Eight years ago Abel paid $325,000 for a one-bedroom, one-bath condo with a view in DT Vancouver. Four years ago he toyed with selling it, and Agent Bob said a good listing price would be $430,000. Cool, said Abel, then working on a short-term contract in Toronto. I’ll keep renting it out, and wait for more profit.
So he did. This week Agent Bob was back in the picture, because the Toronto gig morphed into full-time work. And the Van condo is now worth $400,000. Maybe. On a good day with a tailwind. After finding a buyer at 90% list, minus commission, Abel will walk with $365,000, or $35,000 more than he paid after closing costs and $29,000 after capital gains tax.
“I thought this was supposed to be some hot, no-lose market,” he told me yesterday. “Considering what I had to rent the place for to keep a tenant, I probably lost money.” Of course you did, I said comfortingly. If the $325,000 had been invested in a nice balanced portfolio giving you 7%, for example, today you’d have $455,000.
I didn’t have the heart to remind Abel that for years he collected rent and paid tax on it at his marginal rate, while the hit on a portfolio chunking out dividends and capital gains would have been subject to half the load. And he wouldn’t have to paint his portfolio and install a new dishwasher and toilet tank assembly in order to sell it. Or wait for an offer.
This is a glimpse of the reality for so many people – especially first-time buyers – who bought into the ‘property ladder’ myth. There’s no more ladder. If a guy owning for eight years in the bubbliest market in Canada can barely get his money back, then pity the 5%-down buyers of 2011 and 2012. Especially with what the whale says is coming.
So far, as you know, Canadians have been warned by the International Monetary Fund, most of our big banks, Capital Economics, Deutsche Bank, The Economist, Robert Shiller and even the Bank of Canada that they have turned into house-horny, lascivious, lusty, obsessed real estate fetishists. Hell, even this pathetic blog may have piled on once or twice.
The latest wolf cry comes from one of the biggest financial monoliths in the world, with almost $2 trillion under management. In fact, based on its belief that Canadian real estate “will finally roll over in 2014”, US-based Pimco has just slashed by 50% the exposure it has to Canada in its $250-billion Total Return Fund. Ouch.
Now it’s interesting that this comes on the same day Putin is being a prick, which tanked the Russian stock market, bloated Russian interest rates, spiked oil costs, sideswiped global markets and sent investors into the arms of bonds. This reminds us how close financial or economic shocks can be, thanks to events we have absolutely no control over. Remember yesterday’s post? Plan B? I hope you have one.
Lest you dismiss Pimco as another bunch of fools who do not understand it’s totally different in this northern paradise, try a little Googling. The intellectual firepower the company possesses is formidable, including lead Canadian analyst Ed Devlin, now warning house prices here will fade away by up to 30% over the next two to five years. As you might imagine, that would be enough to put tens of thousands of recent buyers underwater, and roll us back to 2006 prices in many markets. If you have a weensy condo and no equity, or need to sell so you can retire, this is not happy news. So, is it credible?
Judge for yourself. Here is the nub of Devlin’s report, in his own words:
While we think the housing market in Canada is overvalued and due for a correction, the correction will likely happen over several years. There are two important assumptions that underpin our housing forecast. First, a correction is not a bubble bursting in a disorderly manner. Second, the correction will start in 2014.
In our view, for the Canadian housing market to “burst” in a disorderly manner, one of three events would have to happen in 2014: Interest rates would need to rise substantially, the unemployment rate would have to spike higher or the supply of mortgage credit would have to be disrupted. With real growth of about 2% and a relatively subdued inflation forecast, we see no reason for interest rates to substantially rise in 2014. Given this macroeconomic environment, it is also unlikely that the unemployment rate will spike to 8%-10% (which, we estimate, would be needed to cause a disorderly housing correction). Finally, the Canadian banking system continues to provide sufficient mortgage credit to keep the housing market financed.
At PIMCO Canada, we have been bearish on housing for a while from a secular perspective, but this is the first time we are forecasting a cyclical decline in the housing market. Our forecast reflects a number of factors. First, higher housing prices show the market is more stretched than in previous years. Second, the four rounds of mortgage credit tightening implemented by the federal government are now more clearly having the desired effect. Finally, we expect the cost of capital at Canadian banks to rise in 2014 due to regulatory changes and expect the banks to pass on these higher costs to consumers in the form of modestly higher mortgage rates.
Hmm. Where have we heard this before? No disorderly, US-style crash, but a correction grinding things lower over a few years. No major interest rate surge, jobless jump or credit crunch – none of those dramatic factors real estate agents keep telling us are required for any market decline.
Instead, just crazy prices that went too high, more restrictive lending (it happened again last week) and inevitably inflating mortgage rates – exactly as one of our major banks predicted last week.
No bang. Just a whimper.
Same result. More pain.