When
you purchase a home for the very first time, the odds are overwhelming that you
will not have the entire amount saved up in your bank account. You will likely
need to borrow money from a financial institution by way of a mortgage. The mortgage will likely be paid monthly from
your income over a period of 25 years. Assuming you do not have access to a
trust fund, your income is the most fundamental criterion regarding how much
you can borrow and how much you can pay monthly.
The
picture below is 65 Winding Lane. It’s a
relatively modest, entry level home located near Yonge St. and Clark Avenue in
Thornhill - a few blocks from Toronto city limits. At night, you can hear the buzz of trains
going by. You can barely fit one car into the garage and there is enough room
in the front yard for about two lawn chairs.
It has three small bedrooms and the smaller rooms can barely fit a queen
size bed. There is not much in the area
except some houses and a Red Lobster off Yonge Street. It is safe for all of us
to agree that this is a typical entry level home for a young family; perhaps a
little on the frugal side, if anything. We can all further agree that a high-income
family would likely pass over a house like this because, let’s face it, it is a
small dinky home.
Before
I tell you the price, let me first give you some context. My parents bought a
similar home on this very street just a few doors down back in 1986. They paid $128,000.00 and put the then
minimum of 25% down ($32,000). There was no bidding war. The prevailing mortgage
interest rate was a cool 11%. Their combined income was just shy of $59,000.00.
If
we break the numbers down further, the price to income price ratio was 2.17
($128,000 divided by $59,000) and the percentage of their income going to the
mortgage costs only was 18.79% ($924/month times 12 months divided by $59,000).
It was an affordable entry level home for a young couple with two very young
children.
WARNING:
Put your coffee down and stop munching on whatever you are eating to avoid
choking before reading the next paragraph.
This
home was recently listed for only $1,188,000.00. But it gets better! For
reasons only the monkey gods know, its price recently increased to the very appealing $1,388,000.00.
Let’s
crunch the numbers: assuming a couple today paid the asking price of $1.38 million,
they would need $277,600.00 for a 20% down payment or two times the original
selling price of the home. They would also need to pay $5085/month just for the
mortgage (assuming 2.7% interest rate).
How
many young couples have $277,600.00 sitting in their bank account and earn enough
to pay $5085 just in mortgage payments?
Using
various online calculators, this couple would need to have a combined income of
$210,000.00 just to qualify for the
mortgage. If they have any kids or plan on having in the future, well, the
income required will be much higher (think $250,000 +). Having a dog could mess
up the numbers as well.
What’s
happening with incomes in Toronto?
Many
people believe that Toronto is a world class city, or has been since at least
1988, depending on who you ask. If this is true, then we should, therefore,
have world class incomes.
We
believe that incomes have been rising as everyone seems to be affording bigger
and more expense houses and everyone seems to have fancy cars, fancy vacations
and fancy phones. However, we know
something is wrong because it seems like others
have been getting ahead, but we are just languishing behind. It's a paradox
that you likely thought about it at some point recently. Time for some real data. What has happened to
incomes over the past generation?
According
to Statistics Canada,
the median Toronto family income for all family configurations for 2014 was
$75,270. For couples, it was
$83,010. This means 50% of couples made
less than $83,100, and 50% made more. For comparisons sake, Edmonton’s median
family income for couples was $110,490 (and real-estate prices are a lot lower
there).
As
the above chart shows, incomes have been flat for the last 18 years. Except for
a large drop in the early 1990's after a recession, incomes have been pretty
much the same in the last 30 years.
World
class? More like generational stagnation. Incomes have simply been going
nowhere.
What
about all those rich people aka the "1 percenters"?
In
2014, there were 362,670 individuals who made more than $200,000 across the entire country. This represents 1.3% of all income tax filers.
No, not everyone lives in centre of the Canadian universe [Toronto]. A whole
bunch live in Alberta, BC, and Quebec and a few sprinkled elsewhere. The
remainder live in the surrounding Toronto area.
Sure, there might be a few people who work cash or don’t declare all
their income, that is unavoidable. Even considering the few sketchy cash only
individuals, despite popular belief, there simply isn’t a lot of people who are
making the big bucks in Toronto.
Which
begs the question: how many people earning $200,000 year would rush to purchase
65 Winding Lane? How many doctors, corporate lawyers, successful entrepreneurs
or Hydro One executives do you think would want to live in a dinky home like
that?
Can
the average family purchase 65 Winding Line?
For
2014, the median income for a couple in Toronto was $83,010. Half of couples made more, half of couples
made less. This home is the definition of a lower-end entry level home and we
should expect the median income family to be able to afford this property
without issue. Or can they?
Now,
assuming each person earns roughly the same amount, their combined after-tax income would be $66,248. The yearly mortgage payments would be $61,020
or 92.1% of their after tax income.
This would leave $5228 for food, clothes, transportation, insurance, utilities,
other debt payments, vacations, charities, and entertainment. I would imagine that Meow Mix would be a
staple dinner item.
[Fun
fact: In 1989 before real-estate imploded, the average mortgage payment took up
only 82% of a family's income]
And
the down payment? If this couple was super frugal and could save a ridiculous
40% of their yearly income, they would need 10.47
years to save for the down payment. 10 years without any trips, new
vehicles, fun night outs or anything else which costs more than $10. Birthday's, I would imagine, would have to be
celebrated at Tim Horton's.
What
is the price to income ratio for 65 Winding Lane based on the median couple
income?
Many
financial advisors suggest a ratio of no more than 3.5, and up to 5.0 for a
large city such as Toronto. The price to
income ratio for 65 Winding Line is an out-of-control 16.72. The ratio was under 2.5 for most couples in
1986. Assuming a ratio of 5.0, the
property should be no more than $415,050.
Joey,
there are too many numbers in this blog post, explain it like I'm a 7th grade
Let's
recap: It is undisputable that a family income is the key component on how much
they can afford when purchasing a home - without sufficient income, you cannot
pay the mortgage, utilities, food, transportation, child care, and food for the
dog. Income is the crucial underlying fundamental
in real-estate. The median couple income in Toronto is just $83,010.
The
income paradox that many of us ponder - everyone else making more money than us
- is not supported by the empirical evidence. Couples today are making roughly
the same compared to couples 30 years ago. This does not consider that school,
utilities and fuel costs are much higher today than in the past even accounting
for inflation. The cruel irony is
everything costs more now and we make the same amount.
Dinky
homes like 65 Winding Line require a minimum family income of $210,000.00/year
which easily crosses the absurd and delusional threshold. A quick search on
realtor.ca will yield you similar absurd prices for entry-level homes. The income to price ratio should not exceed 5
times the family income in a large city, and 3.5 times in a medium size
city. Therefore, a home like 65 Winding
Line should be priced around $415,050 based on current income levels (5 x
$83,010), not a ridiculous number such as $1,388,000 which is a 16.72 price to income ratio.
Today,
average people are simply unable to buy below average homes. Even higher income
couples cannot afford below average homes. Prices have become completely
detached from the biggest and most important underlying fundamental criterion -
incomes. Many media pundits are adamant that
our incomes will “catch up” to the housing price increases,
but that would require everyone getting a 200%++ raise which is the same
probability as Trump arguing for a constitutional amendment so Obama can run
for a third term.
If
we are not earning more, how is it that everyone seems to be buying more
expensive houses, cars, vacations and toys?
