The Market is Crashing, So They Say.

It’s no secret that things have changed in our economy, and life as we know it has become more expensive. With inflation as high as it is, it’s leading economists and the central powers that be to try to fight it. A tank of gas hurts right now, and groceries are more expensive. But somehow we find ourselves with declining home values if you believe the news you hear.

Don’t get me wrong, prices have come down since the frenzy in January and February, but you need to zoom out and dig a little deeper for the full picture. Once you grasp what’s happening from a market perspective, you need to check the other side of the equation from a fiscal perspective. Let’s break it down in terms we can all understand.

Don’t fight the Fed

Most economies since the dawn of the Pandemic have suffered great losses, Canada and US are no different. Our governments printed trillions of dollars to help support the economy during lockdowns and toilet paper shortages. All kidding aside, when more cash gets pumped into the system, the previous cash in the system becomes less valuable. When money becomes less valuable, everything becomes more expensive, and thus inflation rears its ugly head.

In order for governments to fight inflation, they need to increase interest rates and start pulling the extra cash in circulation in order to make the currency more valuable again. They do this in a multitude of ways that are beyond the scope of this blog post, but you get the idea. Especially if you have any investments in the stock market, you can feel the pinch the economic policies are having on your money.

What goes up must come down, right?

Since December of 2021, we witnessed a fascinating story play out in front of our eyes in the Real Estate markets across the Greater Toronto Area and beyond. Price appreciation that normally happens over the course of 5 years happened month over month, 3 months in a row.

Starting in February, signs of a slow down started with failed offer dates due to buyer fatigue, increased supply, and looming interest rate increases approaching. The growth we experienced was definitely unsustainable by any measure, and for sure prices had to come down.

Out come the “experts” telling you the market is going to crash and Real Estate will be super affordable for everyone, all you have to do is wait! While prices have already corrected by more than 40% for properties outside the GTA (which saw a crazy amount of growth), the GTA itself has only moderately corrected for the most part by 15–20% from their February highs.

Prices, for the most part, when it comes to real estate in and around the GTA, have been steadily appreciating over the last 50 years. For my fellow math nerds out there, we call this a trend. But what happens when prices decide to move away and above the trend? They eventually have to come back down to the trend line. What some experts are calling for in terms of a crash isn’t as likely as a regression to the mean, or in laymen’s terms, back on track to it’s normal appreciation. Can we fall below the trend? Sure, but like what happened when prices appreciated way faster than the trend, it’ll eventually go back to its normal course and go back up.

Prices go down, but you still can’t qualify

Now the scariest part of the equation is your ability to afford your payments. When prices were out of control, interest rates were low. But as soon as interest rates started to rise, and house prices started to decline, so did your ability to afford a home. But how? Let me explain.

Unless you’re the heir or heiress of an Oil Prince in one of the various Kingdoms or Emirates, you’re most likely buying real estate using some sort of leverage. Since the fair housing act was instituted in 2017, Canadians from sea to shining sea have had to qualify for a mortgage by way of a stress test. That usually means having to qualify for a mortgage at a posted rate of an institution PLUS 2% in case interest rates rise, and seeing if you can still afford to make payments for your home.

Instead of boring you with the particulars, higher rates mean lower qualifications in terms of the total amount. Assuming a monthly expense ratio of 40% (banks may have different GDS and TDS ratios they use), a person making $4,000/month in February would have been qualified for a $1,600/month mortgage. With the stress test being at the BoC rate plus 2% (5.25% on average), they would have qualified for a mortgage of $268,000, and with a 20% downpayment, can max out their purchase price at $335,000.

When the rate increases by 1% as it has over the last few months, that same $1,600/month mortgage can only get you approximately a mortgage of $244,000 and a total purchase price of $305,000. This 1% increase has now decreased your buying power by almost 9%. With interest rates expected to increase by the end of this year, the buying power of potential purchasers is going down.

Final thoughts

Let’s summarize what we’ve learned:

1. Governments printing money makes your money less valuable, making everything else more expensive.

2. To stop prices from getting out of control, economic policies are put in place to pull the extra supply out to make your money more valuable.

3. As a result, interest rates rise to help make your money more valuable.

4. Real Estate prices were historically out of control and have come back down to the trend.

5. Higher interest rates mean you can afford less of a home.

With all of these points in mind, can you really afford to wait for the “bubble to burst” and the market to crash, as the experts are calling for? Even if the market dips another 20% from where we are today, and interest rates continue to rise, you’re probably not going to be able to win the race to the bottom and still be able to afford your future dream home.

TL;DR don’t believe everything you see and hear, take a step back and look at the greater picture. If you need a home and are going to hold it for the next 15–20 years, the time to buy is now, or forever hold your peace.