Entries from March 2008 ↓

Get on the foreclosure bus, here.

How different is the Canadian experience from the conditions that caused the US housing meltdown? Not enough.

By Garth Turner, Ottawa Citizen Special
Imagine listing your home for sale, but there are no buyers. You drop the price. Again. And again. The house across the street’s now for sale. And the one two doors down, plus a dozen others in a two-block radius. Nothing’s selling, and every time one home is reduced, all are affected. This property used to represent wealth. Now it’s a wealth trap. Most of what you have is here, and with each day passed, it diminishes.

Imagine your first home – a dream in granite and stainless. You bought it from the region’s largest builder, for 1.5 per cent down – enough to cover closing costs – and mortgaged the rest. Months later, the economy turns abruptly. Your spouse loses his job and the monthly payments – mortgage, taxes, utilities – are crushing. You decide to sell, but the realtor tells you the market’s also turned. Your mortgage is now slightly greater than the value of the home. After paying commission, you’ll have no house, no equity, and still owe the bank more than $20,000. How could this have happened?

Far-fetched? Hardly. For millions of middle-class Americans, this is a reality as housing values collapse in the first nation-wide housing meltdown since the Depression. In some markets, prices have crashed 30 per cent. In Phoenix, there are more than 20,000 new homes, vacant, unsold and unwanted. In suburban Detroit, million-dollar properties can’t fetch buyers at $300,000. Downtown, prices plunged in the first two months of 2008 by 54 per cent, to a median of $22,000.

In Florida and California, homeowners establish web sites to try and sell their homes. Three million American families now have mortgages larger than their home values. Comfortable upper middle-class families with six-figure homes find their wealth evaporated as their properties languish on the market. So many foreclosed homes are for sale, it’s estimated prices will not recover for years. In fact, a recent Credit Suisse report says prices must fall another 40 per cent in Miami and 26 per cent in Los Angeles before they become affordable.

The real estate disaster now in full flower to our south is a fascinating, gripping spectacle. It’s time we looked closely. Because, one way or another, it’s coming here.

Canadians, strangely, believe this country’s immune from the housing contagion sweeping America. The myth results from three powerful forces. Denial tops the list, no doubt the result of having more than 80 per cent of our net worth in one asset, the family home. Add to that the excellent communications job done by the real estate lobby — mortgage-lending bank economists and the CEOs of real estate marketing companies — who claim home values will rise forever. Finally, our belief the Americans screwed up by giving subprime mortgages to unworthy people so they could buy unaffordable homes.

But this is not so. In researching my book, Greater Fool, I was reminded again of why all booms end badly. The inflating real estate market to the south became unsustainable when average prices exceeded the ability of average families to buy homes. This inflation in turn was the result of policy decisions made after 9/11 which gave America (and Canada) the lowest interest rates in a generation. Debt was cheap, and volatile stock markets represented unacceptable risk. So, real estate became the asset of choice.

If you have any doubt, watch a few past episodes of Flip This House. It’s good real estate pornography.

Prices roared to new levels and to sustain the fire, mortgage lending practices went lax. No-money-down deals were common, and home loans with discounted rates were extended to buyers who now qualified, as the bar for home ownership fell. This all made sense while the market advanced, since growing home equity gave even dodgy buyers new money to use for refinancing loans as the introductory ones matured.

But as interest rates increased, the American economy softened and realization spread that real estate was overvalued, the bubble burst – and with a vengeance.

So, how different is the Canadian experience? Not enough.

In the period between 2000 and the market crash in 2006, U.S. home prices increased 74 per cent, while household income rose by just 15 per cent. In Canada, real estate prices jumped 70 per cent by the end of 2007, with family incomes ahead 14 per cent.

In other words, we’ve seen an almost identical pattern of real estate excess – familiar to anyone caught in a bidding war, or staring in disbelief at a new MLS listing. The average home in Toronto is now over $400,000, while in Vancouver it tops $700,000. Last year homes in Saskatoon raced ahead more than 50 per cent in value. A young couple in suburban Toronto with a $450,000 price limit ended up buying a $700,000 home after losing 16 competing bids.

And the Canadian response to this affordability crisis? It’s called the 40-year mortgage, which lowers monthly payments by extending the amortization 15 years beyond the traditional quarter-century and, in the process, grossly inflates the total debt to be repaid. In other words, this loan (now accounting for over 40 per cent of all new borrowings) allows people to buy homes they would not otherwise afford.

Meanwhile, down payments have become almost optional. One of Ottawa’s largest new home builders routinely allows young couples to move in by paying just closing costs, and financing the other 98.5 per cent of the purchase price. With virtually no equity in the home and substantial carrying charges, any market downturn means they owe more than they actually own.

