Entries from March 2011 ↓

Cooked

Four years old, two storey, three bedroom, two bath, 2,400 square feet – all for $64,000. Nice. “We recently purchased a home in Phoenix Arizona,” Crystal writes me, “and wanted to open a business and relocate there from Canada,” she says, “but it did not turn out this way.” And the real estate wasn’t so hot, either – despite scooping a property for a fraction of its former worth. Now it’s worth $61,000, and falling. Crystal just learned about deflation.

“It costs us about $5,000 a year just to maintain,” she says, “so what should we do? Keep the house, try to find renters and sell later? Or sell immediately, preferably to another Canadian, like baby boomer retirees? How soon do you think the Phoenix real estate market will pick back up?”

Of course, the house costs them more than five grand. There’s also the $64,000 cash they put down (plus closing costs), which could be earning five thousand – which means Phoenix is eating close to $1,000 a month, factoring in a trip a year to check on things. Trouble is, there are lots of perfectly fine houses for rent in that city for less than a grand a month, and good tenants are tough to find. Renting will also mean having to file an annual US tax return, and being nailed for any cash flow surplus. Bummer.

And it all seemed like a no-brainer. Just buy a cheap house online.

As I’ve said before, as a long-term strategy, sell Canada-buy America works. We’re inflated, They’re deflated. Both markets have only one direction in which to go. In Canada we fork over about 40% of our earnings to feed houses (it’s70% in Vancouver). In the US now, that number has withered to 13.1% of median family income. We have 70% home ownership, and rising. They are at 66% and falling. We think it’s different here. And so did they.

I said yesterday the US housing market is one of the external factors you need to pay attention to. Its continuing crisis is a potential trigger for continent-wide deflation. Cascading real estate values not only rob American consumers of their wealth, and diminish that country’s appetite for our goods, but also provide us with an example of what can happen when you put your faith in a house.

As I also said, if we do stagger through a deflationary episode the losers will include people with big mortgages and little equity, and those with stock-laden investment portfolios. The winners will be folks who loaded up on bonds and, of course, renters. Liquidity will be worshiped. Debt will kill ya.

Yes, exactly. This is the nightmare scenario for the Canadian middle class – those folks who have drunk the Royal Re/Max Kool-Aid, pigged out on 3% mortgages and turned their RRSPs into granite countertops. We now have more household debt than the hedonist Yanks. The average downpayment is a weensy little 7%. Most new mortgages taken out (at least until two weeks ago) were for 35-years – which means homeowners rent money instead of build equity. We spend what we earn (at least). We pay more taxes than the Americans. Our houses cost twice as much. Guess who’s in the deflationary crosshairs?

I know, I know. Everyone says a ‘US-style’ housing dump won’t happen here. And that’s probably correct. I seriously doubt there will be neighbourhoods anywhere in which houses lose 80% of their value, as they’ve done in some Phoenix hoods. And it’s unlikely we’ll hear realtors in Calgary or Kelowna or Toronto say something like this (uttered this week by an insider in Fort Lauderdale): “If there weren’t vultures out there, you’d have a city of dead carcasses. It’s like the circle of life.”

But that’s not the point. A mild 15% correction in Canadian house values, and a protracted recovery, would finish off more of your friends and relatives than bubonic plague. They’ve borrowed to the max, saved diddly, have no cash reserves and can only afford their homes because of mortgage rates which are the lowest in recorded history. In short, the Canadian middle class has taken one mama of a gamble that from here to eternity it’ll be wall-to-wall inflation. For this strategy to work, houses must increase every year. Yet for that to happen, so do incomes. And have you scored a raise lately?

Exactly. This is what worries me. Should worry you, too. Especially if you’re a hormonal virgin or a crusty Boomer with a two-acre family room.

Now, how about Crystal? Is poor Phoenix ready for a fabled rebirth out of its own ashes? Or, just nicely cooked?

Well, this week’s news is that house prices in 18 or 20 major US cities have plopped again, led by a 9.1% collapse in – you guessed it – Phoenix. The betting is now that housing will soon be in a double-dip recession, with values hitting new lows. Foreclosures are expected to rise 20% in 2011. All gains in real estate values since 2001 (ten years ago) have now been erased. New homes are selling at 2003 prices. Resales, at an average of $156,100, are at 2002 levels. Construction is at a 50-year low.

