June stats

The sales continue. Here's the unofficial stats, press release is out:

New Sales: 946
New listings: 1436
Total active listings at June 30th: 3794
Sales to new listings ratio: 66%
Sales to active listings ratio: 25% or 4 months of inventory.

H/T to Tim Ayres on Twitter for the numbers.

Last month's numbers:

New sales: 879
New listings: 1362
Total active listings: 3789

Sales up, new listings up, total listings up. Clearly Victoria is in an overall SELLER'S market being driven by the low-end and move-up buyers.

The average price for single family homes sold in Greater Victoria last month was $588,186, up from $573,442 in May. The median price also rose to $529,900. The six-month average was $559,827. The overall average price for condominiums was $298,200 month, down slightly from $306,971 in May. The average for the last six months was $294,725. The median price for condominiums in June was $275,000. The average price of all townhomes sold last month was $413,218, up from $400,788 in May. The median price remained unchanged at $375,000. The six month average was $401,829.

Prices aren't going up, 26 properties over $1 Million drove the average higher. Consumers keep preferring SFH's over condos and townhouses:

MLS® sales last month included 539 single family homes, 242 condominiums, 104 townhomes and 18 manufactured homes.

Credit where credit is due

I've taken a lot of swipes at the MSM and the real estate industry for their perceived lack of balance over the years. Today I'm not. I'm praising them for this article instead. Here are the highlights:

Caution, not immediate gratification, should be the mantra for buyers looking to buy their first home

It's easy, but financially dangerous to be mortgaged to the hilt based on today's ultra-low teaser interest rates

Mortgage rates are going to increase by two to three per cent over the next two to four years

First-time buyers should be thinking more long term, arranging their financing based on expected rises in mortgage rates that will be a reality in two years

buyers should not expect their real estate investment to make a fast or big payoff when it comes to sell

Younger buyers should be paying attention to the financial restraint of older buyers

Sound advice if you don't want to eat macaroni most of the time while sitting at your granite kitchen island

Credit where credit is due, indeed.

Truth in numbers

Seems there may be a bit of a communications battle being waged between Teranet and the CREA these days.

You'll remember that CREA recently told us that the average home price jumped over 16% in the last month.

Teranet says:

Repeat sale prices for Canadian homes fell for a fifth straight month in April, dropping 6.7 percent from the same month a year earlier, a report on Wednesday showed.

The National Post had an OK discussion of methodology and what that might mean to the numbers:

With the economy in recession and unemployment increasing, Millan Mulraine, an economics strategist at TD Securities, said it was hard to justify a rise in house prices, as suggested by the CREA survey. But he was not convinced prices had fallen as sharply as the Teranet-National Bank survey had found.

Here's what I think: the numbers really don't matter. If you're a first time buyer, you're buying products in Victoria that are clearly in a sellers market, haven't experienced any kind of price correction at all and you can likely only afford them because of hyper-low interest rates. You may think you're getting a deal, but that's only because you're looking at it based on a monthly payment. I wonder how that will end up looking for you in five years time?

Long term planning

Post by Reid:

Let’s look at the long term financial security of two families both aged age 30 that live in Victoria, earn $100k per year and wish to buy a $500k house. The Optimistic family has $25,000 in their RRSP’s and plan to withdraw this to buy that home and finance the rest over 35 years. They have been told this is a sound financial decision as interest costs and property taxes are less than the rent they are currently paying. They will have to pay back the $25,000 over the next 15 years into their RRSP, so they are told they are not robbing their retirement. This family would like to put money into their RRSP, but each year they simply have nothing left to invest given the high cost of living. This family manages to make all their mortgage payments and in 35 years they are mortgage free just as they retire.

The Balanced family is in the exact same situation, but has done a lot of research on financial planning and has decided they will save their $25,000 deposit while leaving their RRSP account alone. They save hard over the next year and learn how to live below their means. With this new found skill they decide they will pay off their house over the traditional 25 year period while maximizing their 18% RRSP contributions each and every year. Once their mortgage is paid off the Balanced family plans to invest their mortgage payment into the TSFA until they retire at age 65.

These families go about their lives and meet all their payments under the following economic circumstances for both:

• Inflation stays low at 1% allowing five year mortgages to stay a 4.25% throughout the next 35 years
• Their houses manage to appreciate at an average rate of 3% per year, a full 2% more than inflation
• RRSP and TSFA investment return on average 6.5% per annum
  

As these families retire, they are both feeling good about their house purchase decision. The Optimistic family never used their house as an ATM machine and managed to get it paid off before they retired unlike many of their friends who took a mortgage into retirement. The Balanced family made a lot of sacrifices over the year, but they feel really good about their retirement.

The chart below shows how the net worth of these two families increased over the 35 year period. Net worth is defines as the value of their house less outstanding mortgage plus the value of their RRSP and TSFA’s.


