Ugly

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Last week I picked on Paul Etherington, cartel boss of the nation’s biggest real estate board. It was so much fun, let’s do it again. Easy, too, when he writes drivel like this:

“Making regular mortgage payments represents a method of forced savings: as you pay down the principal on your home loan, and your property’s market value appreciates, your home equity builds, setting you on a path to greater financial structure, even if you count poor budgeting or excessive spending among your vices.

“In addition to compelling you to take a disciplined approach toward your financial future, homeownership offers several other benefits that are equally important.  A 2012 study…found that respondents who had recently transitioned to homeownership reported feelings of improved health, pride of ownership and ties to the community.”

See what I mean? Houses always go up, so they’re good investments, and you’ll be okay even if you piss away all your income. Just keep making those loan payments. Hey, and mortgages are healthy, too. So get a big one, kids.

Sadly, our society oozes with people who believe this stuff. And, from time to time, we get a glimpse of the potential mess they’re walking into – not to mention the detritus all their house lust could leave for Canadian taxpayers. Such a glimpse is here, in the latest data from the guys who make 95%-financing possible, CHMC, as flagged by the trade site, Canadian Mortgage Trenda.

The ugly stats tell us this about what the masses are doing lately:

  • In the first six months of this year, CMHC insured 143,151 new mortgages worth $25 billion
  • Of all those borrowers, 88% borrowed more than 85% of the property’s value.
  • The average down payment was just 8%
  • In fact, with 70% of all loans, the average down was less than 10%.
  • The typical loan equaled 92% of the property’s sale value.
  • The average insured mortgage is $231,000.
  • CMHC lending plunged by 13.3% in the first six months of this year compared with 2013.
  • An estimated 80% of all home sales in Canada now have an insured mortgage – meaning the buyer couldn’t muster 20% down.

The federal agency is not telling us how big the mortgages are for those putting the least amount down, but the picture is scary enough. An average down payment of just 8% – when you consider that includes a fat CMHC premium heaped on top of the equity loan plus (quite likely) a repayable RRSP homebuyer’s snatch – shows just how much floating debt most fools are willing to walk into.

So long as real estate values hold or continue to rise (like Mr. Etherington promises), then we might be able to keep the wheels form falling off. But eventually the market will correct, equity levels will decline, and this giant vat of debt will remain. Now there’s a new poll of analysts and housing economists showing more of them are worried. In fact, they think the chances of a “steep fall” in prices have increased in the past twelve months.

The Reuters survey showed most smart guys (“many of whom work for mortgage lenders,” said the company) think house prices will continue to creep higher. But seven in 20 believe the chances of a market meltdown have intensified, particularly in Toronto and Vancouver. Said Queen’s Prof John Andrew: “The risk has increased due to house price increases significantly exceeding income growth and the oversupply of condos in downtown Toronto.”

The big threats are well-known to readers of this pathetic yet spoonable blog: higher mortgage rates, especially when the BoC starts swelling next year, and the expanding sea of debt (shown by the CMHC stats above) being swallowed by people who obviously can’t afford to buy. But the experts don’t expect a massive price tumble, or a US-style houseaggedon.

Maybe they should. After all, the American real estate market peaked in 2005, but didn’t convulse until ’08. It’s simply a myth that these events take place in months, because house prices are massively sticky. Sellers are greedy little things (especially the FSBOs), who would rather sit on the market for nine months, then cancel the listing, than reduce the price 10%. It can take a year or two for a general price decline to ripple through, but once it does then the dominoes start to fall. Listings increase and buyers decrease. It’s already happening in secondary markets across the land.

This does not mean anybody with a house, lots of equity, and other investments should bail in fear. But the vulnerable – house-rich, pensionless Boomers and cashless, horny Millennials – need a reality check.

As for the 143,151 who just bought at peak house levels with 92% financing at rates destined to increase, well, pucker up.

Throwing in the towel

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Jason makes a lot of money on Bay Street and has a spouse who can’t understand why he’s so cheap. “Just my background,” he says. Later he hints he has about two million in cash, works like a dog at his finance job, and just got notice his executive-style rented house has been sold.

