UPDATE 081203: Despite Kirk Wright’s creative rebuttal in the Outlook, the best way to describe PAH housing is still as a “losing less” enterprise compared to renting in Canmore. Above all, PAH CANNOT be considered an investment of any other type than a losing one. Because appreciation is tied to the CPI, it is mathematically impossible for someone to genuinely make money on units in Palliser Village. However, you will lose less than if you know for certain you are going to be renting in Canmore for the next ten years. I had forgotten to include taxes and condo fees in my initial spreadsheet, so I have uploaded a new version here.
I was hugely disappointed to read the latest “advertising feature” in one of Canmore’s newspapers, the Rocky Mountain Outlook. It’s a misleading advertorial that mishandles statistics in order to create the mistaken impression of a “22.5% return on investment” for perpetually-affordable housing at Palliser Village.
In light of people spending hard-earned dollars on real estate in Canmore, and doing so through the long-term commitment of a mortgage, it is crucial that people objectively evaluate the opportunity based on all of the facts. I hope that these details were omitted innocently, but because the piece was a paid advertisement, it begs further analysis.
Among several errors, the most glaring error of omission is this: banks don’t lend money for free. And if a property’s rate of appreciation does not exceed the mortgage interest rate, then you could lose money.
The piece described a situation that included:
- An initial investment of $4,600;
- A 35-year mortgage at an interest rate of 5.79%; and that
- 10 years of payments would yield an increase in equity of $28,600.
Based on a 1-bedroom Palliser unit selling for $192,000, the mortgage would start the 10-year period at $187,400. This demands a monthly payment of $1,034. After ten years, the principal on the mortgage would be down to $164,765, an increase in equity of $22,635 (not $28,600) at an interest cost of $101,410.
In other words, after ten years of payments, you’ve paid down your mortgage by $22,635 and given the bank $101,410. Most importantly, the increase in equity that you gained through mortgage payments ($22,635) CANNOT be later considered as a return on your investment as the article suggests. It is just money you have saved with the property acting as the savings vehicle. To think it is a return on your investment is as nonsensical as putting $100 in your savings account, withdrawing it in a week, and telling yourself you just made $100.
Next to omitting the interest cost, the second glaring error in the Palliser article is to equate the Consumer Price Index as an investment with “a 3% a year… historical rate of return.” One big problem: the CPI is not a mutual fund; it’s a measurement of inflation. IT HAS NO RATE OF RETURN. The CPI is merely a government tool that measures inflation through the average cost of average consumer items compared to previous costs in previous years.
Here are the details and some questions that you need to be answer BEFORE you “invest” in Palliser Village:
First, how much mortgage assistance is in play? Most banks require at least a 5% down payment on a mortgage, but $4,600 is only 2.4% of $192,000.
Second, if you don’t qualify for mortgage assistance, then you’ll want to re-work the Palliser numbers accordingly.
Third, if any investment does not appreciate greater than the rate of inflation (as reflected in the CPI), then you are LOSING money. This is the case because all consumer items get more expensive over time. If you are not increasing your investments faster than the cost of living increases, then you are effectively losing money.
Fourth, if your rate of appreciation and gains in equity do not exceed the cost of your mortgage interest, then you are also losing money in real estate. The reality of the situation is not a 22.5% return on investment, but a loss of $35,381 over ten years. Here’s why:
- If the $192,000 property appreciates at 3% per year, it will be worth $258,029 at the end of ten years;
- The remaining principal on the mortgage will be $164,765, resulting in owner equity of $93,264;
- The down payment was $4,600, and the equity gained through mortgage payments is $22,635, so the equity gained by appreciation is $66,029; so…
- You invested the down payment and a little with each mortgage payment (for a total of $27,235) and came away with more than twice that. Sounds pretty good, right?
Nope. It sucks.
It sucks because you paid the bank $101,410 in interest costs on the mortgage in order to “make” $66,029. The bank is happy, but you’re in the hole -$35,381. Still sound like a good deal and a 22.5% return-on-investment?
