One day last week, a realtor named Chad tried to talk a couple named Darryl and Amy into buying a $500,000 condo in Calgary.
His coup de grace was a poetic email, which came to this climax:
“Don’t do like I did, I DIDN’T buy when I was in my twenties because I swore the market was going to go down, Instead I paid roughly $60,000 in rent (calculating at an average $500/month because I had roommates at times) Instead of buying my first home for $72,000 I bought it 10 years later for $160,000 losing $60k on rent plus $88k on appreciation. If I had not bought then I would have paid (at minimum) another $60k in rent for a total of $120k in rent over 20 years (which is really not reasonable, it would be nearly double that) and this house most recently sold for $275k which is another $115k in appreciation on top.
RECAP: RENT 20 Years – Loss of $120,000 OWN : Appreciate $203,000 and have paid off house worth $275 and spent roughly $120,000 (same amount as renting) leaves me ahead by $170,000 but even if it hadn’t appreciated in those last 10 years at all I would still have been ahead by $40k instead of behind by $120k.”
Meanwhile a blog dog from Calgary was posting this message here:
“This is how BAD the USA market is. My grandma built a small house in FL in 1989 for $50K. At the peak in 2006 it was worth $120K. It was appraised for $43K yesterday.
She has made no money on it… She has no savings and lives off Social Security…sad. With inflation, she would have been better off sticking her money in a savings account. I am honestly glad all this has happened. My generation, Generation Y, hopefully has learned something from it all.”
This juxtaposition is critical to understanding the age in which we live and how off course society has strayed. The realtor appeals to greed, holding out the prospect of large gains that come without working or adding to the economy, but merely by possessing a property. The blogger appeals to fear, citing a relative who may have bought the real estate dream but has reaped the nightmare of a growthless asset.
The realtor takes a past experience from an inflationary time of expansion, and mindlessly grafts it on a future which may be anything but. The blogger uses an extreme example of a USA housing collapse which is unique since the Great Depression and draws from it generational wisdom.
The realtor glosses over the extremely high costs of acquiring and selling real estate, the staggering interest charges of carrying it and gives endless appreciation as a fact. The blogger ignores the fact her grandma has lived for twenty years in a house which cost her $50,000, of which she can get $43,000 back.
We have lost our way by turning shelter into a business, and judging each other by where we live. We stereotype. Condo dweller, or suburbanite. McMansion or bung. Owner or renter. And by allowing real estate values to race madly higher in good times – as greed kicks in – we simply set the scene for lost equity and busted marriages on the way back down.
There sure is enough heartache to the south of us to last a while. Yesterday I told you about an historic drop in the sales of existing homes. Now new home sales have crashed to 1960s levels. Sales are down by a third form last year and off 80% from the bubbly days of 2005. It’s a dose of negativity showing the American economy is growing stone cold, and all the boost housing construction normally brings will be many years off.
It also shows more GenYers are staying put at home, instead of getting married and buying houses. Why? No jobs. And without more economic activity from, say, house sales, there’s no reason to expect more jobs. This is akin to the statement I gave you here yesterday regarding existing home sales: why buy now if you know that prices will be lower next month? It is the essence of deflation – and you know where that can lead.
By the way, a Canadian report today rightly said house sales here may be falling, but the costs of home ownership are not. “As a result, housing affordability in Canada, which has been deteriorating over the past decade, will continue to decline during the next two years.”
My last post told you what I believe lies in store for real estate. And I told you to look elsewhere to build your wealth and avoid danger. Today you have far more evidence this is true, and so long as this most emotional of assets is ruled by our animal spirits, the danger will increase. I found it interesting that last weekend major US media were running stories on how owning real estate is no longer the path to financial security. In fact, it may be the highway to hell.
A year ago a guy bought a sub-penthouse in a sub-interesting condo in a BC resort town and paid $1,300,000. On Saturday a mess of people showed up at the same building, and the same suite was sold at auction for $685,000.
“Interestingly,” said someone with family at the event, “a number of people thought the prices were still a little high.”
