When real estate lawyers worry about cash flow, we all should. Twice in the past week, four provinces apart, I’ve sat with guys I’ve known for years, listening to their report from the front lines. These are the people who close deals at the land office, register deeds and mortgages, arrange title insurance and the transfer of keys. This is not about hype, marketing, listings or offers. It’s where real estate actually moves. If deals don’t close, lawyers don’t get paid.

I ask Greg, now in his sixties, a lawyer for four decades, when he’s going to retire. “I’m working on the Freedom 95 plan,” he growls. “I basically got wiped out in the mess back in the early Nineties, and the same damn thing is happening again.” By the way, his office sits in the middle of one of the most densely-populated suburbs crowding Toronto, the scene of explosive growth. “It was,” he says of the recent downturn, “like a switch being turned off.”

A thousand miles away Stefan sits looking over the condos and wharfs at the ocean. “So far this year,” he says, gazing distractedly out the window, “they tell me at the registry office that mortgages are off by fifty per cent. That’s dollar volume. I knew it was down from my own billings, but I had no idea…”

Making less business worse are lower prices. Legal fees, after all, are usually tied to the value of deal done. “In the last six months I’ve done more foreclosures that in the past three years. And every one of them is a nightmare.”

Lawyers, like real estate agents, insurance guys, mortgage brokers, carpenters, bankers. appraisers and drywall dudes, are all part of the FIRE sector of the economy. Since interest rates cratered the ‘finance, insurance and real estate’ industry has been on a roll. It now accounts for about 12.5% of the entire economy, while manufacturing sits in second place at 11% followed by mining and oil and gas at 8% (see below).

This is another legacy of cheap money, lax lending standards, and government policies deliberately targeted at promoting home ownership. Since 2007 we’ve seen the introduction of 40-year mortgages, 0% down payments, cash-back home loans, first-time buyer tax credits, property tax rebates, home renovation tax credits plus dirt-cheap interest rates, all designed to get people in debt and buying houses. It worked. In major cities three-quarters of families have real estate, and debt’s gone through the roof. All this, plus strong commodity prices, helped the Canadian economy skate through years when others were tanking.

Suddenly, it’s changed.

Commodity values have fallen. Oil sands guys are having a tough time attracting foreign capital as costs rise, demand slags and margins thin. Now real estate’s hitting a ceiling, thanks to inflated prices, stagnant incomes, fat debt and housing saturation. Mortgage rates can’t really fall much further, if any, while the jobless rate is going up and the dollar down. Just a few years after people here looked at struggling Yanks and felt smug, there are hedge funds working overtime to short Canada.

About 30% of our economy now emanates from actually making stuff, digging it up or exporting it. The other seven-tenths comes from consumer spending. The biggest asset people have, where most of their net worth and debt is concentrated, is housing. And since 2009 there’s nothing people have been obsessed with more than real estate. Collectively we’ve taken a massive gamble that this one asset class will hold its value. Because if it doesn’t, the downside risk is immense.

Nathan wrote me yesterday:

Garth, after reading your post this week I find myself wondering what will happen to the rest of us.

If I hold off buying a house (and believe me I intend to), continue to stuff my TFSA following a index investment strategy, and am generally wise with my money will I get swept away in the flood of debt generated by fools or will this nation eventually turn into a society of haves and have nots?  Will the insistence of the masses to measure their worth by “stuff” eventually tank the economy and ruin it for the rest of us too?  Any thoughts?

You’re smart to be worried, Nate. As housing weakens, millions of families will feel poorer with many owing more than their homes are worth. Some people will walk, most won’t. Instead they’ll just stop buying Fords, flat-screen TVs and vacations, resulting in more lost jobs and a weaker economy. It’s a vicious circle destined to melt real estate values further.

As I’ve said so many times, it’ll be the kids without equity, and the Boomers with too much of it, who get nailed the worst.

What to do, Nathan? Exactly as you are. As housing turns cold and unloved, the best refuge is liquidity. Concentrate on building a portfolio with the right balance between safe stuff (fixed income such as corporates and preferreds) and growth assets (like ETFs), plus diversification across asset classes, sectors, capitalizations and economies. Don’t overdo exposure to Canada. Learn what rebalancing is, and do it. Match risk with portfolio weightings. Buy at the right prices – typically along 200-day MAs. Shelter fixed income. Collect dividends and cap gains in a non-registered account. Maybe get some help.

And remember. Over 70% of people own real estate. Only 1.2% have a million to invest.

Yeah, social justice is so overrated.

“We do not have a bubble,” F said one night this week. “I think if we had failed to take some action we would have had a bubble.”

Well, that’s a relief.

In Vancouver the average household income is $83,330. The average bungalow costs $1,013,750. To buy it and not pay high-ratio mortgage insurance requires $223,025 in cash, and a mortgage of $811,000. At 3% that eats $3,850 a month. With insurance, property tax and a little maintenance, the nut climbs to about $4,500.

So, to buy the average Van bung with conventional financing you need a quarter million in cash, and then $54,000 a year. After-tax, an income of $83,330 in BC yields $64,568. This means the average family buying the average bungalow is left with $830 a month for food, clothing, transportation, utilities, medical expenses and as much alcohol as possible. There’s no money left for investing, retirement or saving. Which probably means the average family could never save $223,025 for a down payment.

