Latest posts by FIRECracker (see all)
- Guest Interview with Craig, Author and House Hacker Extraordinaire - October 7, 2019
- Book Review: Choose FI, Your Blueprint to Financial Independence - October 1, 2019
- Are You a Good Fit for FIRE? - September 9, 2019
A European friend, Anna, recently came back from a Vancouver vacation, disgusted. “Why are there vegan dog food emporiums next to homeless shelters?” She asked. “I thought this was a socialist country?”
Clearly, Anna isn’t familiar with Vancouver. She has no idea the average detached home is a whopping $1.65 million, despite an average family salary of only $76,000. The wealth gap is real.
But maybe not for long…
Now, you might be wondering, so what? Canadian newspapers have been saying for YEARS that the market is overheated. Are you unfairly blaming offshore investors for driving up the housing prices?
And to be honest, I don’t know exactly what’s causing the insane housing prices in Vancouver and Toronto. Foreign investors? Locals borrowing their brains out? No one can say for sure. But here’s the thing. If it were the Vancouver locals in Vancouver, how is it possible that the average home is $1.65 million if the average family salary is only $76K? No bank would lend you that much money. The most expensive house you’d be able to afford is $600,000 @ 2%.
So if foreign money is driving the housing market, things are about to get a LOT more interesting. Especially after the 15% land transfer tax.
Now, I know what you’re thinking. “Oh, the Chinese media? Yes, let’s listen those guys. Do me a favour and look up the word ‘Propaganda’?”
And having grown up under a totalitarian government in China, I applaud your healthy dose of skepticism.
That being said, I’m also an engineer. And as an engineer, I trust numbers. People can bullshit as much as they want, but numbers don’t lie.
The article also mentions:
“Canadians have the largest debt-to-income ratio of any G7 country, with the average spending 165% of their salary. To contrast, at the height of the US housing crisis in 2008, Americans carried what was then considered an outlandish 147% debt-to-income ratio.”
WOW! Our debt-to-income ratio is a whole 18 points HIGHER than that of the Americans right before the 2008 housing crash?!
Scary stuff. But you know what’s even MORE scary?
The fact that our economy had the biggest monthly decline since 2009, and yet our housing prices continue going up. Hmm. Seems legit.
This fancy-pants fund manager, Marc Cohodes agrees, and he wants to cash in our inevitable demise.
Here’s why he’s coming out of retirement to short our housing market:
- “Supply and demand doesn’t make sense. Housing prices in the GTA over the past 30 years are up 188% and income has only risen around 1%.
- “Buyers have been piling in faster than people can sell their homes”
- “It’s international money laundering coming into Canada…regulations are very lax.”
- “Home Capital Group has admitted to $1.9B in fraudulently underwritten mortgages last year alone.”
According to Marc, “Not everyone should be a parent, not everyone should have kids, not everyone should own a house. If you think the market is going up and you’re not participating – that’s fine. Just be patient and the market will come down.“
I’m not surprised Marc would think this way. The other day, I met, Justin, another early retiree who writes at RootofGood. He was visiting Toronto with his family and staying in a 3 bedroom semi-detached house he found on AirBNB. When I told him the house was worth“$700-800K “, he did a spit take. “WHAT?! Are you serious?”
“But my house in Raleigh, North Carolina is only $108K! And I can easily rent it out for $1000/month. Why would anyone spend that much on a house?”
To the Americans, buying houses worth more than 10X our salaries and in a city with a price-to-rent ratio (see below for explanation) of more than 22 is INSANE!
Even with all this damming evidence, the housing prices in Vancouver and Toronto continue skyrocketing. None of it makes sense because none of it is supported by fundamentals—like family income.
And yet people ignore these facts and continue buying houses at record levels because “houses always go up” and “renting is throwing your money away.”
Sure, some people made money in the housing market. And some day traders won on individual stocks. But both require market timing. And most bets don’t pay off. Yet buyers continuing attributing their good luck with skill, thinking that they’re geniuses and that the party never stops.
This is why the herd mentality is so dangerous. Instead of blindly following the herd, make decisions based on numbers, not FOMO (Fear Of Missing Out).
Or one day the party will stop (as it always does). And you will find yourself drowning in debt, your home plummeting in value, and then it’ll be too late.
Before buying a house, consider the following:
- What’s the Price-to-Rent ratio?
- PR ratio = House price/(monthly rent*12). If this number is greater 16, don’t buy the house.
- In Toronto, a $700,000 4 bedroom home can be rented for $2650/month. That’s a PR ratio of 22 (1/22 gives us a return of only 4.5%). A reasonable return on your investment in the markets is 6%. So it makes more sense to rent.
- One downside to PR ratio is that it doesn’t take into account all the extra costs that come with home ownership (eg maintenance/condo fees, property taxes, insurance, land transfer tax, etc)
- What’s the Cap Rate?
- Annual Net Operating Income/Cost
- For the $700,000 house, if the rent is $2650 and operating costs/month is around $500 (property taxes, insurance, maintenance, heat/hydro, etc), the Cap Rate = ($2650-$500)*12/$700,000 = 0.037
- 3.7% is again below the 6% market return. So rent is better.
If both indicators are flashing green, it might make sense. But if you calculate the PR ratio and Cap Rate in Toronto and Vancouver, you’ll see more red flags than China.
So don’t buy that house. Instead, build a tax-efficient portfolio using index investing and get paid to do whatever you want. And you don’t ever need to time the market because you get paid dividends no matter which way the market goes (even during 2008, we still got paid dividends). All you need to do is rebalance periodically. Simple, straightforward, and stress-free.
And the best part? No matter which way the housing market goes, you win.
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