Buy or Not to Buy

If Shakespeare's Hamlet were a 20-something living in Toronto today, chances are he'd be working on his first career. He'd have some inheritance in the bank, he might even be living in his mother's basement.

He'd have little job security, no pension and would probably be soliloquizing about the same dilemma as everyone else his age:

To buy or not to buy, that is the question; Whether 'tis nobler on the pocketbook to suffer the outrageous rent, or to take up a sea of mortgage payments, and by doing so, retire with equity.

With interest rates at the lowest they've been in more than 50 years and with home and condo prices in decline for the first time since 1996, many potential first-time buyers are viewing this as their best chance to buy into an otherwise unaffordable market.

That's partly what led Ren Ramkhelawan to buy his first highrise condo near Bathurst St. and Lake Shore Blvd.

Ramkhelawan, a 27-year-old systems architect with a local charity, reckons he spent $18,000 in rent on his one-bedroom apartment at Spadina and Bloor Sts. After feeling he was "flushing rent down the toilet," Ramkhelawan started looking for a condo in October 2007 but was soon priced out of the market.

"I'd make an offer and then the seller would get more offers, and before long it was just beyond my price range," he remembers.

At one point in his search, he'd actually negotiated the purchase of a 500-square-foot condo for $222,000. But he backed out because he felt it was too small and he'd be better off in his larger apartment.

A year later, the economy had tanked, taking the condo market with it. He's now the proud new owner of a 700-square-foot, $227,000 condo.

Though he's paying $200 more per month on the combination of condo fees, mortgage payments and property taxes than he was at his old $980-a-month apartment, he feels he's getting a better deal.

"In the end, I wanted my own place. I wanted to know that I was investing in something instead of just handing my rent money away."

But Ramkhelawan, like many other first-time owners, doesn't see himself living in the condo for more than three years, when he plans to flip it and make a profit.

Problem is, many in the realty business argue Ramkhelawan and others are banking on returns from a world that no longer exists.

"Everyone wants to flip houses and condos like pancakes," says Greg Stanley, a mortgage broker.

"Maybe we should have a change of view, thinking that a house is actually a home like they did in the old days. Back then, if you bought a house and sold it, it would be the same price. No one expected the houses to go up in value; they only expected to pay them off."

The Organization for Economic Co-operation and Development recently released data that show house prices have fallen in Canada, but prefaced it with the view that such prices "will have to fall still more ... if affordability, measured by the ratio of house prices to income, is to return to its long-term average."

If that's the case, then first-time buyers who choose to jump into the market now could see themselves carrying a hefty mortgage on a depreciating house. Anyone who bought a home when the market peaked in 1989 watched their "investment" plunge when the housing market tanked months later. Those homeowners still haven't recovered the pre-bust value of their homes two decades later, if you factor in inflation.

"There's so many myths around real estate," says James McKellar, a professor of real property development at York University.

"Let's not forget that before the 1980s, the motto was that a home was a money pit. Over a long period of time, housing does not keep pace with inflation. Don't look at it as an investment. A house is a cost. You don't buy a car as a good investment – you buy because you need it."

"The conditions (for buying) are favourable in terms of interest rates and affordability, but that's just one concern.

"The decision to buy depends on your personal circumstances – that includes your personal needs and how secure you are in your job situation. Ask yourself: is your ability (to pay down a mortgage) going to be the same in a few years time?"

The results may surprise you as, in some cases, those who rent and invest the money they would have otherwise thrown into their mortgage come out on top in the long-term.

That said, a home is an asset and having to pay off a mortgage forces you to throw your savings into something instead of wasting your money.

Fooled By The Optimists

Against all odds, the U.S. consumer has staged a comeback in the first quarter of 2009, leading some analysts to predict a bottom in GDP and to call a floor for the stock market.

This analysis is based on the shaky premise that consumer spending will remain firm in the face of contracting consumer credit. The stock market has already rebounded, and investors should not get sucked in after the fact.

The optimists are pinning hopes on a recovery in consumer spending in the first quarter of this year, green shoots of growth through cracks in the asphalt of the U.S. economic recession.

"The record shows that recessions are vanquished not by the return of employment growth, but rather by an increase in expenditures owing to unsustainably deep spending cutbacks by both households and businesses," says John Lonski, chief economist, Moody's Investor Services.

But is this sufficient to pull the economy up by its bootstraps?

It is not that consumption has bounced back in a strong way; rather, production has fallen off a cliff, so inventories are now very, very low relative to spending. Businesses have over-estimated the weakness in final demand, according to Tim Bond of Barclays Capital, and the gap has not been this extreme since the bottom of the 1974 economic recession -- which coincided with a substantial rebound in the U. S. stock market.

Pulling a fine-toothed comb through the data may lead to faulty conclusions, however. In this case, a rebound in consumer demand in the first quarter of 2009 may be a hard act to follow.

The US$8.1-billion rise in consumer credit in January coincided with a snap back in retail sales. In February, revolving credit (credit card loans), was down by US$7.8-billion, according to Lombard Street Research.

The problem is that credit is being "ripped out of the wallets" of Americans, according to top-rated U. S. bank analyst Meredith Whitney. Approximately half of the US$5-trillion in credit-card lines will be cut by the end of 2010, says Whitney. If she is right, it will cause a cascading effect on consumer spending because 90% of Americans use revolving credit lines more than once per year and 45% revolve credit lines every month.

The government is throwing households a lifeline by allowing them to refinance their homes at very low rates over the coming months.

"It's the lowering of interest rates by the Fed that is leading to the recent surge in mortgage refinancing and more breathing room in household balance sheets," says Chris Snyder, economist with Moody's Investor Services.

