Last week, Econowatch looked at the latest dire warnings about Canada’s real estate market. Everyone from the big banks, through Bank of Canada’s Mark Carney to Finance Minister Jim Flaherty is sounding alarm bells about inflated property, especially in hot markets like Toronto and Vancouver. With Canada’s economy slowing down and households overburdened by debt, many predict house prices will start heading south in 2012. On the other hand, the current record-low interest rates don’t have much place to go but up. What does this mean for homebuyers and sellers? We asked realtors and mortgage brokers to weigh in.
John Pasalis is a Toronto realtor and the owner of Realosophy Realty Inc. in Toronto, a residential real estate brokerage that focuses on researching the city’s neighbourhoods. Larry Yatkowsky is a Vancouver realtor at Yatter Matters. Realtor Manny Riebeling focuses on Vancouver West and downtown areas and specializes in luxury properties and condos. David Larock is a Toronto-based, independent full-time mortgage planner. Kerri-Lynn McAllister is the editor at RateHub.ca, a website that compares mortgage rates in Canada.
HOW TO NAVIGATE HOUSE PRICES–REALTORS CHIME IN.
Intuitively, a decline in house prices should benefit homeowners who want to move into a bigger house. A 10 per cent decline, for example, means a “discount” of $30,000 on a $300,000 home, but a bigger $60,000 discount on a $600,000 home. Upsizers could pocket the difference. But do these back-of-the-envelope calculations hold up to reality? Should people looking to move into a bigger home wait on the sidelines for prices to cool?
John Pasalis in Toronto: An upsizer’s decision should be driven more by their personal life circumstances than by an attempt to time the market. There’s a lot of uncertainty in the economy both in Canada and internationally. Homebuyers should avoid trying to time the market and instead should focus on buying defensively. Buying defensively means asking yourself the right questions today to help ensure that you are in a good position to weather a future downturn in the market. You should be asking yourself: Are you buying a house you can settle into for five-10 years? Are you and your partner’s job secure? Do you have a good amount of equity in your existing house that you can use towards your next home? If you answered No to any one of these questions then you may want to think twice about upsizing.
Larry Yatkowsky in Vancouver: Most buyer/sellers looking to upgrade to a larger home have usually completed their homework in respect of financing options and in all likelihood the move up is carefully considered prior to taking any action. Of course in a perfect world selling high and buying low is the optimum. That, however, requires perfect timing. With the view that Vancouver’s house market is dynamic the idea of waiting for what may be perceived as that perfect moment is extremely difficult and adds untold stress to life. As an example, wanting to sell high to maximize the benefit and then waiting until the low arrives doesn’t fit into the realm of a growing family where children need to be registered in a new school or daycare within the neighbourhood.
Manny Riebeling, also in Vancouver: Here in Vancouver, I don’t really see a big cool down because we still have a high number of new immigrants coming and a lack of land. That combination makes our real estate very desirable, so I think for 2012, prices will be stable. Based on the previous statement, if someone wants to trade up they can sell in the spring (which is usually a busier market) and buy once they have a firm purchase offer on their current home or rent for a few months and buy in winter time, when it’s usually a slow season.
Does the opposite hold for people looking to downsize?
Yatkowsky (Vancouver): It’s probably safe to assume that downsizing is a function of being an “empty nester.” As such, the financial concerns differ. Most people compromise due to health or wealth; factors that are both unrelated to the market. However, as in the case of the move-up buyer, these concerns mean people may not be able to wait for that precise market moment.
Pasalis (Toronto): That depends. If you’re approaching retirement and you still have a significant mortgage you should be downsizing as soon as possible. Get rid of that unnecessary debt. I just helped a couple downsize from the $650K four-bedroom house they raised their three kids in to a much smaller and more affordable condo townhouse, and they told me the move changed their lives. They didn’t do it earlier because they had pre-conceived ideas about what they could buy on a smaller budget. If you have no mortgage, then I would move when the time is right for you.
How about first-time homebuyers. Should they wait on the sidelines for prices to cool?
Pasalis (Toronto): First time buyers, much like upsizers, need to buy defensively. Consider buying a home you can afford on just one income. Buy a house you can settle in to for at least five years. Don’t buy a house you’re going to outgrow in a few years. If you know you want to have children then you need to start thinking about schools for your kids now. I see too many first time buyers who want to sell their home after two-three years because they weren’t thinking about schools when they bought, and they now find themselves in bad school districts. And if schools are a priority, it doesn’t mean you have to extend yourself financially. Our analytics team at Realosophy recently researched the relationship between house prices and school quality in Toronto and we were pleasantly surprised to see that 45 per cent of all the school districts in Toronto scoring an average of 80 per cent or more on their English and Math EQAO tests had an average home price below $500,000.
