If you read statements from some Canadian real estate boards it seems like homeowners have been fairing well over the last few years. So, when one of the MetroActive members who’s had to drop her rental income over the last few years in order to attract renters decided to list her home she was surprised that it was valued over ten per cent less than three years ago. She contacted us looking to understand what is happening.
Most people understand that a house is worth what someone is willing to pay for it. Realtors will tell you that location determines the price. But, what if the buyer’s not willing to pay what the realtor says the location is worth? Who’s opinion will win out? Well, if you were one of the buyers of the homes across from the South side of Casa Loma in 1989, the home you purchased for $1,000,000 (along with the dozen or so other similar homes on the strip) would have sold for $400,000 just a short year later.
According to statistics released by real estate board’s (mandated to serve realtors) and the Canada Mortgage and Housing Corporation (CMHC, mandated to promote home ownership) you would think that value of one’s home in Toronto has been increasing. So, why has more than one person not been able to sell their home for more than what it was worth just a few years ago?
In examining the value of a home, it is important to separate the value of the access to land from the actual structure for accommodation. In the case of a bungalow priced at $400,000 for example, the land could be worth $300,000 and the bungalow itself $100,000. In the case of our member above, her bungalow was valued at $430,000 a few years ago and now is valued at $380,000 at a time that the statistics show the average price of Toronto homes going up.
Most homes are depreciated at a rate based on a 60 year life span. That means that at 60 years that home should be torn down and replaced and they usually are. In the neighbourhood for the house above bungalows like her rental property of about 1,200 square feet have been replaced with two story homes of about 3,000 square feet. These more expensive homes start weighing the price statistics upward as they increase in numbers, increasing the “average price” of homes on that specific street. That is why realtors attempt to compare bungalows to other bungalows that have sold recently nearby, but what if there aren’t any bungalows like that which have sold in a similar street nearby? Well, they just keep looking until they find the closest comparable, which may not be comparable at all.
In looking at what’s happened in specific neighbourhoods, it was revealed that in situations where homes were not knocked down and replaced in the last few years and the price went up for those homes, they had been renovated. Over the last ten years there have been a number of organizations that have been showing, persuading and guiding people in how to buy, renovate and “flip” homes for resale at higher prices. These individuals have bought older homes and invested in some cases up to $150,000 to increase their value and resell them. The idea being that if they buy a $300,000 and spend $75,000 in renovations, then they could sell the home for $425,000 or more, and pocket the profit.
House flipping works well when real estate prices are rising and about five to ten years ago investors were making very attractive profits. Some of the more expert flippers started to realize that it was getting tougher to maintain their profit levels, so they decided to start teaching others to do it and charging them for it. As they recruited more and more real estate investors there were more and more flippers looking for homes that could give them a margin. With the economic downturn and sheer numbers of investors the profit margins decreased until the point where it is now rare to be able to flip homes in Toronto in that way and make money. Many of these investors have even found themselves losing money on deals.
This is the driver behind two important dynamics. First, if you’re comparing a renovated bungalow on the same street as a non-renovated bungalow, then it is going to be worth more if for no other reason the structure itself has been increased in value through the money you invested in it. Second, if you want to know whether true real estate values are going up or down you have to discount the first dynamic to get to the “land value”. That means that you take the value of the listed home, subtract the renovation and other expenses and that is the “land value”. It is only when you compare the land value that you can truly tell what is happening to real estate prices.
When these calculations were used in trying to understand what happened in the home value above, it all made sense. From examining other neighbourhoods around Toronto, including condominiums it was realized that in fact Toronto housing prices have been going down for a while. In the case of condominium prices, builders have been throwing in more and more upgrades, some even giving away trips and cars in order not to drop the price of new condominium units. But, if you take these incentives into account the true price of the units is much lower than the statistics show.
Did you notice the term used earlier, “average price”? Another dynamic of these statistics is that they don’t take into account specific types of homes, locations or other considerations. The averages are skewed by considerations such as the fact that only higher value homes are being built or put on the market for sale and that the lower valued homes may not even have many listings do to people not wanting to trade up.
Try these calculations for your own home and neighbourhood. If you can, follow the history of the homes similar to your own in your neighbourhood, their renovations, sales activity, etc. It is best if you can have a couple of examples to homes that were very similar to your own on your street. That’ll tell you whether your home value has been increasing or decreasing. Regardless, in the end it is the buyer that will determine your price. The end test of the value of what you have is what the buyers will pay for your home.