And why didn’t the Palliser Village “advertising feature” contain this crucial piece of information?
Palliser Village may be a good investment, but definitely not with the numbers as presented — and especially with the huge omissions — in this “advertising feature”. Buyer beware.
For a spreadsheet of the numbers, click here.
{ 25 comments… read them below or add one }
Hey Semple,
Nice little letter to the editor! I’ve always thought that the affordable housing projects weren’t a good deal but I didn’t have the numbers to back that thought up. Now I know more…thanks
Thanks, Rebecca. The important thing is to compare cost versus equity and appreciation. Different combinations may yield different results, positive or negative. I’m not saying all PAH housing is bad, it just has to be objectively evaluated like everything else.
Scott,
I agree, way to go on calling bullshit. But….
As you know I am in PAH.
I figure to rent my place we would pay at least $1100.00 per month after utilities etc.
We pay about $1420 including everything.
If I rented, with the money I saved, I could invest $320. At 10% per year for 10 years that would result in about $64,000 in equity…… if I invested that money and got 10%…
After 10 years of renting and investing the extra cash I saved by renting, I would have spent $132,000 on rent and have an extra $64,000 in the bank.
With owning: after 10 years of payments, plus 5% down, lawyers fees, all utl etc. I would have coughed out $189,000 on a house that was worth $220,000 when first bought. That house would be worth $293,000 at a flat 3% compounded increase per year. I would still owe 168,500.
If I sell the house after 10 years it would look like this:
$293,000- 168,500 (based on a 4.5% interest which is higher than what is available now)=$124,500 in equity
Comparing the cash flow available to invest due to renting vs. owning, and a present day interest rate the renter after 10 years would have 64,000 in the bank and the PAH owner would have $124,000.
I am likely forgetting something and also there are many variables that will change the outcome either way (interest rates, rental rates, whether the owner can put down more per month toward principal, inflation, home repair)
And…renting sucks.
The other consideration is buying market value. With good, 10% plus, yearly increases it would only be the better option. But looking at monthly cash flow, with lower priced PAH (about 1/2 price) one may have the ability to invest an extra say $1000 (pah house=$200,000 mortgage vs $400,000 mortgage at market)per month that they save on their mortgage payment.
There are many ways to go and all have benefit and compromise, socially and capitally.
@Rob: Good points, all. My biggest beef with the article was the 22.5% ROI that was proposed. I didn’t mean to suggest that all PAH was a bad investment.
It could definitely work out in the positive as you laid out. Also, the psychic benefit of owning versus renting has value as well. It’s just up to each person to determine how much.
My biggest issue with PAH is the cap on what you can sell it for. If I understand correctly, you can’t sell for more that the rate of inflation over the time you owned. If the market booms… you don’t get the upside. On the other hand, I guess thats what makes it “perpetually affordable”.
Thanks, Johan. You’re exactly right. The appreciation cap (at the rate of inflation in Palliser Village’s case) is intended to maintain the affordability over the long-term rather than allow for a better ROI.
Palliser Village is intended to match the CPI, but there are other PAH setups which are CPI+1%. CPI+2%. The risk with PAH with better appreciation is that, if incomes do not keep pace with the appreciation, then even the 4% and 5% PAH complexes could become out of reach over the long term.
In general, PAH’s priority is the PA part: perpetually affordable, and it offers owners a chance to maintain at least partial equity in a property compared to no equity in a rental.
In addition, PAH (as expressed in my conversations with them) is a bit vague as to what happens in a falling market.
The impression I have gotten is there is an upside cap, but no downside cap.
Regarding comparisons, Rob is correct, you can’t leave out cost of living (ie. total cost to shelter yourself). The computations however, are not that complicated:
Take the same down payment sum multiply it by expected rate of return by number of years holding the investment. One scenario (usually renting), will have a cheaper monthly outlay in total cost of living. In that scenario, add the monthly difference between it and the scenario with the more expensive monthly cost to your down payment sum every month.
