Greater Fool - Authored by Garth Turner - The Troubled Future of Real Estate http://www.greaterfool.ca Book and Weblog - Authored by Garth Turner Fri, 27 Mar 2015 19:57:47 +0000 en-US hourly 1 http://wordpress.org/?v=4.1.1 Phantoms http://www.greaterfool.ca/2015/03/26/phantoms/ http://www.greaterfool.ca/2015/03/26/phantoms/#comments Thu, 26 Mar 2015 22:26:24 +0000 http://www.greaterfool.ca/?p=10366 BMW modified

Remember Junior, the Italian mama’s boy with the hots for an eight-hundred-thousand bung? As I told you yesterday, the $649,000 Toronto beater house turned into an $810,000 sale after 13 competing bids were tabled. (Junior lost.)

Or were there?

Bidding wars are back, at least in the GTA and YVR (while markets like Calgary and Halifax spiral into despair), and buyers absolutely loath them. No wonder. Unlike in Australia, where blokes stand around and make verbal offers to buy a property – transparent and thrilling to everyone present – multiple offers in Canada are one of realtors’ dirty little secrets.

If you compete for a property, you’re blind to the process with no recourse but to believe what an agent tells you. The guy with the listing might say nine registered offers are coming and they’re all for more than the sellers are asking, prompting you to offer a massive premium. But you never know. There could be three low-ballers. There could be none. And you’ll never see what those offers contained in terms of price or conditions. All that’s revealed is the winning amount.

In one famous case a woman was informed a listing would be hotly contested. So, she upped the offer by tens of thousands. It later turned out hers was the only one (accepted, of course). She sued.

Phantom offers undoubtedly happen. It’s just one of the sleazier tactics used to inflate prices and commissions at a time when inventory may be low, and mortgage rates lower. Another slimy strategy is to list a property vastly below market value, prompting hysteria and dyspepsia among the virgins, and purposefully creating a feeding frenzy of offers.

Remember the North Toronto unrenovated pile that went for 195% of the listing price last April, after 72 offers hit the kitchen table? Sure ya do. And the buyer who ‘won’ was a client of the listing agent – the dude who orchestrated the whole thing. Hey, that seemed fair.

Well, something may be about to happen to curtail these orchestrated slugfests. The real estate regulator in Ontario, known as RECO, is hot to slap down cheaty realtors who manufacture phantom offers. Soon agents will have to keep records of all the bids on a property (for at least a year), and be prevented from claiming there are competing offers unless they actually exist and have been registered. Failure to do so will bring deregistration – which means you have to give the Audi back.

Unclear is whether a jilted bidder can petition to see the other, competing offers. But don’t hold your breath. This is still a process stacked in favour of the seller and their omnipotent agent. And RECO (like real estate regulators across the country) is an under-staffed and complaints-driven outfit. They have no roving realtor cops to police the 108,706 people flogging houses.

The best advice? Don’t go into a multiple-offer situation. Establish what you can offer and still have a financial life. Make your first offer the best (if competition looms). Always get pre-approved for a mortgage. In writing. Engage a realtor to represent you instead of dealing only with the listing agent. Don’t sign a BRA. If you’re forced into it, make the BRA specific only for the property being sought. On the day you offer, wear your special underwear backwards or whatever it is you do to find private joy. This is a not a fun process.

It’s also a process destined to get more bizarre and stressful before we’re done and this gasbag of a housing market pizzles. For that you can thank mortgage rates and our dithering central bank. Head guy Stephen Poloz ‘s latest media encounter actually opened the door to no rate drop on April 15th.

He downplayed the oil collapse, put more faith in a manufacturing rebound and suggested the poodles may wait until the middle of the year to reassess rates. Observed Capital Economics’ David Madani: “The speech earlier today by Bank of Canada Governor Stephen Poloz and his remarks during the press release shortly afterwards suggest that the Bank isn’t in any hurry to cut rates further. Accordingly, the odds of another rate cut coming in April are lower than we previously thought, though we still wouldn’t rule it out completely.”

In response, the Canadian dollar rallied a little, even as poor Alberta was bringing in a budget drenched in red ink (a $5 billion deficit). Thus, the Bank of Canada has done it again. It surprised markets in January with an unexpected and unannounced rate plop, killing the dollar. And it looks like the stage is being set for another surprise. Maybe April 15th. Perhaps May 17th. Or it could be July 15th. Or never.

You know what that means, kids. Buy now, or buy never. Hurry.

POSTMAG

Finally remember that little tussle I reported having a couple of weeks back with Condo King and Omnivore Brad Lamb, plus mortgage-broker economist and former bank star Sherry Cooper? The media event has now been published, and you can read a version here. I had a quick read and came to the conclusion Mr. Lamb stole the audio tapes, secretly altered them, and had an irresistible, creamy, raven-haired realtress drop them in the editor’s worn briefcase during a tryst they engineered. But that’s just a working theory. Or, they don’t type well.

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The inbreds http://www.greaterfool.ca/2015/03/25/the-inbreds/ http://www.greaterfool.ca/2015/03/25/the-inbreds/#comments Wed, 25 Mar 2015 22:30:52 +0000 http://www.greaterfool.ca/?p=10363 HERMAN CARTOON modified modified modified

“We can’t live with my parents. They’re still living with their parents!”

________________________________________________

“I’m a blog dog,” she said, “but I’m Italian.”

So, I replied?

“So real estate is kind of inbred with us. But still, I need you to tell me what’s going on this is completely nutso. How long can this last?”

Seems Junior went to offer on a house last night in a Toronto burb near the family home. There were 13 bidders and the scene was chaotic. Cars idling everywhere. Thick with realtors. Tense.

