Garth Turner - Real Estate in Canada

[Liberty]

Hey,

 

I've recently discovered Garth Turner's blog. I'm probably the last one here to find it, but just in case...

 

http://www.greaterfool.ca/

 

I thought it might interest those who want to hear the case for the "big real estate bubble about to burst in canada". If you read his past 4-5 posts you should have a good idea of what his arguments are.

 

He can be a bit over the top, but in general, I find the thesis pretty convincing. It's just impossible to know how long it'll take before there's a day of reckoning (but I'd be surprised if it took longer than 2-3 years)...

[Viking]

I have read Garth's stuff for the past 10 years. He certainly is entertaining (must have been fun sitting beside him when he sat in Parliament as an MP in Ottawa). I think he is generally correct in his assessment (i.e. housing is at historic highs) but I am not sure about his conclusions (a bust is just around the corner). Will Canadian residential real estate be a great investment moving forward? I doubt it; with prices at historic highs there is no margin of safety.

 

My guess is real estate prices go sideways for the next 10 or 15 years. With inflation running at 2 or 3 percent per year, real prices will correct over time to a more reasonable level.

 

Should China get ugly (causing the resource part of the Canadian economy to tank like 2008 & 2009) then Canadian real estate could be in for a hard landing. Should the Canadian ecomony sputter along the next few years I am not sure what the catalyst would cause a precipitous fall.

[Liberty]

My guess is real estate prices go sideways for the next 10 or 15 years. With inflation running at 2 or 3 percent per year, real prices will correct over time to a more reasonable level.

 

I often hear this (in fact, it seems to be as far as anyone from banks or the government is willing to go in newspapers). Can you elaborate on what makes you think this "sideways" scenario is more likely than a bust?

 

My understanding is that markets generally tend to overshoot both ways and rarely find some stable middle path, especially when there's leverage/government intervention/irrational beliefs among market participants/hot money pouring in/people think something is safer than it truly is/etc (I know this describes almost everything everywhere, but that's my point -- this isn't different). With everybody in debt to their ears, interest rates at historic lows and random economic shocks bound to hit the Canadian economy at some point or other, I kind of have trouble seeing how this would just result in prices stabilizing rather than in a panic-bust like we've seen in so many other places in the past.

 

I used to kind of accept the "generally accepted wisdom" that seems to be repeated everywhere on how Canada doesn't have the subprime/bad lending standards that the US had, which is why we'll be ok. But after reading this, I'm not so sure:

 

http://www.greaterfool.ca/2012/02/20/canadian-subprime/

[EdWatchesBoxing]

I've been reading the blog since 2008!

 

I like Garth's humour and his choice of pictures. I don't think housing will travel sideways while we wait for salaries to catch up to housing prices. In the GTA, where the average house is about 5.5 times average salary, I don't see how there won't be some sort of correction. Vancouver's in worse shape. I wonder what the house price/salary ratio was in the late 80s/early 90s. 

 

I just looked it up: http://www.torontohomes-for-sale.com/4a_custpage_2578.html

So current home owners are not as screwed as those that were buying back then. But looking back to the mid 1970s, I'm sure that type of drop wouldn't be out of the question these days. Even a 10% will be really bad any one who put less than 10% in the last few years will have their equity wiped out. Well, except the one's that got the zero down/40 year ams. They'll just carry a mortgage much higher than the value of their house.

 

They may not call it subprime lending in Canada, but people that can't afford the houses they are "purchasing" are being approved for mortgages. They just slap mortgage insurance on it up front and dump the guarantee on the tax payer through CMHC/CHT.

 

EDIT: wow, they must have been smoking some really good stuff in the 80s.

[Liberty]

Been reading the archive.. On page 20 I found this overview of the main thesis:

 

http://www.greaterfool.ca/2012/01/08/in-the-end/

[SharperDingaan]

The 24 yr old with the massive mortgage goes bankrupt, moves back in with mom/dad, & CHMC covers the bank against loss. Highly visible, but there are not many of these, & the CMHC/Bank/BoC have more than enough capital to hold houses off the market, en masse, if needs be.

 

Financing for mortgages this big is usually by LOC. Rates increase, the house(s) get sold at a deep discount, & the new buyer finances via conventional mortgage (or the bank/BoC doesn't give the mortgage. Prices drop, but they don't melt down 30%+, en-masse. Financing goes from unstable to stable, with monthly amortization continuously lowering the risk going forward.

 

Victoria McMansions may lose 40% of their value, but they dont drag down the nation overall.

 

 

[Liberty]

Doesn't sound realistic to me. In a country where 30% of the economy is now real estate and 70% of people are home-"owners", with debt levels  over 150% (a lot of it financed with HELOCS), will affordability measures and rent ratios all in extremely bubbly territory, lots of speculation and over-building, hot foreign money, loose lending standards and "cash-back" mortgages, baby boomers retiring with most of their savings locked up in their houses, interest rates at historic lows bound to go up eventually, etc, I don't see how CHMC is going to help. It may protect banks from a direct hit, but it won't protect the country's economy when this thing bursts, IMO. The only reason why things went as far is because - like in all bubbles - people have started to believe that prices doesn't matter because what they're buying is going to be worth more in the future anyways (I hear it all the time - this time it's different!). As soon as that's not true anymore, the spell is broken and we'll look like the USA. No other way to explain why crappy suburban shacks are now worth millions while salaries haven't kept up with inflation...

