It has a million people, an average temperature of 82 F, mountain ranges on three sides, a rapid growth rate, and a median house price of $150,000. In fact, the cost of houses has actually eroded in the past year. Last winter (normal February temp, 64 F) the average home was changing hands for $177,500 – 15% more than today. Indeed, prices have crashed $15,000 in the last two months.

And unlike Vancouver or Toronto where a shortage of listings means higher real estate values, in this city the number of houses for sale is on the decline – off 10.5% in a year – while prices crumble. Moreover, mortgage delinquencies have recently doubled, while the number of properties taken over by lenders for non-payment of loans is up 75%.

This city’s moribund housing market is also at odds with the economy, which is supported by a massive university, a famous military base on the edge of town, and companies such as Raytheon, Texas Instruments, IBM, Intuit, Universal Avionics, and Bombardier Aerospace. There are so many optoelectronics companies that the area’s called ‘Optics Valley.’

So, why is Tucson so cheap?

I mean, they have bargain mortgage rates. It ain’t a one-horse town, like Detroit. It’s in a desirable sun belt state. The unemployment rate, at 8.2%, is two points less than the US average, and the same as here.

Paradise, it’s not. Actually, it’s a desert. But why does a house in Toronto cost $450,000; in Vancouver $750,000; and in Tucson $150,000?

The best explanation is probably investor psychology, since Tucson (like Phoenix, Vegas, Stockton or Dade County) is a place where people don’t believe in real estate any more. Sure, there are still multi-million dollar palaces with soaring mountain backdrops, but the average family doesn’t look at a house the way a Canadian does.

Here, we see real estate as (a) a social statement about our inherent worth, (b) a retirement plan, (c) something to lord over your relatives, (d) a ready pool of accessible capital, (e) a perpetual money machine and (f) a place to put the kids at night. In the majority of American cities, houses are in the same category as cars – useful assets which may or may not appreciate in value, and therefore should not be slobbered over.

It’s valuable to bear this in mind. Our two countries share many things. So when the US middle class went delusional over real estate, created a bubble and now – five years later – still reels from the gasbag blast, maybe we should pay attention. Real estate is now judged by 72% of the American population as being a poor place to invest money, Meanwhile last week’s RBC survey showed 92% of Canadians swear to just the opposite.

Perhaps the emotional pendulum swung too far in the States after the bubble burst. Maybe people are just irrational and bitter after being bitten so hard and losing so much. But by the same token, there’s little doubt when 9 of 10 Canadians lust after a house at its highest recorded price, we’re equally nuts.

As I have said before, this basic disconnect between the two countries poses one hell of an arbitrage opportunity. Sell Canada, buy America. Markets here are vastly overvalued as they are vastly undervalued in US. Both have but one direction in which to go.

Dollar at parity? Our national bird should be the vulture.

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A virgin's lament: 'Looking at hell-holes'

Hi Garth,
I was just introduced to your blog after receiving a note from my landlord to check you out. I recently let him know that my wife and I are interested in buying a home over the next few months and that we’d likely be moving out before the end of the year. He quickly introduced me to your blog and explained how right now real-estate agents are regularly pressuring him to sell his home, promising ridiculous pots of gold at the end of the buyer’s rainbow.

After reading a few of your articles and reflecting on my experience in this market so far, I know that it’s not a great time to be a buyer. We’re in no financial rush to buy, other than sitting on a pretty big down payment and putting $22,000 towards rent on an annual basis (which is extremely frustrating). Since starting our search, we’ve looked at hell-holes asking for $440K and incredible properties listed the same and selling for 150K over. It’s like we don’t know what anything is actually worth any more.

I’m a commerce grad, and I have studied economics long enough to know that demand is far outweighing supply right now in Toronto, which is obviously affecting prices. I know the HST and interest rate conditions have caused an increase in the total number of buyers. So I guess after that long preamble I have three questions for you.

1. As a new buyer, how do you judge what a fair price to pay for a home in Toronto is any more?

2. What do you expect in the short term once interest rates rise and the HST goes into effect?

3. Is it just stupid to buy right now? And if so, how long do we need to suck it up and keep renting?

Any guidance would be much appreciated. I’m sure you get a ton of questions on a regular basis, so I understand if you don’t have time to get back to me. I look forward to more great posts now that I’ve discovered your blog. It’s going straight to my RSS reader. – Alex

Well, Alex, I have posted your note to me because we love new virgins here @ Greater Fool. Naiveté is so refreshing. And to find one with a principled landlord is even more unique. So, welcome. Addiction has its rewards.

You best point is, “we don’t know what anything is actually worth anymore.” This defines a market which has strayed from fundamentals into hormones. People want houses so badly that they pay almost anything for them, which imbues real estate with such value that it makes others want it even more.