“The asking price for this place – just a plain bungalow – was $649,000,” she said, “and my son was ready for that because the agent told him there would be competition. So he had a good offer – $785,000 with a closing in just two weeks. No conditions. Not even an inspection. And that still wasn’t good enough.”

The property sold for $810,000. She was enraged. “How can this be allowed to happen? Who the hell is doing this to us, so we get thirteen offers on a single house? I want to know who’s responsible for creating this mess.”

You are, I said. At least your child is. And twelve other idiots.

Turns out her son is 25 years old, lives in the basement and is single. What does he need an $800,000 house for, I asked? Why would he want to do that, no matter how much he’s saved?

“Well, where else is he going to invest? Condos are too scary with all of them being built and the window problems. Plus he thought about a duplex or a triplex, but that might not be so good later on when he moves out. So, what else is there?”

Then I asked her why she’d want Junior buried in a mortgage for the juiciest part of his life, instead of being mobile, debt-free, flexible, young and quixotic. “What?” she hissed. “You mean, have him…. rent?” I felt so dirty.

Well there you have it. When 25-year-old studs think they need a bung, an epic mortgage and a horny mom to prove their manhood, we’re all in a little trouble. (I’m not sure that sentence came out quite right.) But these are the days in which we live. This is what 2.6% mortgages, a cultural obsession and rampant financial illiteracy have done. Every day the house lust and borrowing continues, at least in the two remaining property bubbles, we drift closer to a hard landing. When people think the whole range of their investment options is limited to three flavours of real estate (condo, multi-family or detached), wise people run in the opposite direction.

We’re in a mess now, with a severely weakened economy and disintegrating household finances. More and more middle class net worth is being stuffed into a single, over-inflated asset, puffed up with extreme leverage. So just imagine what’s gonna happen three weeks from today when the goofs in Ottawa drop interest rates again. Thirteen hormonal bidders could turn into thirty.

The ‘buy now or buy never’ drums are beating as big lenders drive rates to insane new lows, seeking to suck in as many clients as possible before everything changes in the months ahead. And change it will. US rates will start their ascent in 2015. Our dollar will be clobbered further. The shock waves of oil will spread. And already we have the worst job creation record in 40 years, double-digit youth unemployment, a declining savings rate, record family debt and 25-year-olds turned on by bungalows.

Instead of using history’s cheapest interest rates to trash debt, Canadians are embracing them to borrow more. It’s not how big the mortgage is that matters any more, but the size of the monthly. Scarier, a whole generation of moist millennials and genuinely numbed GenXers has now matured (sort of) in a time of runaway house prices. These little tweets think it’s normal.

So, shame on those who feed the myth. Like Vancity, the Vancouver-based mortgage sausage factory which has refined the art of giving loans to people who don’t deserve them. The latest technique is a ’report’ – which gained massive media attention on Wednesday – claiming the average YVR house will cost $2.1 million by 2030, and take 100% of household income to carry.

The title: “Downsizing the Canadian Dream: Homeownership Realities for Millennials and Beyond.” Now, do you have any doubt who it’s aimed at?

And what does the Vancity report suggest in order to ensure people in our most delusional city can continue to indenture themselves for an entire lifetime to mortgage lenders like, oh, Vancity? Financial institutions should give out mortgages which allow borrowers to add as income the money they can get from renting out bedroms, and to provide 100% financing by making loans for down payments as well as the mortgage, it says. (Vancity will already give you half the down payment, provide a mortgage for someone living in your garage or garden shed and offer financing if you and your swingles club decide to buy a property together.)

The main message here is simple. If you don’t buy now, you’re screwed.

They sure got that backwards.

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The illusion http://www.greaterfool.ca/2015/03/24/the-illusion-3/ http://www.greaterfool.ca/2015/03/24/the-illusion-3/#comments Tue, 24 Mar 2015 22:07:09 +0000 http://www.greaterfool.ca/?p=10359 SHUT modified

What to do when the housing boom turns to bust
Financial Post

Housing market hints at changes with declines in key cities
The Globe and Mail

There ya go. Headlines earlier today in a couple of the mainstream national papers. Finally.

As this consistent but obsessively repetitive and oft-terrifying (but manly) blog has been yammering about for a few months, the housing market is sick. Sales are stagnant or declining in 80% of regional markets. Personal finances are in worse shape than Smoking Man’s teeth. Debt is off the chart, wages are stagnant and the savings rate has tanked. I hear RRSP contributions were a shock this year. And with the oil peril spreading, we have a two-market housing bubble that looks increasingly delusional.

TD now says the economy will soften more in 2015. A realtor dude in Calgary credibly suggests prices there could fall 40% and not recover for eight years. Some analysts look at US oil stockpiles increasing by 1-2 million barrels a day and are forecasting $20 crude within a few months. We have a federal government too chicken to bring in a budget. And people in YVR and the GTA are still snorfling houses? What are they high on?

Crack cocaine mortgages, of course.

This week one of the country’s major mortgage insurers, Genworth, came out and stated the obvious. Alberta is a time bomb:

“What we’re doing is we’re looking at the stacked risk factors a lot closer — so people that have higher debt service ratios, that are employed in the oil and gas sector, that may be dependent on one income versus two, that are buying a home with five per cent down — we’re going to take a lot closer look at that deal.”

What comes next: Panicked feds will lean on the Bank of Canada to drop its key rate another quarter point at 10 am on Wednesday April 15th. (What a sad thing that we have come to this.) The dollar will dive more, immediately. And a five-year, fixed-rate mortgage could be on its way to 2.5% at the major banks – at least for a while. The stock market should jolt mildly higher.