So, how exactly do American subprimes differ from Canadian 40-year mortgages? How are mortgage lenders here more prudent when they allow appraisals based on postal codes, rather than actual home inspections? Why should Canadian real estate values, as inflated now as were those to the south two years ago, hold when our families are no better off? As a global economic slowdown and an American recession take hold, what impenetrable barrier is wrapped around this country?

Meanwhile, what about the future? Won’t nine million house-rich and pension-challenged boomers be forced to dump billions in real estate over the coming decade? Won’t runaway energy costs and the uncertainty of climate change breed a popular taste for smaller, more efficient, more urban housing, rendering four-bedroom, three-car-garage suburban palaces unsaleable?

Most of all, won’t those who understand what’s clearly coming, and sell now, rejoice that they found a greater fool?

Garth Turner is the MP for Halton, Ontario. Greater Fool: The Troubled Future of Real Estate is his eighth book, published by Key Porter Books. www.GreaterFool.ca

© The Ottawa Citizen 2008

For breaking real estate news go here.

So many questions, so little time. Since my latest book has snaked its way into Chapters and Indigos across the land, my inbox has been teeming. I cannot respond to everyone personally, but I will try to address some representative questions from anxious and curious people, wherever they may reside. We are all in this together. — Garth

Hello Garth,
My wife and I are Americans from New York City planning to emigrate to Ottawa in the summer time. Our decision to move came from a desire for a slower pace of life and a more affordable housing market. After considering most places in the states, we looked into Canada and settled on Ottawa. We expect to land in July or August.

Being keenly aware of the economic developments in the US, we put our NYC apartment on the market last September and sold for a huge profit. We are now in a sublet, biding our time until our Permanent Residency arrives.

Needless to say, our desire is to buy a house, specifically a detached bungalow. We’ve already looked at several and have begun discussing what fits in our needs and budget.
We certainly don’t want to buy at the top of a market that is headed for a serious downturn. However, looking through all the information I have been able to find, it’s unclear how much the Ottawa housing market falls into this category. Ottawa is no Vancouver or even Toronto. Ottawa ranks as one of the most affordable cities anywhere according to this report. The RBC housing affordability report indicates that Ottawans spend ~30% of pre-tax income for housing expenditures. Also price increases seem to be reasonable over the past few years.

I can imagine that prices may go flat for several years as they did in the 90’s, but a severe drop in value seems unlikely. (Leaving out but not ignoring the fall in value that flat prices cause due to inflation.)

However, I always mistrust any economic opinion that implies “this” is different. So I’m questioning this argument as strongly as I can.

What is your take on the Ottawa real estate market? Is it the more rational city of the Canadian real estate or does it share just as many challenges as other cities? Could a melt down in Vancouver reach into other markets?

Any feedback is appreciated.
Trent in NYC

Well, we welcome your devalued American dollars and spirit of frontierism, and I am sure you will enjoy living in Ottawa. Too bad you just missed a winter with 6,742 centimeters of snow.

The Ottawa market is, as you have rightly concluded, a tad more stable than that of Toronto , Calgary or Vancouver, in part because of the pervasive economic influence of the federal government, and a population with more predictable growth and fewer excesses in terms of new real estate development. Price appreciation has been slower, but the average home has still increased substantially over the last five years. Ottawa does boast a wide disparity in price for homes of equal size and character – with a Rockcliffe bungalow at $700,000 and a copy five miles away at less than half the price.

My advice, however, would be to eschew the whole city and move across the river into Gatineau, Aylmer or one of the gorgeous villages within 30 minutes of Parliament Hill. You will find a quantum leap in value, and learn to parler francais at the meme temps.

Garth,
As soon as I wake up tomorrow morning, I’m heading out to buy your book. In the meantime, perhaps you could give me some insight into the next real-estate move I should make thats in the best interest of my family.

My wife and I both work in the public sector. We have “secure” employment, and have an annual combined income of approximately 130K. We live in Barrie, north of Toronto and live in a very modest 1100 sq ft home that we purchased two years ago. We’ve managed to save up a nice sum of money, approx 50K, which we intend on putting down on a larger home that will better suit our young family. Our home’s current market value is around $240K and we have an outstanding mortgage of approx 140K. This gives us around $150K to use as a down-payment towards our next home.

I have several colleagues in the same income bracket who have recently undertaken massive mortgages of $350K +, with new 450K – $500K homes that will be built this summer. In some cases, these homes have increased in value by 30K before even being built. We were tempted to do the same, with promises of tax-free increases in home equity and 40 year mortgages that we could simply pay off sooner as our monthly cash flow increases in the coming years, (salary increases, short term daycare expenses etc). Some of my colleagues have even rolled their vehicle payments etc into their mortgages to “free up” cash in order to make the payments. After much thought we decided not to venture down this path purely based on instinct. Some of my friends and colleagues who have taken this risk, fear that we’ve missed the boat and are still encouraging us to try and get in.

