The rich

RICH3 modified

If you want to be in the top 1% of income-earners so Millennials can hate you and your divorce turns into hell on wheels, then make $217,000 a year. About two hundred and thirty thousand people qualify. So, 99% of Canadians don’t cut it.

How can this be when a majority of houses in Vancouver and 416 are now worth a million bucks? Hasn’t the real estate boom made all these people rich, too?

Well, there’s a difference between high-income and high-net worth. There are 320,000 people of wealth, defined as families with $1 million investible assets, excluding their principle residence. Houses are not counted because most of them are leveraged, they’re not really liquid, and they act as personal possessions, not investments. At least that’s the way financial guys think, which makes them different from realtors.

As you know, the gap between the rich and the rest is growing faster than yeast. The Occupy kids were exactly right when they flooded onto Wall Street. The middle classes are being hollowed out and the generation of genius kids now being farmed in the basement could be the first one in modern history to be less financially secure than their parents.

They’re pissed, as you might expect. And blame everything. Especially the 1%.

But this could be seriously misplaced anger. At least part of the reason rich people are getting moreso and the middle’s in trouble is where money is deployed. For starters, men (who are as a group wealthier) invest more, while women save more. Given the fact that interest rates have collapsed since 2008, savers have been creamed. The return on bank accounts, GICs, bonds and most fixed-income assets is pitiful. After inflation and taxes, these investors have seen negative numbers.

Also since 2008, the world’s been in an asset bubble. The collapse in interest rates has diverted a torrent of money into things which grow in value and throw off capital gains. Central banks have played their part by flooding economies with cash, trying to stimulate growth and job-creation, which has added to corporate profits, then reflected in healthy stock markets.

Of course, cheap money and an ocean of easy credit have done the same for properties. Canada’s real estate market is a prime example of what happens when you let people without savings buy houses with 3% financing. They pig out. Prices go up. They pig some more. Bigger prices.

But the difference between a guy with a seven-figure portfolio of financial assets and the person owning million-dollar beater house in East Van is debt. Almost always the house is leveraged, while the portfolio is not. Moreover, the returns on a balanced portfolio for the past six years have far eclipsed those enjoyed by a real estate investor, even in Van, 416 or Cowtown.

But there’s more. A US economics professor, in studying the same phenom there, has come to this conclusion: while middle-class people have 63% of their wealth tied up in a single asset (the house), wealthy people have 75% of theirs sunk into investment assets. So, the wealthy have harnessed diversification to actually increase returns and lower risk, while the workies have rolled the dice, gambling that a one-asset strategy will yield financial security. In doing so, they’ve amplified risk.

American families bet on a real estate boom, fuelled by easy credit and rising prices, then lost horribly. After the property market crash of 2007-9, middle-class Americans sold assets in order to pay off debt. The rich were buying. And the gap between them turned into the Grand Canyon.

Professor Ed Wolff also found the wealthy earned double the return on their stock and bond investments as the plebes did on their houses and savings accounts. “The differences reflect the greater share of high-yield investment assets like stocks in the portfolios of the rich and the greater share of housing in the portfolio of the middle class,” he says. “Middle class Americans’ reliance on home values, which still make up two?thirds of their total wealth, and their high levels of mortgage debt have been the main cause of increasing wealth inequality since 2007.”

Will the same experience be repeated here? Of course. Already is.

Real estate values have peaked while the cost of debt can’t go much lower. The easy money’s been made in this asset bubble, as new buyers will discover, unhappily. And, unlike dividend-producing stocks, houses earn nothing and yet have substantial ownership costs. If there’s no yearly capital appreciation, they drain net worth instead of building it. And just wait until mortgage rates normalize.

So, that’s one reason we have rich people. They invest more than they save. They diversify. They’re unhouse-horny. They buy stuff that pays them to own it. They take less risk. They shun debt. And they know it’s not just how much you earn, but what you do with it.

Finally, I know all you metrosexual urban latte-sippers don’t care about a provincial backwater like Saint John, New Brunswick, but add it to the list of places where the housing market is toast. Almost 10% of all homes currently listed for sale are foreclosures.

Says a prominent local realtor: “The last time I saw foreclosures in the numbers I’m seeing was in 1980. That’s when interest rates were at 18 and 21%.”

Imagine what might be coming.

Parents

PARENTS modified

Mortgage brokers made the news yesterday talking about the Bank of Mom (and Dad). More on that in a moment.

The big report that CAAMP turned out also gave us some scary insights into the housing market, which continues to stir loins. Here’s what we know.

So far this year 425,000 properties have sold, and the average price was just over $400,000. (The typical Canadian property is now $419,699, and the median US home price is $209,700.) The aggregate value of these houses was $173 billion.

Where did this giant pile of money come from?

Well, all but 50,000 of those families took out a mortgage, but half of them signed up for a HELOC instead – which is roughly the same thing. In other words, 94% of the buyers arranged financing and just 6% bought with cash. That suggests almost all of the buyers were new to the market, or moving up to more grandiose digs.

How much did they borrow?

The best estimate seems to be $113 billion, which works out to an average of $282,000. That seems reasonable until you layer on this fact: 49% of all of the buyers (or 210,000) so far this year were virgins, who certainly would not have had an average down payment of $120,000.

Of course, some of the move-up buyers carried old mortgages they needed to discharge and replace with new ones, so the brokers figures we added about $90 billion in net new mortgage debt during the time of the study. That’s an average of $10 billion a month – in fresh borrowing.

This is happening as mortgage rates are at record lows, as you know, and when house prices have crested. There\s no doubt whatsoever that when all of these people come to renew their mortgages in two or three or five years, they’ll be paying more. And, as a result, their houses will probably be worth less. It’s hard to fathom the additional risk Canadians are accepting every week, as they gorge on cheap money.

But there’s more to worry about. The wrinklies, say the brokers, are now massively subsidizing their over-educated, under-employed offspring, luring them out of the basement with fat cheques.

The brokers say Mom & Dad are handing off an average of $10,000. In fact, when it comes to down payments, we’re told that half the money is saved and the rest comes from the parents, from another loan or borrowed from an RRSP. So, yes, we’re clearly in an age when most people think nothing of buying real estate with gobs of leverage, since they fully expect prices to go up forever. God help them.

And how about the thinly-veiled message from the mortgage dudes that parents actually have an obligation to get their kids into condos and fat mortgages? Says the association head, Jim Murphy: “I think there are a generation out there of retired people or people getting close to retirement who have a lot of wealth and there will be a transfer of wealth and that is including assistance on their home.”

Transfer of wealth? But all the surveys we’ve seen show that a majority of the Boomers have accumulated jjust a fraction of what will be needed to keep buying thirsty underwear for the next three decades. Fully half say they’ll need to sell their own houses and downsize or rent in order to free up retirement cash. Seventy per cent do not have corporate pensions, after all, and for a lot of Boomers they won’t even see any OAS until they hit 67 – the age when stuff starts falling off you.

So is this largesse just an extension of the helicoptering times we’re now in, or is it a bribe to get the 26-year-olds out of the furnace room? Beats me. (My offspring have cold noses, waggy tails and 10-inch-long hair growing from their butts.)

The other big issue, of course, is what all these gifted down payments may be doing to the real estate market. As you know, the feds killed off long amortization and raised mortgage qualifications in the specific hope of keeping people without money from buying houses they couldn’t really afford. The theory was that would cool sales and ultimately reduce the pressure on prices, once the moist virgins realized that without a wad of savings they simply wouldn’t be able to borrow.

Well, kiss that one goodbye. The kids are loose.

What an interesting life lesson this will be.