The variable with the greatest effect is purchase price, which equates to higher monthly cost of living.
On the averages, if you can buy for close to what you would pay in rent, then it is better to buy. If the monthly cost of ownership is much higher than that of renting then it is usually better to rent.
All bets off in volatile markets.
True, with the rent-to-mortgage payment cost comparison. That should be taken into account and may not always play in ownerships’s favor.
However, it’s not as simple to take your down payment and multiply by the rate of appreciation. The property is appreciating, not the down payment, so the returns are much greater in that regard, because a much greater value is the source of the appreciation.
On the down side though, servicing the debt cannot be ignored when you’re figuring out your return on investment. Every mortgage payment you make will increase your cost, which decreases your return.
See spreadsheet from original post for details.
Yes, yes… obviously you use property value x rate of appreciation on the one side vs. down payment amount x rate of appreciation on the other.
However, contrary to what you are suggesting… for purchasers of primary residences, you DO ignore a portion of debt service– the portion equal to the amount that you would be paying in rent for the equivalent space. You have to live somewhere, so everyone will always pay some monthly expense (ie. not investment- expense) for shelter. Depending on your situation this will be equal to: rent payment for space, rent payment for money to purchase space (mortgage) + taxes + bills + upkeep, or simply taxes + bills + upkeep if you own outright. In any scenario, there is always some non- zero monthly outlay.
For purchasers of second / investment homes, then you need to consider the debt service. Minus rental income obviously.
The property and down payment appreciation aren’t on opposite sides. Only the property appreciates; the down payment just sits as initial equity. If you appreciate both, then you’re double-ending it and artificially inflating your gains.
The “I would be paying rent anyway” thing is true, but hypothetical. If I were renting I wouldn’t be interested in calculating the loss, because it is more akin to paying for a product or service — i.e. like staying in a hotel.
However, if I’m buying, whether living in the property or not, I would definitely want to approach it from an investment point of view. The bank is certainly calculating their profit margin; I would feel foolish not to do the same when so much money (over the long-term) is at stake.
Perhaps an example will explain it best:
Bob is thinking of buying a house. He has $30,000 saved for the down payment. He can get a mortgage for $250, 000– enough to buy a 2-bedroom PAH unit in his community. Appreciation on the PAH unit is capped at 100% of CPI, which is currently 3%, so works out to 3.3% appreciation annually. Emotional value of owning is not a factor. He plans to sell after 10 yrs. His other option is to invest the down payment. What should he do?
Buying Scenario:
Downpayment- 30, 000
Purchase price- 240, 000
Mortgage amount- 210, 000
Monthly Payment- 1,576 (using 25 yr ammortization period and 7.8% advertised interest rate for 10 yr fixed)
Monthly Cost of owner ship- 1, 800 (includes mortgage, taxes, condo fees)
Appreciation- 3.3% annually ^10 yrs.
Sale Price- 240, 000 x 1.033^10 = 332, 058
Amount Remaining on Mortgage after 10 yrs- 168,189 (using current 7.8% advertised rate on 10 yr fixed mortgage
10 year return- 332, 058 – 168, 189 = 163 869
Renting Scenario:
Initial investment amount- 30, 000 (the down payment amount that is now not going into a house)
Average (expected) rate of return- 10%
Monthly rent- 1,300
Monthly investment contribution- 1, 800 (monthly cost of ownership if buying) – 1, 300 (rental cost for equivalent space) = 500
Value of investment (30k lump sum + 500/ mth for 10 yrs) @ end of 10 yr term- 177, 774
Both scenarios use a 30,000 lump sum and a monthly outlay of 1800, going to a combination of shelter cost and investment contribution.
Buying nets Bob ~164k of gain, renting and investing nets him ~178k of gain… both uncorrected for inflation.
