Could My House Blow Up?

Jordan sent me an interesting link yesterday on the predicted collapse of the Western Canada real estate market. Where the report states BC is overvalued by 35% and SK is over valued by 50%. Then he asked a few questions:

Not being an owner yet myself, that made me wonder what a financially savvy person would
do if they found this out and deemed it to be true?

I recall your net worth gained a lot from the value of your house going up, if
you now stand at the top of possibly large declines would you consider selling
your family home to avoid the downtown? Pocket the appreciation and wait to
re-buy when prices were a deal or is the value of home ownership / stability
too great?

First off I do think the report is somewhat true, but a little late.  We are already experiencing a downturn in Western real estate markets and there will likely be some more dropping of prices for at least a year or two until supply and demand get balanced out again.  I think the 50% over valued number is just plain bullshit in SK personally.   Why?  Well first off that would wipe out all the gains in the province since the boom started, which seems to me like a little over simplified math.  Basically SK cities has historically been grossly undervalued compared to just about every other major city in Canada.  I bought a house here which would have easily cost me $300,000+ anywhere else for $190,000.  Hell even the provincial government knew that and used to sell the idea of SK’s low cost of living to attract people.  Part of the boom up in prices is just bringing us up to par (I would guess about 25%), then other 25% is unstable due to speculation.  So we are going to continue to fall, but I don’t think we will drop by 50%.

I won’t sell my home to try and cash in and try to avoid the downturn.  My home to me is more than just an investment, it is also my shelter and my wife’s place of business.  We choose this home over all the others due to price, location and most importantly the floor plan.  It is ideally suited to a our lifestyle (no dining room) and running a daycare (large family room and a main floor bedroom and under 1km to three schools).  So finding a replacement as a rental where my wife could continue to run the daycare would be difficult.

Additionally my wife is sick of moving (I believe our total now is 6 moves in the last 8 years).  So I’m doing my best to stay put here for at least 10 years total.  So with that in mind I don’t dare place a for sale sign on my front lawn until 2016 unless I can come up with a REALLY damn good argument to move us.  So in the mean time my net worth will continue to look like a yo-yo until my investments out pace my equity in my house.

15 thoughts on “Could My House Blow Up?”

  1. I definitely do not agree with including in Net Worth an asset that you can’t or won’t sell … it just doesn’t contribute to wealth; it’s a possession to own and enjoy like a stereo or a delicious sandwich.

    That said, I would consider the family home a source of wealth. If I thought my home would decline in value by 50% then I would not hesitate to sell and rent for a couple of years. To not do so would be like giving up $150K in my case. I suspect you don’t think that it will decline or you are not sure.

    I’m selling my properties in Northern Alberta for that very reason. I suspect we have hit close to the peak.

    How do you like Sask? Which city do you live it? I missed that boom.

  2. Canadian Dream – I agree with your comments. A home is such an emotional investment – it is much more than a financial decision.

    Also, I don’t necessarily think that you can “time the market” with housing. I recall when I first moved from Saskatoon to Calgary. My wife and I bought a place for what seemed like “the top of the market” being very suprised with the level of housing prices but not wanting to rent.

    Since then, house prices in Calgary kept climbing and climbing reaching levels that we didn’t think were possible.

    If a person sold their home thinking prices were about to tank, they would have out of pocket costs to sell (think commission and legal fees). In the interim, they rent and build no equity for themselves and then have legal fees to purchase another home. There are also moving costs and mortgage costs to consider as well. The cost of being wrong and the market picking back up again is also of concern.

    Flipping investment properties is one thing, but personally, I would not be inclined to give up home ownership in what is essentially a bet on where prices are going. Respectfully, people smarter than me lose money thinking they can time the market, so what would make me think I can do better than them?

  3. dc: You’re right, long term I think that owning your home is a great strategy. It’s pretty much how most people can retire: paying their mortgage off and reducing housing expenses to almost nothing. What I’m saying is that if you believe the house will drop then sell it. If you’re unsure, that’s another thing entirely.

    Real estate transaction costs are pricey, but in Canada you get tax free capital gains on your residence so the costs are defrayed. Sell now, rent for probably less than a mortgage payment, then buy back in 2 years when the market is much lower netting (if you believe the 50%) a $100K+ gain probably. During the two years he’ll have a lump sum of some huge amount equaly to his principal plus appreciation earning returns as well.

    You home is deceptive regarding how much money is involved. People just automatically pay the mortgage so the dollars involved never get seen. If you add everything up then months or years worth of salary are at play, so a decision is well worth contemplating.

  4. Er, I’m not really sure that by properties in Saskatoon were “undervalued” by being worth less than comparable properties in other major cities in Canada. Saskatoon is a bit different from Vancouver, Montreal or Toronto when it comes to earning potential and quality of life. Let’s be realistic here. If it cost the same amount to live in those three places, I’d be willing to bet you’d have a lot of people leaving Saskatoon.

  5. TS – Your comment is interesting. I would think that if people knew/thought the value of their homes would drop 50%, then that would imply that the economy of that particular region had a pretty shaky future and you might have to sorry about where you might get the money to pay the rent.

    Despite tax free gains on your residence, there are still real dollars going out the door in real estate commissions and rent that don’t come back to you. At least with a mortgage payment, part of your payment increases the equity you have in your home.

    Doing some quick math, say you bought a house today for $400K with 25% down. You immediately realize that the house is overvalued, so you put it up for sale, get a price of $400K (what you paid for it). Take off 3% for commissions, $750 for legal fees (ball park amounts), pay off your mortgage (assuming no penalty) and you have net proceeds of $87,250.

