The big question

For the first time in more than four years, the average Canadian house costs less than it did the year before. Soon it will be considerably less. Even in Van and 416. But it’ll take a big drop, and a long time, for most Canadians to lose their fixation with bricks. This autumn should speed that along, with the October 25th rate hike and the universal mortgage stress test.

In the meantime, people like Devon struggle with the notion of risk.

“I have been following your blog for couple of months now and I think you are doing an awesome job,” his note starts out with the obligatory suck-up. “I do share the same view as you, that the housing market is due for a correction, so back in May I sold my house and moved in with my parents. I now have around $800K of cash that I need to find investment opportunity for.” So far, so good. Smart boy, this Devon.

“I know that you encourage a diversified portfolio (ETFs, preferred shares, bonds, etc…) that on average can make 6%/yr. But given the all-time high of the US stock market and the geopolitical uncertainty (Donald Trump), it is too risky to buy into the stock market now? At a high level, how would you construct a portfolio in this environment?

“I was thinking another option is to buy 2 condos, $400k each, and rent them out for $2k each. That would give a 6% return. The rental market is crazy hot so it shouldn’t be a problem to find tenants. I know there will be risk of bad tenant, additional expenses maintain the properties, and tax credits might not be as good as buying stocks. But as a long term investment is being a landlord a good way to investment your money?”

This is something many struggle with. They see “investing” meaning “stocks” which translates into “danger.” Meanwhile real estate looks benign and is so, so easy to fall into. Without a doubt, society has tilted in favour of properties, thanks bigly to cheap loan rates, mortgage-pimping banks and mom. But as this pathetic blog always points out, risk is everywhere. The best way to control it is to have diversification and balance, and putting all your money into a couple of condos blows up both of those principles.

If D buys those two units he’ll pay $20,000 in closing costs and end up with $820,000 invested. Condo fees, property taxes and insurance will equal at least $800 a month, and the average rent in Toronto for a one-bedder is $1,800. That leaves a return – without any vacancies, repairs or the cost of fishing iguanas out of the toilet – of $12,000 a year per unit, or 2.9% on an investment of $820,000.

But wait. That twenty-four grand is considered income in Devon’s hands, and lumped on top of his regular, working-dude wages. If he earns the average (about $80,000) his marginal tax rate is 31.5%, and he ends up paying $7,500 on the rent. Net return: $16,500, or 2%. Sucks, of course.

And what of risk? Bad tenants, condo fee increases, higher property tax or special assessments (they’re coming for glass-walled buildings) are all beyond his control. More concerning should be illiquidity and net loss – the consequences of a real estate market that can lose altitude fast. If condo values correct a modest 15%, D is screwed over for $123,000. If he decides to bail, he faces paying commission of $40,000 – if he can find a buyer.

Incredibly, there are thousands of people who do this. Blindly.

So what happens if D goes balanced & diversified with a liquid portfolio of ETFs of the kind oft described here? If the last seven years is a guide, he might make about 6.5%, with most of the returns in the form of capital gains and dividends. Given the tax breaks, his actual net return would be a tad over 5% – putting him about $24,000 a year ahead. Of course, ETF portfolios do not come with condo fees, property tax, insurance premiums or guys who pee off balconies. There is no 5% commission when you sell and no land transfer tax when you buy. And they’re instantly liquid, the cash flows a couple of days after you push the button.

But what of risk?

It’s everywhere. Trump. That Kim dipstick. Record Dow. But while the US continues to expand, and global growth has returned (both good things), investors need to dampen volatility and squish risk by having the right assets in the correct weightings. That’s why 40% in safe (fixed income) assets and 60% in growth stuff (of which a minority is exposed to US markets) makes so much sense. The same rising interest rates that can sink real estate, propel preferreds. Of course higher rates also tank bonds (keep the weighing low) while they signal more robust economic growth (helping equities).

The bottom line? Investing in a liquid, well-built portfolio beats the pants off buying two apartments. In every regard. Even now, in the Trumpian era, and especially given the trajectory of Canadian real estate.

But investing is hard. Condos are easy. And nobody can see your ETFs, the way you can point to a building. There may even be some women who are not turned on by dividend income, high liquidity or low embedded MERs. Imagine.

Think this through, Devon. We’re pulling for you.

‘Far worse’

Dave took this picture while walking his pooch this morning in North Vancouver. “In loving memory of Jezzie,” it says. “Please help yourself to a tennis ball for your dog to play with. Keep it or drop it back in the bin for another dog to enjoy. Remember to cherish your time together.” Amen.

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Someday soon we’ll be able to ignore the Toronto and Vancouver housing markets. But not yet. After all, who can stop staring at a car crash?

