Entries from May 2014 ↓

Race to the bottom

DNA modified

Ten years ago this spring the US house market was on fire. Rates were low and people were horny. House prices in California, Florida and Nevada were at unheard-of levels. Bankers were pushing teaser loans (called ARMs, or adjustable-rate mortgages) and zero-down deals were everywhere.

Nobel-winning economist Paul Krugman played Cassandra. In his syndicated newspaper column he wrote, simply, “Now for the obvious point: many American families and businesses will be in big trouble if interest rates really do go as high as I’m suggesting.”

What did he suggest? That home loans – then in the 5% range – would eventually go to 7%, and wreak havoc. The critics, including the National Association of Realtors, called him a kook. But by the summer of 2007, the 30-year mortgage rate was just a hair under 7%, and the housing market was in crisis. A year later it was all enough to prompt a global financial meltdown.

By the way, almost all mortgages in Canada are ARMs. Only a tiny percentage of people have mortgage commitments of longer than five years, which leaves the bulk of the population far more exposed to rate changes than American homeowners – who were creamed in the housing correction. In the US, as you know, once you get a mortgage it’s usually good for 30 years. The rate never changes – unless it’s an ARM with a teaser rate. Like at Scotiabank.

Our No.3 bank has just stepped up the race to the bottom with a five-year fixed-rate home loan at 2.97%. It’s the lowest fixed fiver ever for a major bank, beating BMO’s short-lived 2.99% mortgage by a whisker. Of course, some dinky credit unions, cheesy brokers and unheard-of online lenders are offering money for less. Plus they give great deals on duct-cleaning. Check your blue box for details.

As for variable-rate deals, Investor’s Group is the current leader, with a prime-minus-1.01% deal that makes money available at 1.99% for three years (unless rates rise).

Why are the lenders doing this?

Simple. Business sucks. Mortgage volumes and originations are way down from historic levels. The Spring has been cool and late almost everywhere in the country, with sluggish house sales and horrible conditions in some key markets, such as Montreal. Overall, with mortgages such a key hunk of the bankers’ balance sheets, there’s a frisson of freaking going on down there in the Bay Street canyon where a solitary, rebel blogger is oft seen humping along on his cane.

So, they put money on sale. Margins are cut so thin between the cost of funds and loan rates that the bankers make nothing. But this is about market share more than profits. Mortgages are relationship products – once they have you as a customer, you’re likely to stay one, getting hooked on other banking services.

Borrowers benefit from cheap money and easy credit, as they did in the US, with homeownership levels spiking to the 70% mark, and house prices soaring to all-time highs. Real estate becomes a cult, so easy to buy and carry. Until it isn’t.

Of course, the real benefit of cheap money is when it’s used to trash debt – to pay it faster than when mortgages are twice as expensive. Sadly, there’s no evidence this is happening in Canada, as overall aggregate consumer and mortgage debt goes up every consecutive month. Seriously, do you know anybody pre-approved for a $700,000 mortgage who buys a $400,000 house just so they can pay the 3% loan off?

After all, if people were borrowing below their capacity and using low rates to reduce debt, real estate values would no tbe bloating as they are now. Obviously the opposite is true.

Meanwhile, the longer rates stay low the more people who believe they’ll never go up again. Comments on this pathetic blog support such delusional thinking. It’s just naïve to believe inflation will not eventually return, along with economic growth, meaning bond holders demand a premium, and the cost of money rises. It may not be this summer, or next Spring. But it’s coming – big news to a nation of house hornies who borrowed to the limit and will likely end up years later with fat debts and declining equity.

Now this wouldn’t matter if you were taking a 30-year mortgage from Scotia, with fixed payments at 2.97% for the next three decades and zero debt when it was over. But you’re not. And in 2019, when the rate adjusts, there’ll be no sub-3% gift. Will you be ready? After all, that’s just 60 payments away.

Or do you think the bank is your bud?