    Let’s say for arguments sake that rent and mortgage payment are equal and you save no additional money while you are renting. Assuming you put your net proceeds as a downpayment and use another conventional mortgage, you can only afford a house worth $349K. This means that you need house prices to fall 12.75% just to be in the same place you were in before.

    This doesn’t count moving costs or the additional equity you would build up over the 2 years if you stuck with the house. Perhaps this is a little oversimplified, but I think it illustrates some details that are easy to overlook.

  6. I think it’s naive when people recommend you sell and rent for a period of time. Can you really find a good substitute for your house for 1/2 the costs (ie. desired location, condition, etc)? And is it worth your time, legal fees, and taxes?

    If you’re convinced the housing market will bust maybe there’s a derivative you can buy instead of moving. In hindsight you could have shorted US home builder stocks or regional banks with subprime mortgages. Neither have perfect correlation to house prices but would have been a decent hedge.

    Not sure how you would do this in Canada either, maybe there’s a REIT you could take advantage of.

  7. dc: You forgot to include gains on the proceeds and savings of interest. If you park 87K for a year making 4% then you make $3500 from that so you now have 90K. If prices drop by 30%, instead of 12.5% (remember, he was using 50%) then the same house is worth $280. You’ve just made $120K minus fees of 13K = over 105K. If only 20% then the profit is 80K-13K=65+K.

    Double check the math as I have to catch a train, but it’s big dollars.

  8. TS – I won’t deny that your math makes it look enticing. But the downside of being wrong and finding out that house prices didn’t drop as much as you thought, or worse, actually started creeping back up is unsettling to me. Remember that many of the western Canadian markets that took off did so rather quickly.

    20 or 30% drop is a pretty dramatic decrease. I would think that a correction is housing prices is already factored into current pricing in some of the markets that got overheated.

    I tend to be a bit more conservative, so I won’t pitch my wife on the idea that we should sell our house and live in a UHAUL until we can buy it back cheaper! Our house is our home.

  9. Cico,

    Nice summary. That just about cover it. I could tell you some truly funny stories about denial and listing prices here.

    Christine,

    Actually I was more referring to be even in the ball park of Edmonton, Calgary or Winnipeg. I’m not saying Regina and Saskatoon are equal to these cities, but we should at least be in the ball park rather than down in the sewer for price.

    O, by the way, most companies couldn’t pay me enough to live in a larger city. I’ve done it and hated the traffic with a passion.

    TS- I love living in Regina. It has its issues, like high property tax and cold winters, but overall I find everything I like/need/want in the city.

    Additionally it’s not that I won’t sell my home. It is just I need a damn good reason to do it like a very good career move to another city.

    Interesting debate everyone.

    Tim

  10. There was a good article in the press a couple of days about the merrill lynch’s economists’ views on the market. This was the first time I’ve heard an expert admit that affordability is worse than in 1989. Note that he uses housing prices / income instead of the more popular mortgage payments/income which has made things seem less bubblicious. But with those idiot 40-year mortgages do you really want to be betting on interest rates always being lower than that 1989 peak.

    In my own analysis, I’ve listed a number of ways in which people try to convince themselves that things will be hunky dory.

  11. I am also from SK. I sold my house 2.5 years ago (due to illness). I was going to get myself well and then buy another house or condo. Then the market went crazy, and I was priced out. (Plus, the rental market is really tight, so I couldn’t find a decent apartment eithor). I have been really upset about my housing situation (or lack thereof).

    So for me it would be a good thing if housing prices dropped. My sister has been scaring/telling me that there will be increased inventory, but that prices will remain stable, and maybe continue to slowly increase. However, I have started to see Price Reduced signs.

    Several months ago there was a news programme called Saskaboom. It indicated that people from New York and Florida came in and bought up a lot of real estate. So it wasn’t local or relocating people buying property. It was people buying and holding that helped to drive the prices up, speculators I guess you would call them. I thought this was interesting.

    So I guess I will just have to wait, see what happens and keep my fingers crossed. Wish me luck!

  12. Kyle,

    “I think it’s naive when people recommend you sell and rent for a period of time. Can you really find a good substitute for your house for 1/2 the costs (ie. desired location, condition, etc)? And is it worth your time, legal fees, and taxes?”

    With these super inflated real estate prices? Absolutely.

    Nice house on the same street as my house, very similar layout (slightly larger), large corner lot, whole house rents for $1,400 per month. If I sold my house and moved in there, it would be a slight upgrade for my current house.

    That house on the open market would sell for $379,000. 25 am at 6% is a monthly payment of $2,425, $1,850+ for interest alone. Add to that property taxes (almost $200/mo), repairs/maintenance (on a 35 year old home, a good $300-$500/mo) and other expenses and that puts it at $2,300-$2,500 per month (and I’d argue more, houses are EXPENSIVE to own!). Granted, you’d put a down payment on that house, lowering your monthly payment, but then you lose the opportunity cost of your down payment money being invested elsewhere.

    So the family living there is spending about $1,000 less per month than they would if they had bought the same house.

    Right now, renting is the more economical choice by far. Either rents will continue to drive upwards or housing prices will continue to decline. 20%-30% is certainly within the realm of possibility… Canada’s market always follows the US. And no, this time really isn’t magically different.

  13. Great discussion, just where I am at with the selling a house because I think they are overpriced.

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