It’s a gamble. Will Canadians keep on toking, or start choking? With mortgages already totaling $1.2 trillion – double in the past few years, despite swampy incomes and higher unemployment – how much more cheap debt can people absorb? Now that most housing markets are flatlining, even with the lowest mortgage costs ever, will buyers stay home – the way they are in Calgary? Will these mainstream news headlines help turn the tide so moist millennials, even in Van and Hogtown, see the towering risk real estate now poses?

Beats me. I just ask the questions here. But we’re certainly closer to a turning point, it would seem.

When we do turn, prepare to see a lot of tears shed over false equity. This is a good term for absolute illusory wealth – the kind that turns nice, good friends into insufferable dorks when they talk about how much money their houses are making.

In reality, there is no money until it’s realized in a house sale and put into your bank account on closing day by the lawyer. Then it’s real. But until that point it’s a fiction, based on market value which can quickly change (remember Calgary?). False equity also refers to the unsustainable gap between what people pay for houses these days, and what they cost to (a) replace or (b) rent.

A US firm studying real estate values nationwide found something interesting. Prices have rebounded from the GFC lows by an average of 13.2%, but rent and reconstruction costs have increased by only 1.9% and 3.3%. So what? So, the market value of properties is exceeding the utility value of them – which is a good gauge of speculation. People are willing to overpay because they expect prices to keep rising, plus interest rates are thin and they can carry the additional debt.

In a correction, this ends quickly. House prices tumble back to their utility value, or below, especially when the number of buyers is seriously reduced. As you know, inflated real estate appraisals were at the very heart of the US bubble that produced excessive prices and epic debt. (Sound familiar?)

So, when was the last time you heard of a bank appraiser here factoring in how much it would cost to rebuild a house, or what it might rent for? ‘Never’ is the correct response. Residential real estate only costs what it does for one reason. Cheap money.

Now it’s about to get cheaper. God help us on the trip down.

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Surprise! http://www.greaterfool.ca/2015/03/23/surprise-10/ http://www.greaterfool.ca/2015/03/23/surprise-10/#comments Mon, 23 Mar 2015 22:03:27 +0000 http://www.greaterfool.ca/?p=10356 SURPRISE

There are 5,800 families trying to sell a house in Calgary.

You don’t live in Cowtown, and don’t care? Tough. Quiet up, sit still and listen. This affects you.

So far this month the number of days-on-market to find a buyer in Calgary has increased 35%. Sales are down 31% from last March. The median price has started to drop, now off 2.5%. Given what’s coming, that’s probably not much. As I mentioned the other day, the city is actually doing quite well compared to Fort Mac, Grand Prairie or other places where oil reigns.

What a difference a year makes. Here’s what the Calgary Real Estate Board told the media twelve months ago:

Calgary – Residential sales activity improved across all sectors in March. However, declining new listings in the single family sector combined with further gains in sales activity decreased single family inventory to the lowest March level since 2006.

“There are several factors contributing to the growth in housing demand, including the inflow of people to our province over the past two years, strong gains in employment and tight rental conditions,” says CREB® chief economist Ann-Marie Lurie. “However, supply conditions vary amongst the different property segments, impacting the number of sales and price growth. If supply constraints persist in the single family sector, prices are expected to record further gains as we move into the spring market.”

Single family sales at the end of the first quarter totalled 3,901 units, a 9.5 per cent increase over the same period last year. Meanwhile, the amount of new listings declined by nearly five per cent. As sales growth outpaced the amount of new listings growth in the market, inventory levels dropped to just over 2,000 units.

Persistently tight market conditions prevented any relief in terms of price gains. The unadjusted single family benchmark price totalled $490,600 in March, a 9.9 per cent increase over the previous year and monthly increase of 1.6 per cent.

See what I mean? Last March folks in Calgary were convinced the market was bullet-proof. More people moving to town. More jobs and higher wages. Little available to rent. Cheap mortgages. And momentum. Tons of it – sales surging 9.5% and prices bloating almost 10%. This is exactly the kind of realtor bravado which people in YVR and the GTA are coated with monthly. No sirreee. Can’t happen here. We have immigrants, jobs, confidence and horny buyers.

Well, here’s a reality check.

Deric Burton is a Re/Max guy in Calgary – a rare realtor with the experience and intellect to understand the macroeconomics impacting the housing market and the stones to honestly report it. He’s traced the impact of the oil downturns of 1981 and 2008 on real estate, and arrived at two scenarios for what likely lies ahead. Neither are happy.

From 1981 to 1986 oil lost 66% of its value and Cowtown housing plunged in price by 38%. It took two years for property values to fall and seven years to recover. The oil bust of 2008-9 came during the GFC, when crude fell 70% and real estate lost 18%. But this time the drop was quick – just 18 months on the way down, yet it took almost six years for houses to get back to pre-2008 levels. It’s worth remembering the Bank of Canada goosed this recovery with an historic plunge in interest rates – which cannot be duplicated.

What now?

Well, if this is a long slump, Burton figures the real estate bottom won’t come until July of 2017, by which time houses will cost 39% less than they did in September. It will then take until June of 2022 to recover to the 2014 peak – eight long years. If the oil collapse is short-lived, he says you can expect house prices to lose 18%, bottom a year from now and recover the lost ground sometime in the spring of 2020.

Here’s the chart:

CALGARY modified

Says the realtor: “If oil prices replicate 1981 with a steep drop and long protracted flattening of prices, then the resulting effect on the housing market (blue line) would be significant and long-term. On the other hand, if oil prices mirror the 2008 trend (green line) which resulted in a steep drop with a fairly quick recovery, then prices should rebound accordingly, but still take until May 2020 to recover…. There can be no doubt that the significant drop in oil prices has already been severe enough to cause a substantial decrease in prices but, more importantly, to undermine the confidence in making one of the largest family purchases.”

