Are You “Chasing The Market?”

We use the term “chasing the market” in several different situations, but today I want to talk about saving for a higher down payment, and continuing to hold off on buying a property in an increasing market.

There is no right or wrong here – let’s make that clear.  To each, their own, is another saying that would appropriately apply.

But I figured going through a real example, with complex mathematical equations including calculus, trigonometry, and advanced functions, might help to clear things up a bit…

ChasingTheMarket

It’s all so damn easy, right?

The Toronto real estate market has increased, every year, for almost two decades.  So the “right” time to buy is always NOW!

But there are other factors than just market appreciation at play when you’re a young, first-time buyer, and it doesn’t always mean the best time to jump into the market is as soon as you can write a cheque.

I have a client who is looking to purchase a 1-bedroom unit with parking, which on the east side of Yonge, in the downtown core, is going to cost anywhere from $310,000 to $380,000.

Wow, that’s a big spread, right?

But that’s the true price range we’re looking at, and it makes a huge impact on her affordability, and thus her decision.

The 1-bed units with parking that cost $310,000 are probably not the type of unit I’d want to sell to her, and I’d be shocked if she pulled the trigger on one.  This represents the lowest-end of that market, or the “bottom-barrel” if you want to get descriptive, and negative.

But at the other end of the price spectrum, it’s also not necessary for her to go as high as $380,000.  There are some great 1-bed units with parking available in King East for $350,000.

So while the actual purchase price of the unit is going to impact her decision, believe it or not, it’s not at the top of the list.

Her issue stems from the down payment, the CMHC premium, and the timing of the purchase.

Any buyer who makes a down payment of less than 20% pays an insurance premium to CMHC, according to the following sliding scale:

CMHC Loan Premiums

These premiums were increased on June 1st, 2015, by approximately 15%.

The premium is calculated on the loan amount, not the purchase amount.

So if you had enough money to buy a condo with a 5% down payment, but not a 10% down payment, your CMHC premium is going to be higher.

This is where a would-be, first-time buyer would have a decision.

Let’s say you’re purchasing that coveted 1-bedroom condo with a parking space, for $350,000.

If you have saved enough money to make a 5% down payment, or $17,500, then the balance of $332,500 will be mortgaged, and you’ll pay an $11,970 fee to CMHC, amortized over 25 years, at $39.90 per month.

And keep in mind that while the premium is amortized (ie. repaid) over 25 years, if you sold the condo next year, you still have to pay out that entire amount.  Once you purchase, that CMHC fee is payable in full.

Now if you have a 6%, 7%, 8%, or 9% down payment, you still may as well only make a 5% down payment, because until you reach that 10% threshold, you’re still paying the same CMHC fee.

If you did have 10% down, or in this case, $35,000, the mortgage amount of $315,000 would come with a CMHC fee of $7,560.

And lastly, at 15% down, or $52,500, the $297,500 mortgage amount would come with a CMHC fee of $5,355.

To some people, these might seem like nominal costs.

You’re paying $1,825 in land transfer tax on this $350,000 purchase, which would be $6,950 without the first-time buyer rebate.

You’re paying upwards of $2,000 in legal fees to close the transaction.

And you’re probably going to spend $5,000 furnishing your condo, but that’s up for debate.

To other people, these CMHC premiums are outlandish, and they might suggest that a buyer do everything in his or her power to avoid them.

In my opinion, there’s no right or wrong answer here.  It all depends on the buyer.

Let’s say that the buyer with 5% down, looking at an $11,970 CMHC insurance premium, wanted to save up enough money to pay only $7,560, by hitting that 10% threshold.

That would save the buyer $4,410.

In order to hit that 10% threshold, the buyer would have to come up with, in the example of a $350,000 condo, another $17,500 for the down payment.

So how long does it take a buyer to save that much money?

That is the burning question!

Let’s say that a buyer makes a $55,000 per year salary.  His or her after-tax income would be approximately $42,674 or $3,556 per month.  I won’t complicate things by getting into CPP and all that.  Let’s just keep it simple.

