Sunday, June 7, 2009

So what happens when it's time to renew?

Update: Sunday Funnies added below today's post.

Saturday night coffee with work colleagues and the conversation turns to Real Estate. Several have recently bought homes and another in our inner circle is about to make a purchase.

And no, they do not read this blog. I shake my head at them.

When asked why they are buying homes at this point in time, the answer is always the same: affordability.

Yet while Real Estate prices have declined by 15% (a decline no where near the bottom of this market, btw), that is not the 'affordability' they are referring to. The deals that have finally begun to materialize, in their minds, come not from plummeting prices, but from record-low interest rates.

Whether consumers are borrowing long-term or short, the historically low interest rates are the key factor in the new real estate affordability. It's all about cheap money.

Cheap money provided by a federal government interested in the economic spin off of a housing industry the Feds so desperately want to rekindle.

I cringe as I watch it happen.

The real estate industry is busy pumping out the statistics to back up the affordability argument. CREA and others in the industry point to three straight months of improving sales activity, adjusted for seasonality. April sales were 32% above the decade's low point reached in January.

But it's highly misleading. While sales are 'up', the numbers still show very slow sales for 2009. April sales were off 9.2% from a year ago while sales for the first four months of 2009 were down 20.7% from a year earlier.

It's an artifical frenzy, hyped by the real estate industry to get people on board.

It has created a classic economic battle. In one corner stands the real estate industry, trying to lure buyers with rates so low it is now cheaper to own than to rent. In the other corner is the skittish consumer who is too focused on what is coming down the road to care how low interest rates go.

Consider a $300,000 mortgage. At the 3.75% rate some mortgage brokers claim they can get for a five-year closed mortgage, the monthly payment is $1,537.67, based on a 25-year amortization.

A couple of years ago, when the rate was closer to 5.75%, the same mortgage would cost 22% more or $1,875.07 a month.

So low intestest rates suddenly make a real estate purchase affordable. But what happens when it's time to renew?

Toronto appraiser Barry Lebow, of Lebow Hicks Ltd., said the Canadian real estate market has nowhere to go but down -- no matter how much cheap money is thrown at consumers. "There are going to be tremendous changes in real estate... There are just not enough first-time buyers. Those people buying today, they are not really first-time buyers. You know what they are? They are renters of cheap money, cheap variable-rate mortgages of 2.99%," says Mr. Lebow.

"If mortgage rates were 8% to 9%, these people wouldn't be buying. It's an artificial market. One hiccup in the rates and it's all gone."

And that's the rub. These are historic low interest rates. Even when I ask my colleagues, "do you expect interest rates to stay this low for 25 years?"

They answer, "no".

Ummmm... So let me get this straight. Two years ago, when interest rates were at 5.75%, that was unaffordable.

To lock into a 10 year mortgage today, the rate today is 6.95%... presumably unaffordable.

If you don't think interest rates will stay this low forever, and it's too expensive to lock into a long term, 10 year mortgage... what are you going to do when rates go up and you have to renew?

I shake my head.

Sunday Funnies

(Click on image to enlarge)


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