 

The average person seems to think that real estate is totally different from bonds or stocks or gold or whatever. It isn't. Sure you are living in it and it's a lot less liquid (which is another problem when things go south), but aside from that, value and price are two different things. The more I learn, the farther away I would stay from a business's stock that had the characteristics of the Canadian real estate market.

 

I sure am glad we're renting.

[Labrador]

Agree 100% and am glad I am renting too!

[cwericb]

I have been told by real estate people that they a lot newer large houses where several rooms are sparsely furnished or bare simply because the home owners are at the limit of their budget.

If you think that is scarey, read on.

 

I am involved in the credit end of the building supply industry. When customers come in to set up a line of credit for the construction of a new home the conversation often goes like this.

 

A well educated, well employed young couple are sitting in front of me and I say...

 

“ Hi folks, so you are going to build a new home and all your financing is all arranged?”

 

“Yes, everything is ready to go and our contractor is starting next week.”

 

“Well that’s that’s great. So what is your new house going to cost?”

They look at each other with a blank look on their faces and say “ Well we don’t know, but our payments will be $x,xxx per month.”

 

“Yes well that’s fine, but do you know what the actual cost of the house will be when finished?”

 

“Aaaaa... no, but our mortgage is $xxx,xxxx and our payments will be $x,xxx”

 

“But what is the cost of the house?”

 

‘Aaaa, well I guess we never asked.”

 

“So you really have no idea of what the house will cost?”

 

“No, I guess perhaps we should ask, but we do know that our mortgage payments will only be $x,xxx ”

 

“Well folks, you realize that your 3% mortgage rate could increase in five years from now when you renew your mortgage and your payments could jump substantially?”

 

“Hahaha, well that better not happen, hahaha”

This is NOT an isolated incident.

 

The only reason I can see for this frame of mind is that these people have been brought up in a world where leasing is a way of life. They seem to equate a five year lease with a five year mortgage term. A mortgage is not a car lease. When rates rise you don’t ease into a cheaper model or walk away at the end of five years.

[Liberty]

wow, cwericb. Thanks for sharing that.

 

I see it all around me. People spend more time thinking about xmas gifts than about the house they're buying.

 

They don't consider it an investment in real estate, just something they're entitled to do when they're old enough and have a "real job". Renting is universally considered to be a waste of money "because at the end you've got nothing".

 

They don't realize that for most people the choice is between renting an apartment/house/condo or renting money from the bank (to buy a house/condo).

 

People who would never borrow to invest in stocks are leveraged 10-to-1 or 20-to-1 on a potentially very illiquid asset.

 

Owning a house is not seen as something you achieve (by saving a lot and then waiting for the right bargain), it's seen as something you have a right to (price doesn't matter, it'll go up anyways!). That's dangerous.

[cwericb]

"Owning a house is not seen as something you achieve (by saving a lot and then waiting for the right bargain), it's seen as something you have a right to (price doesn't matter, it'll go up anyways!). That's dangerous."

 

If you mention the idea of "saving up" to buy something, people tend look at you as if you were out of touch with reality. The idea today is that you use other people's money so that you can get what you want - now - and worry about paying for it later. That is when the problem comes in - later. Eventually later comes around. Then, when they find themselves in deep it's everyone else's fault, the bank, the government, the credit card companies, etc.

 

Here is another scary scenario. I have had people actually say to me, "We doing pretty good, we are making the minimum payments on all our cards and we still have enough credit to buy that new ....... we want.

 

First off, I cannot believe people think of their credit capacity as an asset rather than a pending debt.

Secondly, I received this month's Visa bill. Hidden on the last page (and required now by law), is the statement "if you only make the minimum payment it will take you 37 years to pay the amount owing".   And my Visa bill was for only $1,770.

 

[SharperDingaan]

You cannot prevent people from hurting themselves, it is their choice. 

[Liberty]

You cannot prevent people from hurting themselves, it is their choice.

 

Indeed, but you can sure make it easier or harder to do so. (ie. remove all seatbelts from all cars)

[Guest Hester]

So what do we short, guys. What securities are going to get killed when Canadian RE prices fall.

 

Probably not the banks. Damn CMHC...

[cwericb]

Speaking of CMHC, does anyone have any idea of total potential liability that CMHC and the Canadian taxpayer has if a meltdown occurred in housing prices?

[EdWatchesBoxing]

It's awful to see people voluntarily harm their financial health.

[Guest Hester]

Speaking of CMHC, does anyone have any idea of total potential liability that CMHC and the Canadian taxpayer has if a meltdown occurred in housing prices?

 

I had the same thought a little while ago. Here's their 2010 annual report. http://www.cmhc.ca/ar-ra/2010/en/mda/

 

Of course a potential meltdown has to be modeled out by the investor.

