix (Mesa)

$1250 / 3br - 2Ba-Single Story-2160 SqFt-3 Car Garage-Inc Gardener (Mesa)

This is a Spacious near new 2160 SqFt 3br 2ba single story home. 3 car garage with electric garage door opener. Beautiful earthtone carpet, and tile through out. Large master bedroom with sitting area and a hugh walk-in closet, garden tub, and separate shower. Raised vanities, ceiling fans, separate laundry room and Faux wood binds throughout. Upgraded kitchen cabinets, gas range and microwave. Grass landscape in rear with rock landscape in front all irrigated by electric timer. 1 mile South of 60 Freeway close to schools and shopping. More pics and floor plan on request.

  • cats are OK - purrr
  • dogs are OK - wooof

Saturday, October 17, 2009

Right question. Wrong answer.

I'm back, and it only makes sense to start with a post about a mortgage calculator after a six month break. Remember the buy vs rent calculator? Well this is similar except the scary thing is I don't think it's broken.

Mike from the Albert Bubble blog commented on this mortgage calculator from President's Choice Financial.

How much can I afford?

I was shocked at the vast sums of money one could qualify for based on a 35 year amortization and a 2.25% VRM. Consider 3 cases:

Case 1

Income: $66,000
Down: $20,000
Debt payments: $0
Taxes: $2200
Heating: $75

Pre-qualified for a $391,970 mortgage! It was limited *not* by the income, but by requiring a 5% down payment.

Case 2

Income: $120,000
Down: $80,000
Debt payments: $100/month credit card
Taxes: $4000
Heating: $180

Pre-qualified for a $711,371 mortgage! The reason one can get qualified for so much money is it uses a rate of 3.64%.

Case 3

Professional Couple
Income: $170,000
Down: $80,000
Debt payments: $100/month credit card +
Debt payments: $300/month auto loan
Taxes: $4000
Heating: $180

Pre-qualified for a $ 1,058,721.73 mortgage!

Right question. Wrong answer.
3x income is probably a more reasonable measure and allows for more normal interest rates and some discretionary income.