Transcendental Success

Canadian Free at 55 wrote a post recently about a report he read predicting a drop of housing prices in his city of up to 50%, which sparked a debate about speculating with your own house. I did a little analysis as to what would happen if a home-owner sold her house and rebought after prices went down.

I ran 4 scenarios: Housing prices hold as they are, prices drop 10%, prices drop 20%, or prices rise by 10%. I calculate the gain or loss under each scenario and make the following reasonable assumptions about our hypothetical person:

* She owns a house worth $400,000 today, and has $100,000 equity with a $300,000 mortgage.
* She makes the decision to sell today, sells the house with a 3% commission, puts the money in the bank at 4%, and rents for one year at the same amount as the mortgage payment,
* After a year she buys another house at the new prices (0%, 10%, 20% or –10% lower). On the bottom line is what she gains or loses after each deal.

You could have easily predicted it. She makes money if prices go down and loses money if prices stay the same or go up. It costs her about $2500 per year extra to live and transaction costs are a big expense.

The surprising thing is the magnitude of the dollars involved. If housing prices drop by 10% then she makes over 25K, and hits the jackpot at over 65K if they drop by 20%. For some people 25K is more than their take-home pay for that year, which cannot be ignored.

Why are the dollars so big? Because the asset is large, almost too large to comprehend for those of us dealing with monthly expenses and paychecks. We have to remember is that the overall asset is at the centre, not the payment or the discount.

A $400,000 house is about a $1,600 per month mortgage payment and can be easily “owned” by a family making under $60,000 per year, or $5000 per month. A 10% slide in price has an immediate value of $40,000, not $160. The $40,000 is pure cash that could be sitting happily in your bank account, which is a lot better than the 10% off sign in mall shoe store. Worth a second look for sure, and I say that it is responsible and mature thing to look closely if you really think your house could lose 10% in value much less 50%.

So how do you profit?

#1: Decide what you know. Real estate markets follow similar patterns everywhere, just not at the same time. In Canadian Free by 55’s case, his province saw an oil boom just like neighbouring Alberta. The boom caused workers to swarm in like bees to the honey of oil jobs.

Prices shot up there because large numbers of houses take many months or years to build, just like in Alberta. Interest rates were low and optimism flooded everyone. Housing boom fever seized the speculators, who gathered up even more of the inventory and caused the shortage to be even more acute.

Since then, in Alberta, we’ve seen migration slow and the supply of houses catch up a lot, which has caused the market to crash by 20% or more in some places from the peak a year ago. There are thousands of units on the market and nothing sells with a bidding war on listing day anymore.

This scenario is standard and predictable. Booms always bust eventually, you just have to decide when. Why would one believe that Saskatchewan will not mimic the outcome of Alberta?

As an aside, to let you know that I practice what I preach, I escaped the Alberta oil boom market with a large profit, missed the Saskatchewan boom because I was already too invested, and got into the Newfoundland resource boom that is now proving to have been a very good move.

#2 Decide on what’s the worst that is likely to happen: The simplest form of risk management. If the worst result is still drinkable, or better yet, still tasty, then you can rest easy with your decision. If the worst is too bitter then you have tie up the analysis more. How can you wipe out the downside? How can you convince yourself that the worst is better than you think? Downside is mostly imagined and compounded by fear. See my post on beginner’s fear inoculation.

Trying to understand Saskatchewan’s housing market you can ask yourself a few things. Who bought the houses during the boom? Why did they buy the houses they did? Are they likely to want to keep their houses? Were there too few houses for the immigration? What kinds of houses were bought? Ask yourself all the same questions for the future and you will begin to form opinions as to whether housing will go up or down.

#3 Act: The old real-estate saying is that the profit is made when the deal is signed is totally true. Use your foresight to find an opportunity and then take it.

Before you say that you shouldn’t mess around with the family home you should remember that most young or middle-aged people don’t own anything larger than their houses. It’s the largest resource they have and can generate the largest transactions with the largest profit potential. Money is money, whether locked up in your home or in the bank. If you have access to a $400,000 asset and an opportunity to profit, why not take it?