The stock market has already discounted a lot of good news. The S&P 500 index staged a solid 25% rebound since its March low in line with the historical precedent between 1974 and 1976, cited by Barclays. Gains beyond this point won't come as easy.

The S&P 500 appreciated 34% between December, 1974, and February, 1976, but thereafter acted like a tired sprinter in a distance race. After that quick sprint up, the market eked out a narrow gain of 8% to the end of the decade. In inflation-adjusted terms, the market passed out on the track.

In fact, even including the market bottom in 1974, the S&P 500 total return index appreciated a grand total of 8.7% after adjusting for inflation. Over the second half of the 1970s, the market was basically flat after adjusting for inflation. So any comparison to that period does not present a compelling case for buying the market today, rebound or not.

The market will have to digest the results of the U. S. Treasury stress test on bank capital in the coming months. The matter of bank insolvency is the next big test for the market, and any indication that a major bank requires further capital to regain solvency is likely to overwhelm the current market focus on economic recovery.

Housing prices stronger in Q1

Local housing prices were higher across all three residential real estate categories in the first quarter of the year, amid declining prices elsewhere in the country due to an expected market correction, according to a quarterly report by Royal LePage Real Estate Services Ltd.

The report showed that the average price for detached bungalows in Ottawa rose 1.9 per cent from the same quarter a year earlier, to $317,500, while standard two-storeys sold for an average of $318,500 in the first quarter, up 2.8 per cent year-over-year.

The largest price gain was in the standard condominium category, which sold for an average of $207,833, up 4.9 per cent.

The report noted that in Ottawa and elsewhere, the housing market had been surprisingly "resilient" in the quarter, especially considering the expectation that the lower consumer confidence during the downturn would drive prices downward.

"Increased buyer activity at the end of March suggests that spring will bring its typical increase in unit sales activity as buyers target summer moves," the report said.

Atlantic Canada had the strongest performance in the country across all three housing types surveyed, with Royal LePage Real Estate Services CEO Phil Soper pointing to Newfoundland as "Canada's sole remaining seller's market" due to recent investments in the province's bustling commodities sector.

Still, overall prices were somewhat lower due to pressure from markets in the Greater Toronto Area, British Columbia and Alberta. The average price of a two-storey home in Canada declined 6.5 per cent to $379,636, while a standard condominium sold for $232,877, 3.4 per cent lower than in the first quarter of 2008.

"Canadians in most regions should not expect the prices of their homes to begin appreciating again until the overall economy begins to stabilize, likely in the first half of 2010," said Mr. Soper in a statement.

However, the report indicated that stabilization could soon be on its way in the hard-hit western markets, since B.C. and Alberta saw housing market corrections "well ahead of the full impact of the current economic crisis."

Fixed versus Variable

Traditionally, the most important consideration in choosing a fixed or variable mortgage has been which strategy would save the most money.

But that might no longer be the case: Choosing a type of mortgage and term today may come down to what makes sense for the individual homeowner rather than what saves cents.

"If you were buying a house 10 years ago, fixed versus variable was the biggest decision you made," says Moshe Milevsky, finance professor at Toronto's York University and executive director of the Individual Finance and Insurance Decisions Centre. "But now there are more important things in place. Equity prices are falling, housing prices are falling. I think there are three or four things more important than fixed versus variable now."

Mr. Milevsky's 2001 study of five-year rolling interest rates from 1950 to 1999 showed that 88.6% of the time, homeowners would have been better off with floating or short-term mortgages rather than five-year, fixed-rate mortgages, saving an average of $22,000 on a $100,000 mortgage amortized over 15 years.

"The last time I looked at it, a year ago, the same strategy was holding up. Roughly ... 85% of the time, you were better off going with variable rates, rather than fixed rates."

Another, lesser consideration was peace of mind: New homebuyers might sleep better when essentially paying an insurance premium as part of locking-in payments for five years.

But saving a few dollars should no longer be the determining factor in the fixed-variable dilemma.

"Too much emphasis has been based on this study," Mr. Milevsky says. "It's the most-downloaded item on our Web site. But if you look at interest rates right now, you're debating over a per cent. When fixed rates were 9% and variable rates were 5%, that's a big difference. That's another issue."

The flattening of the bond yield curve in recent years meant you might pay only 1% or 1.5% more to lock in a long-term rate, and that made the stability of fixed rates much more attractive than it was five years earlier.

Many homeowners with variable rates below prime are now offered renewal rates above prime. Discounts can sometimes be negotiated on longer terms, and other times on variable rates.

"Renewing is not just a day at the bank, it's a major event in the life of your house," says Mr. Milevsky, adding that low mortgage rates make other considerations more important in the fixed-variable debate. "If you're going to renew in a year or two, what if your housing price is lower than the value of the loan, and the banks won't give you that again? What about locking in as long as possible? If I

get the five-year rate, they're not going to bother me.

"No. 2 is how much money is put down. If you put down only 5%, how much of an effect will that have on your credit rating? Banks are more cautious. Getting a deal might depend on whether you go fixed or variable.

"[Then] there's the question of employment. If you do not have a mortgage with flexibility, what if you can't make a payment for months?"

One compromise may be a combination mortgage that is part-fixed and part-variable.

"I'm getting to be a bigger fan than I used to be," Mr. Milevsky says. "I used to say 'diversify your assets, not your liabilities,' but if you can make the deal to lock in some of your mortgage, that might be a good thing. But that's two mortgages, with two sets of prices, and if it's an extra $200 that's one thing, but an extra $1,000 is another."