It now appears an oil rebound is as likely as the renaissance of my political career. Supply is swamping demand, monetary stimulus is being sliced back (the US Fed is preparing to raise rates, not lower them), and the bulk of oil patch layoffs is yet to come as most producers lose money with every barrel they suck from the tundra. In fact, this is just the latest blow. Overall job creation in Canada has never been as weak as it is now – at least not in the 40 years people have been counting.

But this post is not about Calgary. Or oil. It’s about surprises.

Are you ready for one?

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The mortgage that eats http://www.greaterfool.ca/2015/03/22/the-mortgage-that-eats/ http://www.greaterfool.ca/2015/03/22/the-mortgage-that-eats/#comments Sun, 22 Mar 2015 15:41:00 +0000 http://www.greaterfool.ca/?p=10352 BURRITO modified

Ever noticed how this blog sinks into generational warfare? The wrinklies think the young are gonzo for lusting after property, trading freedom and mobility for debt and obligation. The kids think the geezers are selfish and hectoring, saying they can never have what their parents got so easily.

Average houses that cost a million are screwing up social values and personal goals. When most people should be striving for life-long financial security for their families, instead they’re obsessed with getting real estate. This strategy never ends well. We can see that already.

Frank and Faye own a bung in the west end of Toronto, which their two adult children covet. “Isn’t gonna happen,” says Frank. “It’s all we’ve got, basically.” They paid $680,000 for it ten years ago, and figure it’s worth about a million now, mostly land value. Frank retired two years ago, not his idea, at age 61 and his defined-contribution company pension plan had a grand total of $220,000 in it. They were unable to save any money in RRSPs or TFSAs because Faye stayed at home to look after the kids, and Frank worked his tail off to pay down the mortgage. That happened the year before he was punted from Loblaws.

“That was always the thing for me. Get rid of that debt, and I thought we’d be fine. Now, honestly, I’m not so sure.”

You bet. The $220,000 is already being depleted (it’s taxable), and besides that they have only $1,100 a month between them in CPP. It’s ironic. On paper they’re millionaires, thanks to a seven-figure house and a market windfall. In real life, they can hardly afford gas, groceries and property taxes, and worry every single day about what happens when the cash runs out. After all, twenty or thirty years of life lie ahead.

Frank wonders what things might have been like if he’d saved or invested some of the money he put into the mortgage (it totalled over $800,000 during those ten years, plus the hundred they put down), then just sold the house when he lost his job. He thinks about selling it now, but Faye won’t abide it. So he wrote me.

“I always worry if we have enough to survive. So here is my question, I see a lot of advertising about reverse mortgages for retired couples like us who own their home mortgage free. What is your opinion on these mortgages if retired couples run short? Are they a good option?”

Some people think reverse mortgages are about to explode in popularity. They’re probably right. In fact, a whole new generation of savings-poor, house-rich people is rapidly approaching middle age in an era when corporate pensions are fading and real estate has never been such a burden. What, exactly, do these people think will be financing their decades-long retirement, once they pay off those epic mortgages?

If they believe the house will support them, I sure hope they know the facts.

A reverse mortgage sounds idyllic, the way the happy, white-haired, affluent people on the TV commercials tell it. If you’re over 55 you get to cash in 50% of your equity, as a lump sum or as income, pay no tax on the proceeds, and never pay off the debt so long as you continue to live in the place and don’t croak.

CHIP modified

You can use the money to renovate, to travel, to invest, to pay bills or to shower on your deadbeat offspring. The cash received is not reportable income, so it won’t result in a clawback of your government pogey. If interest rates rise or the house value falls, it’s not your problem – there’s no repayment required. Besides, houses always go up, right? So surely over a few years the added appreciation will just balance off the equity you sucked out.

Sounds appealing to many people. For some of them, it’s a solution. For many others, a trap.

Here’s why. A reverse mortgage is just that – a debt that grows and eats your equity, instead of one you pay off, increasing equity. The longer it’s in place (and most people take one out for their remaining lifetimes), the bigger is swells – since interest is steadily accumulating – and the more that will have to be repaid when you sell the house or depart this vail of tears.

Reverse mortgages have interest rates significantly higher than conventional ones (almost double in some cases) plus big set-up fees – money deducted from the cash amount you receive (and yet which is amortized up over the years ahead). There can also be a hefty penalty if you decide to retire the debt early. Worse, if you decide to up and die, it can often take longer for your kids to settle the estate, sell the house and get the cash than the reverse mortgage company gives you to repay the loan and accumulated interest. It’s also possible the estate may owe more money to the reverse mortgage dudes than the house is worth – leaving the heirs ziltch.

Remember that every month a reverse mortgage is in place, regardless of how much you borrowed, your equity is falling and your debt is rising. So if after a decade or so you decide you want to sell and downsize, you might not have enough equity left to do so. Or if house prices correct and the market value of the home fades, people with reverse mortgages could easily be trapped in those properties forever, unable to sell and move, while seeing their only asset robbed of value.

There are better options. For example, Frank and Faye could sell, take their million, invest it prudently and add $70,000 a year to their income – more than enough to rent a better place. They could use their equity to secure a HELOC, which will not grow in size so long as they make interest-only payments. They can sell and downsize to a $400,000 condo, investing the remainder. They could sell the home to their children on condition they get to stay there in a suite.

The reverse mortgage? The last option they should consider. Unless they hate their kids.

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The Rule http://www.greaterfool.ca/2015/03/20/rule-of-90/ http://www.greaterfool.ca/2015/03/20/rule-of-90/#comments Fri, 20 Mar 2015 21:57:05 +0000 http://www.greaterfool.ca/?p=10349 ADULTS modified

The odds of a big slowdown in the Canadian economy are growing. “The downturn in the energy sector could push the economy close to stagnation during the course of the year,” says Capital Economics guru, David Madani, “particularly if it is compounded by a housing slowdown.”

