April 2007

New Climate in Residential Real Estate

Housing prices are free falling in the U.S. and many mortgage lenders are actually going under. Although the situation is less precarious in Canada, it doesn’t mean we shouldn’t adjust.

Residential real estate in the U.S. is experiencing a major slowdown. While, at the beginning of 2006, average housing prices were still rising at a rate of 10% annually, frightened American families are now watching their homes lose up to 6% of their value every year. Some will have to sell their property, often at a loss.

What about in Canada?
On the other hand, as the table below illustrates, Canada seems to be experiencing a softer landing, even in the Western provinces where the rise in prices is still quite impressive. Still, we can learn a great deal from the American experience.

Growth in average price of homes in Canada
  2006 2007* 2008*
Canada 11.1 6.9 4.8
British Colombia 17.7 9.4 6.1
Alberta 30.8 15.5 7.2
Saskatchewan 7.6 8.2 6.5
Manitoba 12.2 9.5 7.7
Ontario 5.9 4.0 3.1
Québec 5.1 4.0 3.3
New Brunswick 5.2 4.0 2.7
Nova Scotia 6.3 5.7 4.3
Prince Edward Island 7.0 6.3 3.1
Newfoundland -1.2 2.6 2.0

* Forecasts

Source: Canadian Real Estate Association

Buyers Beware
For those who are thinking of buying a home, the first lesson is obvious: manage your credit intelligently!

The problem for thousands of Americans right now is that, when markets were good, they took out mortgages that maxed their credit and, as such, their ability to make their mortgage payments. They put down very little cash and chose variable rate mortgages, often with rebates for the first few months. Bolstered by artificially low monthly payments, they bought expensive properties without realizing the reckless financial decisions they were making.

Now, they’re in double trouble: interest rates have gone up and their rebates are a thing of the past. The impact on their monthly payments is catastrophic. A family who took out a $200,000 mortgage at 4.0% over 25 years may today find itself with a rate of 7.5%, which means their monthly payments have gone up by $400!

As well, as American property values are falling, homeowners who put very little down may now find themselves with properties that are worth less than their mortgage. Some 25% of houses with a variable rate mortgage since 2004 are now worth less than the mortgage used to pay for them.
If a homeowner has to renew his mortgage or sell his house in the near future, his situation could be quite dramatic.

The moral of the story is that a family must always make sure its debt load is manageable. Generally, home-related costs should never be more than 32% of family income. In fact, the lower this percentage, the better.

No Ordinary Investment
The second lesson for homeowners is just as obvious as the first: never confuse home with speculating. When housing values are rising quickly, it’s very tempting to compare this “return” with the return on “other” investments and to want to cash in. But, that type of comparison is misleading. Homeowners mustn’t forget that their house is, first and foremost, a place
to live and to bring up children, and it should be managed somewhat conservatively. As many Americans are now finding out, speculating on this type of asset can be very risky.

Retirees and Pre-retirees – Wisdom is Key!
Homeowners who are nearing retirement can look at the existing situation as a good opportunity to review their long-term planning. The recent market performance reminds them that, in the long run, both the value of their home and the costs related to it - for example, real estate taxes and maintenance – will tend to rise. If their income is likely to stabilize, a typical retired couple should, as part of their long-term plans, think about moving to a smaller home or one with less upkeep. The current situation lends itself well to this type of thinking.

Back to Reality
Nowadays, we’re finding out that residential real estate can’t always be looked at as a magical, get-rich-quick solution. More importantly, a mortgage is a major financial commitment, one that must be managed with care.