Party on

Fran and Sal were in touch with me last summer while they shopped for a house in the Leslieville area of Toronto. They sent me a photo. “It looks like a bombed-out dumpster,” I said helpfully. But they bought it, for $615,000.

Actually it was a wood frame house, largely unrenovated, on a 25-foot lot three doors from a former factory and beside a semi with a front porch held aloft by cases of Canadian empties. They bought it for $85,000 more than the listed price, since there was a bidding war. “Good bones,” Fran rationalized. Rats have bones, too. And they like Leslieville.

As you might imagine, I told them they were idiots and would seriously regret the move.

Sometime soon, September maybe, will come word that Canadian house prices have increased over the past year by zero. This is more profound than it sounds.

Hundreds of thousands of buyers in the past two years – like Fran and Sal – have rolled the dice on a massive investment based on a single premise: prices would endlessly rise. The party would last forever. It’s why they paid too much. Why they borrowed 95% of the purchase price. Why they bought a house that was barely habitable. Why they were caught up in animal spirits.

After closing costs ($17,000 for land transfer taxes and $4,000 for legals and moving), interest costs for one year ($27,500), property taxes and remedial renos ($34,000), and downpayment (30,700) their cash outlay equals $113,200. If they decide to sell this year before the market crumbles further, and ask $700,000, they will face commission costs of $35,000 (5%), mortgage penalty of $9,000 and mortgage repayment of $584,000, for a total of $628,000, leaving them $72,000. Net loss: $41,200.

But what are the chances of selling a house you bought in Leslieville (or anywhere) last summer at $615,000 for $700,000 this year? Yeah. Zip. So if Fran and Sal get what they paid, less commission, the loss equals their expended cash: $113,000.

The CREA numbers I forecast here before their release Monday were as expected. (As were the Toronto stats released hours ago.) Sales have sogged, listings have dried and prices have started to limp. Year-over-year price increases across Canada are now 1%. That means people who bought in the last 12 months cannot possibly sell and break even. Next month it will be worse. And before long, prices for the last few months of 2010 will be below those at the conclusion of 2009.

While this is making news, it was utterly predictable. (And laughable how the poor little HST is being blamed.) Also predictable is the reaction of mainstream economists, like TD’s earnest Grant Bishop, who got his first serious camera time this week predicting a “peak-to-trough” decline in real estate values of 10%. We should be so lucky. Bishop caught more attention, however, for predicting that this would be followed by “several years of stagnation of price growth.”

Hmm. Not what they want to hear in Leslieville. Or among the condos in downtown Edmonton or Vancouver. It means hormonal young buyers who swallowed the Phil Soper Kool-Aid and bought units with 5% down might be faced with zero equity growth just about the time they have to renew their 2% mortgages at, say, 6%. They’d rolled the dice, counting on consistent price inflation to paper over their rash purchases, only to find they paid tens of thousands in mortgage interest for units they might as well have rented for half the cost. And let’s remember that with 35-year mortgage amortizations, there isn’t even any real equity to show for five years of payments.

This – not the fluff happening now – is what real estate disasters are made of. The resetting of teaser mortgage rates to market levels in America led directly to the decimation of many markets and the subsequent descent of a quarter of all homeowning families into negative equity.

This week the federal agency partially responsible for facilitating this potential mess issued its annual Mortgage Consumer Survey. It’s intended to trumpet its work in building a nation of homeowners. Among the results:

* First-time buyers who do not check the interest rate on their mortgage to ensure it was the lowest possible: 35%
* Buyers who did not understand how much mortgage they could afford, but bought anyway: 15%

* Buyers who bought despite not being able to come up with a downpayment: 29%

Yes, and people without money took high-risk, high-ratio mortgages from lenders who approved them only because they were being backstopped by the Canadian taxpayer: 100%.

There’s little doubt how this will end.

> > < <

Vancouver, as you know, is particularly at risk. I’ll be describing this in detail and presenting some options to people who might like to avoid sliding into the sea, when I am there next month. I’ve been informed that 700 tickets for my talk are now spoken for. But I do not want to leave that city before everyone possible has been traumatized. So, register here, and we’ll see what we can do about a second night. — Garth