Blessed by the Potato

I normally like to look at the housing market from the bottom-up using a rent-vs-buy analysis. After all, you have to live somewhere and that’s the key to deciding what to do with your own life — the macro stuff will work itself out eventually over many years. I still like reading and thinking about the macro stuff, it just wasn’t really my area of expertise for analysis and Ben Rabidoux used to post a lot about it. But he’s not posting any more so screw it, let’s have a look at the Toronto market with some Fermi-esque math.

In 2013 the overall average price of a detached house in Toronto (416) was $842k; 11.4k such houses traded hands, according to TREB. Some of those would have been $500k crack shacks, while others would have been multimillion dollar mansions bringing the average up. TREB doesn’t publish median figures. Up in subwayville/North York a “normal” house runs for about $700k so let’s take that as a reasonable average for the city based on those numbers.

How much income do you need to carry a $700k house in Toronto?

Property tax would be about $5,600/yr.
The mortgage, if you want to use 4.5% to give yourself a small buffer against increasing rates, and assuming 20% down, would run $37,356/yr.
Utilities, insurance, maintenance, etc. we can ballpark at $10,000/yr.
Rough total with these minor contingencies/conservative estimates: $46k/yr.

Assume that the owners of such lavish mansions have other things to spend their money on (cars, daycare, hot yoga, Muskoka cottage, pusateri’s, retirement savings) so they want to limit their spending on shelter to something reasonable like 45% of their pre-tax income. That means they need to make over $100k to afford a house at this level. At least. Of the roughly one million households in Toronto, fewer than 120,000 180,000 290,000 of them have household incomes over $100k. How many houses are there to buy at those prices? If the average detached house turns over every 10 years, then there are only 110k or so.

That doesn’t look so bad: as long as everyone who has the income to do so is behind the current prices and willing to ignore traditional affordability rules-of-thumb (forever), they can be sustained.

Except that about a third as many semi-detached houses traded hands last year at an average price exceeding $600k, so we’re looking at at least another 1,000 sales and 10,000 units or so of semi-detached houses over our $700k threshold. A quick scan of MLS also tells us that there are still a few thousand units that cross our $700k level, even though condos may have an average price of less than half the detached/semidetached class. That’s another 15,000 or so rich families we need to be committed to the expensive property cause, getting us well within the error bars of the total number of rich people available.

Looking closer at that estimate of detached houses, it comes out kinda low — mining the StatsCan data suggests that there are closer to 300k detached houses in Toronto [edit: or if you have the power of Ben Rabidoux to find the correct table rather than subtracting others, you can say it is precisely 275,015].

I’ve heard the argument more and more lately that the housing bubble is just a new reality in Toronto: the days of an average or middle-class family owning a detached house — even in the burbs near the subway — are over, and such things are only for the rich. Condo living or extreme commuting are the new normal. Except current prices are so insanely high we don’t even have enough rich people for that narrative to make sense.

Toronto’s going to run out of rich people before all the houses can turn over. Fixing the income numbers, I can’t say definitively that Toronto doesn’t have enough rich people to support the house prices any more, but we’re still cutting it kind of close. The question circles us back to many people needing to commit to stretched affordability to keep the prices up, and with prices increasing every year how stretched can affordability get before it all falls apart? Unfortunately that’s been a question for a few years running now, and kind of depends on how insane people are willing to let things get. The longer interest rates stay low, the more willing people are to stretch every last dollar and throw out their contingency for rate increases. So the median detached house price is right now $700k. At what point does it rise enough that the question I raised here does become an issue — when is affordability stretched so much that there aren’t enough rich for all the houses? Maybe when the median price hits $875k, another 25% increase from here? So like, 2 years at current price increases?

[Edit: I had a report that put the percentage of households with incomes over $100k at 18%, and I had the total number of households as about a million. In the original post I multiplied those out to get 120k, failing once again at simple math. That report was based on 2005 data, I’ve since been informed the 2011 census figure is 26% of 1.1M households.]

