In these ever interesting times, I find it fascinating to watch the goings on in the real estate market. Over the past several months (if not years) there have been lots of pundits and moon lighting real estate “experts” predicting the collapse of the Canadian real estate market. In particularly in the two hottest Canadian markets Toronto and Vancouver.
In July the finance minister Jim Flaherty yet again changed the laws around government backed mortgages (think CMHC) yet again. These changes were designed to cool the market a little bit and help slow the decent many Canadians are taking down the debt highway. They will work in my opinion but not necessarily quite the way people expect.
As I wrote about previously http://chuckbrady.ca/?p=143 the Canadian real estate market in many ways is quite predictable. (yes I know stuff happens which can temporarily through it for a loop) Despite the high profile of some real estate investors, most purchases (96%) are home owners looking for a place to live. These buys generally do not really care what the sticker price of a property is, they simply pay attention to the monthly payment, aka “what can I afford”.
One of the most high profile changes made by Flaherty was to move the maximum amortization period (only on government backed mortgages) down to 25 years from 30 where it was before. This little move has the same effect as a 10% price reduction to the market. Let me explain:
In June, Joe and Sally home buyers go to their bank looking for a mortgage approval to go house shopping with and Mr. Banker says ok you can spend up to $1800 per month. Based on average prevailing rates of 3.5% at the time and an amortization of 30 years Joe and Sally could go out and spend $400,000 (monthly payment comes in at $1790). Come July the changes are announced, Joe and Sally still make the same amount of money so Mr. Banker says they can still spend the same each month ($1790) but since the amortization period is now 25 years they can only spend $358,600. This equates to a price reduction of a little more than 10%.
This makes the government happier as now Joe and Sally are building in more of an equity buffer each month and not going quite so fast down the debt highway. Though now Joe and Sally look at what is available to them to purchase and they do not quite like what they see so they sit on the sidelines and watch. As more customers begin to sit out for a while the market quietly adjusts down to what people are able and willing to spend.
The simple fact is that since 96% of the real estate market is home owners, they will dictate what the prices are. Over time the market has to adjust accordingly. Nothing happens over night and there are events which can temporarily through the market off course but the fundamentals always return.
So yes, the market is going down probably in the ballpark of 10% but no it is not the end of the world. It really means very little at the end of the day. As interest rates slowly begin to climb (it is not an if but a when, though possibly not till 2014) the rising rates will have a similar effect on the market but it will make very little difference if you buy today or wait a year. If you of the belief you should wait to buy because you think the prices are going to fall, all you are really doing is losing a year of building equity. Sure maybe you can wait two more years and save 10% on the purchase price. Over time the money you saved on the price will be eaten up by the added interest you will be paying. Find something you love and can afford and just get on with it already.
Opportunity knocks with new transit projects
In the never ending cycle of the real estate market, there always seems to be patterns emerging. When you are able to study these patterns and learn from them you will see opportunity where others see only bad things. I believe in many Canadian cities right now opportunity is knocking quite loudly for real estate investors and all one really needs to do is open up the door.
One such opportunity is the infrastructure spending that governments of all levels are partaking in. The most notable area of this in my opinion right now is through the transit expansion. In the Vancouver area construction is about to begin on the sky-train extension known as the Evergreen Line. In Edmonton they are building out the light rail (LRT) and Toronto continues to talk of subway expansion.
So how exactly does one go about taking advantage of this opportunity? Well, for starters, you should begin by looking at the rule of 800 meters. Simply put if you were to put a dot on a city map of the location of an upcoming transit station you would then draw a circle around that dot with the radius being 800 meters. This will give you a focus area that will provide an increase in property value and market rent of about 10-15% higher than comparable properties outside this circle. It is important to note this increase in value will take place a few months after the project has been completed.
Now, let’s get back to the true opportunity that is presenting itself right now. I am going to use the Evergreen Line as the running example in this article. Construction for this project has begun now, early in 2012 and is scheduled for completion in 2016. Right around the time construction is announced and starts people get excited and a temporary bump in value (or asking price) will take place. Then as construction gets under way, noise will pick up, roads will be closed or congested and people begin to get irritated, thus values will reduce. AKA, opportunity is knocking. The beauty of this is not only will prices recover they will jump due to the value increases of the 800 meter rule.
Another interesting phenomenon is that often times city planning departments will run new transit projects through rougher neighbourhoods they want to rejuvenate. This is done for several reasons:
- Any land the city needs to acquire can be done so more economically.
- Neighbourhoods which have been run down have land developers can pick up
- Rezoning in rougher neighbourhoods can be easier as the residents do not always have enough money or lobbying power to cause a fuss.
- Long term project completions can allow developers a chance to build large scale projects that can complete around the same time as the transit projects
- Increases in population density and property values means more tax dollars for the city. (property tax is one of the few methods of collecting money a city has)
So this means you have an opportunity to pick up property at a discount, in an area where prices are already lower than those around it. Moreover, you know that once the projects are complete the property and the neighbourhood are going to see a significant INCREASE in market value and potential rent. A prime example of this was Yaletown in Vancouver. Once an industrial wasteland where no one wanted to be, now it has some of the highest property values in the world.
So there is one neighbourhood I believe has enormous potential for the next 36 months or so and that is Burquitlam (I agree it is a silly name). This area is the site for one of the new sky train stations, is full of older single family homes, the city has been approving mass rezoning for the area and a number of developers are about to break ground on new buildings. There is an opportunity to find decent properties at a reasonable price, gain positive cash-flow in the short term and have a big boost in the medium term. There are no guarantees in life but some good research and a little action you can dramatically increase your odds of success.