Entries from August 2012 ↓

Too cheap to care

Outside Yorkdale Mall, Toronto. A blog dog exclusive.
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More than a year ago I said Sell Canada, Buy America. Real estate values there could only rise. Here they could only fall. Immediately this weedy blog was overrun with detractors who said the US was pre-depression, and I should donate my tiny brain to science. Months ago I told you housing to the south of us had probably bottomed, more evidence only losers bet against America. And the usual gang showed up to say there’s no hope. The system’s screwed. We’re all going down.

Well, let’s see what’s actually happened.

First, the good news. “The crash is over.” So says the chief economist for Moody’s Analytics, taking a look at the latest US housing data. And he’s right. It is, ahead of schedule. The implications for the biggest economy in the world are profound.

The latest S&P Case-Shiller home price index came out this week, tracking the 20 largest cities to the south. The result was all sunshine and puppies – the first year-over-year increase since 2010 and the best absolute jump since 2006. This was a big deal since it came without any new government stimulus program, rate drop or tax break. Simply put, more people want houses and figure they’ll never get cheaper. They also have enough confidence to buy.

This is the fourth monthly increase in prices, hiking them by a fat 2.3%. Meanwhile another index of home prices logged a 6.9% jump in the latest quarter. This comes amid the renaissance of bidding wars for cheapo properties in a number of cities and massive media coverage about a resurgence of bricks.

Prices are rising because demand is increasing and supply falling. Buoyed by the steady but glacial growth in the US economy, more people are bidding, while listings are down to levels not seen since the boom years prior to 2006. A consensus is emerging that the storm is abating, equity’s rising again and housing’s a steal. Hard to argue that. Residential real estate lost 32% of its value to crash the average house down to $173,000, before an abrupt turn higher about ten weeks ago.

Is it real? Yep, looks that way. US interest rates will stay lower than those here for a lot longer. Unemployment is inching down every month. The inventory of foreclosed homes is starting to shrink, instead of swelling as it’s done for four years. And most importantly, people think it’s safe once more to borrow and buy – especially in cities where values collapsed by 60%. Such an opportunity to own a house may never come again in this lifetime.

Of course, consumer sentiment’s still laced with fear and incomes have barely budged. But serious housing deflation has made money more valuable, and goosed affordability. It could not be more dramatically different from Canada.

Here real estate has inflated, not deflated. Since wages and salaries have flatlined, debt’s exploded. We save less, while Americans are saving the most in a decade. We’ve leveraged. They’ve deleveraged. We’re far more vulnerable to rising rates, have less disposable income and think we’re immune. But the average family in Vancouver, Calgary or Toronto cannot afford the average home, without spending between 52% and 92% of gross income. Anywhere in the States, that would bring belly laughs.

Meanwhile it’s interesting that CMHC profits have slipped as the agency that insures high-risk mortgages suffers more claims. Losses on loan insurance have surged 16% in a year, which suggests a growing number of people losing their homes. At the same time, CHMC said this week it’s spending more money on “work-outs”, trying to prevent even more losses by allowing crushed homeowners to defer payments.

CHMC is creeping close to its $600-billion insurance ceiling (it’s now at $580 billion), which is why Ottawa’s trying to prick the housing gasbag. After all, this is a steaming pile of risk equal in size to the national debt, with a lot of it riding on the gossamer wings of newbie homeowners. The feds would be delighted with a 15% haircut for real estate right across the country, because they secretly fear it will be thirty.

So here we are. The early days of the recovery to the south. The fledgling hours of the correction in Canada. There’s no money to be made on housing here. But serious coin to be collected in Phoenix and Miami. Risk is everywhere during times like these, of course, but there’s far more in 604 and 416 than in 415 or 312.

What happened to them will grasp us. Not necessary in the same way, or with similar results. No banks here will fail. No waves of foreclosures or defaults. But slowing sales and falling prices will bring an equity crunch into every home where mortgage debt equaled 80% of the purchase price.

The average down payment is 7%. Figure it out.

