For every economist who tells you Canadian real estate prices are headed for a crash, there is another who says prices will remain stable — with both sides using a lot of “averages” to justify their points. Who is right?
When it comes to Toronto real estate, one argument goes like this: The average home price is $500,000. The average income for a family is less than $100,000. In the U.S., when this same one-to-five ratio was reached, the real estate market began its collapse.
The second one argues that the ratio between average household income and average household debt is currently 153 per cent, which also means that for every household earning $100,000 per year, they owe $153,000.
• Instead of averages, should we not be focused on whether a home is in fact affordable for those currently renting a home?
Last July, GWL Realty Advisors, an investment adviser providing asset management, property management, development and specialized real estate advisory services to pension funds and institutional clients, published a study that argues that in major cities like Toronto and Vancouver, renters paying the top 20 per cent rate are in fact able to comfortably afford a home in the bottom 10-20 per cent of these markets. This is true even if they only have a 10 per cent down payment.
The fact is that in Toronto, the lowest 10 per cent of properties, worth around $200,000, are in older condominium units. This is where the majority of first-time buyers enter the market. They do not — and in most cases should not — look at a detached home, where prices routinely start at $500,000. This is clearly beyond their means.
As shown in a recent affordability index, home ownership is in fact more affordable today than it was 20 years ago.
For example, in Toronto, 20 years ago, the average two-bedroom condominium sold for $250,000. The interest rates were 12 per cent and the amortization rate 25 years. You needed 20 per cent as a down payment, which in this case was $50,000. Your monthly costs to carry the unit in 1990 were as follows:
• Mortgage payment: $2,072
According to CMHC guidelines, the household income required to afford these payments is approximately $94,500.
The average rental rate in 1990 for a similar two-bedroom condominium in Toronto was $1,200. It thus made little sense at that time for renters to enter the housing market.
Today, the same condo averages $500,000. The interest rate for a five-year mortgage is 3 per cent and the amortization period is 30 years. With a 20 per cent down payment, the monthly cost to carry this condo would be as follows:
• Mortgage payment: $1,682
The average rent for a similar unit today is $2,300, so you can see that it is conceivable for those renting even in these price ranges to afford to buy.
According to CMHC guidelines, the household income required to afford these payments is approximately $93,000.
If you have only 10 per cent as a down payment today, this will add approximately $250 to your monthly payment. If you have 5 per cent, it will add about $350. If the government changes the amortization period back to 25 years, this will add about $250 to each of the above mortgage payment numbers.
Since the top 20 per cent of renters average more than $100,000 a year in income, they should be able to comfortably afford those properties in the bottom 20 per cent of the GTA. Some can even look higher, depending on their individual situation.
In other communities, where the average price is much lower, the math works out even better. As your main expense, your mortgage payment, is still based on the lowest interest rates in history, still at favourable amortization rates.
When pundits point to the high income and household debt ratio, while true, it costs much less to service this debt at 3 per cent than it did at the 12 per cent rate of 20 years ago. If buyers take advantage of these low-interest rates to lock in for five- or ten-year terms, they will not be subject to the fluctuations that characterized the recession of the early 1990s.