Yatkowsky (Vancouver): If history proves anything, then waiting for that perfect stainless steel granite topped home that has a high walkability factor is tantamount to watching trains pass your station. With Vancouver ‘s price income ratio sitting at 10, the effect of interest rates is a massive determinant in affordability. In this city, on this basis alone, any upward movement of interest rates will wipe out the buyer’s market. The sad part is that buyers are seemingly unprepared or ill-prepared to consider the alternative of an older, more basic home with laminate tops and white appliances in working order. A metaphor for the first time buyer dilemma might go something like this: You are standing in the cold and need warm boots. You only have $10 but the boots you really like are $20. The less stylish fleece-lined rubber pair are $9. You can choose to wait for the much-anticipated $10-boot sale but while you wait your feet are getting wet and cold. What should you do?
Several analysts are particularly concerned about the condo market in Toronto and Vancouver. Should potential buyers stay away from condos and focus on single-family homes? And should sellers hurry up to offload their condo units?
Pasalis (Toronto): There’s definitely a lot of uncertainty surrounding Toronto’s condo market but I don’t think buyers need to avoid condos and I don’t think owners need to rush for the exits quite yet. There will continue to be a strong demand for affordable condominiums in Toronto both from end users and from tenants. The segment that is most vulnerable is the luxury segment. If you’re considering spending $1,400 per square foot for a luxury condo downtown, you may want to think twice. The other vulnerable segment is pre-construction condos. Many buyers of pre-construction condos are paying significant premiums over what comparable resale condos are selling for which makes absolutely no sense. So if you’re thinking of buying a pre-construction condo for $750 psf today expecting it to be worth close to $1,000 psf when it’s done, you may want to reconsider that assumption before jumping in.
Riebeling (Vancouver): It’s never wise to panic, it’s better to be informed, set a plan, make an informed decision. Real estate is not a gamble. Potential buyers need to buy where their life’s necessity takes them, which could be either a house or a condo. Buyers should not rush and buy just to follow a trend or a tip, buyers should buy because they need a place to live. People shouldn’t hurry and sell their condos, unless they have to, at this time in Vancouver, the condo market is quiet, but the sky is not falling. On the other hand, if people panic and put their condo on the market at the same time, they will be creating an oversupply and this will really hurt them. Remember: in real estate, people who don’t track the short-term ups and downs tend to do great over the long-run.
KEEPING AN EYE ON INTEREST RATES–ADVICE FROM THE MORTGAGE EXPERTS:
Long-term fixed-rates have hit a record low. Is it time to hurry up and lock in?
David Larock: Although locking in is not a bad idea, I don’t think fixed rates are going anywhere until the world looks very different than it does today. We have just reached the end of the Debt Super Cycle, which was forty years in the making, and the world is now beginning a necessary but painful period of deleveraging (think of what Canada went through in the 1990s). As the world borrows less and spends less, it will grow less. That means that deflation, not inflation, is the primary risk. That said, I think Canada is well positioned for the tough times ahead and, barring a systemic financial meltdown in Europe, I expect the conditions that have led to our ultra-low mortgage rates to remain in place for some time.
Kerri-Lynn McAllister: It’s always a good idea to get a pre-approval and rate hold if you know you are going to be purchasing in the near future. Not doing so can mean you miss out on limited-time offers. The Bank of Montreal’s recent 2.99 per cent five-year fixed rate is a great example of an offer that came and went quickly. In general, though, we wouldn’t necessarily urge homebuyers to accelerate purchase plans to lock in. Low mortgage rates are here to stay for the near future. From where we stand now, we do not foresee rates making any material movements in the next year or so. Looking at variable mortgage rates, the Bank of Canada does not have a lot of flexibility to raise the target interest rate, which variable rates follow. The state of global economy and in particular Europe and the United States will continue to limit the fiscal policy of Canada’s central bank. Fixed mortgage rates, which follow bond yields, may see a little movement, but nothing out of line with the economic conditions affecting variable rates. Foreign investors continue to see Canada as a safe haven for their international money, driving down yields on bonds and, thus, mortgage rates as well.
What’s the best deal out there in terms of fixed rates?
McAllister: The much publicised 2.99 per cent five-year fixed rate offered by BMO is no longer available but the best five-year rates continue to be attractive (at around 3.09 per cent). The two-year and four-year rates are also good options looking at the spread (difference) of trading down or up to the one- and three-year rates. The fixed 10-year rate is sitting at an all-time low and is definitely worth considering as well. The spread between the best discounted five-year fixed mortgage rates and 10-year rates now sits at around 0.7 per cent, compared to 1.5 per cent two years ago. You could very well end up paying less interest with a 10-year mortgage than with two consecutive five-year terms. This will depend on interest rates rising to long-term averages in five years, of course, which is possible considering interest rates have nowhere to go but up right now. Plus, there is also the peace of mind and budgeting certainty that comes with locking in a set mortgage rate for 10 years.