But, says F, no bubble.

I wonder if he’s read the latest RBC housing affordability report. The bank figures it takes 82% of a family’s gross income to pay for all aspects of owning that Van bungalow. In Toronto, where people earn more and houses cost less, families need to devote 54% of gross income to real estate. Across the country, says economist Craig Wright, owning a standard two-storey house will absorb an average of 48% of a household’s gross income.

Now this is meaningful, since banks (and CMHC, which F oversees) have a rule that all home-related expenses should not exceed 32% of a family’s gross income. It’s called the GDS ratio – gross debt service. Plus, total debts of all kinds are not to exceed 40%.

Here are the actual CMHC guidelines:

Affordability Rule 1
The first rule is that your monthly housing costs shouldn’t be more than 32% of your gross monthly income. Housing costs include your monthly mortgage payments (principal and interest), property taxes and heating expenses. This is known as PITH for short — Principal, Interest, Taxes and Heating. If you are thinking of buying a condominium or leasehold tenure, PITH also includes half of the monthly condominium fees. For leasehold tenure, PITH also includes the entire annual site lease.

Lenders add up your housing costs and figure out what percentage they are of your gross monthly income. This figure is called your Gross Debt Service (GDS) ratio. To be considered for a mortgage, your GDS must be 32% or less of your gross household monthly income.

Affordability Rule 2
The second rule is that your entire monthly debt load should not be more than 40% of your gross monthly income. Your entire monthly debt load includes your housing costs (PITH) plus all your other debt payments (car loans or leases, credit card payments, lines of credit payments, etc.). You have calculated these on the Monthly Debt Payments form. This figure is called your Total Debt Service (TDS) ratio.

This raises a few questions. Like, if banks (and the government) have strict ratios to determine who qualifies for a mortgage, how is anyone in Vancouver (or Toronto) buying houses? If the average Canadian family can’t meet the criteria to afford the average home, how can we not have a bubble? How can anyone be surprised the saving rate’s collapsed, that a quarter of families have never saved anything or a third say they have ‘no wealth’?

And how could Craig Wright therefore state (as he just did):  “A significant nationwide price correction isn’t imminent as long as affordability stays within the current range”?

The only reasonable conclusion is the longer this artifice endures, the more that F and the bankers fib on, the slimmer the odds of a happy landing for the hemorrhaging housing gasbag.

This week mortgage brokers warned 150,000 jobs will be lost as housing and construction crater. “Some people thought the market would come back (this spring),” says head broker Jim Murphy.  “Well it hasn’t come back. It is a definite trend.”  New housing starts will be 25% lower within a year or two, he adds, and in Toronto a drop of 50% will erase 35,000 jobs.

Don’t you just hate being treated like morons? I thought that’s what the Senate was for.

The lowest interest rates since ever have been with us for about four years now. Instead of using cheap money to retire debt, people have gorged on it. Like all those pitiful equity mutual fund investors who bailed out on the afternoon of March 9th, 2009, they have taken the mirror opposite of rational action. But this is way more consequential.

This week we were handed independent and believable evidence of what happens when a whole nation falls for house porn. When 70% of all families own real estate (76% in Toronto, 77% in Ontario), and have taken on epic debt to get it, how can we be that surprised at what the accountants found?

According to the Certified General Accountants Association, we’re so screwed. In less technical terms, it means household income that should be saved or invested is being sucked off as mortgage payments. A third of families now save nothing. A quarter of families have never set aside anything. The savings rate for all of us was 20% in the early 1980s, and is now 3.8%. A third of all Canadians have ‘no wealth’. Only 30% think it’s important to try and build wealth. And of those people who do have money saved, 80% say they’ll probably blow through part of it within three years.

So, not only have most of the people you know, including your idiot relatives and old boyfriends, squandered he cheapest rates of our lifetimes, but they’ve pretty much guaranteed a lousy future. Worse, they don’t think this is a big deal.

And here’s the hilarious part. This week’s new BMO survey (they sell mortgages, don’t they?) finds 45% of Canadians plan to buy a house within the next five years and 56% believe house prices will be higher by next spring. Fully half of people under 40 say they intend on purchasing a bigger house. At this pace we’ll have 100% home ownership and a 0% savings rate.

Says bank spokesperson Martin Nel, who did not giggle or throw up: “The relative strength of the Canadian housing market continues to bolster homeowners’ confidence.”

Now back to the accountants for a moment.

Most people aren’t even paying attention. The bean counters found over a quarter of folks don’t monitor ‘any of the key external factors’ that would affect their wealth. Like, oh, the economy. And we already know that two-thirds of all the money Canadians have in TFSAs is sitting in brain-dead savings accounts making less than 2%. We know from this pathetic blog there’s a widespread belief interest rates won’t rise again. Ever. And we know that 73% of the largest demographic group in the country (making up a third of the population) have no pensions.

