Street Value

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Some months ago I told you about a hotshot young lawyer who bought a hotshot house in swishy North Toronto for $1.25 million. He put 5% down, tacked on a few closing costs and mortgaged it for $1.2 million. Now he had a driveway for his leased BMW. Because he made $300,000, but had no actual money, the bank gave him the down payment in the form of a cash-back loan, and Ottawa guaranteed his borrowing.

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Oh my, how things have changed.

Today the same house no longer qualifies for CMHC insurance, since the feds cut off $1 million-plus properties. That means a 20% down payment. Plus, quietly, bankers have bowed to pressure from the regulator and adopted new loan-to-value limits. In Toronto, that’s 80% to a million, and 50% of the rest. On a $1.25 million house, the max is $925,000 in financing. And there are no more cash-backs. It all means, with closing costs, the buyer now needs $375,000 in cash.

This is probably why there are no more multiple offers in the hood. Seven months ago the house would have fetched 15% above list. Not it’s likely to get 10% less. That’s a decline in street value of $312,500, or 25%.

This is why projections from Bay Street economists that real estate will have a ‘soft landing’ of 5-7% are so yesterday. Just 100 days after F tanked amortizations, with CMHC and the bank cop ushering in new regs, real values are in retreat. High-income buyers – even lawyers making three times the average family wage – are now booted out of the market because of a credit restriction.

Meanwhile, as I described yesterday, the bottom end – condos, mainly – is being severely thumped by the death of 30-year amortizations, the end of cash-backs and higher standards for virgin borrowers. Buyers without savings who last year could buy a condo more easily than a Kia and now forced to retreat to mom’s basement. Oh, the infamy.

Conditions are changing quickly, if you haven’t noticed. The Bank of Canada’s ‘slow-growth’ rhetoric yesterday is something you’re going to hear a lot more about. The world is tilting more towards deflation than inflation, and in Canada real estate will be the fall guy. This is one reason why, at the Ol’ Time Revival Meeting last night in Toronto, I let people know a 20% price reduction across the GTA is now a distinct possibility. Some hoods will be more impacted than others, but the downward momentum is now obvious.

But, Angelo asks, what if you know a price dump is coming, and you can’t sell, for wife reasons?

“My situation is the wife refuses to sell as she likes the “security” of owning our home (condo actually) and the low monthly carrying cost “if anything were to happen”. We’ve been mortgage free for about 2 years; purchased the 1400sqft. condo in 2006. We have many “discussions” about why we should sell now, but she gets very emotional at the thought of moving or selling. At least she agreed to come to your talk last night.

So… if the issue of selling will cause more marital strife than it’s worth, should I instead be looking at leveraging RE to take advantage of the low rates, tax deductible interest, and try to mitigate my RE asset deflation with a balanced/dividend yielding portfolio? (Another relevant financial metric is that we have almost $400k saved and invested between my wife and I in RSPs, TFSAs, and other unsheltered accounts including the Orange Guy’s Shorts.)”

Well, Angelo, sounds like you already got the memo about diversification and liquidity. Having $400,000 in financial assets is good, but not in the OGS. There’s no longer any such thing as a ‘high-interest savings account,” since every one is paying less than inflation and yielding fully-taxable interest. Why would you not have that money in bank preferred shares, or quality real estate investment trusts, or even a low-cost dividend or monthly-income fund?

As for the equity in your paid-for condo, a fifth or a quarter of it could melt away over the next year or two, and never return. If the place is worth $500,000, that’s a loss of at least $100,000 in capital gains tax-free wealth. Is that what your wife means by “if anything were to happen”? How would she feel about holding financial assets and losing a quarter of them? Would she ever forgive you?

At least you could counter the decline and loss in equity by removing some of the money and getting it growing. A home-equity line of credit would let you access funds and get tax-deductible interest at the same time. Hopefully your bank could give a secured line at prime (3%), so after taxes it might only amount to 1.8%. If you can invest in stable bank preferreds (just an example) giving 5.2%, payable in lowly-taxed dividends, then the net spread should be about 2.5% in your favour. A diversified portfolio with a 40/60 fixed/growth split would likely do much better, but with more volatility.

Should you do it? Ask her. There’s no rate of return which can compensate for a busted marriage.

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But I’m sure after last night, hallelujah!, she is saved.

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avatarGarth Turner - The Greater Fool posted Tuesday, October 23rd, 2012.

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