Entries from April 2013 ↓

The trouble with shorts

short1

Almost 5,000 properties over a million are listed for sale at the moment in Greater Vancouver. In the GTA, 2,500 are on the market for more than seven figures. This represents at least eight billion dollars worth of real estate, some of the most vulnerable in the nation.

Why? Simple. First, if you have a million dollars and you put it into a balanced, fairly conservative investment portfolio, you made about $100,000 last year. If you bought a house on the other hand, you made nothing, paid $60,000 in land transfer and property tax and now have to buy a new Audi for the driveway. Second, million-dollar listings no longer qualify for CMHC insurance, which means a buyer has to pony up at least $300,000 in cash to move in.

So what? So people with wealth know it makes more sense to use the bank’s money at 2.8% to buy a house, and invest your own cash to get three times that. Especially when you structure a tax-deductible mortgage. This is why a huge number of houses changing hands in 2012 for a million or two carried 90% financing. It was just smart.

But now that’s gone. So are sales. Prices are next. And if homes in this category decline by just 10% (seems to be a given), that carves close to a billion out of the property market.

How serious is this? Listen to realtor Arnold Shuchat, who works the mean streets of Richmond BC, where almost every house last year sold for a mill or more:

“Primarily in Richmond, most people who bought in the last 3 years are technically under water. What I mean is that they are for sure going to be unable to sell their property for more than they purchased it; they are definitely likely to have a selling price net of commissions yield proceeds of disposition less than the amount owing on their mortgage.

“I say this because in our previously expensive real estate market, buyers were throwing everything they could at the down payment and they would be lucky for a house purchase to be able to do so with a conventional mortgage at 20% down. The market being down some 25-30% depending upon neighbourhood, means that they are 40% through their 5 year fixed mortgages and in the event they were at term today, the discussion at the bank would most likely revolve around them coming up with sufficient equity in the form of a new 20% equity payment to finance a conventional loan, or CMHC insurance for a non-conventional one. Both scenarios are grim and place yet another purchase of the next house phase in jeopardy.”

It’s this realization of immediate and pending losses that has more and more people asking, like Dave, how to short the market.

“Garth: I enjoy reading your blog posts and maybe you’ve written about it already and I’ve missed it or maybe you haven’t written about it.  But what is a good way for someone to take advantage of the coming housing downturn?

I am in the camp that thinks that commodities will decrease as china slows and it will impact commodity exporting currencies/economies like Canada.  I don’t think there will be another type of 2008 crash but I do think in the future our stock market will get hit.  Perhaps that’s part of the reason the TSX is down for the year and US equities are up. Besides shorting the TSX, the loonie and the banks, any other way for an individual investor?”

And Gary writes this: “From the US housing experience: short REITs exposed to residential and multi-family real estate; short the banks; short home-improvement companies, such as Home Depot (which is due for a correction soon, anyway).”

Truth is, Canada has almost no financial instruments available to profit from a housing correction, and those who claim otherwise are blowing smoke. The banks, which control 75% of the market and hold 65% of all mortgages, are bullet-proof. That’s because they have already securitized a ton of high-ratio loans through CMHC, which (by law) also provides insurance against default on all risky home borrowings. Even if real estate values collapsed by 30% nation-wide in a year, bank profitability (now at record levels) would barely budge. Shorting the banks hardly seems swift when you give up juicy dividends and cap gains.

REITs? Forget it. Most trust managers have used cheap rates to refinance their portfolios at favourable, long-term levels. Second, most of the big REITs own office towers, shopping malls and business parks full of good tenants with lengthy leases. The economy would have to collapse into a protracted, deep recession (which won’t happen) for these guys to see any impact. Meanwhile, the worse a housing correction ends up being, the better residential REITs specializing in apartment buildings (like Boardwalk or Canadian Apartment REIT, with 65,000 units) will do. When people stop buying condos and houses, they rent. Duh.

HD   Home Depot? Nope. Companies like that and Loew’s do the bulk of their business in the US, where real estate is flowering again with sales and prices ascending. You should be wanting exposure to companies like these, not gambling against them.

So what can you do?

Well, I covered a lot of this ground in my last book, which has been out now for three years (jeez, time for another…).  The best shorting strategy is to sell your real estate when everyone is horny for a house and buy one later when nobody wants one. In places like Richmond, for example, that moment is passed, and with 30% declines it’s evidence that, sadly, I was correct. In other locations, like 416 (sub-$1 million), or poor Calgary, there’s still time to exit.

