Sunday, June 14, 2009

Don't Dive Into Real Estate Before Reading Garth Turner's Blog

I've become a regular reader of former Conservative and Liberal MP Garth Turner's blog Greater Fool. In addition to providing readers with some insights into life on Parliament Hill, he has taken to doling out what I consider to be some very sage advice on the economy in general and real estate in particular.

I would strongly suggest that anyone even considering a foray into real estate, that they read a few of his blog entries first. You'll find his commentary flies in the face of almost everything presented in the mainstream media. That should come as no surprise, pick up any daily or weekly newspaper in this country and check out all the advertising being done by those who's livelihood depends on the buying and selling of houses and condos. If you want a short lived career in journalism try writing newspaper articles that are bearish on the housing market.

Popular wisdom has it that with interest rates so low, and with housing prices being depressed in many parts of the country...that now is the time to dive in and buy or regret missing the boat as affordability drifts away.

Just this past weekend I was over at a friend's house, and flipping through the local rag's real estate listings we came across a detached home for about $150,000 which would carry for around $550 a month on a mortgage amortized over 35 years at a variable rate of about 2.6%. Given that this friend pays almost $800 a month in rent it would seem a no-brainer to some.

"Why am I paying $800 and building no equity when I could be paying less and owning"??? The ad predicated its assumptions on a 5% down payment, which would mean scraping together about $10k from savings, borrowing, or drawing on an RSP. But if that could be swung...why not dive in?

Here are some very good reasons. The monthly payment is very low, yes...but it's predicated on a variable rate mortgage. Going fixed would mean a higher rate and higher mortgage payments. One could gamble and pray that rates stay where they are, but we've already seen the banks hike interest rates a couple of times recently. Reality is that rates are so low right now, there's only one direction they can move, UP!!!

People are already leveraged to the hilt, living beyond their means and using home equity to finance their lifestyles. We haven't seen a major correction in real estate prices in this country like what has happened in the US. In fact the most recent spring market has provided something of a mini-boom to the market, with many first time buyers being lured in by media reports and heavy industry advertising.

If our market does suffer a sharp correction, and with job losses mounting and oil prices spiking again that is a very strong possibility...then a lot of people could find themselves being forced to sell their homes to get out from under a mountain of debt. If listings increase significantly you can expect to see prices tanking, real estate is not immune to the laws of supply and demand.

So buying that $150,000 "bargain" might not look so good in a year or two if interest rates climb as everyone is expecting. And if a glut of homes start hitting the market, that tiny little $7,500 in equity could evapourate overnight. Who wants to own a home with more money borrowed against it than what its worth?

There are many who will point to the axiom that..."Real Estate always goes up". The same people trotting out this little chestnut are likely the same people who bought Nortel at $75 in anticipation that it would hit $180. Or maybe they bought into oil at $140 per barrel US because it had to keep climbing.

Our governments are borrowing money on a Biblical scale which can only mean higher taxes in the future. If not higher taxes then we'll see a huge reduction in government funded programs and services meaning we'll be paying for things our taxes used to....while our tax dollars get diverted into servicing the mountain of debt being racked up.

The economy may be bottoming out, that's what everyone seems to be hoping for. But already we're hearing talk of a 'jobless recovery' meaning chronically high unemployment could be hear for a long time to come. Hard to envision huge increases in wages and benefits with so many on the outside of the employment window looking in.

Garth does a better job on Greater Fool, so give it a look. If you're curious about what "Greater Fool" means, its a concept not unfamiliar to many market players. Its based on the idea that when someone buys a commodity (stocks, real estate...anything with no tangible value) that a 'greater fool' will eventually come along and be willing to pay even more for it. Of course if you buy at the peak of a bubble (or after a sucker rally) you may not be able to afford to wait out the arrival of that person even more foolish than yourself, in which case you'll be the Greatest Fool.

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