Add this all up and it’s safe to say most people you know have no clear idea whatsoever of what comes next. They don’t have investments, nor worry about it. They do not understand equity markets, don’t trust anyone looking vaguely financial, measure success in stuff, think debt is totally fine and consider August extreme long-term planning.

These are the folks the banks go after. In past days I’ve shown you the deceit and misinformation of two of the largest. The Royal lied in print about the equity advantage of buying a condo. TD is misleading mortgage clients into thinking they can painlessly skip payments. This blog will have absolutely zero impact on their actions, because they know nobody normal reads it. Normal people are busy telling BMO they plan on buying a bigger house.

So all that information I gave you – on real estate sales levels from Halifax to Victoria, on the next wave of mortgage changes, on monetary policy and the generational shift out of real assets, on price/rent ratios, income growth and demographics – well, forget it. This train will run out of track all on its own. Few are listening, fewer acting. Each month that drifts by with sustained house lust even as the market weakens brings us closer to a hard landing.

An innumerate nation will find its level. The lowest common denominator wins again.

Silly me.

The teller rolled her eyes when she saw me looking at it. “I’d like to meet the idiot who dreamed that one up,” she said softy, as she did banky things at our wicket.

Between us was a poster of two young hormones, she pregnant and he beaming. “We’re taking a vacation form our mortgage,” it said. On a wall nearby was a picture of a nymph who’d written about her mortgage on a bus shelter. “My husband went back to school just last year,” it said. “He told me we could take a payment vacation to get away from you. I said he could take his studies to Paris for some of the semester. We can afford to do it with a payment vacation from you, my dear mortgage.”

Seriously.

Welcome to the new world of Canadian banking. It’s not enough to talk the kids into unrepayable mountains of debt to buy houses at inflated levels, now the bankers are aggressively suggesting people stop paying their mortgages. TD, for example offers a payment vacation (up to four months), payment pause (skip a payment once a year) or a payment reduction (cut up to one full payment).

Why would they do this? First, since 90% of the market for new mortgages comes from first-time buyers, most of whom have no savings, blow whatever money they have on a downpayment, and can’t budget, this is an emotional come-on. It makes the kids feel like they can get preggers, run away to divinity school or still be young and impetuous, when in fact they’ve entered into a Faustian pact. So, it’s marketing. A stab at increasing market share in a shrinking business.

Second, when people skip mortgage payments, the bank makes more money. Huh?

This is because all those vacation payments, paused payments, reduced payments and ‘we’re-goin’-to-Paris’ non-payments result in interest capitalization. The bank is not letting people miss making an obligation, but rather taking that amount and adding it on to the outstanding debt. Then, of course, that debt is amortized, which means over the life of an average mortgage it will be at least doubled in size.

This is what the mouse print says:

Flexible Mortgage Payment Features will result in interest capitalization. That means the interest will be added back to the principal outstanding on your mortgage.

• Interest is added back on each mortgage payment due date.
• The amount of interest being capitalized cannot cause your mortgage to exceed the lesser of a 90% loan-to-value ratio or exceed your original principal balance.
• The loan-to-value (LTV) ratio expresses the amount of a mortgage as a percentage of the total appraised value of a property, as determined by TD Canada Trust.
• If necessary, we will adjust the amortization period remaining at renewal so that the mortgage does not exceed the original amortization period remaining. This may result in an increase to the amount of your regular payments after the renewal.

Now, imagine you had one of those 30-year mortgages coming up for renewal in a year or two, and that you’d taken a ‘payment vacation’ a few times. Given that the maximum length for mortgages is now 25 years, and you’d actually increased the debt, you can imagine how ugly that renewal might look, even without a rate increase.

Canada’s bank cop, the OSFI (Office of the Superintendent of Financial Institutions), is already worried about this stuff. It’s been staging ‘major reviews’ of the mortgage portfolios of all the monster banks, concerned that four years of cheapo interest rates have encouraged consumers to become pigs, and turned bankers into pariahs.

Head bank cop Julie Dickson put it this way in a speech this week: “This environment can provide incentives for banks to grow their earnings asset base by trying to gain market share (a zero sum game), increase fee income activities, reduce expenses, enter new markets, and by increasing the proportion of higher-yielding assets (both in the lending and investment portfolios). Of more concern, products and businesses that are over-reliant on low financing costs tend to grow and borrowers are strongly incented to increase leverage.”

When it comes to real estate and bank mortgages, Dickson fears bankers will get too aggressive to “maintain revenues,” that some housing markets are “overvalued” and (mostly) that “customers’ debt serviceability could be masked by low interest rates.”

This is what ultra-low interest rates do. People borrow too much. Bankers hide risks and encourage indebtedness, such as TD’s bogus skip-a-payment (and look at yesterday’s post). House prices lose touch with reality. Then the trip back to normal is brutal.

Do not be mistaken. OSFI, the Bank of Canada and F want interest rates to increase, lest the combination of a credit bubble, banker greed and consumer stupidity blow up the economy. There is zero chance the key rate will fall further. This will not be Japan. You have but months (not years) left of 3% mortgages. And you’ve been warned. Repeatedly. F did it. Carney did it. Now here’s Julie.

If you still have the bulk of your net worth in your house, well, good luck.