That buyer is probably renting right now, with a roommate, at a cost of $1,100 per month.

I have to think that food, and other necessities of life, are costing $500 per month.

So even if that buyer was a hermit who didn’t spend a penny of his or her disposable income on discretionary purchases, that leaves $1,956 per month in savings.

So according to these very conservative estimates, it would take 8.95 months to save $17,500.

Now what does the real estate market do in 8.95 months?

Here’s where you can really, truly, make numbers say anything you want.

Toronto’s “average home price” was up 12.3% from June of 2014 to June of 2015.

And through April, May, and June, we saw double-digit increases across the board for just about everything.

But again, let’s be conservative, and recognizing that we’re talking about a $350,000 condo, let’s use a very modest 6%.

That equates to a $21,000 yearly increase, or in our example above, over 8.95 months (let’s round up to nine), that’s $15,750.

So for the would-be, first-time buyer, looking at a $350,000, 1-bed with parking, waiting nine months to save the additional $17,500 for a down payment to go from a 5% down payment to a 10% down payment, and save $4,410 in CMHC premiums, the property in question will cost $15,750 more.

$4,410 versus $15,750.

It doesn’t make financial sense, does it?

If you were to look at the difference between 10% and 15%, where the premiums are $7,560 and $5,355 respectively, it makes even less sense, given that gap is only $2,205, compared to the $4,410 difference between 5% and 10%.

Suffice it to say, it makes even less sense to “wait” to save money and go from a 10% down payment to a 15% down payment.

There are other factors at play here, of course.

The young buyer could be “waiting” until he or she gets a big bonus, and thus it might not take 8.95 months to save.

The young buyer could be locked into a one-year lease.

We could be looking at interest rates going down, and thus waiting could result in a lower monthly mortgage payment.

But in lieu of all these maybe’s and might’s, the always-appreciating Toronto real estate market provides tax-free capital gains that typically trump any other caveat.

I certainly don’t want to sound like a naive, cheerleading, market bull, so I’m not going to suggest that in 100.00% of cases, “the right time to buy is now.”

But I do believe that buyers can get caught “chasing the market” if they’re trying to save money.

The market appreciates at a far greater rate than a buyer might save on CMHC fees, or a modest drop in interest rates.

Take a would-be home-buyer who said in 2012, “We’re saving for a larger down-payment,” and the $600,000 house in 2012 is $725,000.  That’s a $125,000 tax-free, capital gain, that the would-be buyer can never get back, and the “higher down payment” only served to lower an already-low monthly interest cost.

No, this market isn’t going to go up forever.

But it’s going up today, and it’s going up tomorrow.

And buyers who continue to chase the market might want to run their own numbers, and see if it makes sense to get in…

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  1. […] We’re going to give a shout-out to our friend David Fleming over at Bosley who wrote a fantastic piece back in July about chasing the market, i.e. why, in a lot of cases, you’re probably not saving money by waiting to buy. You can check it out here. […]

  2. bugeyedbrit says:

    We bought a house because we were ‘done’ living in a condo, and were looking to stay in the house pretty much till we drop, so it had to be the right house in the right neigbourhood (thankfully achieved), so to me if the market dips, I am not really all that worried, as our time horizon for ever trying to crystalize the value of the house is 20+ years from now, I intend to live in our hour till then, rather than try and capitalize on the value and move up the chain.

  3. steve says:

    Nobody knows what will happen to this market …. 20 years of going up guarantees nothing. Just look at what happened to the price of oil (or the current RE in Fort McMurray). None of us want to see a deep decline in sales or prices, but a little prudence is well warranted here.

  4. condodweller says:

    David here is an idea for a future post: condo parking space costs. The highest new construction parking space cost I recall was $50k for a downtown condo a few years ago. What is the highest cost today and how much of it can one recover in a resale? Are they worth buying vs renting? How about two spots?