[Kiltacular]

Buffett in the just released shareholder letter:

 

Homeowners everywhere felt richer and rushed to “monetize” the increased value of their homes by refinancings. These massive cash infusions fueled a consumption binge throughout our economy. It all seemed great fun while it lasted. (A largely unnoted fact: Large numbers of people who have “lost” their house through foreclosure have actually realized a profit because they carried out refinancings earlier that gave them cash in excess of their cost. In these cases, the evicted homeowner was the winner, and the victim was the lender.)

 

Yet, the "scandal" is robosigning.  Comical.

 

It likely that the biggest "winners" in the Candaian version will also be those most irresponsible.  The key is that you have to be unimaginably irresponsible to win big.

[Liberty]

So what do we short, guys. What securities are going to get killed when Canadian RE prices fall.

 

Probably not the banks. Damn CMHC...

 

That's a good question. The way I'm playing my conviction is by being ready to continue renting for a few years. We'll try to be really patient because if (when) it happens, it could take a while to reach bottom line in the US, and it won't bounce back quickly, so no need to hurry up. Would suck to be right about this but buy way above the bottom...

 

But as for shorting stocks, I'd look at companies that are heavily leveraged and closely tied to construction in Vancouver or Toronto. No idea what the best company to short would be, though.

[Liberty]

Buffett in the just released shareholder letter:

 

Homeowners everywhere felt richer and rushed to “monetize” the increased value of their homes by refinancings. These massive cash infusions fueled a consumption binge throughout our economy. It all seemed great fun while it lasted. (A largely unnoted fact: Large numbers of people who have “lost” their house through foreclosure have actually realized a profit because they carried out refinancings earlier that gave them cash in excess of their cost. In these cases, the evicted homeowner was the winner, and the victim was the lender.)

 

Yet, the "scandal" is robosigning.  Comical.

 

It likely that the biggest "winners" in the Candaian version will also be those most irresponsible.  The key is that you have to be unimaginably irresponsible to win big.

 

I think this was a better deal in most US states because the creditor of the mortgage can't go after you personally. The way I understand it, in Canada they can. Unless they spend all that HELOC money on intangibles, they'll get repossessed.

[Liberty]

http://business.financialpost.com/2012/02/29/canadas-home-prices-drop-for-second-straight-month/

[VAL9000]

http://business.financialpost.com/2012/02/29/canadas-home-prices-drop-for-second-straight-month/

This is probably just seasonal weakness.  Look at the chart - those markets demonstrate weakness from November through about March every year.

 

I think this was a better deal in most US states because the creditor of the mortgage can't go after you personally. The way I understand it, in Canada they can. Unless they spend all that HELOC money on intangibles, they'll get repossessed.

 

This is exactly right.  Mortgages are non-recourse in the US, which is why "it's different" in Canada.  You have to declare personal bankruptcy to get out of your poorly devised home ownership plan.  The result is that downward price trends are throttled because home owners can't just walk away like they did in the US.  I think RE prices will be forever buoyed by two things that people are loathe to do: one declaring bankruptcy and two selling at a loss.

 

[enoch01]

 

Mortgages are non-recourse in the US, which is why "it's different" in Canada.  You have to declare personal bankruptcy to get out of your poorly devised home ownership plan.  The result is that downward price trends are throttled because home owners can't just walk away like they did in the US.  I think RE prices will be forever buoyed by two things that people are loathe to do: one declaring bankruptcy and two selling at a loss.

 

Wait until the stigma wears off once people start looking at the economics of their situation.  Or maybe you were being sarcastic, sorry if I couldn't tell.

[VAL9000]

Wait until the stigma wears off once people start looking at the economics of their situation.  Or maybe you were being sarcastic, sorry if I couldn't tell.

 

No, I'm serious.  I think that real estate prices correct downwards more slowly because of the bankruptcy requirement and an unwillingness to sell at a loss.

 

If the economics of their situation dictate a change in lifestyle, you will see the impact in credit card debt, auto loans, rv loans, lines of credit, etc. well before you see the impact in housing.  It's like Maslow's hierarchy of needs for debtors :P

 

[Liberty]

http://business.financialpost.com/2012/02/29/canadas-home-prices-drop-for-second-straight-month/

This is probably just seasonal weakness.  Look at the chart - those markets demonstrate weakness from November through about March every year.

 

Possibly. Possibly not.

 

This is exactly right.  Mortgages are non-recourse in the US, which is why "it's different" in Canada.  You have to declare personal bankruptcy to get out of your poorly devised home ownership plan.  The result is that downward price trends are throttled because home owners can't just walk away like they did in the US.  I think RE prices will be forever buoyed by two things that people are loathe to do: one declaring bankruptcy and two selling at a loss.

 

States in the US that had that exact same legal system didn't fare much better than others (Arizona and Nevada among others, iirc). Garth Turner has addressed that point fairly convincingly, IMO. I suggest you read a dozen of the most recent posts and see how it tickles your fancy, as most of the counter-arguments that I heard everywhere are addressed.