Entries from October 2012 ↓

Creative destruction

“People,” the lawyer said, “wouldn’t be looking for the return of their deposits if the units were worth more than or as much as they purchased them for.”

Remember those words. You’ll hear them again.

This is what happens when (take your pick), (a) the economy starts fading, (b) real estate prices slide or, (c) people realize they were horny idiots. The words will be repeated in most cities, and apply to many buildings and housing developments where buyers understand what looked sexy a year ago is now just butt ugly. Worse, dangerous.

The latest glam project to falter is Vancouver’s uber-condo, the Residences at Hotel Georgia. This 48-story excess sprouting from the carcass of an art deco downtown fixture was all the rage in 2010 when everyone believed in the Power of HAM and thought it was different there. Units sold for nosebleed prices of $1,400 a square foot, with the developer promising closings in December of 2011.

The damn thing’s still not finished, and meanwhile Van real estate is crashing back to earth. So an error on the part of the developer – inadequate notice of the delayed closing date – has given regretful buyers a chance to wiggle out of their deals. At least six of them have taken legal action to recover their deposits (typically around $400,000 on deals averaging $2 million), and walk.

This could spell financial disaster for a landmark project. Already 60 of the 156 units remain unsold, years after sales began. If these six deals fall apart, more will likely follow, leaving a signature building half dark.

The timing, of course, sucks. But it always does. Real estate is all about confidence, and this week it’s in shorter supply. For the first time since 2010, the economy’s actually shrinking. GDP growth is negative, thanks in large part to housing – which shows you how a virtuous circle (more borrowing, more buying, more jobs) can flip into a vicious one (more debt, more fear, more jobless).

Manufacturing is slumping, not exactly news given lousy global demand. But the hard brake on the property market has sure grabbed economists’ attention. Weak housing demand, says TD Economics, is now constraining national growth. Construction is fading. Mortgage brokers are drying up and blowing away. Real estate company revenues have crumbled for the fourth month running.

Nobody reading this pathetic blog for the past couple of years should be surprised. The only shock is that the reasonable, sentient, educated people around you could have been such lusty dorks, actually believing (as they still do in Calgary) that real estate can ascend endlessly on the back of debt, cheap money and hype. But to be fair, the ‘it’s different here’ meme was repeated endlessly by mainstream economists plus the robotic temptresses hired to read the news on Global. How could you fight off the hormones and endorphin?

Anyway, it’s over. The next phase is creative destruction – now happening across from the art gallery in downtown Vancouver as the Hotel Georgia tower wobbles, and among the forest of condo spires in godless Toronto. As this blog has said so often it’s beyond boring, there’s no question how this will end.

Last week, for example, I reminded you of the role that shriveled, omnivorous Boomers will be playing in this destructive process. As a group they have most of their net worth in houses, few pensions, fewer liquid assets and will be the first generation of retirees with widespread mortgage debt. Hippie dust to hippie ashes. Freedom’s just another word for nothing left to lose.

As much as I hate it when banks agree with me, another one just did. BMO’s new report claims a third of the country’s nine million wrinklies will have to sell off their houses to stay in Depends. “Boomers could be in serious financial trouble if they are relying in their home,” it adds. “The rally in house prices has given people the false sense of security that investing in a house is safe and an option to fund their retirement.”

False indeed. The bank reminds us that “tighter lending standards and higher interest rates could reduce the number of eligible homebuyers and push people into smaller and less expensive homes.” So, just imagine all those suburban streets full of Boomer particle board McMansions, with their energy-sucking pools and property tax bills to match.

Hard to see how this isn’t shaping up as the perfect storm. Slow growth. Credit crunch. Debt. Demographics. Fear. No wonder rich people with fancy lawyers are wriggling out of luxury deals they see tanking. Wouldn’t you?

I’ll say it again, real assets are in trouble. Love liquidity. Sha na na.

