Walk a Kb or Two in my Moccasins- Nobody 'splained it to me like that!

Simple answers to Complex Questions and Complex Answers to Simple Questions. In real life, I'm a Greater-Toronto (Canada) Realtor with RE/MAX Hallmark Realty Ltd, Brokerage. I first joined RE/MAX in 1983 and was first Registered to Trade in Real Estate in Ontario in 1974. Formerly known as "Two-Finger Ramblings of a Forensic Acuitant turned Community Synthesizer"

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Monday, April 20, 2009

If cash is "King" when Interest Rates are High ... what about now?

If cash is considered “king” in a high-interest, market environment, how is “cash” characterized now?

I met a married professional couple (mid-30’s) at a friend’s soiree and we talked about residential real estate, because they wish to buy a home. They sold their home out west in 2007, moved to a small city just outside Toronto and have been renting since then, while holding their ‘down payment’ of more-than $250,000 in cash. They want to move to Toronto, buy in Toronto and start a family here in the next few years.

We had a conversation about their particular financial “problem” - parting with the security of the “nest egg”- and a recollection of the concepts discussed follows.

a) How can the “best time to buy” be decided?

b) What is the price of doing nothing?

c) What market conditions will prevail in 2 years hence? Why?

d) What market conditions will prevail in 5 yrs from now? Why?

e) Are market behaviours and conditions in the stock market the same as behaviours/conditions in residential real estate? Can we predict/learn about realty cycles from the stock market?

In reverse order,

e) Market behaviours. Yes, both markets are affected by consumer confidence, interest rates and supply&demand.

In addition, the stock market is influenced by the actions of the market’s participants and the self-interest of its intermediaries. This “influence of intermediaries” also appeared in the GTA resale realty market this century with the widely-adopted “List Low- Sell High” Listing Broker strategy that purposely-underpriced a subject property (by 5-15%) and delayed acceptance of bids until a fixed, future date when multiple, condition-free offers were ‘entertained’ (ironically, an application of the butt-covering methodology of the bureaucrats at the Ontario Public Guardian & Trustee).

Compared to stocks, residential real estate is conducted at a much slower pace –there are far fewer ‘trades’, each trade is an independent entity and as a result, market changes and trends take a week or a month to become apparent and reported vs. the 60 second analysis of everything that does happens and the 6 month anticipation of everything that might happen in the stock & bond world.

Plus, people/ families/ lives are LIVED in residential real estate, the decision to sell a home is balanced by practical, “human being” reasons to stay put. As a by-product of the “inertia factor”, home prices are considered “sticky”- in adverse times, few homeowner/occupiers will “sell at a loss” unless compelled (or motivated by a greater “buying opportunity”).

Real Estate is similar because it IS a market, but is different because of its shelter (vs. commodity) component – everyone must LIVE somewhere and few people disrupt their home-lives without very good reason. The only thing real estate can learn from stock trading is “what the smart money is doing” and then decide whether to follow or be purposely contrarian.

d) 5yrs … too hard to say with any assurance of accuracy. Could you (or anyone) have imagined April 2009 in April 2004 (5 years ago)?
Oh, maybe the most “monetarily astute” of us would have had a strong inkling in April 2007 (2 years back), but likely, very few of them would have bet their whole portfolio (and household) on that inkling …. even though it would have been the wise and correct thing to do (20-20 proven again).

Nevertheless, irrespective of the accuracy of any one person’s 5-year prediction, we all must have an opinion of the best-possible, worst-possible and most-probable, near-future outcomes in order to set our course between then and now.

c) Two years from now we’ll be experiencing the reaction to /repercussion from the actions taken in 2008’s Fiscal/Financial/Monetary “Emergency Rooms” around the world to ‘fight the recession’, ‘keep liquidity in the system’ and ‘save’ the banks/companies deemed too big/valuable to be allowed to fail.