  5. condodweller says:

    For me it’s difficult not to think of my home as an investment, however, for someone who wants a home where they will stay for a long time it probably makes sense to buy anytime as you don’t realize a gain/loss while you live there. Even if you sell at a loss, you will probably buy something else which will also be cheaper so you don’t really lose anything. This only becomes an issue if you have additional investment properties. One thing we know is that the real estate market is cyclical, furthermore, a cycle can last 30 years. By definition, there will be a correction/crash/soft landing sooner or later. I maintain that the higher prices go the larger the correction/crash is going to be. Perhaps circumstances have changed since the 80’s, though it’s debatable, but human behavior has not. Whatever spooks the market in the future, people will head for the exits and drive down prices more than necessary as fear will set in and the opposite mindset will prevail. They will not buy homes because they will think it will be cheaper the next year.

    The problem is that people will get into trouble with their mortgage much faster than now with $500k mortgages than before with $200k mortgages. On a $500k mortgage you will have paid down such a small amount of principal even after 10 years that a job loss or significant rate increase (which is more likely over 10 years) will still have a devastating effect. My first mortgage was less than $100k. I locked in for 5 years and after the 5 years regardless of what happened I would have been ok. I realize people buying today weren’t in the market 20 years ago and these prices are all they know, but I still can’t wrap my head around the idea of taking on a mortgage of $400k plus.

    At the end of the day, in a two income family you better crash test your finances with one income, and a single income person should crash test theirs with a $40-50k income in case of a job loss where they can’t replace a high paying job. Also, at these debt levels life/disability/creitical illness insurance becomes much more important of a consideration.

  6. Appraiser says:

    The bottom line is that no matter how smart you are, you still can’t predict the future. A fact of which the bears are all too aware. Five years ago they were saying exactly the same things as today…. “it’s just too risky”

    But that’s just how life is. Risky.

    As the Red Hot Chili Peppers say…”life is more than just a read-through”

  7. Jimbo says:

    http://www.cra-arc.gc.ca/pdoc/

    $3,016.48 a month after tax provided you don’t pay into an rrsp, employer pension or have your employer pay into your RRSP.

    This amounts to paying CPP 219.66 and EI 86.17 a month until you are topped up. After you’re topped up you would make roughly $3316.

  8. Kyle says:

    The whole is “this the right time to buy” question, doesn’t make any sense without considering the who, what, why and for how long aspects. Most of the bears will say it is not a good time, because their delusional belief perseverance tells them prices in Toronto will fall at some point. If (big giant if) prices do fall does that mean it was a bad time to buy? Sure, if you only ever considered your house to be a speculative investment that you were going to exit at a gain. But for the vast majority of people buying with the intention of living in their place for a while, falling prices aren’t really impactful, unless you’re a downsizing Senior or selling for the last time in your life.

    What is more impactful is affordability. If interest rates rise increasing the carrying cost then yes timing matters, but this really is more of a question about whether it is a good time to go variable or fixed (long or short), not whether it is a good time to buy or rent.

    1. daniel says:

      I think the labour market is a much bigger factor on how good a decision owning a home is for most families. A family with a $500k mortgage would have their carry costs go up by hundreds of dollars a month if rates rise two per cent. It sucks, but you cut back on vacations, dining out, whatever.

      Now, one spouse loses their $80k a year job and can’t find a new one, now the family is down $5k a month. Cutting out little luxuries doesn’t plug that gap.

      I think the market can weather a rate rise, 10% unemployment would hammer it.

    2. Joe Q. says:

      But for the vast majority of people buying with the intention of living in their place for a while, falling prices aren’t really impactful, unless you’re a downsizing Senior or selling for the last time in your life.

      They could be impactful if a job loss (as Daniel mentions) or relocation comes into the picture. But along the same lines, just as falling prices shouldn’t be a major consideration for most long-term owners, I think that the “always-appreciating Toronto real estate market providing tax-free capital gains” cited by David should not be a major consideration either. Again, unless you’re a downsizing senior, relocating to somewhere cheaper, etc.

      1. Kyle says:

        “I think the market can weather a rate rise, 10% unemployment would hammer it.”

