Market update

A year ago a guy bought a sub-penthouse in a sub-interesting condo in a BC resort town and paid $1,300,000. On Saturday a mess of people showed up at the same building, and the same suite was sold at auction for $685,000.

“Interestingly,” said someone with family at the event, “a number of people thought the prices were still a little high.”

And I’d say they’re right. This is not the end of a real estate correction, even in sleepy Penticton. This is but the start. Everywhere. As my correspondent pointed out, “Penticton always gets clobbered before Kelowna. Kelowna gets clobbered before Vancouver.” And as that happens, you can count on Edmonton, Calgary, Toronto and even Fortress Ottawa getting whacked.

Over recent weeks I’ve been yakking on about deflation. Some people will think a fool losing six hundred thousand on a concrete box in a town with no economy constitutes deflation. It doesn’t. This is a price correction of the kind that will sweep into major urban areas. It restores some sanity by revaluing properties closer to what would be normal market levels. And if these were normal times, that’s where it would end. Big losses for recent buyers. Three or four years of crappy sales. Then a slow grind higher.

But this is not normal, and to see what comes next I counsel you once again to look south.

Yesterday economists were pulling out words like “devastating,” painful” and “fateful” to describe the current state of American housing. I’m sure you heard the news. Resales in July plunged by 27% across the US to the lowest level in 15 years in the worst one-month freefall since they started counting this stuff 42 years ago.

But the news gets worse. The biggest drop in sales came with affordable houses middle-class families would snap up, priced between $100,000 and $250,000 (the average US house now sells for about $180,000). There is a 12-month supply of unsold homes. Foreclosures have risen 1,000% in four years. Demand for single-family homes is at a decade-and-a-half low. Foreclosures and short sales account for a third of all transactions (vultures). Almost 25% of families with mortgages in the US are now in negative equity. Over 4,000,000 live in homes they have stopped making payments on, since there’s no equity.

It gets worse.

This has happened despite Washington giving $8,000 to anyone who would buy a house. It’s happening despite the lowest mortgage rates ever – barely over 4%, locked in for 30 years. Despite mortgage interest deductibility. Despite a new billion-dollar federal program loaning as much as $50,000 to homeowners “in hard hit local areas” to make mortgage, tax and insurance payments for two years. Despite an estimated $1 trillion the Obama administration has spent trying to stem a real estate holocaust.

Now, this is deflation. It’s when people refuse to buy things which are falling in value, because they know they’ll soon be cheaper. As a real estate agent in hard-hit California said yesterday, “It really is a self-fulfilling prophecy. If all buyers perceive that home prices are coming down, then they will stop making offers – and home prices will come down.” And this is exactly what economists now expect to happen, as American real estate catapults quickly over the next few months towards some kind of capitulation. As a senior economist at Merrill Lynch in New York put it, “We will reach a new bottom… There’s going to be a prolonged, painful drop.”

As you might imagine, all this tanked stocks markets and rekindled the usual talk about a double double recession and the US entering a deflationary decade like that which has withered Japan (by the way, China passed Japan as the second-biggest economy this week). Talk like that had investors beating down the doors of the bond market, where they once again pushed prices higher and yields lower. (I seriously hope you took my fixed income advice of a few months ago.)

So, here are my points for today.

First, what’s now happening in Canadian real estate is nothing but a warning. Heed it or get set for a memorable, wealth-robbing ride.

Second, the odds of this correction becoming deflation are far higher than even I (your cuddly little bear) foresaw six months ago. My musings on a multi-year melt for real estate may have been too tame.

Third, there is no rescue plan possible. Even if the Bank of Canada wiped away its last two rate hikes, the HST was suspended and Ottawa cut income taxes (none of which will happen this year), real estate is cooked. This is not about affordability any longer. It’s about animal spirits – confidence. Buyers won’t pony up when prices are eroding, jobs are elusive and the future uncertain.

Fourth, houses are on the verge of becoming illiquid. For first-time owners, it means negative equity. For boomers with the bulk of net worth in their homes, financial disaster. For any family which is over-extended or simply needs to get out, real estate could be a trap. That has certainly happened to our American cousins.

Fifth, you still have time. Believe it or not, there are fools left who listen to realtors, trust the government and gets the hots for granite.

The best real estate strategy is to exit.

The best investment strategy is contrarian.

– From Florin Torcoci, Toronto