The undoomed

When I look out my window I can tell if the Air Canada pilots are drinking Coke or Pepsi. Sometimes they nod. That’s what happens when you have a corner office with massive glass walls on the 54th floor.

Two weeks ago I changed my downtown Toronto location, and now take a long elevator ride up into a big red thing called Scotia Plaza, arguably one of the best office towers ever built in Canada, fully leased to blue-chippers. But Scotiabank doesn’t own it anymore, and herein lies a tale. Two, actually.

First, the real estate part. Scotia sold its 68-storey landmark, plus a neighbouring Art Deco 27-storey older bank tower and a few related buildings a few months ago for $1.266 billion. The buyers were two REITs, Dundee and H&R, who paid about the same per square foot as virgins are shelling out for slap-bang, concrete-&-rebar condos — $600 a foot. Only the REITs own the real estate, the dirt, the stones and (above all) the cash flow.

This is why every portfolio should have some REIT exposure. In an era of ultra cheap financing and strong corporate profits, these funds know exactly what they’re doing, adding irreplaceable properties that generate buckets of money. Investors in these have seen steady and relentless appreciation in the share values of REITs, as well as solid income distribution. Why would you not want to have some exposure to an asset class that is not correlated with the stock market and pays you to own it?

The other side of this trade, of course, was the bank.

Scotia signed a 13-year rental deal with the REITs, so it’ll remain the dominant tenant until 2025. In return, it gets the billion. In fact the first payment of about $600 million flowed to the bank in time to be counted in its latest quarterly earnings, announced Tuesday. In other words, the bank did what I tell you to do. It harvested significant capital gains in a decent market, so it can get liquid. Smart.

Besides that windfall, Scotia made more than a billion in profit in that 90-day period, up from last year by about 11%. At the same time another bank, BeeMo, was busy awing investors with its own revenues – ahead 37% from 2011, in part because of fewer bad loans. Both of the banks jacked up their dividends, which means part of those profits will flow directly to shareholders. The other big banks report later this week (Thursday is the big reveal), and will also likely sweeten the payments they make to investors.

What do the unexpectedly gross profits tell us?

Hmmm. Well, that those hairshirted, Depends-wearing doomers who skulk around this pathetic site telling us we’re a few gasps away from bank collapse, systemic failure and universal hemorrhoids are dingdongs. They make it up, then sell each other pieces of gold. I’ve said repeatedly there is zero evidence of a financial crisis brewing, despite the volatility, debt and change in the world. It just ain’t happening, dudes. Stop stockpiling that toilet paper, and use it.

The bank results also tell us the Bay Street guys have this record-consumer-debt thing pretty much figured out. Households may be impoverished from monthly payments, but the lenders are feeling no pain, despite record low interest rates and thin margins. There’s no financial stress, and now enough extra millions (at least at Scotia and BMO) to throw at stockholders.

And what happens if the housing market meltdown, now cheapening Vancouver, takes hold everywhere? How much hurt will the banks feel if prices decline nationally by 15% or 20%, then fall into a years-long funk? Probably none to little. Lower house values do not mean less mortgage debt. Nor does it presage a spike in defaults, since most Canadians would never dream of walking out on a loan which will pursue them forever. Home loans will be paid. So will credit card debt, car loans, HELOCs and unsecured lines.

Those who are really munched in a crunch are the borrowers, not the lenders. After all, CMHC stands behind all those hundreds of billions in high-risk, high-ratio mortgages, so a wave of defaults (as unlikely as it is) would hurt the taxpayers, not the bankers. And Bay Street has now had four years to get ready for any rerun of the GFC, learning the lessons of Bear Stearns and Lehman Brothers. Once again, do you think they’d be raising dividends if they had any problems with capitalization?

All this should lead you to two inevitable conclusions, as it does to me when I watch the flyboys ogle the stews. You should own income-producing REITs that possess big buildings full of rich banks. You should also own the banks. And the a boffo way to do that, with the least amount of volatility, is through preferred shares – stable, dependable assets that today churn out more than 5% in tax-efficient dividends.

Or, you can swap rocks that pay nothing, take a dump on a few blogs and moan.

Tough choice.

See me waving?