The details of what happens in either scenario (ie. how much goes to principle vs. interest or how much is investment return vs. monthly contribution) don’t matter.
Because:
The starting parameters are the same-
Amount available to invest (30k) & amount available each month to pay for housing and investment (1800)
& The finishing parameters are the same-
How much is in Bob’s pocket (164k or 178k).
Meant to say: PAH appreciation is capped at 110% of CPI, not 100%.
Aren’t there any non-insane people on here? Your overpriced Canmore real estate is going down along with oil prices, the dollar and eventually the modern economy. SO why are people talking about property values increasing?
F*ck it I’m going climbing.
Pimp your title: caveat emptor = buyer beware in Latin. Now you can make like Jesus on one of his non-Aramaic days.
This is a different topic, but I can’t resist…
Chris, when prices are deflated, it’s not time to talk about the sky falling. Since the stock market ws created there have been 11 crashes. The Great Depression was obviously the worst, with unemployment rates around 30%. Currently, unemployment rates in the US are around 6% (yes, and climbing), and other statistics make this market correction rank as about the 5th or 6th worst — i.e. middle of the road, despite what the fear-mongering media is pedaling.
When the sky falls, buy clouds.
Semple, when *is* time to talk about the sky falling?
Fair enough, unemployment is lower– right now– than it was in 1932. However, we also have 6x as many people, 90% less natural capital, no access to cheap energy, and a much more expensive infrastructure to maintain than we did back then. Also, every past recession (except for 73-76) was caused by raising interest rates too high. We now have the lowest real interest rates in Canadian and U.S. history, to no avail. Every silver lining has a cloud.
Now regarding the world economy…what basically happened is, the Yankees swindled the world into lending them enough money to build fucking billions too many houses. Now the bills are due and the Yankees have nothing to pay with. So– and I know this sounds crude– what has to happen is, the U.S. needs to be given about $2 trillion (this would take care of the housing bubble), plus all of the $$ for the upcoming credit-card crisis, the commercial real-estate hassles, and of course the government’s debt. $4 trillion should do it. Now that is basically two year’s worth of U.S. GDP that they need to be GIVEN to start spending again. If they don’t spend, dollar drops in value, and everybody loses.
I also remind folks about the reverse bubble. In a bubble, the longer you stay out of the market, the more you appear to lose out, so as the bubble increases, more and more people have an incentive to get in, prices ri9se faster– feedback.
When you have a reverse bubble (deflation), the longer you stay IN, the more you lose. Get out now, get 90 cents on the dollar; wait 3 months, get 60 cents. So, as the world economy deteriorates, we are seeing a steady decline in the U.S. dollar, in real estate, and in stocks. Lots of heretofore unlistened-to economists (e.g. Nouriel Roubini) speculate that a 6000 point Dow is about right. This is essentially going to annihilate the future plans of basically everybody in North America, Europe, etc, and cause a very long-term contraction, cos, well, why spend when the future is bleak? Thinking which characterises consumers as well as business right now.
Now I am going to buy an Ambler hat, in trendy argyle. I am going to need it when I come and visit you in your house in the clouds
Very well put.
How long is it gonna take to rebound? What day is it gonna bottom?
A) A long time
B) I dunno.
This one is going to be very long, very ugly and very hard to fix.
One thing has been clear so far: government interventions are doing basically f**k all. When you look at the size of various bailouts (e.g. US $700 billion) compared to their economy ($13 trillion/year) you realise that the stimuli are basically drops in the bucket. In addition to this, bankers do note that you can’t print money indefinitely…
Every sector of the economy is now looking down– consumers indebted and wary of spending, business pessimistic about future consumption and also loaded with debt (esp. U.S. business and their real estate and credit-card problems) and governments facing falling tax revenues as a result of a slowing economy. In order to reverse this problem in the short term, you would basically have to give every American the value of all their debt, PLUS a guaranteed good job, PLUS some kind of guarantee that the economy will be looking up.