This madness is fueled by dirt-cheap money, which many newbies totally fail to recognize. Because a mortgage is, oh, 2% today, that becomes the norm for first-time buyers, who base their entire budgeting process on a number which is extreme, and about to swell like a horny blowfish. These emergency rates, combined with 5% downpayments, 35-year amortizations and banks willing to lend to people with no money since the government is backing them, have created the situation you now face.

Half-million-dollar skanky dives. Greedy sellers who even don’t bother rinsing curlies out of the sink before a showing. Real estate agents who collect commission for showing up. And a disconnect from reality for a commerce grad like you.

But, Alex, there is hope. This will not last. So let me get to your questions:

(1) A fair price for a house is what people can afford. That seems to be somewhere around four times income today with these cheap rates. With normalized mortgage costs, fair value is probably a little less. The media income in T.O, is about $77K, so the average house should cost $308,000. The average now, however, is $431,500 – a $123,000 premium. Yes, Alex baby, this means the market is overvalued by 28%

(2) What comes next? Well, my view is that 2010 will be a tipping point. The combination of rising interest rates this summer with the HST, more job losses (check out Siemens), government cutbacks and buyer fatigue will start the process. Sales volumes will fall even as prices rise, then both will decline together – starting a process which will probably last for years.

(3) Stupid to buy now? Yeah, Rahim Jaffer stupid. Your LL may like cashing your rent cheques, but he’s actually saving you from your own self-destructive juices. Wait as long as you can. All of this year, for sure. And a good chunk of 2011, too. You may end up with a higher mortgage rate, but a far smaller loan. A smart boy like you would get that.

So, Alex, we welcome you to this oasis of contrarianism. Drink deeply, son.

And don’t mind the dogs. They always do that to a new leg.

Got your party hat on? It’s anniversary time.

Ten years ago today we were at the zenith of the dot-com age. Nortel ruled. Pimply-faced kids with no business plan and a cool domain name were making millions in IPOs. The Nasdaq crested at 5,048, profits were without limit, buyers could not get enough and it was ‘different this time’.

One year ago today we were on the cusp of depression, staring into a cauldron of fear. The Dow and the TSE had collapsed, losing half their values in just a matter of months. Wall Street banks were in crisis, TV newscasts were wall-to-wall with layoffs and investors were stampeding for the exits. Canadian investors dumped equity mutual funds in droves, leaving billions on the table.

So what do these two events have in common?

Everything, of course. They show without qualification that when the herd gets moving, it’s usually in the direction of a cliff.

Those who gulped tech stocks in 2000 went on to lose up to 70% of the value of their investments – in fact, 100% in some cases. And those dummies who dumpstered their stocks and funds last March took a giant paper loss and turned it into a real loss, only to miss a 58% upward trajectory.

Greed kills. Fear kills. But going with the crowd is the deadliest move of all. That’s roadkill.

This brings us to now.

As I keep telling people silly enough to come and listen to me, this is one unpredictable momma of a time. Volatility is always with us. A 20% market dive could be but a heartbeat away. Real estate has peaked with only one direction in which to travel. Ditto for interest rates and bond prices.

So how can we tell what lies ahead?

Easy. Look around you. Watch Global news. Read the daily paper. Wander through Best Buy. Spend an hour at mls.ca. Then do the opposite – because most people have absolutely no idea of the potential danger they’re walking into.

As I’ve tried to point out here, the economy is hopped up on government meth and will be coming down over the next few months. There can be no meaningful recovery without new jobs being created. Higher taxes, inflation and interest rates are 100% certainties. And families have been on a debt binge for months, sating themselves on houses, hi-def wallhangings and whatever it is Martha Stewart sells.

But that’s just the obvious danger. Governments are even more out of control than we are. For example, Washington last month spent almost $10 billion more – per day – than it collected in taxes, which is a record. The US deficit this year will be $1.6 trillion, and by the time Barack Obama finishes, more debt will have accumulated during his watch than under all previous presidents.

What this means: our biggest customer is imploding. How can that be good for us?

Meanwhile Ottawa and the numbies who run the provinces are also chalking up record deficits, which forecasts higher taxes and fewer services, just as inflation and gas prices are also rising. The end result of all this should be crystal: we hit a wall.

For much of the past year, since it looked like the world would end but didn’t, people have been consuming far beyond their means. Since salaries haven’t increased and jobs have been lost, the difference between income and consumption has been debt. By September it will be clear to everyone this movie ends badly.

So, be a seller, not a buyer. Trade your bonds for equities. Get your assets in a shelter. Lock in your rate. Trash your debt. Buy commodities.

And when you hear thundering hooves, run.