Can You Believe What You Read?

It’s time for a reality check. For the past 13 years, there have been reports in the media that the real estate market is due for a correction or is about to slow down or that the bubble is about to burst. As far as I can remember, this prediction has come true exactly once in central Toronto; prices did decline by approximately 10% in late 2008/early 2009 when the entire economy slowed down. Incidentally, the market rebounded quickly and prices are now higher than they were prior to this decline.

I don’t know about you, but when I read these doom and gloom headlines I get the impression that they’re suggesting a complete collapse or something very close to it. However, when you look beyond the headlines that sell the newspapers and magazines (and, indirectly, the products being advertised therein), you see that this is not the case at all. In many cases, the story behind the headline is that real estate prices might remain the same or decline slightly over the next few years. Bold and brazen headlines attract attention, but they can also detract from or misrepresent the true story. [Note: major shifts in the economy as a whole and in the real estate market have historically arisen due to circumstances which were unforeseen by most experts. While always possible, most experts feel that they’re unlikely to occur at this time because of the fundamental strength of our economy and our real estate market.]

If these predictions do in fact come true and prices do decline slightly, how exactly will this affect you and will it be as big a deal as some are making it out to be?

First, keep in mind that most predictions deal with the country as a whole and not with individual markets. The market in Toronto might remain strong while the market in Vancouver stagnates or vice versa and, more particularly, the market in central Toronto might remain strong while the outlying areas stagnate or vice versa. Second, many of these predictions involve possible price decreases of only a few percentage points and not the drastic price reductions that have occurred south of the border. To their credit, this point has been made by the writers of most of these articles.

To get a better idea of how much (or little) you should be concerned if these predictions come true, let’s look at several examples of how a price decrease might play out in real life. Assume a hypothetical decrease in price of 5% over the next few years (which is actually larger than the possible decrease which is being predicted in most cases).

If you’re thinking of buying a larger home, you should welcome any price decrease because it will reduce the spread between your existing home and your new home. How does this work? Say your existing home is worth $750,000 and your new home is worth $1,400,000. You will have to pay an additional $650,000 for your new home. If prices decline by 5%, your existing home will be worth $712,500, your new home will be worth $1,330,000 and the spread, or difference, between the two will be $617,500, resulting in a savings to you of $32,500. As long as you’ve been paying down your mortgage and have enough equity in your home to make the move, from a purely financial point of view, the decline in prices will have worked in your favour. However, you still have to decide if it’s worth the risk waiting for prices to decline and if you’re willing to continue living where you’re living for a few years in the hope of saving $32,500.

On the other hand, if you’re thinking of scaling down to a $750,000 home from your $1,400,000 home, the same decline in prices will result in you putting $32,500 less in the bank after you sell. In this case, you should ask yourself if you’re willing to accelerate your plans and move now on the chance that prices may decline, in which case you might receive an extra $32,500.

Should you be thinking of selling your $1,400,000 home in central Toronto in the next few years and moving out of the city or renting, then you’ll have to determine if you prefer to accelerate your plans and sell your home now for $1,400,000 or wait a few years and move when it’s convenient, realizing that the price might decline by $70,000 during that period.

Lastly, if you’re considering buying your first home for $750,000, you should be asking yourself if you’d prefer to continue renting on the chance that you might be able to buy the same home for $712,500 in a few years if prices decline or if you’re ready to become a homeowner now. Apart from the lifestyle decision, you should also think about how you view your home from an investment point of view. Are you concerned about its value from year to year, or is it a long term investment the value of which will fluctuate over time, but increase over the long term? Finally, given the limited supply of homes in central Toronto, you should also consider that it will likely take you some time to find a home so you might want to start looking now and see where the market goes.

Basically, it’s a question of risk and reward since prices may move up or down by any amount at any time. In its simplest form, the analysis boils down to two questions: First, is the extra amount of money that you may earn or save if prices decline worth the inconvenience of postponing or accelerating your move? Second, is it worth taking this risk because if prices increase instead of decline you’ll lose money? Personally, I believe that the demand for homes in central Toronto is still stronger than supply so prices are unlikely to move downwards significantly. However, if they do decline as some are predicting, remember that this potential decline is minor in nature and that, in most cases, you’re probably better off living your life as you like and not worrying about the real estate market.

But what if interest rates also rise? Won’t this dampen the market? Like everything else, there are varied opinions on this issue. I may be starting to sound like an eternal optimist, but when Katherine and I bought our first home in North Toronto in 1991, we locked in a 5 year rate of 11.75% and thought we were getting a great deal. The 5 year rate now sits at approximately 3.5%. The increases being predicted to interest rates are in the 1-2% range over the next couple years. If the 5 year rate increases by 2% over the next couple years, it will reach 5.5%. To put this into perspective, when prices started rising in central Toronto in 1997, the 5 year rate was at approximately 7.07%. Do you think that these small increases in interest rates might dampen the market?

To summarize, if things play out the way some are predicting, and it’s not a certainty in central Toronto, then there’s probably not much to worry about in most cases. The sky is not falling. Yes, homes may take a little longer to sell, buyers may be able to negotiate on price instead of participating in bidding wars, prices might decline a bit and interest rates might increase a bit. All in all, however, if this is what happens, life as we know it will go on and there won’t be any catastrophes as some headlines might suggest. So make sure you read the full articles and not just the headlines, keep enjoying life and cross “prepare for real estate catastrophe” off your to do list.

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