The people benefiting the most from this are the wrinklies with the bulk of their worth tied up in a single real estate asset, and deflowered virgins who purchased in the last few years with little or nothing down. The former need to get liquid and invest in financial assets. The latter must act fast to avoid being wiped out, lest they move  back to their moms’ basements, where they’ll be tormented mercilessly and turned into psychotics.

Of course, remember how to sell: At this point in the market cycle, go for a short closing (why tempt fate?), even if it’s inconvenient or more costly. Avoid any offer with conditions, especially the sale of an existing home – you may waste valuable spring-market time on a dud. Get a home inspection done yourself before listing to negate that condition, or avoid the surprise of a butchered price if the report finds big flaws. Use a realtor who can properly paper the deal or, at the least, a lawyer specializing in real estate transactions. Insist on a fat deposit (you usually don’t get it if the deal collapses, but it’s good incentive for the buyer to close). Most important thing: sell now. Next important thing: don’t buy. For a long time.

Oh, and if you own in Richmond, learn to snorkel.

All in this together

VEGAN

A brief follow-up on the woman starring in yesterday’s post. Kerri-Lynn McAlister is an exec at an online company selling mortgage referrals, and a media-savvy promoter. The Toronto Star’s real estate writer (Susan Pigg) featured her yesterday in a splashy piece on how condo-renters are being screwed by big rent increases. The back story: investor-landlords rake in the money and tenants suffer. Just the kind of message mortgage lenders get all juiced over.

The Star portrayed McAlister as a distraught renter. It did not reveal her position as a mortgage player, a real estate spokesperson nor someone previously interviewed by that paper as a housing expert. Until this blog got involved. Editors then went into damage control. Another writer was added to the story, the piece was rewritten to identity KLM as an insider, and the focus was shifted to the demands of a tenants’ association for more rent control laws.

In addition, this was added: “Note – April 26, 2013: This article was edited from a previous version to include the age and occupation of Kerri Lynn McAllister.

Now, this is not a seminal story by any means. Poor KLM was just doing her job, which is to trash renting and promote buying. If I ran a website churning dollars with every click-through loan referral, I’d want this little digger on my bench.

But if I ran, say, the Toronto Star, I’d be wondering, Did the writer know this information and suppress it because the ‘victim’ angle was stronger? Did the writer not bother to Google the person she devoted a half-page to? Was it a lack of ethics or competence? Or is the writer’s undeclared mandate to promote real estate ownership, since the newspaper cannot afford to lose more lineage from developers, builders and realtors?

As I mentioned yesterday, this is hardly an isolated instance. Blogs like this and Whispers from the Edge of the Rainforest have routinely detailed similar examples of media deception over the past year. It comes at the same time mainstream media outlets are in serious financial trouble. Just days ago employees at the Vancouver Sun and Province were warned of looming buyouts and layoffs in dire terms. Revenue declines, the publisher told employees, are “alarming and unprecedented.”

In a long letter begging staff to voluntarily quit, he says: “Please understand that we need your help. And if you do anything every day of the week, let it be this: ask yourself if you are part of the solution or are willing to be part of the solution. If you aren’t part of the solution, ask yourself why that it. We are all in this together and we are all fighting not only for the future of The Vancouver Sun and The Province, but for the lives and well-being of our families.”

Indeed, Postmedia, owners of the BC papers and slew of others, is bleeding $1 million per week. Advertising has fallen another 14% in the past year. Meanwhile the nation’s largest newspaper, the Star, has just announced its own ‘please-quit’ program for employees and is actually farming out production of its pages. The Globe, as you know, erected a paywall around its web site, as it also jettisoned staff.

CTV  has recently laid off on-air people, camera operators and radio hosts. The CBC’s been punting 650 employees for the past year. And Rogers, with a massive cable monopoly, shocked workers months ago with hundreds of layoffs.

The point is that revenue models no longer work for traditional media organizations because they’re based on eyeballs. As readership and viewership wither, so do the ad dollars. Gone are the days when everybody in town had the same morning paper tossed on their doorstep, or tuned in to the same supperhour newscast.

Part of the reason is the proliferation of new vehicles (I recently discovered the Fireplace Channel), plus alternative information sources like this blog. Another reason: print and TV newsrooms are whoring themselves. As media turns from useful, original content to the delivery of advertising messages, it gets irrelevant and annoying. If a paper wants to succeed, the last person shown the door should be a reporter. These days they lead the exodus.

I spent many years in newsrooms, and will never forget the first day I showed up, all shiny and new, at a small daily. The grizzled editor stood over my desk, staring at me getting organized.

“There’s no news in here,” he growled. “Get the hell out the door.”

I did. Still there.