Larock: That depends on what type of borrower you are and where you think rates are headed. If you’re willing to be somewhat aggressive and if you think rates are going to stay low for an extended period, a three-year fixed rate at 2.79 per cent is very attractive and may give you one more chance to lock in another low fixed rate at renewal before the rate tide eventually turns. But that’s a gamble. If rates start rising sooner, you’ll wish you’d locked in for longer. For more conservative borrowers, the ten-year fixed-rate mortgage is also compelling at 3.89 per cent. This rate is getting the attention of savvy borrowers who think that rates are eventually going to go up but don’t want to try to guess right about when that will happen. Locking in for a decade makes the timing less of an issue, and when you consider that the average five-year rate over the last ten years has been about five per cent, locking in a ten-year rate below four per cent could end up looking like the deal of the century in retrospect. Even the ever-popular five-year fixed rate (which rarely works out to be the best deal, by the way) looks good in the 3.1 per cent range if you use any historical comparison.
Should people consider breaking their current mortgages to take advantage of these incredibly low long-term fixed rates?
Larock: Absolutely. There are three factors to weigh when deciding if now would be a good time to do this:
1) How much is it going to cost to break your current mortgage?
2) How much can you save in interest by refinancing at today’s rates?
3) How much can you save in interest by consolidating more expensive debt or by freeing up cash flow to pay it off more quickly?
The numbers will tell the story. A good mortgage planner will analyse your current situation and, if it makes sense, help you refinance your mortgage and build an overall plan to become debt free faster. (To maximize your potential options, look for planners who have strong financial backgrounds and access to a wide range of lenders.)
McAllister: It is definitely worth investigating whether it makes sense to break your mortgage to take advantage of today’s low mortgage rates. You will need to evaluate whether the savings accrued at a lower rate will make up for the penalty charged for breaking your mortgage contract. The major cost of refinancing is the refinance penalty, which is supposed to capture the lost revenue to your lender when you terminate your mortgage contract. On a variable mortgage you will only pay three months interest, while on a fixed rate mortgage you will pay the greater of three months interest or the typically higher Interest Rate Differential (IRD). High IRD penalties often take away much of the incentive to refinance with fixed mortgage rates, and we often see more opportunities to save with borrowers currently in variable mortgages. This is especially true when variable discounts have dropped significantly over your mortgage term. Right now, however, the market is moving in the opposite direction. When you refinance it is a good time to consolidate other high-interest debt into your mortgage as well, so you need to consider the savings potential there too. It is best to talk to your bank or a mortgage broker who can take you through the exact calculations.
The Fed is projecting low rates through 2014, something that’s likely to influence the Bank of Canada. Does it mean variable rates are still the best way to go for another two or three years?
McAllister: Actually, variable rates are generally less attractive right now compared to fixed rates. Typically, variable rates follow the direction of the target interest rate set by the Bank of Canada; however, while the target rate has remained unchanged for over a year, variable mortgage rates have risen. This is because banks have reduced the discounts they offer on the prime lending rate. A few months ago five-year variable rates could be found at a discount of -0.95 per cent to the (3.0 per cent) prime rate but now are closer to -0.25 per cent on the prime rate (2.75 per cent), or at a premium-to-prime (3.1 per cent) with the big banks. Comparing this to a fixed rate of the same term duration, the spread between them is very small. Or, put another way, there is a very small premium to pay for the security of a fixed rate. Variable rates with shorter terms (one-three years) are actually higher than their fixed counterparts right now.
Larock: Variable rates are not nearly as attractive these days because lenders have greatly reduced their discounts from prime. A market five-year variable rate is now priced at 2.8 per cent and when you can lock in a fixed rate for that same period at an additional cost of less than 0.5 per cent, I think the premium you pay for interest rate certainty is worth it. That said, I do think variable rates will stay low for an extended period. Five years, though, is a long time, and it would take only two rate increases by the Bank of Canada to make today’s variable rates more expensive. That doesn’t give you much of a margin of safety to work with.
What’s the best deal out there in terms of variable rates?
Larock: You can find variable rates as low as prime -0.2 per cent or -0.25 per cent (if you know where to look). You also need to pay close attention to the important differences in the terms and conditions contained in variable-rate mortgage contracts. Specifically, borrowers should look for lenders who compound their variable rates semi-annually, instead of monthly, and who calculate prepayment penalties based on your contract rate, not their prime rate. These are just two examples of terms and conditions that can make a significant difference to your overall borrowing cost. The good news is you don’t have to pay a higher rate to secure them. You just have to do your homework or partner with a mortgage planner who really understands the fine print.
McAllister: Given the small premium right now to lock in a five-year fixed rate over a variable rate, there is only a small window to pay less interest over your mortgage term with a variable mortgage. For example, on a $200,000 mortgage, you will only pay around $680 [(3.09 per cent – 2.75 per cent) * $200,000] more annually for a fixed mortgage rate. If interest rates were to rise, even just slightly, the savings accrued with the variable rate could easily be wiped away over the remainder of the term at a higher interest rate. You can be sure that the Bank of Canada will not be raising interest rates in the immediate future, but three-five years down the road, that is less certain. On the other hand, there is also the possibility, albeit small, that the central bank could cut interest rates further, in which case variable rates would fall too. However, it would be highly speculative to bank on a cut at this point.