So far this year manufacturing stats are bad, wholesale trade numbers are awful (worst on record), retail sales are weak and job creation is minimal. Wages are stuck in the ditch, and debt’s quickly rising. The dollar is well below 80 cents, and oil is sub-fifty bucks.

“We have already seen a marked slowdown in business investment generally, but that likely only marks the beginning of a sharp decline,” says Madani. “Based on the past relationship between energy price movements and investment, it seems likely that the worst is yet to come.”

I mention these things not to bum you out, but to remind (in light of little Amanda’s missive yesterday) that today’s cheapo mortgage rates and amped-up realtors do not present a fair picture of where we’re headed. If you’re horny to buy a house, do it the right way. If you own a house, make sure you don’t have a one-asset financial strategy. Which brings us to my Rule of 90.

“I read your blog almost every day,” Patrick says. “The articles are always well written with a sense of humor.” But he wonders about the rule. “I believe it is 90 – age = % you should allocate to real estate.”

That’s correct. Take 90. Deduct your age. The remainder represents the percentage of your household net worth you should ideally have allocated to residential real estate.
“I am curious of your thoughts of two questions I have in mind: does the percentage include the mortgage, so say 90 – 40 = 50%, then 50% represents the price of the home including a mortgage? Also, how does an RRSP count in one person’s net worth. Is it a straight addition?”

The point of this rule is simple. It’s a guideline to not putting too much of your net worth into a single, immoveable, costly, potentially-deflating asset the financing on which will only grow more costly in years to come. At the same time, it’s a reminder you need to be building wealth in the form of liquid, diversified, balanced assets that will inevitably provide you with security and an income stream. Remember the Rule of 90, for example, and you won’t be shoving every dollar you have against the mortgage.

The rule is age-specific for a reason. The older you get, the less exposure you should have to a house and the bigger your wad of financial stuff should be. After all, what everyone needs in retirement is income, not a roof. You can rent one of those.

So, to Patrick’s questions. First, a mortgage is not included in the value of a house. I know this may come as a shock to millions of moist millennials, but it’s called ‘debt.’ When calculating net worth, you add up the assets you possess and then subtract the obligations. So a $500,000 property bought with 5% down and a mortgage of $490,000 (including the CMHC premium), means you have $10,000 of net worth sitting there, not $500,000.

Second, it’s general practice to include all registered accounts (including RRSPs) as assets when calculating net worth. Yes, they’re taxable. But the rate of tax is unknown, since you might cash some in when you’re taking a year off to learn body art, or retire in a low tax bracket. Money built up inside TFSAs, of course, comes out taxless.

Here’s an example: If 40-year-old Patrick had $25,000 in the orange guy’s shorts, $35,000 in a TFSA and $145,000 in an RRSP, plus a house valued of $500,000 with a $300,000 mortgage, he’d have a net worth of $405,000. The Rule of 90 suggests that a max of 50% of his net worth should be in his real estate. So the $200,000 he has in house equity equals 49%.We have a winner!

Now imagine 35-year-old Amanda, who puts $100,000 down on a slanty semi worth $800,000, and has a mortgage of $720,000. That’s all the money she and her squeeze have, so her net worth is reduced to $80,000 (thanks to closing costs). While she should have no more than 55% of her net worth in a house, she actually has 100%. Worse, a 10% fluctuation in house values will reduce her net worth to zero. And she still has over seven hundred grand in debt. Risk. Bigtime.

Of course, by the time you’re a dried-up, wheezy, pruned wrinklie, liquidity is the goal. So a 65-year-old couple should have no more than 25% of their net worth in residential real estate. Thus, if they live in a $400,000 mortgage-less house, they’d be secure with $1.6 million in total financial assets if they were without a pension plan (other than CPP).

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By the way, projections for Canada’s economic growth this year are going down fast. Looks like we’ll be lucky to scrape by with 1%, with the mess from Alberta spilling widely beyond its borders. Adds Madani: “We fear this slowdown will trigger a disorderly unwinding of household sector imbalances, depressing economic growth even more than otherwise would normally be the case. We still believe that the housing market in particular is overdue for a potentially severe correction.” He says (and I now agree), this will lead the Bank of Canada to another rate decrease. Yikes.

I sure hope the house-lusty virgins feeding on 2% mortgages realize what they’re doing.

But I know they don’t.

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The goal of life http://www.greaterfool.ca/2015/03/19/the-goal-of-life-3/ http://www.greaterfool.ca/2015/03/19/the-goal-of-life-3/#comments Thu, 19 Mar 2015 22:39:12 +0000 http://www.greaterfool.ca/?p=10347 TRUCK modified

“I just stumbled upon your blog today,” writes Amanda, on the most important day of her moist millennial life, “as I’m in the process of deciding whether or not my partner and I should take the leap into buying a house in Toronto. The reviews are so mixed.  Lots of people saying it’s never a bad investment, it will keep rising, etc.  And if we are in it for the long term, as a home, we need one anyways….”

Well, I know where this is headed, when a twenty-something tells me she “needs’ to own real estate. Anyway, little A sets it out this way:

“Then there’s your camp, who say this is a terrible idea.  But to be honest, after reading your blog haven’t you and others been “predicting” this for many, many years?  Sure, it’s bound to crash, or softly land, or whatever sometime… But am I not missing out now?  Will I maybe just have to pay even more later on?

“My partner and I are both professionals.  We have a combined income of almost $200k/year.  And we have a huge chunk of savings that we could put into a down payment (over 100k).  Yet it still seems impossible to fight with people who seem to have even more than us (or do they?)… lest we buy in a crummy area.