        “They could be impactful if a job loss (as Daniel mentions) or relocation comes into the picture”

        100% agree with these two statements. What will cause house prices to correct, is significant job losses and/or a shrinking population, full stop.

        Inferences from all the other stuff like historic Price/Income, Price/Rent, rising interest rates, foreign ownership, what happened in the US, what the Fed does, what happened in the late 80’s is nothing more than baseless speculation.

    3. BRBB says:

      “But for the vast majority of people buying with the intention of living in their place for a while, falling prices aren’t really impactful, unless you’re a downsizing Senior or selling for the last time in your life.”

      Hmmm….I think someone who bought a house for $1 million and lived in it for 50 years (and whose value rose to $10 million) is much better off than the guy who bought the house for $2 million and also lived in it for 50 years (and again, whose value rose to $10 million.) He’s better off by….and here’s the math, $2 million – $1 million = $1 million. I’d say $1 million saved is in fact, impactful. For instance, the guy could have bought 2 houses in instead and rented one out. He’d than have two houses worth $20 million (pre-tax) and a bunch of net rental income.

      I always smirk at this argument – all you have to do is wait long enough, and the house will rise above your cost! OK, so you buy a house at the top of a highly speculative market for $5 million and in then falls to $1 million a few years later. But don’t worry, because in 35 years. that sucker will have risen back above your cost (in nominal terms, that is!) Hooray! Hooray? Hooray to the guy who bought at $1 million!

      1. Kyle says:

        Try re-reading. I’m obviously NOT saying there will be no impact from the prices one buys vs sells. That would be a pretty foolish interpretation. I’m saying once someone buys, there would no impact from price fluctuations while the person is holding the property and enjoying the utility when they have no foreseeable intention of cashing out of real estate…until they go to sell.

        But lets say for the sake of argument, we’re talking about someone who is considering whether to buy or not. Your arguments are wonderful in hindsight, but utterly useless in the real world. Obviously, we can all look back from our deathbeds and say, “if i had bought at so and so point, i would have been better off”. WELL DUH! Unfortunately the path of real estate prices over one’s lifetime, is not something anyone knows or can predict when they’re deciding to buy. So trying to maximize the gain/loss one realizes from real estate over their lifetime, by picking the right time to get in or out, as you yourself said “timing is near impossible” should not be a high consideration. Instead when it comes to decision making they should be taking into consideration information that is available at the time: Can i afford this house? How stable is my job? Do i plan to stay here for a long time? Will i enjoy living here? Will this house suit my needs now and in the future?

        If you disagree with this try using logical arguments rather than a hypothetical situation pulled from your butt, because it would obviously be just as easy for me to come up with some make-believe, fantasy case with low real world probability or applicability that tell the opposite story.

      2. Kyle says:

        “I always smirk at this argument – all you have to do is wait long enough, and the house will rise above your cost! OK, so you buy a house at the top of a highly speculative market for $5 million and in then falls to $1 million a few years later. But don’t worry, because in 35 years. that sucker will have risen back above your cost (in nominal terms, that is!) Hooray! Hooray? Hooray to the guy who bought at $1 million!”

        If this makes you smirk, i think it is because you lack understanding of two very important concepts: Probability and Relative Value – which seems really odd for someone who claims to work in Investments.

        1. Let’s first ground this debate in reality. TREB publishes the historic sales price for each year going back to 1969. So we have close to half a century of data that we can analyze. The average return over that period is 7.21% with LOW volatility. To give you an idea of how low, here are some stats:

        probability of a negative return = 13%
        probability of a positive return = 87%

        probability of a negative 5% return = 7%
        probability of a positive 5% return = 64%

        probability of a negative 10% return = 0%
        probability of a positive 10% return = 16%

        The largest single year loss was -8.25%, so can we agree that a house going from $5M to $1M in a few years is complete and utter nonsense? When people say prices will eventually rise beyond a pull back, it isn’t an argument based on hope for the future it is an argument that is well supported by very high REAL WORLD PROBABILITY.