At the end of 35 years, both families own houses outright that are worth $1.4 million making their investments in those homes 35 years earlier look pretty good. But the big difference is that the Balanced family has investments worth over $3 million and the Optimistic family only has about $150,000 saved in their RRSP’s. The only way the Optimistic family can finance their retirement is to sell their house or take out a reverse mortgage.

You may say that this example is extreme, but if you research how much average families actually invest in their RRSP’s, the Optimistic family is like many typical Canadian families and most will have to sell their homes to support retirement. A key message here is that you have to save a lot more money for retirement than one thinks and it needs to far exceed the value of your home. Although three million dollars may seem like a lot of money it is actually about what a 30 year family will need in 35 years to properly support themselves under the above economic assumptions.

Proper financial planning will not stop you from buying an overpriced house, but only make you realize that you must factor in proper retirement and other financial matters into the overall buying decision. For most it takes many decades to generate real wealth, but it can be achieved.

Value in relation to rent

We know there are two common values typically associated with houses: the market value obtained through a current market analysis (CMA) evaluated by a REALTOR® and the BC Assessment value which is largely obtained by a less-than-accurate averaging/evaluation based on like/similar property transactions within an immediate area.

Most home owners likely have an expectation of what their house is worth that is as accurate as either of the two previous estimates through browsing MLS for a few days. Ultimately, market value is determined by the buyer, who either agrees to pay a given price or doesn't.

But what is fair value and how can we calculate it in real estate? What ratio should a home sell for comparatively to rent? Is the ratio static or does it change with market conditions? Can we learn from fundamental analysis of stocks and apply the same criteria to homes?

One of the keys to fundamental analysis is revenue. After all, who wants to own the shares of a company that doesn't sell anything (risk taking speculators do). How do we easily measure revenue as it relates to what we own? In the world of stocks, we use the price to earnings ratio: market price per share divided by earnings per share.

Here's a quick example: ACME Corp. has 10 outstanding shares. ACME Corp. earned $200 in 2008, or $20 per share. ACME's share price closed today at $400 per share. To calculate your earnings per share ratio today you divide $400 by $20 to get a price to earnings ratio of 20.

Determining what is a good price to earnings ratio is easy: the answer is the lower the better. Determining what is a fair price to earnings ratio is open for debate and depends on the stock you may be analysing and how its share price compares to peers.

Can we use a similar metric for housing to determine fair value?

I know I can rent a 3 bed 2 bath home in Victoria for about $2500 per month. I know that same house will sell for about $550,000 depending on the area of town. But let's keep those numbers simple for explanation's sake only here, OK? To calculate the price to earnings ratio I divide $550,000 by [(12 x 2500) - costs*] to get the price to earnings ratio. Remember that reported earnings in relation to a stock are accounted for after expenses--earnings are what the company returns to shareholders.

In our housing case, costs* are the key part of calculating value. Do costs, once accounted for, leave anything to report as earnings? Or do costs result in a loss?

For simplification's sake, let's assume you're buying with cash and renting the house out; your costs should be minimized here. Property tax ($200), income tax on the rent collected ($750), maintenance ($250) and insurance ($75) are added up ($1275) and subtracted from $2500 to get earnings of $1225 per month. The price to earnings ratio is then calculated as $550,000 divided by $14,700 to get 37.4.

I would not use a price to earnings ratio to determine fair value in the residential real estate market, it's just too problematic and open to too many variables that can greatly skew the importance of the numbers. Besides those problems, a price to earnings ratio is a weak analysis of true value if you don't have a historical or side-by-side comparison to use. But if you're working on your financial literacy, hopefully this post has provided you with another term to add to your vocabulary.

Your home: the investment you think it is?

Note: edited on June 19 to fix formula, H/T to Just Janice and NanHousing in comments for corrections, added two future assumptions below

Many people consider their home to be their primary investment. There are a number of financial and other reasons for long term home ownership including:

• "fixed" cost of shelter
• pride
• perception of security
• historical market value growth

But is your home the investment you might think it is? The classic definition of investment goes something like this: you take something you have today (money) and create something with it (business, consumer good, income producing asset) to cause a return on investment. Simply put, a return on investment (ROI) is calculated as gain from investment minus investment cost divided by investment cost.

For example: you give me $1 (cost) I agree to give you back $1.10 in 1 year (gain) = $0.10/$1 = 10%.

There are a number of factors that go into determining the quality of an investment, not the least of which are:

• ROI rate
  
• liquidity
• risk of capital loss
• ROI factors (interest, dividend, yield, capital gain etc)

Usually, the higher the risk, the bigger the gain or loss. Stable, liquid investments historically offer low rates of ROI as a trade off for security of initial capital. If the only source of ROI achieved by a particular investment is capital gains, the investment is usually labeled speculative.