And I’d say they’re right. This is not the end of a real estate correction, even in sleepy Penticton. This is but the start. Everywhere. As my correspondent pointed out, “Penticton always gets clobbered before Kelowna. Kelowna gets clobbered before Vancouver.” And as that happens, you can count on Edmonton, Calgary, Toronto and even Fortress Ottawa getting whacked.
Over recent weeks I’ve been yakking on about deflation. Some people will think a fool losing six hundred thousand on a concrete box in a town with no economy constitutes deflation. It doesn’t. This is a price correction of the kind that will sweep into major urban areas. It restores some sanity by revaluing properties closer to what would be normal market levels. And if these were normal times, that’s where it would end. Big losses for recent buyers. Three or four years of crappy sales. Then a slow grind higher.
But this is not normal, and to see what comes next I counsel you once again to look south.
Yesterday economists were pulling out words like “devastating,” painful” and “fateful” to describe the current state of American housing. I’m sure you heard the news. Resales in July plunged by 27% across the US to the lowest level in 15 years in the worst one-month freefall since they started counting this stuff 42 years ago.
But the news gets worse. The biggest drop in sales came with affordable houses middle-class families would snap up, priced between $100,000 and $250,000 (the average US house now sells for about $180,000). There is a 12-month supply of unsold homes. Foreclosures have risen 1,000% in four years. Demand for single-family homes is at a decade-and-a-half low. Foreclosures and short sales account for a third of all transactions (vultures). Almost 25% of families with mortgages in the US are now in negative equity. Over 4,000,000 live in homes they have stopped making payments on, since there’s no equity.
It gets worse.
This has happened despite Washington giving $8,000 to anyone who would buy a house. It’s happening despite the lowest mortgage rates ever – barely over 4%, locked in for 30 years. Despite mortgage interest deductibility. Despite a new billion-dollar federal program loaning as much as $50,000 to homeowners “in hard hit local areas” to make mortgage, tax and insurance payments for two years. Despite an estimated $1 trillion the Obama administration has spent trying to stem a real estate holocaust.
Now, this is deflation. It’s when people refuse to buy things which are falling in value, because they know they’ll soon be cheaper. As a real estate agent in hard-hit California said yesterday, “It really is a self-fulfilling prophecy. If all buyers perceive that home prices are coming down, then they will stop making offers – and home prices will come down.” And this is exactly what economists now expect to happen, as American real estate catapults quickly over the next few months towards some kind of capitulation. As a senior economist at Merrill Lynch in New York put it, “We will reach a new bottom… There’s going to be a prolonged, painful drop.”
As you might imagine, all this tanked stocks markets and rekindled the usual talk about a double double recession and the US entering a deflationary decade like that which has withered Japan (by the way, China passed Japan as the second-biggest economy this week). Talk like that had investors beating down the doors of the bond market, where they once again pushed prices higher and yields lower. (I seriously hope you took my fixed income advice of a few months ago.)
So, here are my points for today.
First, what’s now happening in Canadian real estate is nothing but a warning. Heed it or get set for a memorable, wealth-robbing ride.
Second, the odds of this correction becoming deflation are far higher than even I (your cuddly little bear) foresaw six months ago. My musings on a multi-year melt for real estate may have been too tame.
Third, there is no rescue plan possible. Even if the Bank of Canada wiped away its last two rate hikes, the HST was suspended and Ottawa cut income taxes (none of which will happen this year), real estate is cooked. This is not about affordability any longer. It’s about animal spirits – confidence. Buyers won’t pony up when prices are eroding, jobs are elusive and the future uncertain.
Fourth, houses are on the verge of becoming illiquid. For first-time owners, it means negative equity. For boomers with the bulk of net worth in their homes, financial disaster. For any family which is over-extended or simply needs to get out, real estate could be a trap. That has certainly happened to our American cousins.
Fifth, you still have time. Believe it or not, there are fools left who listen to realtors, trust the government and gets the hots for granite.