Obedience

WHISPER modified

Recently a lot of investors have decided the second half of 2014 will be a mess. Or so they hope. They’ve bought financial assets that will jump in value when volatility (as measured by the VIX) erupts. In fact, there are more of these bets now being made than at any other time since 2008.

It’s impossible to know if they’re prescient or not, but I’m guessing the months to come will rock. We’re overdue for a juicy little correction on US stock markets for example, which might knock prices back 15% (before the next leg higher). And now one of the country’s leading economists (Craig Wright, of RBC) is forecasting mortgage rates could be three-quarters of a point higher by the end of the year, or into the Spring.

I’m a lot more concerned about houses than stocks. Equity markets are big short-term news, but so long as economies creep ahead and companies make money, investors will do fine. There is no 2008 in the cards, after all.

But houses? Oy. Way worse.

Real estate investing has three giant warts that financial portfolios don’t – illiquidity, leverage and duration. When a housing market decays, buyers disappear and sellers can’t escape. Bad news for property-rich wrinklies. As that happens, prices decline and kiddies with 5% equity soon find they’ve been squished.

Housing plops also last a lot longer. A balanced portfolio taking a hit in 2008 was fully recovered by the end of 2009. But the average Toronto house which was driven 30% lower in 1991 didn’t recover until almost 2007. If 2014 or 2015 brings a real estate correction (it may already be happening in Montreal, Halifax, Victoria…), just imagine the consequences after the entire population has pigged out on 3% mortgage debt.

Speaking of piggies, a new development of 48 high-end houses in the distant GTA exurb of Markham, called Oakford, is busy engendering an onslaught of them this Saturday. The developer (Grandfield Homes) has just emailed a billion people telling them they’re invited to an event that they probably won’t be able to get into. Seriously.

“Due to the incredible demand, this invitation is not a guarantee that you will get through on the first day of this two-day event as it is on a first come first serve basis,” it says. But just in case you make it through the wall of bodies clamoring to spend a million, “Please ensure you have government issued photo ID, a pre-approval letter from a financial institution and your cheque book with at least 5 cheques in order to reserve a home.”

Now, remember that these are unbuilt homes nobody can look at, and yet people are expected to buy them like they’re lining up on a Saturday morning at The Sausage King. Here is the four-step obedience process Oakford has prepared for three days from now:

(a) Registration: “First Come First Serve (Queue number will be given shortly before 12pm, May 31th). One number per family. Photo ID, mortgage pre-approval, and 5 blank Checks.” (Yes, they said ‘checks.’)

(b) Model Home Tour: “20-minute limit due to large traffic volume. 2 persons per family (3 persons including agent). Please keep your kids at home to avoid unnecessary worry.”

(c) Sales Centre: “Information package pick-up. Inquiries and purchase preparation.”

(d) Agreement Signing: “Follow our guidance to designated area. Onsite mortgage consulting (if applicable). Agreement signing”

Oh yes, and here are some helpful hints: “Please come a little early…however do not come too early or stay overnight…. Please wait in the line and maintain your order… Grandfield Homes is free from any responsibilities and liabilities that may occur.”

Well, I rest my case. I bet people will actually go to this event. Lots of them. Clutching their photos IDs and five personal cheques. And based on a maximum 20-minute exposure to a staged and artificial model home, they’ll be expected to buy an expensive house without any conditions or legal counsel. Will all 48 sell? I bet those people put more effort and research into picking out their $40,000 car than their million-dollar home.

There’s little doubt where this is headed.

Back to RBC for a minute. The bank just released its latest affordability report, and you can imagine the conclusion. Prices have risen even as mortgage rates have softened, and real estate’s becoming less affordable despite demand for it decaying. Even with a massive (and rare) 25% down payment, the average Toronto now house eats up 56% of pre-tax income (that’s two-thirds of what families actually bring home), while the number is an incomprehensible 82% in Van.

See you in Markham.