“I know your advice will be to hang tight.  But for how long?  Is it not possible that it can keep going up, up, up because of the amount of people that want to live here?  How can you be so certain it will come down (when it hasn’t yet) – and by how much? I’m feeling overwhelmed and scrambled by the whole experience and am looking for guidance and evidence for same.”

If Amanda and her professional other buy a slanty semi for $800,000, they’ll have no money and a mortgage of about $750,000 (with tax and CMHC premium). They’ll also have a 2.79% five-year mortgage that will carry for $3,300 a month. With property taxes and insurance (no maintenance), the total will be about $4,000. Renos are extra, plus the usual utilities, garbage tax, street parking permit and annual racoon removal. After five years they’ll have paid $99,000 in interest and still owe $640,000.

Is this wise? After all, that’s more than I pay in rent to live in my two million dollar property, where the landlord kindly subsidizes me. And it’s not a semi. With four-car parking, a garage, three levels, landscaped backyard, motorized awning, and festive patio lanterns. So, the price of ownership – even with the cheapest mortgage rates ever – ain’t cheap. Besides, if my high-efficiency furnace quits or the designer apron sink leaks on the travertine flooring, I speed dial the LL, and have another scotch.

But, some people just have to nest. So should Amanda, with a hundred grand burning a hot hole in her bank account, take the plunge into Toronto’s steamy realty waters?

There’s no correct answer to the question, of course. If the kids do it, they’ll be gambling every shred of net worth they have – and most of their cash flow – while taking on a massive amount of debt, to buy an asset whose value has never been higher because rates have never been lower. This seems like the perfect definition of ‘risk.’ If Amanda wants a house of her own that badly (and it sounds so), she’ll ignore this risk and start seeing it as security. That’s the way the brain works. It’s why a lot of people fail.

House prices don’t need to crash, or even soft-land to make this happen. In some markets they could just reach a plateau (about where we are now) and stay there. In that case these virgins would end up spending double the amount they need to for accommodation, which will materially zap their ability to save and invest, while exposing them to market risk, rate risk plus employment and mobility risk.

However, nobody listens to me, which is oddly liberating. We’ve bred a generation of offspring with one goal in life. It’s not world peace, career success, good deeds, entrepreneurship, animal welfare or even self-fulfilment. Nah, it’s a house. Nothing else really matters. How sad is that?

Well, here’s the latest forecast: the domestic economy is doing badly and will get worse. GDP numbers suck. Employment stats suck. Government budgets suck. The oil thing is just starting to whack corporate and public finances. Family debt’s increasing and wages aren’t. Same old story.

So I wouldn’t be surprised if the Bank of Canada panics again and lowers rates another quarter point, which will kill the dollar, make commodities fade and import more inflation. 2015 could go down as the year family finances degenerate as never before. But because house values in a few cities rise as mortgages deflate, the wealth effect will mask it. Kids like Amanda will puff out their chests, invite their little friends over to drink white wine out of plastic cups and brag about their equity and their acumen.

I sure hope that’s a big moment, given the sacrifice. Not just in money.

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Buns of steel http://www.greaterfool.ca/2015/03/18/buns-of-steel/ http://www.greaterfool.ca/2015/03/18/buns-of-steel/#comments Wed, 18 Mar 2015 22:43:41 +0000 http://www.greaterfool.ca/?p=10345 BUNS modified

Since this pathetic blog is brimming with macroeconomists obsessed with monetary policy, as opposed to things most people actually care about, let’s get at ‘er. After all, it’s rutting season once again and the bankers have just launched a new mortgage war to suck in the virgins. So, where are rates going?

Down a little, actually. Then up. There’s now little doubt what the coming months will bring.

Immediately, the banks are fighting for market share in a market that’s shrinking. Real estate has been saggy in 80% of the country’s regions, while it effuses in two others. No wonder, with commodity prices circling the drain, incomes stagnant, jobs being shed and citizens pickled in debt. As I told you on Monday, hours before the war broke out, this would take a five-year fixed-rate home loan to a new level as lenders raced to the bottom. Now we have word from the front of 2.5% fivers, 2% variables and 3.69% tens.

Of course, if the elfin deity were still with us, there’d be hunks of fur and blood splots across the board rooms of the Bay Street towers. F made it clear that cut-rate, teaser, special-deal, come-on-down-kids mortgage rates were bad news because they encouraged debt, inflated houses and hurt families. But his wimpy successor would rather hide than fight.

In fact it was left to the prime minister himself to make a comment on Wednesday. Said the big deity: “I’m not saying I’m unconcerned. But we are watching it. We’re not planning to take any immediate action. We continue to watch the housing market and the lending and borrowing situation very carefully. We have taken some steps over the past several years to cool the market somewhat.”

Hmm. He denied not being concerned. He didn’t rule out action, just ‘immediate’ action. Most significantly he said the government had ‘somewhat’ cooled the market. And it’s watching.

Sure sounds like there’s something coming in the budget, no?

Anyway, let’s obsess about the Fed for a few sentences. The US central bank bosses emerged from their recent meeting to confirm American rates will be rising in 2015, as I told you they would. The first increase may be in June, if employment and inflation data is reasonable, or in September, if it isn’t. Either way, it’s happening. The general belief is rates will rise about half a point this year, then be adjusted as warranted into infinity.

Here’s the news: this is the end of the most aggressive loose-money period in the last century that the central bank has existed. Not only were rates pushed into the ditch, but the Fed has spent a few trillion buying bonds and otherwise pumping liquidity into the economy to bring it back from the brink of the 1930s-style collapse which loomed in 2008.

