Investoid

Well, within a week of considering buying a place we have now purchased a home. I can’t believe that we moved that fast, but the more time we spent on the buy/rent analysis and the overall market/economy analysis we did we decided that the time was right.

Given the major increases in house prices in Alberta, our options were to:

1. Buy a condominium, either in a high rise downtown or a low rise near family (likely price: $250-310K)
2. Buy a detached home, entry level ($330-375K)
3. Buy a 1/2 duplex unit ($280-370K)
4. Buy a detached home, one step up ($400-430K)

In terms of appeal, the most expensive option was in line with what we had in mind for ‘our house’. This would have meant picking up a fairly large mortgage, but one that would be approved without hesitation by any lender. However, I don’t believe in the 30% ‘GDS rule’ (gross debt service ratio, read Million Dollar journey for all the lingo details). Gross income is a meaningless number, unless you can pay our bills with your tax dollars somehow (please contact me if you know how, I’ll give you half of mine!). A 30% GDS rule implies that for a $100K earning family with a 35% marginal tax rate that you should be spending nearly half of your net income on your house. That doesn’t leave much for transportation, food, yet alone any quality of life things you enjoy. If you max out the GDS rule, you’re nearly working solely to pay for your house, once you factor out the other essentials. That doesn’t sound like fun to me.

Nonetheless, the most price appreciation has happened at the lower end of homes since first time buyers have flooded the market and are trying to get whatever they can. The low end (particularly condos and duplexes) has been historically a good leading indicator of the overall housing market. Thus we weren’t really interested on being part of the rise up and down.

So, we didn’t want a $400K+ house, we didn’t want a condo, duplex, or entry level detached home. What does that leave us?

In the end we decided to look at entry level detached homes with basement suites. There is an incredible demand for additional rental housing right now, and prices have skyrocketed in the past 6-12 months. By renting out a portion of our home, we get to keep our overall housing costs roughly where they are today (20% of net income), while being able to build up our equity. This means we get to keep our current lifestyle, more or less.

We ended up getting a 1170 st foot bungalow with a separate entrance for the basement suite. The suite has 2 bedrooms and 5 appliances. The home went on the market 4 days ago and was listed at $340K. The seller had decided to consider multiple offers simultaneously, so all interested buyers had their Realtors present their offers today one after the other. We knew that there were going to be at least 3 other offers, with the possibility of more. This guaranteed a sale price above list value.

We determined our maximum price using a cash flow analysis based on what the top and bottom could currently rent for. After discussing with our Realtor, we decided to go slightly below this value as he was confident he could ensure that as long as the top offer was not higher than our maximum, we would be able to get the house.

Sure enough, an additional bid was faxed in that was higher than ours. However, our Realtor had made a convincing case and the sellers allowed us to match the offer.

On top of the cash flow analysis, we used scenario analysis to determine the affordability of our mortgage in the worst case (Alberta’s economy tanks, people start leaving en masse a la 1982). We could still pay the mortgage, eat and get to work even if only one of us was working for a period of time and we had no other way to pay for our monthly expenses. Since one of us is in an extremely recession proof job, we feel we are prepared to ride out any economic downtown, which eventually would cycle again (unless inexpensive alternative energies make oil/gas permanently irrelevant).

Conversely, in the best case (strong steady growth continues, population increases), both rent and equity prices will continue to go higher. In this case we will be paying down our mortgage on an accelerated basis thanks to the rent increases, and will also have unrealized capital gains.

Either way, I’ve had a crash course in residential real estate buying (I have had experience on the commercial side before), and in boom-time buying. When I participated in buying commercial real estate in 2004/2005, we had months to analyze and negotiate. Now deals are done in as little as a day.

I’m sure I’m in for a lot more education in the coming months as we prepare to take possession as well.