        2. Unless one is ok living in a tent, it’s safe to assume that at some point we all need to pay for a permanent roof over our heads. So the choices are to buy or to rent. Judging the return from owning a house in isolation as you have done is totally pointless. What makes more sense is comparing it to the alternative. I realize this is simplified, but in your scenario the guy who buys a house for $5M and 35 years later owns a house that is still worth $5M, has essentially made 0% return….But he has lived for free for 35 years. The alternative is to have paid rent for 35 years. In this case only an idiot wouldn’t say hooray for the home buyer.

  9. Marina says:

    When we bought our house 5 years ago, everyone was telling us to wait a year or two.
    If we had, we currently would not be able to afford our house.

    If you are looking for purely investment purposes, maybe the math carries more weight in terms of timing. But when it’s your home, I think the right time to buy is when
    1) you can afford the carrying costs, purchase costs, and moving costs without too much trouble
    2) it’s the right time in your life to buy
    3) you find a place you like in your price range with your must-haves

    Anything else is pure gambling.

    1. Kyle says:

      I totally agree with this. I would also add one more: you are looking to stay in that place for more than just a few years.

    2. jeff316 says:

      Exactly. Timing is tough. Waiting to purchase may not price you out of a neighbourhood or housing type forever, but it certainly may price you out of a neighbourhood or housing type when those factors would best suit you and your family.

      I would never argue against someone making a financial decision based on sound calculations, but if you come out slightly ahead waiting on buying your home but you’ve crammed your family of four into a two-bedroom condo for the last nine years you have to ask about the tradeoffs.

      I do think prices will peter out and drip down – but certainly not to the extent that some people pray for. It will be interesting to see, at that time, how people judge the “correction” if and for how long prices are below peak but above traditional metric norms.

      1. BRBB says:

        Yes, timing is near impossible.

        I work in investments, and the CEO of company I work is run by a very famous investor who is a billionaire. He is considered to be one of the savviest investors in Canada. He is very astute in all asset classes, including stocks, bonds and real estate.

        What was his advice on Canadian real estate over the past bull market? Well, he was very very negative on it in 1999! Yes, 1999! So, its tough, very tough to time. Maybe impossible! When I bought my first condo in 2001, I think my career took a turn for the worse, because my boss would have thought I had absolutely no investment intelligence.

        I bought a house in 2009. I was very nervous about it. I almost SH** my pants after the deal was signed. I thought for sure it was worth 20-30% less than what I was paying for it, but I bought it because a house is not just a pure investment. And I bought it because it was a near-perfect house for me. And we know that ‘near-perfect’ can be hard to find. Thank goodness I bought it, because a few years later I got married and then had two kids.

        Biggest points, repeated here in this blog: a house is not just an investment AND it is near-impossible to time.

        And consider this: let’s say you are considering the purchase of a $2,000,000 home. Over the very long-term, I believe real estate has risen 5% per year. Thus this $2,000,000 home (assuming it is at fair value) will go up by about $100,000 per year. If you decide to try and time the market, then you must consider that while waiting, the true value of the house is rising by $100,000 per year. You better be a damn good timer because in 5 years, the house would have risen in value by $553,000. Another way to look at it: Suppose you are looking to buy a house that is selling for $2,000,000 today but you think that real estate prices are too high and will fall by 25%; thus this house will fall to $1,500,000. So you are going to wait it out and try to time it. If it is really worth $1,500,000, in 5 years it will really be worth $1,914,000 with growth of 5% per year. Thus in just 5 years of waiting, the house is now worth very close to the current price of $2,000,000.

        So perhaps the last point is, there is also a very high cost to waiting. I know someone who has been waiting to buy a house for over five/six years. He’s experienced first hand the cost of waiting. Even if home prices now fall by 35%, he’ll still be paying more for his home than he could have paid five/six years ago.

        Now….just reading my email, should make one wonder if this is the top in the market! Ahh, the fun of trying to predict markets!

  10. Boris says:

    When this thing corrects, its going to be a real bitch for a lot of people.

    Don’t know when, but it will happen.

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