Clearly, a home you own can fit the classic definition of investment. There are two classic ways to achieve ROI in your house: growth of its market value over time concluded with a transaction and rental income (no transaction necessary).

Here's the wrinkle: most people today see this as the calculation that makes the home they've owned over the past 7 years such a great investment: sale price ($500K) minus purchase price ($250K) divided by purchase price = 100% over the ownership period or 10.4% annually.

What happens when you calculate the real--and keep in mind this formula is very rough--ROI as: sale price ($500K) minus [down payment ($12.5K) + interest paid ($72K) + principle paid ($11.5K) + taxes paid ($14K) + maintenance paid ($17.5K) + sales costs paid ($20K) + mortgage balance repayment ($228.5K)] = $124K/$24K = 516%.

The above formula doesn't account for inflation of 2%-3% per year and guesstimates the interest, maintenance and taxes (conservatively).

There are costs associated with "investing" in a house. The over-simplified model of ROI used by the media and the real estate industry typically ignores those costs. Even my simplified model formula doesn't include all of the myriad extra costs that homeowners pay that renters don't. Ignoring the costs associated with home ownership clouds the true ROI, even in so-called boom times like we've just experienced. If housing only stays flat year-over-year for the next several years, ROI diminishes then disappears as time goes on. Here's a couple of examples (ownership costs * = sum of above list):

Buy today, flat market for 5 years
Purchase price = $500K
Down payment = $25K
Principle payments = $31.5K
Sale price = $500K
Ownership costs* = $601K
ROI = loss of $101K or -178%

Buy today, falling market for 5 years
Purchase price = $500K
Down payment = $25K
Principle payments = $31.5K
Sale price = $450K (10% loss over 5 years or approx. 2%/year)
Ownership costs* = $601K
ROI = loss of $151K or -267%

Assumes a 5 year 30 year amortization mortgage at 4.5%.

Market movement

Up to date stats for June in Victoria from Tim Ayres on Twitter:

New sales - 433
New listings - 710 (sales to new listings ratio is 61%)
Total active listings - 3773 (sales to active listings is 11%)

I'm seeing chatter all over the place of multiple offer scenarios and price gains. The market is once again in full frenzy at the low end (did it ever stop?) and first time buyers are drunk on cheap money and the prospect of pre-approval time limits ending. I don't think this will end anytime soon and we may see a record summer for sales volume (prices may peak above April 2008 too).

So, you're sitting on a 5% down payment for a $400K house. There's currently around 71 houses for sale priced below $425K within the CRD. Pickings are slim, you've got a down payment burning a hole in your pocket, a pre-approval time limit weighing on your mind, and the feeding frenzy atmosphere at every open house you attend. What's a savvy buyer to do?

If you haven't already, perhaps you should start acting like you've already bought? That means start saving the difference between owning and renting right now, every month. Here's a quick, back of the envelope calculation for you:

(Mortgage payment amount - current rent) + property tax amount + utility payments + house insurance payments + estimated maintenance costs = ($1800 - $900) + $125 + $200 + $85 + $200 = $1510.

You've got a $20,000 down payment, and you're adding $1510 to it every month. In 3 month's time, you'll have almost $25K to put down. If you keep this up for 6 months, that will grow to almost $30K. Should you wait a year, you'll have a 10% down payment, not a 5%, should you still buy a house for $400K. You will also have a very real understanding of the true costs of owning a $400K house in this city.

There is a time value of money calculation that needs to be worked out here. You need to sort out whether your money is better served in a cash savings account/money market fund (where else are you holding your down payments?) or actually spent on real estate. Considerations include mortgage interest rates (are they headed up or down in the next year?), interest account rates (what's the best you can get?) and the future value of the house (will prices be the same, more or less, in a year?).

Here's my personal assumption: mortgage interest rates will be higher, likely by 1% on a 5 year term; home prices will be the same or less than May median price of $525,000 (but the low-end will be the same regardless). Here's the scenario crudely:

Buy today
Mortgage amount: $380K
Interest rate: 4.5% (5 year term)
Monthly payment: $1788
Principle paid in 12 months: $4615
Interest paid over the term of the mortgage: $82,044
Mortgage balance at term end: $354,728
Interest paid over the remainder of the mortgage (after the first 5 years): $338,846 (assumed 25 years, 6.2% avg interest rate)
Total mortgage interest (est.): $420,890

Buy in one year
Mortgage amount: $360K
Interest rate: 5.5% (5 year term)
Monthly payment: $1918
Interest paid over the term of the mortgage: $95,365
Mortgage balance at term end: $340,245
Interest paid over the remainder of the mortgage (after the first 5 years): $325,012 (assumed 25 years, 6.2% avg interest rate)
Total mortgage interest (est.): $420,377