We still need a bigger home, but would be willing to wait a while to see how the market pans out up here North of Toronto. Would you recommend selling our home now and renting for a year or two? I’m also tempted to put our 50K against our existing mortgage, but fear it may do better for us in a high-interest savings account.

Any advice or predictions for those of us living in the “bedroom communities” that serve as commuting hubs to the larger metropolitan centers? Barrie is a great example, but I’m sure the same advice would be appreciated elsewhere.

Micheal R.
Barrie, Ontario

First, you need new friends. Those guys stand a very good chance of going down, and will not be fun to be around when they’re forced to take possession of McMansions which are unsaleable, and whose illusionary gains have evaporated in the summer sun.

Good boy. Be cautious. Buy what you need, not more, and remember that the end goal is to be financially secure, not to live in a house that suggests you’re in a socio-economic bracket you are not. Do you actually need a bigger home, or just lust for one? Can you put on a second storey, or add a new room for the $50K you have saved? That would achieve the need for more space, and yet not plunge you into double your existing level of debt.

If that’s not a solution then, for sure, sell now before the real estate crap hits the fan and either rent or have a long closing (with a big deposit and a clause to keep it). Trust me, your buddies will envy your acumen, but never have the balls to tell you.

Good morning Garth. It has been with great interest that I’ve been reading your predictions on Canada’s housing “boom”. I was wondering if you may be able to help me with a question.

I live in a small village (called Craven) just outside of Regina, Saskatchewan. I have lived in Craven for the last 2 years and have commuted to Regina daily for work. Due to rising fuel prices my commute is becoming slowly becoming unaffordable and I wish to return to the city. The problem with this is that Saskatchewan has been experiencing
a rapid increase in the cost of housing over the past few years, especially in the cities of Regina and Saskatoon.

Craven has seen some of this increase but not to the extent that Regina has. At one time
selling my home and investing an additional $20-30,000 would have bought me a nice home in Regina, now it will hardly buy me a home at all. I am concerned that Regina’s pending oil and potash booms will mean house prices in Regina will remain high even if Canada’s housing market crashes. Any thoughts? What do suggest I do? Should I sell, move to the city and rent? Should I stay put and deal with the fuel costs? I am confused, depressed and scared and can use any advice that you have.

Thank you for your help Garth.
Dave

If this scares and depresses you, then maybe getting out of Craven is what you need. But at what cost?

Regina and Saskatoon have seen massive price hikes, however you must remember that this was from an extremely low initial level compared to the rest of Canada. The province has also been experiencing an economic boom and even an increase in population, but remains one of the sparsest places in the country, with just over a million souls. Thus, I think the housing boom is just about done, despite the frothy hyperbole and stunned rhetoric of the local real estate community.

The choice is yours – move and suck up lots of debt to live in the same kind of house but get to look at street lights at night. Or buy a hybrid. I know my answer.

US sales crash 11% in month. More here.

This email came flying in this week. Its message is powerful in its simplicity and directness. Thought you might find it instructional, as Canadians awake to a disturbing and unstoppable economic, social and personal reality. — Garth

I had come across the five stages of grief (Kubler-Ross model) watching the Simpsons of all things one evening a few years back during my time I was researching why bubbles happened and the psychology behind them. I started thinking that the five stages could be easily applied to the current real estate situation in North America.

After I did a little more research into the stages I had learned they were written by Kubler-Ross with all personal in mind tragedy, but she later focused these principals to people diagnosed with terminal illnesses and disease for her book “On Death and Dying”.

I figure Canada is in the Denial phase at this point as the cracks are only beginning to show, our American friends are a little farther ahead and are in between “Bargaining” and “Depression” stages.

The five stages of grief are:

Denial – “A bubble can’t and won’t happen here…”
Anger – “Its the banks fault, the governments fault, I was lied to…”
Bargaining – “Please let me sell this property, please don’t let the value go down!”
Depression – “I’m financially strapped, I’m inside out on my mortgage, what am I going to do?”
Acceptance – “Things are going to work out, over time.”

I just wanted to applaud you for going against the grain and being upfront and honest, unlike the mass media over the last few years whom have helped incite and prolong the hysteria for obvious rea$ons. A lot of people do not want to face the truth at this point, being a politician your taking a chance on alienating yourself from the majority as we know home ownership is something we all have in common and hold dearly.

Nobody wants to hear that all that money “they’ve thought they’ve earned” being real estate gurus, could potentially vanish into thin air but the underlying economic fundamentals aren’t lyin…

Shawn