My opinion is that:

1) “prices” for tangible items (e.g. real estate in Toronto) and imported items (gasoline, cauliflower/grapes/bananas) will be higher in 2 years. Real estate will be up due to low interest rates encouraging demand from first-time buyers and secure-job, owner-occupiers. Imported articles will be up due to the currency devaluation occurring through “quantitative (quantity or amount) easing” of the money supply and the flight to the so-far maintained, reserve-currency status of the $US. In addition, Canada’s classification as an oil-producing currency has now come back to bite us (remember $1.09US in 2006);

2) interest rates will be higher in 2 years, because they cannot go much lower. Rates will trend higher as inflation re-establishes itself;

3) as time goes by, experts and regular folks will be more concerned about inflation than with the risk of deflation. Check it yourself - in 2007 were cars, butter, cauliflower, grapes, gas at the pump, stock indices, average house prices, etc. higher or lower? With all this upheaval going on, is that what you’d expect? Continue monitoring these items (or your own list);

4) the only way governments will be able to generate the higher dollar sums in taxes necessary to pay off their bail-out/ stimulus/ deficit-financing borrowings is by allowing wage-price inflation to devalue the currency (remember the 1970’s?)
May 19/09 Bloomberg NewsWeb
--U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff --

4th & 3rd last paragraphs -- J.Simpson
Globe & Mail June 11/09

Note on #1) Average realty prices in Toronto did fade from 2nd quarter 2008 peak because the top end of the market - $900K & up in (416), $600K & up in (905) - stopped almost dead in 4th quarter 2008.
By April 2009, prices at the bottom end (under $350K) had almost fully recovered and multiple offers (but not over the listing price) were evident, but not commonplace. Unfortunately the arithmetic of “average prices” masks the subtler shadings.


b) Doing Nothing. The Price/Cost of doing or not doing is measured as a “compared to what” and in hindsight. Case in point, earning 1-3% for the last 2 yrs as my new friends have done is MUCH better than the 10-50% loss that others have experienced in the last year.

“Opportunity cost” is a phrase we use to quantify what “cash” might have done elsewhere and thereby to give a benchmark annual value to the equity portion of a real property investment for comparison purposes with other types of investments.

My new friends have enjoyed the security of knowing they possessed 100% of the proceeds of their earlier good decisions and now must find an asset (or class of investment) that gives them the same feeling of security, at no worse an annual return that “prime plus 1%”, less inflation, less taxation.

This returns me to their original objective – buying a personal residence – which in addition to tax-free appreciation, provides shelter in the style and community of their choice.

a) The best time to buy. The new friends that started me writing this note (and all owner-occupying buyers) are only looking for ONE property – so general market conditions really don’t matter.

It’s a matter of THEM deciding THEY want to buy, determining WHERE THEY want to buy and then looking at possibilities until THEIR needs are financially and emotionally satisfied in just one property.

The “Principle of 5’s”. What activities in their/your life occur 5 times a week, 5 times a month, and 5 times a year? The 5/week activities will most greatly influence their/your locational selections and then once they/you have isolated a few super-suitable neighbourhoods (AAA), they/you will develop a list of a A’s and AA’s, that will also be considered at lower price points.

The best time therefore, is when they/you find the house that meets their/your budget objectives, their/your needs list, some/most of their/your wants list PLUS possesses the ability to excite them/you emotionally when they/you consider the possibility of owning it – the best time to buy is when you’ve found exactly what you are looking for.

I mean, if you LIKE the place, nay, if you LOVE the place (and I’m assuming that neither this professional couple, nor you, would be buying next to the airport or a highway or sewage treatment plant) what does it matter if it’s temporarily worth 2-5% less?

Particularly, what does it matter if you put 33% (or more) down and are financing the balance with a 5 year mortgage at 3.75%.

And, even more particularly, since the “irrationally exuberant froth” has evaporated from the price expectations of sellers of trade-up and executive homes and most owners in these property classes are open to honest bargaining on price, there is very little chance of “paying too much or losing money”.

Further, if the above ideas on inflation materialize, we’ll soon be looking back on today as an opportunity to “buy on the dips”.

NB. Beware of the catchy sayings of insiders & traders … and never “average down” except with mortgage rates.

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