Trish Bongard Godfrey

Worried About Overpaying?

26 May 2014
Trish Bongard Godfrey

A few days ago I asked a friend who is in the process of buying and selling what was top of mind as an active real estate consumer. She immediately flipped back an email back saying, "Overpaying." I think that is probably the state of mind of all buyers, and sellers too in the reverse. Sellers dream of buyers overpaying!

Is it really common to overpay in this market? I am sure my parents, when they bought their first home in Moore Park in the 1950s for about $24,000, thought that they were overpaying – or at least paying a lot of money for that house. That same house recently sold – much renovated of course – for about $1.8 million. And I bet these recent buyers also thought they were paying too much!

I happen to know that there have been at least two major renovations on the house. I will ballpark the cost at about $200,000 each in today's dollars. If my parents had held on, made the same investments, maintained and improved the property as did the subsequent owners, it would have repaid them about a 7.3% annualized return. Not bad, especially when the investment also provides shelter, security, and a great deal of personal enjoyment and health.

According to the Bank of Canada inflation calculator based on the Consumer Price Index, a $24,000 "basket of goods" bought in 1956 would cost $213,106 today. What is in that basket of goods? It includes a lot of consumables such as food, housing, transportation, furniture, clothing, and recreation. I'd suggest however that this isn't really a totally fair comparison. Property is something that cannot easily be replicated, and it lasts longer. The old hackneyed real estate maxims still make sense: "They aren't making any more of it" (land/property) and "Location, Location, Location" (why Moore Park has increased so well).

Other things to consider: You can change the value of a property. You buy it, hold it, actively improve it, and then sell it. You might get more money. Meanwhile, you have a place to live with many benefits. You buy eggs and they just rot (well, you can make an omelet, but that has a short shelf-life too). A home doesn't usually physically depreciate as fast as other "CPI things", like clothing. Recreation, also important in our lives and in the CPI basket, can't really be sold. A home and property have many more attributes than a lot of the other items in the basket of the Consumer Price Index.

Did the most recent Moore Park buyers pay too much? Well, the house sold over the listed price, so there were probably multiple buyers. That means it probably sold at fair market value, that day. I figure that a property which gets listed on MLS, available for the world to see, and is represented by a good brokerage which knows how to set the price, present the property to show off its best features, and negotiate the deal with an arms-length buyer, will get fair market value in the moment.

The other thing we say a lot around here is, "The price is the price." In other words, if someone paid it, that's what it is worth that day to the one and only person who bought the property. We don't always agree with people's particular taste and judgment, but when so many buyers are pushing the envelope of property price levels in this city, we can believe that people really value Toronto real estate, on the whole.

According to the Toronto Real Estate Board, the average household income that goes toward mortgage, principal, interest, property taxes, and utilities for the average-priced home in the GTA (subject to some assumptions) has roamed between 27% and 35% for about the past 25 years, and is now near the higher level of around 35%.

It doesn't take much to figure that a significant bump in the combined costs of the mortgage, heating and cooling costs, and taxes could mean that a whole bunch of people are now spending 35%-40% of their income on their homes – and that could be a game-changer for some stretched-to-the-limit buyers.

But with the number of buyers acting in the market today, immigration projections, and poor transportation to the 905 (yes, I think our lousy transportation is inflating house prices by keeping people in the Central core), I think the Toronto market will stay strong.

As owners of larger Central homes (Boomers) start to see sale prices they would like, and their kids move out, they will cash out. I don't think they'll all want to move to a cookie-cutter condo. I think Boomers will still want their space, and will, as my parents did years ago, take their cash and move out of town to places outside the GTA but within driving distance of their families. They may also want cool and unusual spaces such as The Glebe church conversion condo I have listed at 660 Pape Avenue, Suite 208, at Danforth Avenue.

So, are people overpaying? Is a capital gains tax-exempt annualized rate of return of over 7% on a Toronto family home exorbitant? It's a good return, a fair return – not a killer return. A killer return would be more like a double-your-money-every-couple-of-years me, anyway. Therefore, I think both buyers and sellers should be comfortable with their Toronto real estate investments. Over the long haul, it seems to be fair.