Cool. It’s over. First the massive ($85 billion a month) bond-snorfling program was ended last autumn. And this year emergency interest rates will be lifted. This is a fundamental shift in monetary policy that I hope nobody misses. The Fed is shucking its job of trying to rescue the economy by giving away money, and re-establishing its role as a referee. It will continue to slowly increase rates as wages, prices and economic activity rises in order to contain inflation, and it will rest when job creation needs a lift or the dollar must be reigned in. But gone for now is the super-bank mandate. No cape. No tights. No buns of steel.

For Canadians, there’s no resisting. The Bank of Canada will follow suit as it always has. It may not be before the end of the year, but it’s coming. To fail to act would be to sacrifice the dollar, import inflation, and raise the misery index. It would also fuel more consumer debt, and since we’ve all proven we can no longer be trusted with money, this is a giant risk to the future.

Someone asked Wednesday evening if, given all that’s happened, if it made sense to take out a 10-year mortgage. You can score one of these for about 3.6%. And while your rate is carved in stone for a decade, because of the Canada Interest Act the mortgage becomes fully open after five years. So, if rates were to be lower then you could pay it off without penalty.

But I have a hard time understanding how that might be possible. There’s only one direction for the cost of money as the global recovery progresses, the US expands, Europe gets back on its feet and China moves out of economic adolescence. Over the next five years rates could easily double. People borrowing now at 2.7% will be renewing at more than 5% – if they are very lucky.

So, what would I do if I were nutso enough to buy the $2 million midtown Toronto house I rent for $3,800 a month and didn’t pay cash? Grab the cheapo five-year Spring Special? Or pay an extra 1% for no surprises until 2025?

Well, actually I’d go variable for 2% and invest every extra dollar into a robust balanced portfolio expected to grow 50% by renewal time. But that’s me. It’s not the wusses who read this blog.

For you, it’s a unique moment. Lock it up.

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The gamble http://www.greaterfool.ca/2015/03/17/the-gamble-2/ http://www.greaterfool.ca/2015/03/17/the-gamble-2/#comments Tue, 17 Mar 2015 21:55:52 +0000 http://www.greaterfool.ca/?p=10342 PLANTS modified

The latest data (out on Tuesday) shows that Canada’s petroleum sales took a 11.9% dive in January. Ouch. It’s the seventh monthly decline, and the worst yet. This helped to drag down the whole of manufacturing sales, which sucks when a 78-cent dollar was supposed to save us. (Wednesday update: loonie now in the 77-cent range.)

Meanwhile oil just won’t quit. It’s flirting with $42 a barrel, and the momentum’s to the downside. Nobody will be much fussed to see it slide into the thirties. The reason is simple – too much supply, overwhelming demand. US production continues to escalate, even as the rig count drops. The pipes are full. The storage farms are filling. There’s never been this much. That whole thing about peak oil is so old. Americans have doubled their output in recent years. Suddenly the world’s swimming in the stuff – which is big news since oil is our No.1 export. Even being so cheap, sales are falling.

The impact in oily places is about what you’d expect.

Calgary house sales are down by a third, prices are wobbling and it’s taking sellers a lot longer to find buyers. But the impact in Fort Mac (lots more layoffs announced this week) is withering. Sales plunged 66% year/year in February, and were trashed 53% in January. This week there are about 930 properties for sales (in a town where the average house costs $200,000 more than in the GTA), and yet last month only 48 sold.

Down the road, Grand Prairie saw a 37% plop in sales while Lloydminster deals fell by almost half. In Edmonton, sales last month declined 17% over 2014 levels.

But all this is likely just the start. It takes many months for the impact of layoffs, reduced payrolls and family disruptions to ripple through a local economy. Most sellers start out with an optimistic ask and start reducing it after sixty or 90 days on the market. If oil prices remain in the zone (seems more than likely), then the summer ahead could be a dry one indeed for those who need to exit.

OIL

As mentioned yesterday, denial is the river running through Toronto and Vancouver, fueled now by the bankers’ latest mortgage war. Yesterday this alarmingly pathetic blog broke the news that BeeMo would drop its five-year rate to 2.79% on Tuesday. It did. Down twenty bips. It took only a few hours for TD to match it, which meant a thirty-point decline. No doubt all of the majors will be in play by Friday.

It’s historic. A fixed-rate fiver has never been offered by the mainline banks at this level before, and comes as a direct result of the environment created by the goofs at the Bank of Canada. The results of the January central bank drop are already coursing through the marketplace as citizens rush to gobble new heaps of debt. In the first two weeks of March average GTA prices were 10% higher than a year earlier, and the average detached 416 digs now sells for $1,099,239.

Just what I told you yesterday. Lower rates. More borrowing. Higher prices.

So today mortgages have never cost less and houses have never cost more. The direct connection should be lost on nobody. Real estate has not appreciated because it’s inherently more valuable, and will retain that value, but because debt got cheaper. So it stands to reason that when debt costs more, houses will be worth less. This is the fat gamble every buyer is taking.

Wednesday afternoon at 2 pm the Fed makes one of its closely-watched announcements. Analysts will hang on each phrase that bosslady Janet Yellen releases, to see if key words (like “patient”) remain from previous statements, or is dropped and replaced. The betting now among economists is this: (a) absolutely US rates will rise in 2015. (b) This will start on June 17th or certainly in September. (c) By the end of the year rates will be either a half-point or three-quarters of a point higher.

This is a big deal because the Fed rate has been at a quarter point now for six years. Changing it is a bold new step in monetary policy and will likely usher in two years of gradual tightening until the benchmark is between 2% and 3%. And Fed-watchers say Yellen is determined to reduce the central bank’s role in goosing the economy, in favour of just being the benign shepherd (how’s that for a mixed barnyard metaphor?). In fact, says Bloomberg:

“Beginning in June, and for the first time since 2008, officials would be making rate decisions meeting-by-meeting, based purely on the data in front of them, rather than committing themselves to keeping borrowing costs low.”