Just before Blueberry was born, we had a discussion about why we didn’t need life insurance for our situation. I’d like to broaden that discussion a bit, but I have to tread carefully. There are many who are under-insured not because they have decided that insurance isn’t for them, but because they just haven’t gotten around to it yet. I don’t want to encourage further procrastination (well, I do — don’t go off and work, read my blog!), and it can be very important for many people out there. But at the same time the insurance sale may be a bit heavy-handed and the base assumptions seem to increase the apparent need. Part of that may be my perspective: my value system is compatible with the idea that my survivors’ lifestyle shouldn’t be completely untouched (let alone improved) by my passing.

Here is why I’m out of the mainstream:

1. my idea of dependents
2. my idea of lifestyle of survivors
3. my assets/situation

The idea of dependents is a bit of a strange one these days: kids are and always will be, but we are long past the time when the typical family consisted of one breadwinner head-of-household and a stay-at-home spouse (who was typically the female head-of-household). Many families are dual-income now, and even many of the ones that presently aren’t could be (modern stay-at-home mom or dad is likely university educated and had a career before getting hitched at an ever-later age and spawning). So your family would be without your income if you died, but they could still have some income. In our case, Wayfare actually has a much higher earnings potential than I do, and after Blueberry’s in school she could ramp up her hours worked to fully offset any loss of income from my death.

The assumptions of what the needs of survivors will be also seems a little over-the-top to me: some sites suggest full income replacement until you would have retired. But if I’m not there to spend part of that money, it means that my survivors would have an economically better life than if I were still there (except for the dark void in their hearts). Liabilities are also a typical factor in calculators estimating your needs: having enough to instantly pay off the mortgage is common, but seems to imply that they would or should stay in the same house, rather than downsizing, and that the surviving spouse wouldn’t be paying any of that down. For mortgagees, some insurance is a good idea because house prices can go down and transaction costs can be high, and you don’t want your survivors trapped and unable to extract the equity to move on.

The typical assumptions seem to imply that the survivors won’t make any adjustments in their life, work, or spending to compensate for the loss, which can lead to some large insurance needs. Instead, I figure that if I die, Wayfare and Blueberry will be free to move to a smaller, cheaper rental. There will be no need for a place so large with one person down (my whole dual-monitor home office set-up will reduce the room needs by one, and I don’t think Wayfare needs a kitchen half as large as the one I insisted on). And part of the reason for living in the over-crowded fourth circle of hell Toronto is the arcane arithmetic of the two-body problem and large populations; freed of that constraint they could move to a cheaper centre like Hamilton or London. Combined, a smaller place in a less-expensive town (or even less-expensive part of Toronto) could cut rent costs in half. On top of that is the significantly non-zero probability that Wayfare will find a replacement spouse who is gainfully employed.

Having a contingency so that these adjustments don’t have to happen right away makes sense, as does enough coverage for daycare until Blueberry is in full-time school. That’s where our situation also helps with my estimate of minimal insurance needs: we already have over a year’s worth of expenses saved up, and supportive parents who could provide an additional layer of security if we badly screwed up the math. As it turns out, my job came with group benefits for some measure of life and disability insurance (and it is the disability insurance I am more worried about).

Death is tragic, but from a financial perspective it’s not the biggest cause of young families losing an income. Divorce can not only rip daddy away, but cause massive upheaval and lead to a chunk of the “estate” being lost to lawyers. I’m ok with the idea that if I die, even with just 2 years of income for insurance coverage, my family will still be better off than those who started from similar circumstances and got a divorce. But I don’t want to make the delta so large that perverse incentives form.

Back to insurance: I actually found it quite hard to find ballpark quotes on disability insurance outside of my group plan. For life insurance I think it is important to disaster-proof your life, but the actual coverage need might not be quite as high as some calculators suggest, if you’re ok with the idea of your survivors taking basic steps to adjust for the loss.