If you live in Toronto, is buying really a good idea?

1. Buyers are overpaying for real estate.

Buyers are overpaying for real estate.  One measure of real estate values is the cap rate (capitalization rate).

The cap rate is the profit of a property divided by how much it cost to buy.  The profit is basically the rental income minus all the various expenses (plus a contingency for tenants from hell, vacancy, etc.).  The cost to buy includes all the various transaction costs like the realtor’s fee (if you used one), taxes, etc. etc.

Currently, the cap rates for Toronto real estate range from 2% to 6%.  Properties in undesirable areas like Jane and Finch make up the higher end of that range.  Newly built condos and upscale housing in desirable areas make up the lower end of that range.

Renters are getting an amazing deal on middle and higher-end housing.  Paying 2% of what it would cost to buy these properties is a great deal.  Instead of getting a mortgage and putting down a downpayment, you can put that money into the bank and collect 3% interest.  Yes, interest rates are pathetic right now.  But the cost of rentals are even more pathetic.

2. Mortgages can be really risky

If you get a mortgage with a 20+ year amortization period, you may be really uncomfortable if you really understand the risk.

After 5 years, you will need to renew your mortgage.  If interest rates rise, your mortgage payments can jump dramatically (e.g. double).  In the 70s and early 80s, interest rates rose to historic highs and many people lost their homes.  It’s financially devastating and also emotionally devastating for it to happen.  History will sometimes repeat itself.  And no, this time is not different.  I am not saying that interest rates will definitely skyrocket, but that there is a possibility that it will happen.  If you can’t stomach a good possibility of a devastating financial loss, then perhaps a mortgage is not a good idea.

Do your own thinking

  1. “Real estate always goes up.”
  2. “You are throwing money away if you rent.”
  3. “But other people are doing it.”

1- Real estate does not always go up.  Historically, there have been many drops in the Toronto real estate market.

2- Please crunch the numbers for yourself.  For some cases, landlords are throwing money away to renters.

And if you don’t mind living in unattractive areas like Jane and Finch (I actually wouldn’t mind), then it can make sense to buy housing there.

3- Other people have credit card debt.  And payday loan companies have a lot of customers.  That still doesn’t make it a good idea.  You need to do your own thinking.  Crunch the numbers for yourself.  Figure out your tolerance for risk.

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