Now whether the people snorfling 2.79% mortgages to buy $1 million houses like it or not, Canada will end up following suit. It won’t be immediate. It may not be before the October election. But it will happen, because without a response here, the dollar’s endangered. Maybe the Swedes can diddle with their rates and survive, but Canada – linked at the hip to the American economy – doesn’t have that luxury. As with every other Fed move in the past, the Bank of Canada will eventually comply.

So if you’re loading up on cheap debt, have a plan to survive renewal in 2020. Seriously.

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To the bottom http://www.greaterfool.ca/2015/03/16/to-the-bottom/ http://www.greaterfool.ca/2015/03/16/to-the-bottom/#comments Mon, 16 Mar 2015 22:13:49 +0000 http://www.greaterfool.ca/?p=10338 POOL modified

On Tuesday Bank of Montreal dropped its five-year fixed mortgage rate to (drum roll, please), 2.79%.  (You read it here first.) That’s twenty points less than it was on Monday and 30 bips below the nearest big bank (the green one). To get a rate lower than this, you have to become a customer of an unknown mortgage outfit some guy runs out of the trunk of his Cordoba.

Seriously. It’s a race to the bottom.

This is the regrettable consequence of the goofy move by the Bank of Canada to lower its key rate a quarter point in January, when it freaked out at the slide in oil prices. What’s already happened – and which BeeMo will accelerate tomorrow – is the creation of two distinct and fragile economies within the bosom of a single nation.

In the oily part, low rates mean nothing. They won’t rescue anyone’s job, raise the price of crude, save any truck nutz or keep a single energy project from being mothballed. And they sure won’t help the suffering real estate markets in Calgary, Edmonton or Fort Mac.

Mike Fotiou knows that. For a realtor, he’s an astute dude. The tsunami of new listings in Calgary has subsided so far this month, and while sales are still down by a third, he says nobody can say the housing market has bottomed. It’s all about jobs.

“Why is it too early to be calling a bottom in Calgary’s market?  Because Alberta’s economy hasn’t found a bottom.  Last month, employment fell by 14,000 giving back the 13,700 jobs gained in January and then some.   Since there haven’t been any developments to suggest there aren’t more job losses on the way, we can expect a slow market for the short-term at the very least.”

Demand for houses has shrivelled like a corner-store banana in those places where people are worried about their paycheques. The same oil patch that was showering 22-year-olds with $200,000 payouts has taken away the riches just as quickly. Camps are closing. The free flights have ended. The layoffs are swelling. So the buyers are gone.

But in the last two bubble markets in Canada, the absolute opposite. As interest rates get shoved lower by desperate policy-makers (seven months before a federal election), people are pigging out on the cheapest debt of their lifetimes. The consequence has been a spurt in sales, prices and hormonal secretions, pushing YVR and the GTA into uncharted waters.

You know the numbers. Outstanding mortgages just shot up another $80 billion as we hit a new debt record. Savings are falling, spending is rising, and it’s all based on borrowing. We’ve now blown past the debt levels of those crazy Yanks just before their real estate market blew up.

Here’s a no-crap warning from Capital Economics; David Madani:

“Lower mortgage rates… will only result in greater imbalances in terms of housing overvaluation, household debt and overbuilding. Over the past two years, increasing numbers of higher-risk home buyers have turned to smaller banks and other non-traditional lenders. As the Bank of Canada warned in its last Financial System Review, mortgages provided by these “less regulated” institutions have grown rapidly. Since much of this lending is essentially sub-prime, we fear that this type of lending and its support to home sales in the short term will only lead to even greater problems and more painful adjustments in the longer term. Exactly the same thing happened in the US housing bubble with the rise of lenders like Countrywide Financial. These excesses are another reason why we believe housing is overdue for a major correction.”

As this pathetic blog has argued for so long it’s now painful, the inverse relationship between mortgage rates and house prices is all the evidence anyone needs of why beater houses now cost a million in these two cities. It’s not Chinese moneybaggers. It’s not the economy. Instead it’s the insatiable appetite delusional Canadian families have for financing. If five-year mortgages were 5.49% tomorrow, instead of 2.79%, houses would still be affordable.

So, look at this chart. Here’s why real estate costs what it does:

DEBT CHART modified

Warns US-based Wolfstreet.com:

“And if interest rates ever rise even by a smidgen? The blue line would do what it started doing in 2006. It would roar higher. With consumer indebtedness at these levels, even a small increase in interest rates will make a big difference in the interest expense consumers would have to fork over. The Bank of Canada will have trouble ever raising rates, regardless of the distortion and mayhem near-zero rates are causing. Households can no longer afford higher rates. They have too much debt and not enough income. Higher interest payments would eat into spending on other things. Higher mortgage rates would crash the still magnificent home prices. Consumers would buckle under their burden and default. Not to speak of the already struggling oil companies. And then there are the banks that have lent with utter abandon to all of them.”

Lots of logic there. Higher rates, even marginally increased, will push many people to the wall and materially impact the overall economy. This is why the Bank of Canada’s No.2 person told MPs a few days ago our central bank would not necessarily move in lockstep with the US Fed, which will be pulling the rate trigger later this year.

But, rates will go eventually go up. And houses will go down. Just stand on your head and look at the chart. Madani is sticking with his prediction of a 25% price decline nationally – which will mean a lot more in you-know-where. Adds the Wolf Street economist: “Gravity is already and very inconveniently inserting itself into Canada’s incredible housing boom.”

You should get ready for this.

Or you can post a comment below saying rates will never rise. That’ll protect you.

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