The trick

Two years ago it seemed, well, reasonable. After all, $529,000 for a perfectly-restored, 3,000-square-foot heritage home on a double lot in a bustling tourist town 45 minutes from the city was not a stretch. But in this part of the country, Nova Scotia, the market was already softening. So it sat. Lots of showings. A few lowball offers. No deal.

Eventually the price dropped to $489,000, then $475,000, and finally to $399,000. It sold this month for $385,000. The discount off original asking: 27%.

Five thousand, nine hundred clicks to the west, where the wrinkly people go to die, a similar story. Here’s a two-year-old rancher with a three-car garage on half an acre nestled beside a prestigious golf course, stuffed with granite, cedar beams and stainless. Listed 11 months ago at $929,000 (market value at the time), it’s now $789,000. The Vancouver Island agent who took the listing tells me the vendor would be orgiastic to get $750,000. And that would be a discount from original listing of 19%.

This week CIBC said not to worry. “When it comes to jitters regarding a US-type meltdown here at home,” a new bank report concluded, “the only thing we have to fear is fear itself.”

Economist Benny Tal, sounding like a guy who works for a bank in the mortgage business (oh, wait…) says Canadian real estate will have a soft landing. That’s because we have better quality mortgages than in the States, where Okies buy McMansions so they have a place to go after they marry their sisters. As well, there are fewer speculators here, which is news to Toronto condo developers who sell 80% of their units to flippers.

Tal does admit that two main arguments used by house-humpers and desperate realtors are junk. A low mortgage default rate is no indication of housing health or family finances, he points out. And forget about the myth of Americans being able to walk away from mortgages we must pay. Only a dozen US states are non-recourse, and this didn’t save their real estate markets from blowing up.

But where the bank, and all housing apologists, fail is with this ‘US-type meltdown’ denial talk.

The implication is that because we won’t have a ‘US-style’ housing correction there won’t be one at all – life will just go on. The Spring 2013 market will be sunshine and ponies. Prices and sales will restore. The beat will go on because, of course, it’s different here.

But it’s not.

The two small examples mentioned above are not atypical. As this depressing and irrelevant blog has shown of late, sales levels have tumbled in almost every major Canadian market, while prices are already rolling back in many. Hell, a feature in the Wall Street Journal yesterday carried the headline, “In Vancouver, Home Sales Hit the Brakes.”

Said the piece: “The average home price in Vancouver stood at 722,681 Canadian dollars ($721,958) last month, down more than 11% from the market’s peak of C$815,252 in April 2011, according to the Canadian Real Estate Association. Home sales are falling, suggesting more price drops may be on the way. Home sales in Vancouver and the surrounding metropolitan area dropped 33% this September from a year ago, according to the Vancouver real-estate board, while the total number of listings rose 14%… In Toronto, where average home-sales prices rose 8.2% in September from a year ago, the condo market has seen a sharp slowdown. Condo and apartment sales fell 21% in the third quarter, compared with 2011, according to Greater Toronto Area Realtors.”

Gee, when they can see this stuff on Wall Street you’d think it would be obvious on Bay. Sales fall first. Prices thereafter. And it’s not different anywhere.

I like Benny Tal. Always have, and we’ve met often. But I think he needs to get out more. When the mortgage brokers state categorically the average down payment in Canada is less than 10%, Tal is swimming naked telling the media that, “In Canada, only 15 to 20 per cent of new mortgages have less than 15 per cent equity, and the negative equity position is nil.” Fact is nine of 10 new mortgages are CMHC-insured because they are high-ratio and high-risk. And any correction puts folks under water.

But, he’s right. There won’t be a ‘US-type meltdown’ in Canada. It will be a Canadian-type meltdown. Prices will be lower this time next year, sales fewer and real estate more illiquid. The correction’s already taking place, as every seller longing for a buyer knows. Asking prices are no longer demands, but wishes. Toronto houses that went for 115% of list last year now sell for 90% – which is a drop in street value of a quarter. Once the masses discover this, game over. People only crave stuff that’s rising in value.

Economists need to know this. Should we tell them?