This won’t happen cos the U.S. is (a) broke and (b) it’s obvious by the bailout package where their priorities are– save the rich. $700 billion directed to ordinary Americans would do a lot of good; the bankers are just taking the money and running.
What would probably work best is some kind of New New Deal– and an international New Marshall PLan as well– foreign countries and firms get given U.S. loans with which they can buy reconstruction stuff, and U.S. workers + middle class go on a domestic rebuilding spree. But in the absence of any signs from the Obama admin that anything different is on the horizon, we can assume that it will be business as usual.
A minimum of two years of recession; consistent negative growth and some very ugly politics are all headed down the pipe. Canada, you will not be spared.
But WHEN, Chris? When are you (and the macro-economists) going to ACT on your expertise, double down, and make tons of money on the rebound? What date, what stock(s) and how much money?
Lemme know and I’ll tag along…
Hey Scott, good post and good responses from lots of people.
Two points:
Right now people are buying the payment, not the true cost of owning housing. It’s a bit like buying a car at Slick Eddie’s dealership where all he wants to do is sell you the payment. Right now, almost anywhere in Canada, it costs way more to “own” than to rent. Historically, prices follow rents very closely. When I first bought in Canmore prices were about 125 times monthly rent. I bought another place at 200 times rent and thought it was a bit high. Now prices are commonly 300 to 400 times rent (PAH excepted). That’s madness, and either rents will have to triple or real estate prices will have to come down in real terms by a lot. Looking at the very high inventory in Canmore and the growing number of “for rent” ads in the paper, well, I’m betting real prices end up a LOT lower. It’s already happening here and in Calgary and Edmonton. Prices across Canada are even down… Affordability as measured by income, even in Alberta, is also completely out of whack. The only thing that isn’t out of insanely out of whack is affordability as measured by monthly payment, but even that is very high by historical measures (it used to be you couldn’t do a morgage for more than 30 percent of your income–not any more!). All of this stuff takes a short Google to figure out, no big secret.
Secondly, those invested in real estate in Canada or making their livings off selling it usually say, “It’s different here, no sub-prime, better qualification, etc. etc.” BS. What do you call zero-down 40-year mortgage? CMHC just pulled the plug on those, but a high percentage of loans written in Alberta were exactly that. Alberta is a non-recourse province, meaning that people can walk away from a mortgage and the bank can’t come after anything but the mortgage amount… Just like the US. When somebody is paying a 35 or 40-year mortgage on a property that cost far more than comparable properties are now selling for they are going to walk, especially if they are “investors…” If you bought years ago then it’s probably no big deal as eventually (and that’s a big eventually–Japan still hasn’t recovered!), but the only real estate I’d touch in Canmore is a property that’s selling for about 100 to maybe 200 times rent (PAH isn’t far off, and if you really want to own it is the best deal in town despite the, ah, “confused” marketing). It’s gonna get way uglier, there is just no logical reason for prices to be this high. I’ve followed this for a long time, and every body always thinks their location is “different.” It never is…
I don’t want an economic crash, but I would like my friends to be able to afford a place to live here without mortgaging their future for 35 years. Canmore without the people I like here would be a far poorer place, and enough have left over the years that I don’t have a lot of sympathy for the real estate hype and BS that’s plagued the globe over the last four years and Canmore in particular.
PS–this is the worst stock market crash since the great depression: http://www.greaterfool.ca/wp-content/uploads/2008/11/four-bears-large.gif The number of houses and condos with lights on around Canmore at night is stunningly low, those second-home specuvestors might be a bit concerned about now…
PPS–I’m long firewood, climbing gear, kids clothing and whiskey. The rest I’m short on, including free time, but fun to post up on this.
Thanks, Will. I think housing prices influence rents, but not directly.
