By the shorts


By every measure, it’s overdone, oversexed, speculative and scary.

The latest numbers show it with clarity: Resale home sales of 50,270 last month was a record for July. Activity surged by a third in Toronto and Edmonton and virtually doubled in Vancouver. Even more dramatic was price. In a year, in the midst of a recession – when inflation is negative and interest rates flatlined – the average Canadian home grew in value by a stunning 7.5%.

This, as you know, happened while US home values tumbled another 15%. It also happened as our jobless numbers exploded, manufacturing collapsed, car companies staggered and the country’s finances disintegrated faster than at any other time in history.

This is the tangible face of speculation, when social pressure and greed drive an asset higher because it’s in vogue. It also proves that when something’s drop-dead cheap, people will load up. In this case, borrowed money.

There are many reasons reasonable people should expect this is the top of the market.

Pent-up demand can’t last. It will be gone soon enough, along with record sales numbers.

Unemployment’s expected to rise through much of 2010.

House prices may have gone up almost 8%, but family incomes have not. In fact, they’ve stagnated.

And interest rates have only one direction in which to travel, as do federal and provincial taxes. We know where both sales taxes and mortgage rates will be two years from now.

For these simple reasons, and quite a few others, the housing bubble – bred by cheap financing and human folly – is at or near its inflated, bulging, taut and orgiastic zenith. The question for investors is also simple: How do you make money from something in bloat?

Several ways.

In the stock market, for example, you can short a company whose shares have climbed beyond reason by selling short. That means unloading equities you don’t actually own, by borrowing them from a broker, in the hope of buying them back in days, weeks or months at a cheaper price. The difference in what you got for selling it today and what you pay later is the profit.

But how do you short the housing market?

Bubble Buster # 1

Obviously selling real estate you own at the top of the market (that would be just about now) is a way to realize capital gains. Then short the market by buying back in later at a lower price. In fact, if you were to sell today in a bidding war you’d be able to get any closing date you wanted in an unconditional deal with a serious non-refundable deposit (make that a condition of the sale).

Demand a long closing of, say, next April or May.

One of two things will likely happen: (a) the market will have crested, giving you top-of-the froth sale proceeds with which to buy a new house. Or, (b) the buyers realize they made a horrible mistake and paid far too much in the middle of a bubble, and don’t close the deal. Sweet. Then you get to keep both the house and the serious deposit (and here I’m thinking fifty large on a 400K property).

Bubble Buster # 2

Alternatively, you could sell a property at the top of the curve, get a guaranteed tax-free high yield on your sale proceeds, and quite possibly reclaim the asset, along with pocketing opportunity money at the same time.

Let’s say you have a mortgage-free property that could fetch $400,000  – again, likely in a bidding war. Being a seller’s market, you’re in the driver’s seat and can insist on a large deposit which is non-refundable (BTW, the real estate agent will fight you on this, but tough).

Now, offer the buyer an attractive vendor take-back mortgage  – five-year term, completely open, at less than bank rates. In fact, banks don’t even offer long-term, open loans, and the one-year open is north of 6.5%. So, an open fiver at 5% is a great deal for the purchaser.

Insist on 20% down ($80,000), and a VTB of $320,000 – which will give you a monthly income of $1,860, or $22,332 a year. And it’s tax-free, since it’s flowing from the proceeds of your principle residence. In other words, you have taken your over-valued property, put eighty grand in your pocket, and created enough cash flow to rent a similar home – secure in the knowledge that you’ll still get your $320,000 back in (at the most) five years.

But what happens if the housing market collapses and your buyers find themselves underwater, with a house worth less than $320,000? What if they walk or default on payments?

No probs. Put the house under power of sale or foreclosure. You get the option of selling it again in the open market (and keeping the cash you’ve already collected), or putting it back into your own name. Plus, you have the right to sue the poor buggers for missed mortgage payments, legal costs and any shortfall that might occur between the mortgage amount and a sale amount – no matter how distressed the market might be.

Getting a judgment would be virtually automatic, or just regain title and move back in. And you’d be $80,000 wealthier than you were before, without having had to invest any money.

There’s more. Stay tuned.