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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cre­ative com­mis­sion struc­ture realtors

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