Toronto real estate trap
the journal of Michael Werneburg
twenty-seven years and one million words
The average home in Toronto is now $1.3m in a city where the median income is $40k. You'd need a 20% down payment for this home, and assuming that's somehow possible, you'd need a mortgage of $1,040,000. At 2% that mortgage with 25 year term has a payment of $4,700.
Let's assume that somehow a married couple earning $80k a year before taxes can afford $4,700 a month or $56,400.
But now in the US they're fighting inflation by raising rates. Inflation is hard to fight and interest rates will likely have to go way up. Way up. And where the US goes, Canada must as well, because who's going to buy CSB's that don't beat US treasury bonds.
So what happens with increased interest rates - increased mortgage rates!
At 5% interest my example mortgage payment goes from $4,700 to $6,400. That's $76,800 a year. Again, we're talking about the average home. Not a lot of people can sustain that ($76,800 is, after all, almost 100% of the average Toronto family's pre-tax income) and some will have to sell and find something cheaper. Let's say for a moment that this average family can do this. Since they can sustain a $4,700 monthly payment, the mortgage has to shrink to less than $760,000. This implies a house price around $825,000 (assuming an 8% down payment, which is around what they'd have to provide). $825,000 represents a 37% decline in property value from $1,300,000. Where will this family - the average family in Toronto - find this home? Not in today's Toronto. But if the average family can't afford the average home, there has to be a correction. With more and more average families selling to get into something they can afford, one obvious answer is that the market will provide. Houses that were formerly purchased at $1.3M will be available at $825,000 because that's what the market can sustain at 5%.
But 5% is not much by historical mortgage prices. The average in my lifetime is 8%.
At 8% interest rate, my example $1.3M house and its million dollar mortgage needs a payment of $7,900. That's $94,800 a year, or 19% more than the average family makes in a year, pre-tax. The average family now absolutely must sell. To buy a house with a manageable $4,700 payment (again, at 8% interest) the house would have to cost about $625,000. Or less than half today’s cost.
"Ridiculous," you exclaim. "No way is the average Toronto house worth $625,000! And no way will we see 8% mortgage rates!"
In the ’80s mortgages were at 20%. My example $1,040,000 mortgage would have a monthly payment of $17,700 at 20%. One month's mortgage payment is nearly 25% of the family's gross pre-tax income. At 20%, our average family's affordable monthly mortgage payment of $4,700 means you’d need a house that costs $280,000. $280,000 is a cool million lower than today's average price.
I think this is why Canada is addicted to all those foreign buyers and corporate buyers and everybody else that accounts for the tens of thousands of houses that stand empty in the city. They've long since figured out that the local market can't sustain the housing market as it is today and there's nothing they can do about it. Too bad they forgot that they don't control interest rates.