Entries from July 2012 ↓


While the bread-&-circus thing goes on in London, the Brits are facing the certainty of a triple-dip recession. Austerity budgets are killing them. On this side of the ocean, bond yields have plunged to historic lows. Investors in 5-year US government debt get half a per cent. The rate for a year is zero. Despite a crisis in Europe, gold’s dead.  Growth in the American economy has slowed again. Unemployment around the world is now structural. Can’t be fixed. On Friday seven Canadian banks were downgraded. Why? Too much real estate exposure.

What does all this mean? Simple. Google ‘deflation.’

A year ago on this pathetically prophetic and occasionally prophylactic blog I warned you of an odd thing developing – price inflation at the same time as asset deflation. That’s when you own a house in Surrey which is losing value every week as the real estate market collapses, and yet you’re paying more to insure it, heat it and drive home to it from a job where there’s less security and no more income. This means in order to maintain your lifestyle, you have to add to the line of credit and lie to the spouse. It ain’t a winning strategy.

Most people who have dabbled in amateur economics, like my friend Sammy who runs the pizza place, or the prime minister, know only the classic definition of deflation, which is the opposite of inflation. That’s when the cost of living falls below 0%, the money supply contracts, credit dries up and the price of everything goes down. It can lead to a vicious cycle in which less demand equals less production, bringing fewer jobs and still less demand. Maybe depression, too.

So how can we have this thing today when prices are outpacing wages, governments are printing tons of money and banks will happily loan to a worthy-looking golden doodle? How could there not be tons of inflation with less valuable money, rising house prices and easier-to-pay mortgages?

Beats me. I just come here for the pictures.

But facts are fact. Despite massive government intervention in the economy, the injection of enough liquidity to bankrupt the next two generations, coordinated global monetary and fiscal policy, zero interest rates and HGTV, asset values are doomed. That’s why Standard & Poors cut the credit rating on banks which make mega-profits and why governments (Britain, Greece, Canada) that think less is more, are on the wrong track. Not that paying down debt and trimming deficits is bad. It’s not. If you like deflation.

Many people think this is now unstoppable. Makes sense. After all, interest rates can hardly go any lower, and if they did, would it matter? Government spending has already gone off the charts, with people being paid to buy houses, build a new BBQ deck, close a first real estate deal or get a pickup truck. Since early 2009, every trick in the book’s been used to try and rekindle inflationary growth. In the US it failed to stop the massive deflation of residential real estate. In Canada, the same seems set to occur.

This is why I’ve warned against having the bulk of your net worth in a house, with particular concern for two groups – the vacuous virgins and the decaying wrinklers. Young couples who bought with little or nothing down within the last couple of years have a big chance of being wiped out. And house-rich, financially-poor Boomers not only missed the last chance to harvest a windfall, but now risk being trapped inside illiquid assets.

It’s also why I’ve regularly showcased some viable alternatives. Like preferred shares. Real estate investment trusts. Apartment buildings in Chatham. Exchange-traded funds. And warned you off precious metals, rental condos and anywhere that people ride Vespas.

Deflation, or even the threat of it, makes money more valuable. Like now. This is why people buy bonds and accept no cash flow – because the rising value of protected money is return enough. It’s why stock markets and corporate profits can increase even when the economy falters – because smart firms (like Apple) have cash reserves, which augment in purchasing power daily. It’s why the holy grail of the investment world these days is not capital gains, but yield. And it’s why people like Jessica will reap what they sow.

Somebody asked me the other day if only dumb people write me, or if I only publish the dumb letters.

Actually this one is typical.

Be so thankful you did not marry this woman.

Dear Garth: I’m a “property virgin” from Victoria, BC, but trying to get into the market.  My brother-in-law reads your blog a lot and said that you would be the best person to ask for advice.

I’m 27 years old and recently married.  I just graduated university last year with a Psychology degree and just started working part time as a teacher’s assistant during the school year. (In the summer I can collect EI).  In the evenings I work at a local pub and make good tips.  My husband just started working as a piece-work technician at the local Telco company.  Combined we make betwen $80k – $120k annually, but it fluctuates depending on how many tips I make in a night, and how busy things are at the Telco company (very slow at the moment but usually gets busy in Sept/Oct).  I have about $40,000 in student loans, but I can pay these off over the next 20 years so I’m not worried.  My husband has about $20,000 debt from various Lines of Credit over the years buying cars and going on vacation etc.  He recently also purchased a vehicle for his job, so there’s a $26,000 car loan as well. We have no savings.