So, Crystal, your strategy’s obvious. If you can’t wait five years, snare a Canadian. I hear they’re horny.

Normal?

Paul and Jennifer listed their downtown Toronto condo two weeks ago. Then Jen’s mom sent her a copy of the Post Magazine article on the future of real estate prices – the one I shared with you a few days ago, in which all the experts (but not me) predicted an eruption.

Jen, 28, a hospital worker, sent me this note last night: “Dear Garth (can I call you that??) – We put our perfect two-bdrm condo on MLS last week and then stood back and waited for the offers. Fourteen couples came through. Cool. Then nothing. We priced it $15K less than the same unit upstairs (which has been for sale, we now learn, for four months). So we dropped the price again by $7K five days ago. More nothing. Meantime four more units came up for sale in this building alone. We are dying here. What should we do? We already bought a house in Scarborough. Desperate Jenny in CityPlace.”

Meanwhile in today’s Wall Street Journal a story on Canadian real estate, “Housing Booms North of the Border” rightly points out Canadians are more indebted than Americans, housing has doubled in price in a decade, and people here are buying with picayune down payments. But it also trots out the usual cadre of bank economists, mortgage primers and house pumpers to tell us there’s no bubble, it’s different here and a US-style meltdown won’t happen.

I juxtapose these two items for a reason. It goes to a debate that’s rocked this testosterone-drenched blog now for months. Are we in the middle of an inflationary romp, fueled by cheap money and a recovering economy, that’ll goose houses and stocks higher? Or are we deluding ourselves, since it’s only excessive debt and government spending that are temporarily propping up prices?

It’s the only question that matters. After all, if inflation wins, higher wages and economic output will keep real estate values and stock markets swelling. If deflation wins, homeowners will lose vast sums of equity and people who loaded up on bonds will look like geniuses. For anyone who has the bulk of their net worth in a house (or equity mutual funds); for young couples with fat mortgages and no equity; anyone who traded up within the past three years; or people facing retirement who think their home is their financial saviour, deflation’s a game-changer. It brings disaster.

So how real is this threat?

Ironically, the more real estate values rise, the closer it gets. The reason is families suck up more and more debt in order to buy houses, decreasing their cash flow, making them susceptible to rate hikes and stifling their consumer spending. All of that is bad economics.

The more indebted governments become, the closer it gets. Vast amounts of tax revenues must be flushed away in interest payments, often to foreign bondholders. Governments have less to spend on domestic programs, especially the kind of billions in stimulus we’ve been showered with (Canada’s ‘economic action plan’). The next step is austerity budgets, and deflation creeps nearer.

The further the US housing market falls, the closer it gets. This week came news that 13% of all homes in that country are vacant – a shocking number. Two million more foreclosed properties are about to come on the market. This is robbing the American middle class of its accumulated wealth, as prices continue to plunge. If you think Canada can avoid deflation if it erupts in a  consumer spending-starved USA, you’re nuts.

The more external shocks, the closer it gets. Looks like Japan has a full-fledged nuclear meltdown on its hands now, while radioactive water is destroying the countryside. The Arab world is in flames with war or unrest in Libya, Bahrain, Yemen, Syria and even Saudi Arabia. Oil at $100 is already enough to slow global growth and hasten a retrenchment. Crude at $150 precipitated the 2008 financial crisis. What happens if it hits $200 while nuclear energy is blackballed and planetary energy costs spiral?

There are more threats, of course. Greece and Portugal seem ready to cave. Britain’s in a total funk. The US is now fighting three wars it can’t afford. Everybody you know is in debt, and your 25-year-old children are afraid to leave home. And things are supposed to be normal again?

Oh yeah, and while planeloads of Chinese are supposedly hoovering southern BC, Jenny can’t sell her below-market condo in the heart of Canada’s biggest city. Go figure.

A couple of weeks ago I boldly said (how else would I say anything?) that the real estate correction had arrived. Its presence would be evident, I added, when it was too late to respond. There’s no doubt in my mind the best months of this post-crisis recovery are already in the rearview mirror.

So don’t bother posting comments about multiple offers on the house down the street or the alarming appearance of lawn Asians in your hood. There will be greater fools throwing their money around, jacking prices on dwindling sales, until the end.

Just hope you find one.

Garth radio interview here.