“Now I’m committed. I have to buy, or get a new wife.” The target house (probably an offer this long weekend) is owned by people asking $1.7 million and has been on the market many months. Jason says he gave a verbal of $1.5, and was told the vendors were “highly insulted” by the paltry amount proffered. “Then I found out they’d already bought,” he says. “Not only that, but they bought a place for $1.8 million that was originally listed for $2.5 million. So they can be as insulted as they want.”

Of course, I told him to put the vendor in a vice and show him no mercy. The crumble in prices – even in affluent and snooty parts of the GTA like North Toronto – is now leading to some interesting dynamics. Anyone who believes the realtor hype about ever-increasing prices is missing the real news.

In the upper ranges over $1 million there are no more widespread bidding wars. Activity over the summer has shriveled like a dude in a lake. As I detailed here some days ago, the average price of a SFH in 416 dropped 17% between April and August. Of course there is always a seasonal dip (which is exactly why you should buy before Labour Day), but this year it’s been twice the norm.

That’s a big deal when it comes at the same time as a crash in mortgage rates. As you know, five-year fixed-rate home loans are now available for less than 3%. Variable mortgages are as cheap as a buck ninety-nine, which means carrying a bloated and morbidly obese mortgage is easier than ever.

In fact, that’s just what the Royal Bank had to say this week when it released the latest Affordability Report (love that name).

“Housing across Canada became more affordable in the second quarter of this year because mortgage rates dropped, according to a report from RBC,” says the incisive media coverage. “Even with prices moving higher, homes became more affordable in nearly every market across Canada, according to RBC’s Housing Trends and Affordability Report.”

Of course, this report is a disappointment on many fronts. First, its basic premise is that houses are bought with a 25% down payment, then financed with a five-year fixed mortgage at current rates. Because the average down in Canada is less than 10%, the full absurdity of current house prices is masked.

Second, the bank found that to afford the average two-storey house in Canada (even with that whopper of a down) takes 48% of a family’s pre-tax income. What does that mean? Well, here is the bank’s own explanation:

“An affordability measure of 50% (for example) means that home ownership costs, including mortgage payments, utilities, and property taxes take up 50% of a typical household’s pre-tax income. Qualifying income is the minimum annual income used by lenders to measure the ability of a borrower to make mortgage payments. Typically, no more than 32% of a borrower’s gross annual income should go to ‘mortgage expenses’—principal, interest, property taxes, and heating costs (plus maintenance fees for condos).”

In other words, the average detached house is already unaffordable – even with the lowest mortgage rates since ever. It also suggests banks are routinely exceeding gross debt servicing ratios. Or, where else are all these mortgages coming from?

Of course, Toronto and Vancouver are off the charts. To buy a two-story house in the GTA now takes 65% of the average family’s pre-tax income, and in the Mouldy City that number soars to 85% – which is a tad less than a few months ago when home loans were more expensive. Of course, 85% of gross income is more than 100% of take-home pay, which is why household debt is rising faster in BC than anywhere else.

Jason knows this. In his job he moves vast sums of money and is acutely aware of risk and return. For years he’s resisted buying because it made so much more sense to rent – and his ballooning bank account is evidence. He’s 100% convinced Canadian real estate will fall, the way he watched it happen back in California before coming here five years ago. After all, when most people are gutting their incomes and swallowing debt to buy something they could rent for less, how can the outcome be in doubt?

So here’s his plan: Vultch hard and get a low price. Use a home inspection report to hammer it down further (“There’s always something wrong”). Pay for the place with cash. Borrow 65% of it back on a home equity loan and invest. Write off 100% of the interest expense from his sizeable salary. Mitigate his real estate risk with a nice, balanced, diversified portfolio, financed with a loan costing him 1.5%. “If I make only 5% a year, I’m laughing,” he says, “and I can now sustain a $55,000 annual loss on the house.

“Sure hope it’ll be enough. No new wife, though.”