I think rental prices are more a function of owner cash flow and the cost of borrowing. I suspect that rents won’t change much until interest rates start to climb. New mortgages at higher rates will need to be serviced with greater cash on a monthly basis, and any ARMs (Adjustable Rate Mortgages) still floating around will inch up accordingly, even if they are sub-prime. At that point, I think owners will start looking to their rentals to fill the gap.
Thanks for the post and comments Scott.
Owners can look to renters to fill the gap, but renters have to be willing to pay more. I don’t think that’s going to happen given the number of trades leaving town as work dries up, the increased rental inventory (the Outlook seems to have more ads every week) and so on.
I think you have the relationship between how much real estate sells for and how much it rents for reversed. Rents (or returns) ultimately set prices, not the other way around. Rent is a true measure of what someone will pay to live somewhere; prices are what people will pay to “own” something either to live in it or speculate on appreciation as in the current bubble and every other bubble.
If I buy a property for a million I can’t raise the rent on it unless someone will pay what I’m asking. Over time and except in rare cases such as the current bubble, rents determine real estate prices, not the other way around. This is why you can currently rent a million dollar property in Canmore for $2500, which won’t come close to covering the mortgage (or is a very poor investment if the owner were to pay cash–less than 2 percent return at best, never mind that the property has now depreciated enough to be firmly negative). In bubbles prices go to huge multiples (very low return as in the dot.bomb crash, tulip crash, any other bubble in history) in relation to rents/return vs. prices (stocks or houses).
In Calgary, California, Florida, and many other places around the world there are lots of “investors” just figuring this out now, and it’s not pretty. There is a huge glut of unsold inventory in Canmore right now, and the quantity of rental listings in the paper continues to rise. For some fun graphs check out:
http://calgaryrealestatemarketblog.files.wordpress.com/2008/01/calgary_real_estate_valuation_large.png
Kind of a confusing chart–ignore the word boxes and look a the color coded lines. The red and the blue will come back together eventually, and I’m not seeing that coming from increased rent.
http://www.canadian-housing-price-charts.235.ca/index.htm
Calgary is already off enough to put many if not most home owners who bought in the last year upside down (they have lost more than their ten percent or less down–leverage is a bitch).
http://img85.imageshack.us/img85/4922/calgaryinflationadjustede7.png
So those who have bought in the last year aren’t likely to be able to cover their mortgages with rent, even if interest rates don’t rise… That’s OK when the bubble is inflating, but generally not acceptable when it’s deflating like now. Look out below. Maybe some of our friends who have moved to Revy, Quebec, Golden or elsewhere might be back…
And I’m still pro-PAH in general, it is the least-bubbled housing in Canmore. The marketing is just really wrong, let’s not throw the baby out with the bath on the concept of PAH.
The long-run determiner of rent is supply and demand, obviously, and that’s gonna have a REALLY strong effect in Canmore and Calgary, where you have a very large # of renters– who will not stick around much if there are economic issues– in a place where the housing supply has kept going up.
Canmore has no real industry except tourism; most of what’s there is owned by those rich oil cunts from Cowtown as investment properties (read: sell when troubled; you cannot take real estate to the supermarket and buy dinner with it); most renters have limited stake in the community, and will have very little incentive to stay as the work dries up. All of those peripheral people doing useless jobs (like climbing guides, yoga teachers, masseuses, DJs and what not
) will soon be gone.
it will be really interesting to see what happens in Calgary…the 200,000 folks who moved there over the alst 5 years, what’s gonna happen when they sell their places and go back to Newfoundland?
Scott– a MINIMUM of two years, probably much more, before anything like a rebound. Conventional energy (oil) and NG which is still approaching its peak will be where it’s at.
Will,
I’d like to thank you for your post. It was well thought out and very enlightening. It confirms what I feel is happening in real estate in Canmore, but I didn’t have the evidence for.
Also, thanks for the links. I’m always looking to improve my knowledge of the local market and information for a small community such as Canmore seems hard to come by.
Not investing, but losing less: updated spreadsheet link at top of post including owners’ obligations of taxes and condo fees.