Entries from December 2016 ↓

In disguise


Last year almost half of all the new jobs created in Ontario were in real estate. Agents, mortgage brokers, appraisers, sales assistants and the dudes who pound the signs in. There are 67,800 realtors in Ontario these days, plus 40 real estate boards. Across Canada more than 110,000 people work flogging houses. In Toronto alone there are 45,000. In Vancouver, 13,500 realtors toil the mean streets.

Housing activities directly account for about 7% of the economy. Add in the real estate financing component, and it’s double that. Manufacturing (all of it) comes to 11% of the GDP. Oil, gas, mining and pipelines (including the oil sands) is 8%.

Consumer debt is just over $2 trillion, with two-thirds of that being residential mortgages. Our loans are now greater than the entire Canadian economy. Never happened before. Just like the $1.51 million benchmark price for a detached in Vancouver. We’re breaking records all over the place.

By the way, did you catch this chart the other day in the MSM?


The blue line is the average Canadian house price – now above half a million (a record, of course). The red line is the yield on a 5-year Government bond, which is used to set fixed-term mortgage rates. You can see that real estate spiked because money dropped in price – not because there’s less of it, or it became intrinsically more valuable. This chart also clearly suggests – through impressive negative correlation – that when rates rise, house prices will drop. The debt, of course, won’t.

This is the time bomb at the heart of the Canadian economy. Wage gains over the past year, as explained here last week, are non-existent (after inflation). But borrowing and real estate values have risen consistently. Household debt-to-income just passed 170%. Gulp. Yup, another record. (In contrast, Americans owe about 113% of their incomes.)

Meanwhile surveys show how bad we suck at finances. Over 80% of TFSA money is rotting in interest-bearing stuff like GICs and HISAs. A quarter of us couldn’t find a thousand bucks in a pinch. Half of Canadians could not survive one missed paycheque without angst. RRSP contributions have plunged. Legions of people live in giant houses with lawn chairs in the living room and obese monthly payments. Diversification and balance are unknown in most lives. The cult of the house has delivered us to this moment. And 2017 may be the tipping point.

Now, to be clear, there’s no crash coming in the way people think of equity corrections – ten, fifteen or 20% in the course of a month or two. Housing doesn’t work that way because, unlike stocks, you can’t get out in five minutes. Besides, real estate’s way more emotional than financial assets. Prices are sticky. They shoot higher on speculation, greed, euphoria, FOMO and delusion. They crawl back down on denial. Nobody these days can fathom taking a loss on a property, after seven years of madness. Many would rather suffer behind the drapes than make a rational decision to bail.

But a crash isn’t the threat, nor a wave of mortgage defaults (won’t happen). No US-style foreclosures with bailiffs hauling kids and mattresses out onto the lawn. No Canadian city will end up looking like Detroit. But still, there’s hurt on the way. A crash in disguise.

This year the cost of borrowed money will rise. Lending restrictions will have an impact. Even all those realtors are expecting price declines. The economy’s barely growing, and as housing goes mushy so does a lot more. So the heady combo of rising equity and falling debt servicing costs will reverse. How could it be otherwise?

The likely consequence, given real estate’s stickiness, is a long, slow and relentless melt. The listings drought will end. Price appreciation with it. The erosion will take time, but erode it will. Some people won’t care that they missed the moment to make windfall, historic profits. Others will be bitter they gambled and lost. Many more will end up with faint light showing between their mountain of debt and the remaining equity, knowing the next mortgage renewal could extinguish it.

This is what keeps economists up at night.

Not with a bang, but a whimper.

What matters


What is it about the end of the year that makes us question everything? Our finances. Relationships. Jobs. Love handles. And real estate. It may only be the flip of a calendar page, but every January brings such angst because this is an emotional time of the year. Even for the wealthy. Like Aaron.

“I have been following your blog for 10 plus years and love the dog pictures,” he says, in the obligatory genuflect. “I am an ER doc in the last 10 years of my career.  My wife works part-time and we have 2 kids at university with money leaking out of our bank account for them.  We have $1,000,000 in investments, RRSP, TFSA, RESP and corporate saving.  Our house is in a hot market (Victoria) and is between $1.4 to $ 1.5 million with a $500K mortgage thanks to a reno and foundation issues.  We have an opportunity to sell and rent a nice smaller house ($3000 / month) in the same neighbourhood.

“What do you think?  If we sell where would we invest and what happens if the market hits Vancouver levels and we get kicked out of our rental?”

See? Being full of doubts and turning to a pathetic blog populated by deplorables is not mutually exclusive with being a pillar of society. So let’s parse Aaron.

Being an experienced emerg doc he probably earns about $300,000, so savings of a million a decade prior to retirement is not that stellar an achievement. Sounds like those are expensive kids. Or maybe there’s a mistress tucked away up in Ladysmith. In any case, doctors don’t normally have pensions, so when the salary ends life will change abruptly – even with a million.

Meanwhile there’s another mill in real estate equity plus $500,000 in mortgage debt in a house in steamy little Victoria – where VYR refugees have imported their dread mainlander disease called FOMO. So should the doctor just ride the housing wave higher and cash in later when his digs are worth $2 million? Or bail, get liquid, and prepare for retirement?

That’s easy. The market is over-valued, speculative and on the cusp of big changes (rising rates, tighter lending, Trump), while his medical career barrels towards a fixed termination date. Keeping 50% of net worth in real estate (one asset) likely constitutes more risk than investing in a balanced and diversified way to support the rest of his days. In other words, it’s a stretch to think the house will double in value in a decade, but reasonable to assume his portfolio will – simply based on historic norms and conservative projections.

Selling the house, harvesting the million and investing it in a balanced way for ten years should turn that into two million, while eliminating debt that will renew at a higher rate. The numbers are compelling. A million in equity could be earning $60,000 a year. The mortgage, property taxes and insurance require $3,000. So, that house represents a cost of roughly $8,000 a month. If the family can live in an equal house in the same hood for three grand, with no debt, what’s to debate?

Oh yeah, houses could continue to rise, or Aaron might become homeless. Greed and fear. See how emotions work?

Nothing in life is for sure. It’s a matter of playing the odds. The fact that half of all marriages survive is astonishing, given how they occur. So, yes, Victoria real estate could continue to plump in value, though the odds of that are falling rapidly.  Even if it were so, the doc would have to sell his place at some point to free the money for retirement – and what if the market sagged at just that moment? Unlike financial assets, which can be liquidated in small amounts to liberate cash (no matter what the prevailing conditions) a house is a one-and-done deal. You can’t sell a chimney to make ends meet.

So why not harvest the tax-free capital gain when the buyers are buying? Duh.

As for getting kicked out of a rental, well, deal with it. The chances of this happening are less than the 100% certainty the mortgage will renew at a higher rate or that over time the furnace will croak or the shingles fail. With two kids leaving the nest and retirement within view, it’s probable he’ll want a different (smaller) place down the road anyway. The rental house is not the F home. That forever place might end up being in someplace more exotic and electric. Like Etobicoke.

Well, Aaron, suck it up.  Apply some of the skill, reasoning and intuition you use in saving lives to improving your own. Emotion’s so over-rated. It’s only a house. Not the goal of life. More than anyone, you should know what that is.