RBC Affordability Index Feb 2011

ALBERTA HOUSING MARKET MOST AFFORDABLE IN CANADA: RBC ECONOMICS
TORONTO, Feb. 24 /CNW/ – Alberta’s housing market officially became the most affordable in Canada in the fourth quarter of 2010, according to the latest Housing Trends and Affordability report released today by RBC.
Thanks to lower mortgage rates and further softening in home prices, RBC’s Affordability Measures for Alberta fell yet again in the fourth quarter, by 1.0 to 2.4 percentage points, extending their long strings of declines since late 2007.
“Alberta saw a notable downswing in demand for housing last spring and early summer, giving buyers the upper hand and pushing prices down,” said Robert Hogue, senior economist, RBC. “Alberta’s reign as the most affordable housing market may be short lived, however. Demand has shown more vigour in recent months, alongside a provincial economy that is gaining more traction, and Alberta’s market has become better balanced. We expect that this will stem price declines this year and erase a potential offset to the negative effect of a projected rise in interest rates on affordability.”
The RBC Housing Affordability Measures for Alberta, which capture the province’s proportion of pre-tax household income needed to service the costs of owning a home, eased across all housing categories in the fourth quarter. The measure for the benchmark detached bungalow moved down to 30.9 per cent (a drop of 2.4 percentage points from the previous quarter), the standard condominium to 20.3 per cent (down 1.0 percentage points) and the standard two-storey home to 34.4 per cent (down 2.2 percentage points).

Editorial note: there are concerns that the decrease of amortization to 30 years from 35 years and potential for fixed term rates to increase by 200 basis points (from 4% to 6) in the next five years will cause an implosion of home values because of reduced affordability. These factors result in a 35% increase in mortgage payments, or 6.17% annual compound growth in payments. In 2008, prior to the recession, Alberta average wages were up 6% per year. So long as property tax and utilities keep pace with a 6% increase annually, the effect on affordability remains low.

The RBC report notes that gradual and steady improvements in Calgary’s housing demand have recently started to bolster market conditions as home resale’s increased appreciably since June which helped trim down the slack that kept buyers in the driver’s seat.
A return to more balanced market conditions in Calgary, however, did not succeed in reversing the tide in the fourth quarter of 2010 as home prices continued to weaken for the most part in the fourth quarter. Nonetheless, this contributed to further material improvement in affordability. The RBC Measures for Calgary again fell the most among Canada’s largest urban markets, declining by 0.9 to 3.1 percentage points.
“Affordability in the Calgary area is now the best in almost six years and this attractive level of affordability will support further increases in demand as the local economy picks up steam in the year ahead,” added Hogue.

Editorial note: in Feb 2005 the five year posted mortgage rate was 6.05% and the amortization maximum was 25 years. Today, the five year posted mortgage rate is 5.44%. Until March 18, 2011 the maximum mortgage amortization is 35 years. The rate and amortization difference covers 21.5% more mortgage debt within the affordability factors.
There are additional pricing influences? Unemployment rates in March, 2005 was 3.90%, in January 2011 it was 5.9%. They were at a 16 year high at 7.5% in March 2010. The employment lag from the recession has damped home pricing. What happens to prices when we return to under 4% unemployment?

Elsewhere in the country, a majority of provinces saw improvements in affordability in the fourth quarter. Only the standard two-storey benchmark became less affordable in Ontario and Quebec, as did the standard condominium apartment in Quebec and the Atlantic region.
The RBC Housing Affordability Measure, which has been compiled since 1985, is based on the costs of owning a detached bungalow, a reasonable property benchmark for the housing market in Canada. Alternative housing types are also presented including a standard two-storey home and a standard condominium. The higher the reading, the more costly it is to afford a home. For example, an affordability reading of 50 per cent means that homeownership costs, including mortgage payments, utilities and property taxes, take up 50 per cent of a typical household’s monthly pre-tax income.
Editorial notes by: Phil McDowell. http://www.askphil.ca
Tweets as themortgageprof

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Real Men Rent or Hog Ride, Garth?

Garth Turner’s blog of Feb 8 titled Real Men Rent used Calgary housing prices, so I paid attention. 

If you strongly believe the premise that due to consumer debt levels, anticipated interest rate hikes and amortization reductions that housing prices are going to collapse by 25%….my BIASED arithmetic critique on the article’s content will just put you in a righteous flurry and the spit on your monitor will not do it any good. Economics is a faith-based study supported by statistics.  What’s that little booklet in Statistics 101 called again, “Lies, Damn Lies, and Statistics”   My vested interest is in a stable residential value environment so my numbers will favour real estate purchases.

