Updated: Sep 8
Inflation is not slowing down!
The U.S inflation rate continued to rise in June to 9.1%, so the cost of living went up by 1.3% in the month of June alone.
The Canada inflation rate in May was 7.7%.
The rate for June has yet to be released, but I think we can expect to see a very high number still.
So last week, the Bank of Canada announced an aggressive rate hike of 1%.
We talk a lot about raising interest rates to tame inflation.
But do you know how inflation is actually measured?
What components does it look at?
We’re going to dig into that today.
After that, I’m going to share a very interesting article about how investors may need to sell at a loss because of the higher interest rates.
And as a result, home prices will drop further.
Let’s say last year, I bought 10 things and they cost me $1,000.
This year, I buy the exact 10 things again and they now cost me $1,100.
So there's 10% inflation, very simple, right?
In order for the inflation rate to be meaningful, the things included need to be representative of what most Canadians actually spend their money on.
And the things change over time.
For example, a long time ago, the price of a CD player may be included and now it would be changed to a smartphone.
Each item also receives a different weight to reflect their importance because more people spend money on say gas rather than milk.
So what’s included in Canada’s official inflation calculation?
Let’s check out the official breakdown.
Here are 3 categories, each contributing to around 5% of consumer spendings.
The first one is Clothing and Footwear.
Second one, Health and Personal Care.
Third one, very interesting, Alcoholic Beverages, Tobacco and Cannabis.
Recreation, Education and Reading contribute to almost 10%.
Then the next 3 big categories, each contributing to around 15% of the spendings.
Household Operations. Things like electricity, heat, water…
Here comes the biggest category, takes up 30% of the total spendings.
Of course, it’s Shelter.
And that includes rents and mortgage interests.
We’re running into a deadlock situation here.
When interest rates increase, mortgage interests also increase.
When owners’ costs increase, rents also increase.
And strong demand in the rental market is adding fire to this as well, we have already talked about the significant rent increases last week.
You see, interest rates are increased to tame inflation.
But mortgage rates and rents are also increased and they contribute to 30% of the inflation calculation.
So it’s a very complicated situation.
The inflation rate is not going to magically come down a lot next month just because of the 1% rate hike.
It’s going to take months or maybe even years for inflation to come down to a more reasonable level.
So if you’re simply relying on the government to bring inflation down and you don’t have a plan to protect your cash from depreciating, you might want to think twice.
How would the real estate market be affected by higher interest rates?
Here’s a very interesting perspective from an article in the Toronto Star.
“As rates rise, some real estate investors may have to sell at a loss, causing home prices to fall further.”
“Investors who bought pre-construction homes may find carrying costs too much with higher interest rates.”
Why pre-construction homes specifically?
They are actually referring to flipping.
Buy a property at pre-construction, sell it by assignment sale before final closing to make some money.
The interviewee is a lawyer and here’s what he says, “You’re getting the benefit of a real estate market that is rising without having to take out a mortgage or to put down assets beyond the 15-to 20-per-cent deposit that’s required, so it’s a really good deal.”
Is an assignment sale a really good deal?
If you have been following me, you know the answer is a big NO.
Like I always say, if you plan to flip it, just don’t buy.
Because of the 2 killer tax implications on assignment sales, a majority of your profit will be going to the government as taxes.
If you haven’t watched that video before, make sure you catch it at the link below.
So assignment sale is never a good investment practice to begin with.
The majority of pre-construction investors are definitely looking to close their units instead.
Besides, while mortgage interests are increasing, rents are also increasing significantly to cover that.
The lawyer also expects that it will be a growing problem where people just walk away from their pre-construction purchase and have their 20-per-cent deposit forfeited.
I’m sure there will be some cases like that, but to say that the overall home prices would be dragged down even further because of that, I’ll let you decide whether that makes sense to you.
By the way, if you want to get rid of your pre-construction condo in downtown Toronto at a loss, or even at original price from a few years ago, I have many investors who are very happy to take them.
Speaking of assignments, did you know that the government is proposing a change to HST charged on assignment sales?
That’s going to change one of the killer tax implications and affect all assignment agreements signed after May 7, 2022.
We’re going to talk about that in next week’s episode.
If you haven’t subscribed, make sure you do so you won’t miss the new tax rule.