We are currently renting a 1 bedroom suite for $850/month but we are thinking about buying a house since the mortgage rates are so low and I really want to own our own home.  Why pay somebody elses mortgage, right?  The biggest problem we have is that my husband hasn’t done his taxes in 3-4 years so we can’t prove our income and get approved for a mortgage.  I’ve been trying to get him to do them, but he’s more concerned with playing XBOX and riding his bike.

My question is, how can I convince my husband to get off his a** and do his taxes to get the ball rolling?  And are we screwed if he can’t find all his receipts?  We’re excited to start the next chapter of our lives and buy our own home, but I just a little help/advice from you.  Much appreciated.

Banana Republic

The feds can murder long-term mortgages. The bank cops can outlaw cash-back mortgages and toughen borrowing rules. F and Carney can warn until they’re hoarse. The media can brim with stories of bubbles. But does any of this actually work? Are people borrowing less, getting cautious and parking their house hormones?

Big question. The answer could dictate exactly how the next few years unfold – melt, correction, or crash.

First, to set the scene, here’s a note Kayla sent me last night. She and her BF work in Ottawa for the government (what else?) and they’re the 4,721st couple to ask me this question. Congratulations.

“We are debating whether NOW is a good time to purchase my first home. My boyfriend and I (early 30s) are currently renting for $1200 a month but are becoming increasingly seduced (and almost peer pressured!) into buying a single home with a backyard in suburbia. We make about $120,000 together, have about $15,000 in savings, and no debt. We are confused!!!! And also maybe too poor to actually afford something now that I am actually looking at those numbers that I just typed on my screen. My parents tell us that we need to buy a house in order to save money. If we keep renting we will have nothing to “to show for it” in 25 years. My real estate agent tells me that this is a great time to buy, as apparently prices will NEVER go down in Ottawa. Help! We don’t know what to do.”

So two young people without enough money to buy a new minivan are actively considering purchasing a SFH (Ottawa average residential price, $373,756). Not only are parents rooting for it, but a realtor’s guaranteeing prices and you can bet there will be lots of banks ready to hand over 95% financing. Why wouldn’t the virgins be confused? Most of the authority figures in their lives are telling them to grow up and get mortgaged.

It’s this societal mania which helped create the situation we now have – where real estate has exploded in value, people in each city say ‘it’s different here’, and first-time buyers lust for a suburban spread nicer than their parents own. How is this sustainable?

It’s not. And here’s a new report from Pacifica Partners which underscores just what this pathetic and nasty little blog has been bleating about: A housing boom built on debt will not last.

“The decade long bull market in Canadian real estate has not been the result of ‘healthy drivers’ such as  income growth, growth of the economy, nor is it the result of housing scarcity.  In fact, housing price growth has outpaced wage growth and  GDP growth Instead, housing price appreciation has been made possible in large part due to rampant debt accumulation, both mortgage and personal credit.”

Below’s a nifty chart to prove it. Ten years ago (when houses were still affordable) household debt equaled 60% of the Canadian economy. Today that number has soared to around 90% – which means it doubled in a decade, after taking 30 years to double previously.

But hark! Is that a plateau on the top of that debt mountain? Does this mean F&C&the-Ps are finally having an impact, with warnings that excessive borrowing causes impotency and Vespa carb sputter? You bet. The evidence of slowing demand for loans and mortgages is mounting fast. Here’s another Pacifica chart to demonstrate:

So, if the real estate escalation we’ve experienced – the one that Kayla’s realtor says will continue – was caused by exploding levels of debt (and not income or job growth), what happens when borrowing flames out? If households aren’t racking up new debt as they were in the past, but earning no more money and shouldering fat payments, what’s going to finance all this real estate activity? How can it be sustained?

“Thus a lack of future debt accumulation by households implies that the key driver of past real estate performance may no longer be available to stimulate real estate going forward,” say the economists. This is not economic theory. It’s financial fact. Fires without fuel extinguish. And this is exactly why Kayla and her stud will end up with more debt than equity, and a mess of heartache, if they listen to the squirrelly people around them.

Ottawa is not different. Nor Regina, Etobicoke or Halifax. The declines and adjustments in every market will be local in timing and scope, but the direction is certain. Residential real estate is in trouble.

How much?

“We have attempted to quantify the necessary price drops to bring specific real estate back to historical average multiples of discounted rental income,” says Pacifica Partners.  (Our) findings indicate a required 30% to 40% correction in home prices in some major Canadian markets to achieve a return to long run averages.”

Remember, the US was creamed by a 32% correction. Thank god it’s different here.