Now, instead of critiquing the fundamental arithmetic issues and general processing of mortgage product in Garth’s blog, let’s see what Garth offers as an alternative investment in his February 8th blog.   (By the way, there is none, except one implied.)

Garth says to invest in something other than real estate.   IF you invested into something that gives an 8% return you would have much higher future liquid assets to buy a home at the greatly reduced future prices. 

What is Garth recommending as an alternative investment for this liquid 8% return?  He has nothing specific, but by inference, I assume it has to do with Harley Davidson.    I note that Garth has a “Harley-riding outlaw”s grizzled comprehension.” (Editor’s note- “of investing”, I am guessing?)

Just as Garth has found some numbers about Calgary real estate and rental, I looked for Harley.   I have data on BOB and HOG.   “Investing” as Garth has, in the hard asset of a Harley motorcycle, I used a Street Bob as my Harley asset class.   In 2007 the retail value was $13,595.  A look at the internet finds a retail sale offer for a 2007 Street Bob at $9,995.    That’s a real, not a forecast decline, of over 26%.   OK.  Everyone knows that chattels are bought for life-style and not as an investment or function.  Comparing buying real estate to buying a motorcycle is unfair.

Garth is talking finance, not cruising.  Since he likes Harley, let’s look at a HOG investment. That’s the stock symbol for Harley Davidson, in case your were curious about that.   Stocks can be the kind of investment that are liquid and has an 8% annual growth.  Since Garth has not quite pointed out a particular investment class that is liquid, secure and provides an 8% annual return, the only other hint is his Harley riding reference.  So let’s look at Harley as an investment class.

February 2007, according to Harley’s own website, their HOG stock price was $69.71.   Today?  $41.44.

Never mind the cost of buying and selling securities, that is a 40.55% real decline in value, not forecast decline.    Buying that Harley BOB instead of HOG actually looks like the better investment now.   A least you know you are going for a ride.

Now I am the first to admit that I am just a pudgy pencil pushing peep, not a grizzled Harley-riding outlaw like Garth.  I have no clue about Harley’s.  I just looked at the math for an inferred investment suggestion.

Oh, and comparing ownership to a rental?   Garth, if you took the initial investment of buying a Harley, insuring, buying/selling costs, etc compared to a monthly public transit pass used over a three-year comparative…..how would that Harley do? 

You know what?  I learned something doing this.  I learned it is a whole lot more fun and much easier to tear down an investment choice than it is is to either defend or propose one.    I like it!

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Real Estate Crash first test: 10% decline in March

A number of financial gurus have forecast that with a 2% increase in rates, Canadian residential real estate values will crash by 25%.  Their theory will soon have its first interim test.   By their theory, property values across Canada will crash by 10% shortly after March 19, 2011. This the direct result of a recent .25% rate increase, and the soon to be implemented 30 year maximum amortization.  

What forecasting model have they used to come up with this figure?   They have taken a 35 year amortization at current rates, and using that particular payment they have calculated the amount of mortgage that payment will produce.

Here is how their forecast works:   Per $100,000 loan amount at 4%, amortized over 35 years, that payment is $440.81   These forecasters look forward five years and using the remaining amortization of 30 years, and a 6% interest rate,  $440.81 pays a $74,107.71 mortgage balance.  That’s close to their 25% crash.  Of course, there can be an argument that the mortgage balance in five years with standard payments will be reduced from $100,000 to $92,698.56, so the crash will “only” be 20%. 

However, a new home buyer qualifying today for a $100,000 mortgage at 4% and 35 year amortization, will only qualify in the future for that $74,107.71 mortgage because of the reduced amortization to 30 years and 6% rate.   Therefore, the 25% crash scenario with this logic stays “is as”.

So, the first test of the theory is going to be very soon.  A number of lenders have increased their rates by .25% and March 18, 2011 is the last day for approval of 35 year amortization mortgages.

Therefore, applying the same logic of a 2% rate increase is equal to a 25% crash, a 4.25% mortgage amortized over 30 years and payment of  $440.81- that supports a $90,003.92 mortgage balance. 

Based on these gurus’ theory, shortly after March 18, if there is no change of mortgage rates from the rates to take effect tomorrow, the residential real estate market in Canada will crash by 10%.

Meanwhile, if you cannot wait until March 19, the day the new mortgage rules take effect, let’s see if property values drop 3.25 percent.   That 4.25% rate with the 35 year amortization supports a $96,746.98 mortgage.  That’s real close to a 3.25% decline. 

Or, are these forecasters oversimplifying the dynamics of the real estate market? Time will tell…..and, time is short.

Themortgageprof is Phil McDowell, licenced in BC as Mortgage Broker, Phillip Allen McDowell; licenced in Alberta as a Mortgage Associate with Mortgage Alliance “Mortgages Are Marvellous”

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