daveto
Active Member
The following table illustrates the inflation adjusted price changes in Toronto for standardized freehold properties.
http://cuer.sauder.ubc.ca/cma/data/ResidentialRealEstate/HousingPrices/housing-pri-toronto.pdf
The avg peak-to-peak annual change from $270k in 1981 to $415k in 2008 was 1.6%
The avg trough-to-trough annual change from $180k in 1979 to $235k in 1996 was 1.6%
Surprisingly similar results for both the peak/peak and trough/trough figures. (Note that frequently various RE marketing bodies will quote the annual increase from trough-to-peak, which skews the figures up to a misleading 3% annual increase).
Current property taxes are 0.83%. If one allows for annual maintenance/repair costs of 0.61% of the property price (perhaps a little low), then one neatly offsets the carrying costs
( ie. 0.83% + 0.61%=1.44% annual costs
vs
1.6% appreciation - 0.16% transaction cost on cumulative annual appreciations at sale=1.44% annual income)
The question of the cost of ownership is then simplified to considering the rate of return that one seeks on one's assets net of taxes/inflation. If one seeks 4%, then the cost of ownership is 4% of the purchase price + the amortized cost of the 10% transaction costs on the original purchase price (partly at purchase, but mostly at sale)
So in effect, one is paying approx 4.5 to 5% of purchase price to live in the property. Think if it as rent paid to the owner (ie you), to provide an adequate rate of return on the invested asset Of course, if one is budgeting for a different rate of return on your investments, then the cost of home ownership changes correspondingly.
Mortgages
You'll note that I've not factored in mortgage pros/cons. Ultimately, the banks are not fools, and they are not giving you free money to earn more than they themselves could earn if they bought RE. There are, of course, benefits to mortgages. The main one is that they make ownership more accessible for those who lack the funds to purchase with cash. Many people use mortgages to leverage their returns on their housing purchase. This can cut both ways - both increasing returns in an up market, and increasing losses in a down market
Banks and mortgage brokers refer to a mortgage as a "product". Like all products, it is not free, but rather you pay for it.
Mortgage rates have varied substantially over the past 30 years. However they are typically moving in relationship to inflation. Typically a mortgage will have a spread of 3-5% above the rate of inflation. Thus if one views the figures on a constant dollar basis, the analysis becomes much simpler. Similarly the analysis of variable vs fixed is ultimately an a question of risk pricing, and one that I've left out of this post.
Assumptions
I've simplified some of the assumptions, and several of them are questionable. The past 30 years has seen unprecedented RE appreciation, and many suggest that this has been fueled by the baby boom demographic. As such, one can certainly argue that the avg appreciation over the next 30 yrs will be less than 1.6%. Note further that the 1.6% annual increase applies to freeholds and not condo. The UBC data I used did not have corresponding figures for condos.
The current 0.83% annual property tax rate seems likely to experience upwards pressure as municipalities seek to meet budgetary pressures. And the 0.61% annual maintenance/repairs estimate seems a little low.
Investors
I acknowledge that a lot of RE investors have made a lot of money in the past 10 yrs in Toronto. However it appears that those profits were speculative and derived from catching the market on the way up, and leveraging their exposure via mortgages. The mathematics suggest that this investment model would not work over a full RE price cycle (ie peak-to-peak, or trough-to-trough)
A long term RE investor knows that they need a substantial cap rate (8%-10%?) to make their RE investment worthwhile.
Conclusion
This is simply how I personally price the costs of home ownership. As frequent readers will know, I'm a bear on the current prospects for RE in Toronto and speaking frankly my main goal in home ownership is to simply break even at a 4 to 5% cap rate (net of inflation).
http://cuer.sauder.ubc.ca/cma/data/ResidentialRealEstate/HousingPrices/housing-pri-toronto.pdf
The avg peak-to-peak annual change from $270k in 1981 to $415k in 2008 was 1.6%
The avg trough-to-trough annual change from $180k in 1979 to $235k in 1996 was 1.6%
Surprisingly similar results for both the peak/peak and trough/trough figures. (Note that frequently various RE marketing bodies will quote the annual increase from trough-to-peak, which skews the figures up to a misleading 3% annual increase).
Current property taxes are 0.83%. If one allows for annual maintenance/repair costs of 0.61% of the property price (perhaps a little low), then one neatly offsets the carrying costs
( ie. 0.83% + 0.61%=1.44% annual costs
vs
1.6% appreciation - 0.16% transaction cost on cumulative annual appreciations at sale=1.44% annual income)
The question of the cost of ownership is then simplified to considering the rate of return that one seeks on one's assets net of taxes/inflation. If one seeks 4%, then the cost of ownership is 4% of the purchase price + the amortized cost of the 10% transaction costs on the original purchase price (partly at purchase, but mostly at sale)
So in effect, one is paying approx 4.5 to 5% of purchase price to live in the property. Think if it as rent paid to the owner (ie you), to provide an adequate rate of return on the invested asset Of course, if one is budgeting for a different rate of return on your investments, then the cost of home ownership changes correspondingly.
Mortgages
You'll note that I've not factored in mortgage pros/cons. Ultimately, the banks are not fools, and they are not giving you free money to earn more than they themselves could earn if they bought RE. There are, of course, benefits to mortgages. The main one is that they make ownership more accessible for those who lack the funds to purchase with cash. Many people use mortgages to leverage their returns on their housing purchase. This can cut both ways - both increasing returns in an up market, and increasing losses in a down market
Banks and mortgage brokers refer to a mortgage as a "product". Like all products, it is not free, but rather you pay for it.
Mortgage rates have varied substantially over the past 30 years. However they are typically moving in relationship to inflation. Typically a mortgage will have a spread of 3-5% above the rate of inflation. Thus if one views the figures on a constant dollar basis, the analysis becomes much simpler. Similarly the analysis of variable vs fixed is ultimately an a question of risk pricing, and one that I've left out of this post.
Assumptions
I've simplified some of the assumptions, and several of them are questionable. The past 30 years has seen unprecedented RE appreciation, and many suggest that this has been fueled by the baby boom demographic. As such, one can certainly argue that the avg appreciation over the next 30 yrs will be less than 1.6%. Note further that the 1.6% annual increase applies to freeholds and not condo. The UBC data I used did not have corresponding figures for condos.
The current 0.83% annual property tax rate seems likely to experience upwards pressure as municipalities seek to meet budgetary pressures. And the 0.61% annual maintenance/repairs estimate seems a little low.
Investors
I acknowledge that a lot of RE investors have made a lot of money in the past 10 yrs in Toronto. However it appears that those profits were speculative and derived from catching the market on the way up, and leveraging their exposure via mortgages. The mathematics suggest that this investment model would not work over a full RE price cycle (ie peak-to-peak, or trough-to-trough)
A long term RE investor knows that they need a substantial cap rate (8%-10%?) to make their RE investment worthwhile.
Conclusion
This is simply how I personally price the costs of home ownership. As frequent readers will know, I'm a bear on the current prospects for RE in Toronto and speaking frankly my main goal in home ownership is to simply break even at a 4 to 5% cap rate (net of inflation).
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