Derek DeCloet – CTV

In a west Toronto neighbourhood that once had a healthy contingent of blue-collar immigrants, there is a house that the neighbours talk about – not for its beauty, but for its former ugliness and disrepair. Listed for sale about a year ago, the owner told the real estate agent not to bother showing the place to buyers.

It was just a piece of a land, in other words, not far from one of the busiest streets in the city, with a massive renovation liability attached. But it sold – for $522,000. (Postscript: After rebuilding, the new owner put it back on the market this month and got nearly $950,000, attracting a buyer in just four days.)

Everyone, or at least everyone who engages in the alternative national pastime of exchanging real estate gossip, has a story like this. Tales of an overheated housing market show why Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty worry about Canadians taking on too much mortgage debt. Less obviously, they explain why real estate agents, now at war with Ottawa’s competition watchdog, are losing the battle of public opinion.

Why is there so much antipathy toward people who sell houses for a living? A 2008 poll by Gallup found 17% of Americans rated the ethics of real estate agents as “high” or “very high” – no higher than lawyers and below bankers, building contractors and yes, journalists. I’d bet it would be higher in Canada, but probably not by much.

Some people say agents’ low standing is because the Internet, which has made it easier for people to do their own research when looking for or selling a home, dilutes the broker’s value. Others cite the distorted incentives of their commission structure. But I think it’s also because most people can do basic math, and they intuitively understand what has happened to the pocketbook of a typical agent.

In 1999, there were 335,000 homes sold in Canada through the traditional real estate system at an average price of almost $160,000, according to the Canadian Real Estate Association.

Last year, the number of homes sold was 465,000, an increase of nearly 40% from a decade earlier. But the bigger growth has been in prices, which doubled in that time. Assuming a commission of 4%, a home seller at the average price is now paying some $13,000 for the privilege of having an agent handling the deal. (Commissions can be higher or lower, of course.) So, the total amount of commissions paid to agents was about $6-billion last year, up from $2.1-billion in 1999 (again, we’re estimating using 4% as the rate). That’s growth of nearly 11%, compounded annually.

Comment: Except that this is not the case. In 1999, most home sales paid 6%, 3% to each agent. Now, the rate is closer to 3.5%, with 1% going to the listing agent – if they even get that much. The reality is that commissions would have totalled over $3.2 billion in 1999 when we use the correct commission rates. Again, with the correct percentage, commissions are closer to $5.2 billion today. So the real increase is half of what is stated here, only 5.6% annually, almost identical to the 5.2% yearly price increase we have seen over the same time period. And that is not compounded annually, that part makes no sense whatsoever.

Selling a home did not become harder in many markets; it became simpler. Buyers showed up quickly and tabled offers with fewer conditions. How many people can say that their jobs became easier as their incomes went up?

Comment: And the number of agents doubled in that time. Competition skyrocketed. There are almost 30,000 realtors in the GTA, all fighting for the same 90,000 annual sales. Try that sort of stress in your desk job!

But there is something awfully dangerous about a market that rises so steadily for so long with so few sustained bumps. The recession-induced housing slump of 2008-09 was too short to have a lasting impact on the Canadian view of real estate; it was only a year before average prices were again breaking records. Now, it’s like the correction never happened. Nationally, it has been 15 years since annual home prices took a meaningful hit. Victoria hasn’t had a sustained correction in 25 years. In Ottawa, any dips have been so modest that it feels like an unbroken streak of rising prices going back at least three decades.

Comment: And if we go back 100 years, then we will see that there has been a steady increase every year since then. Some dips and some spikes, but generally an overall increase. Same with the price of cars. And beans. So what? Doesn’t everything go up over time? Why is it bad when it relates to real estate?

A funny thing happens to people when an economic or financial trend holds in place for a very long time. They begin to assume that “a long time” equals “forever.” You can see this clearly in the U.S. Its home prices hadn’t declined on a national level since the Great Depression, so buyers and rating agencies assumed they could never go down – until they did.

Comment: Yes, but that is because big banks and small lenders got greedy and tried to sell mortgages to everyone. Bush erased every financial rule in the country and the big boys ran wild. House prices actually had very little, if anything, to do with it.

And though the case for a real estate bubble here is not clear cut, one can’t help but wonder if Canadians are falling into a similar complacency trap. How do agents play into that? Too often, by fuelling a false sense of urgency.

There are, it must be said, many good agents. But there are many who abuse the power of a hot market, and the biggest problem is the pap they serve up about affordability. A couple with a $100,000 a year in gross income and a healthy down payment can probably qualify for a mortgage on an $800,000 home at current rates. But they probably shouldn’t buy it, because when rates go up they’ll find their mortgage eating up well over 40% of their earnings.

Comment: Says who? When are rates going up? What are they going up to? An awful lot of people speculate about rate changes, yet none say anything about when this is going to happen. I have done the math before. If you lock in at 3.64% today, even if rates go up 2% in 5 years, by the time you renew, you will have paid down enough that the rate hike will not be catastrophic.

Let’s say these people put $120,000 down on an $800,000 home. They have a mortgage of $691,900 including the CMHC premium. At today’s best 5-year fixed rate of 3.64%, their monthly mortgage payment is $3,505.78. If they were smart, they would go with the bi-weekly accelerated payment plan (as I do) which means they are paying $1,752.89 every two weeks. So, after 130 payments – which is 5 years worth – their outstanding balance is $579,109.91. If rates are now 5.64% and they stick with a 20-year amortization (assuming 25 years at the beginning) then their new bi-weekly payments are $2,004.07. That is only a difference of $251.18 – hardly catastrophic for a couple making over $100,000 a year. If they keep their amortization at 25 years, then they are paying $1,791.09 – not even $40 more than before.

Thus, even a 2% rate hike is not such a big deal. And this does not even take into account the savings offered by the current variable rate options as low as 1.75%!

It isn’t complicated to show people the impact of higher rates. (Prospective home buyers who want to do these calculations for themselves can send me an e-mail and I’ll send back a handy spreadsheet to use.) But I’ll bet it’s not an exercise that many agents bother to walk through with their clients. They’re too busy preaching the marketing line that you just have to get in on the market while interest rates are super-low.

Comment: I also have a wonderful spreadsheet that works out mortgage payments, taxes, condo fees, down payments and land transfer taxes. You don’t even have to email me, just click here to download it (Excel spreadsheet). I have nothing to hide, I hope my clients are financially informed. I do my best to make sure they are – nothing worse than  having your clients lose their homes to the bank. I do enjoy repeat business, and my clients come back to me.

If more brokers tried harder to protect their customers from getting in too deep, they might lose a few deals. But they would be worth every penny they earn.

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Contact the Jeffrey Team for more information  –  416-388-1960

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