Looks like total monthly GTA sales will come in around the 4,000 market for August. Yikes. Compare that with 6,000 in July (which was down 40% from last year), 8,000 in June (down 37%), 10,000 in May (down 20%), 11,500 in April (down 3%) and 12,000 in March (up 18% from 2016).

See the pattern? Even accounting for seasonality and string bikinis, the market’s dying before our very eyes. Last August a whopping 9,800 houses sold, up 23% from the summer before. So if the 4,000 mark holds this month, the decline will be 60%. There’s just no barking your way out of this bag. The GTA is pooched. Buyer sentiment has turned negative. Most importantly, the speculators have left the building, and “facts” everyone used to believe have turned out to be fake news. Like, “immigration will always keep real estate afloat” and “there’s not enough supply of houses.”

First, here’s GreaterFool realtor-correspondent Old Ron, with a fresh report from the field:

“Hi Garth: This market is far worse than anyone is talking about. The MSM is soft soaking this crash. It is like two agents on a putting green while a giant Mushroom cloud rises in the background. Even Old Ron, who is good shape financially, thought it was prudent to scrub his fishing trip to Montana, and hunker down.

“Here are some facts. $920,791. That is the high water mark – the average price in April 2017. The question is when will the average price in the GTA reach that number again? Clue: The crash of 1989 took 14 years for the prices to recover and exceed the previous high.

“The realtor haters on your blog will be pleased to know sales have dropped by about 66% from the peak. If that happened to GM, they would be in Chapter 11 within a year. Then consider that the average price is down about 20% or more depending on the region of TREB. Given that realtor income is a percentage of sale price, the agents have taken a further hit here.

“Finally, I have noticed that commissions are getting much softer. Basically Sellers don’t mind forking over $40K in fees to sell a house when they receive  a million dollar cheque. But when the Seller has just been kicked in the teeth by the market, they are not in a generous mood. The agents are starving from 1) Absurdly high number of realtors. 2) A 66% crash in number of sales. 3) A  20%+ decline in sale prices,  and 4) a softer commission picture. A perfect storm.

“It gets worse, many agents are in the bad habit of paying for their previous years Income taxes with a good spring market. I have spoken to several agents who are in the hole for $60,000 or more to the Revenue Agency, with no deals in the pipeline to pay the Government. These are not big hitters, just average people who thought that absurdly high sales and price numbers would last for ever.

“This can all be summed up @ a lunch I had on Friday with a 30 something agent. It was his turn to pay, so when the bill came, and he plunked down three credit cards on the waiters tray. “One of these should work,” he said blithely.”

As the frothiest housing market in Canadian history unwinds at the fastest pace ever experienced, more ugly (for realtors) truth emerges. Like the latest Stats Canada census numbers which just shattered the belief GTA real estate a slam-bunk forever because home construction can’t pace population growth. Well, forget that. Remember all the comments here about 100,000 new immigrants swelling the region annually – adding half a million house-horny, monied interlopers over the last five years?

Bunk.

The population increased by 146,200 households between 2011 and 2016 (1.3% a year), during which time 175,825 new houses were built. Yup, more new properties became available than there were new families to buy them. So much for this statement which local real estate board poohbahs fed the public back in March to explain 30% annual price increases:

“Over the past year, we have reached a point where government policies that target only the demand side of the market, whether we’re talking about foreign buyers or further changes to mortgage lending guidelines, will not be enough to balance market conditions and moderate the pace of price growth.

“In 2017, policymakers at all three levels of government must turn their attention to the supply of homes available for sale. They should consider revisiting land-use designations in built-up areas to allow for a greater diversity of home types, streamlining development approvals and permitting processes, and looking at ways to incentivize landowners to develop their land.”

Turns out we didn’t have too many immigrants or too few houses. Just too many realtors and a local population that swallowed the Kool-Aid and turned into delusional house-lusty speculators. The number of households owning multiple properties exploded to about 9%. Billions of dollars in down payments came out of home equity through the Bank of Mom. HELOCs exploded nationally to $210 billion, most of it going back into speculative real estate investments. And the debt-to-income ratio of most people buying $1 million houses bloated to 450% or more.

Old Ron is right. The property market isn’t coming back any time soon. Nor has it toed bottom. There’s no reason to expect a rebound in September, and many to anticipate new declines. Listings will swell again. Mortgage rates will increase. Closings will be missed. The bank rate will rise. The new stress test may arrive. And thousands of terrified, squeezed amateurs landlords and speckers will keep throwing equity overboard as they try to get out.

There may be some good, though. We might stop believing what they tell us.