Garth Turner - Real Estate in Canada

[LongHaul]

Rules that I use:

 

Anything not sustainable in the long run has to end.

Low interest rates, high debt, rising unemployment, rising housing prices is not a combination that is sustainable.

 

You do not have to play if something does not add up.

No one is forcing my hand to invest in real estate. Maybe I need to develop a hobby outside investing or real estate and wait for the opportunity that I have prepared for.

 

Do not create false expectations that the market will correct in a given amount of time.

 

You will know when the time is right. It will be obvious went it happens. Life is a marathon.

 

Good stuff Wisdom.  I agree.  During the 1920's Bernard Baruch reminded himself that 2+2 still equals 4 when many got sucked into the stock bubble at the time.  I think these times are relatively easy to identify.  The hard part is having the independence, courage, patience and confidence to not get sucked up into buying the bubble even though you may feel alone.

 

[LongHaul]

Let's look out a few years.  Canadian real estate tanks 30% in real terms, unemployment way up, construction and consumer down, CAD down, etc.  Headlines are terribly pessimistic, the world is doing to end, Everyone is scared,  bla, bla, bla.  Typical bust but it will recover. 

 

What are some high quality businesses to own in Canada that are likely to get cheap?  I can only think of the 2 railroads that are cyclical but seem great.

 

 

[Guest 50centdollars]

Rules that I use:

 

Anything not sustainable in the long run has to end.

Low interest rates, high debt, rising unemployment, rising housing prices is not a combination that is sustainable.

 

You do not have to play if something does not add up.

No one is forcing my hand to invest in real estate. Maybe I need to develop a hobby outside investing or real estate and wait for the opportunity that I have prepared for.

 

Do not create false expectations that the market will correct in a given amount of time.

 

You will know when the time is right. It will be obvious went it happens. Life is a marathon.

 

Good stuff Wisdom.  I agree.  During the 1920's Bernard Baruch reminded himself that 2+2 still equals 4 when many got sucked into the stock bubble at the time.  I think these times are relatively easy to identify.  The hard part is having the independence, courage, patience and confidence to not get sucked up into buying the bubble even though you may feel alone.

 

 

+1

[cwericb]

Couple of thoughts.

 

It’s fine to sit out what is likely a bubble, but since this thread began (Feb 2012) how much have average house prices increased in say, Vancouver. Lets say 30%? So if prices suddenly drop by 25%, wouldn’t you still have been better off to have ignored Turner’s warning and have bought in 2012?

 

One other thing. A while ago I suggested that one MAY have been better off to investing in a home three years ago rather than in the markets. Some disagreed. However, they may not be taking into account that the “profit” in the market is taxable when you sell. The “profit” in your home is not.

[mcliu]

What if mortgage rates ever turn negative and you're paid to borrow? How will home prices (or asset prices in general) behave then?

[wisdom]

mcliu, do you want to base a $500k to $800k decision based on what if rates are negative. I personally would not.

 

Also what kind of environment/conditions would lead to negative rates. What are the implications of debt in a deflationary environment?

 

Again - is this sustainable in the long run - negative rates, rising assets, higher unemployment?

 

 

[Liberty]

Couple of thoughts.

 

It’s fine to sit out what is likely a bubble, but since this thread began (Feb 2012) how much have average house prices increased in say, Vancouver. Lets say 30%? So if prices suddenly drop by 25%, wouldn’t you still have been better off to have ignored Turner’s warning and have bought in 2012?

 

When something becomes more overvalued, the magnitude of the price drop that would result from a bubble bursting becomes bigger too. In places like Vancouver and Toronto, it could be quite big, just like in some parts of the US the 2009 house bust was a lot more severe than in other places. Averages don't tell the whole story (cue story of the man drowning in the river 4-feet deep on average).

 

ie. If the tech bubble had burst in 1997 rather than 2000, the drop would have been lower. If the US housing bubble had burst in 2005 rather than...

 

This situation in Canada lasting longer isn't a good thing. It's not like there's a 25% drop written in stone from whatever level. Also, real estate is a very psychological asset that people buy for emotional reasons, and when psychology turns, it can happen very quickly, and a drop doesn't have to stop at fair value. It can go through the floor quite a bit.

 

One other thing. A while ago I suggested that one MAY have been better off to investing in a home three years ago rather than in the markets. Some disagreed. However, they may not be taking into account that the “profit” in the market is taxable when you sell. The “profit” in your home is not.

 

Downsides of that are that houses aren't very liquid, especially not if the market becomes troubled (which is when you might need money most - ie. Calgary these days), if you want to own a house, whatever appreciation you get would just go to pay for the appreciation in whatever place you're moving to. You could try to jump out of the market at the top and rent for a while, but trying to time these things is always very hard. Seems less risky to me to try to jump in from outside when you see prices being low than try to jump out from inside when prices are high -- and I don't see being out as a missed opportunity since we rent quite a nice place, so not a sacrifice, and my capital is compounding in the market faster anyway, and I feel it's less risky to own a dozen high quality businesses than 1 asset in 1 city on 1 street.

 

To me the same questions always remain: Why are houses almost twice as expensive in Canada as in the US? People keep adding debt to buy things that don't generate cashflows. What happens if capital appreciation stops or reverses? What happens when interest rates start rising in the US? Why is Canada one of the most expensive places to buy a house in the world when looked at ratios to rents and incomes, as well as historically for same country? How fast have incomes gone up in Canada in the past 10-15 compared to house prices? How long can that delta keep widening? Etc.

[benhacker]

cwericb,

 

It’s fine to sit out what is likely a bubble, but since this thread began (Feb 2012) how much have average house prices increased in say, Vancouver. Lets say 30%? So if prices suddenly drop by 25%, wouldn’t you still have been better off to have ignored Turner’s warning and have bought in 2012?

 

One other thing. A while ago I suggested that one MAY have been better off to investing in a home three years ago rather than in the markets. Some disagreed. However, they may not be taking into account that the “profit” in the market is taxable when you sell. The “profit” in your home is not.

 

I don't have an answer for you, but I'll share an example that I think you may like, and comment on it generally.

 

A very smart poster over on the Fool who I respect a lot recently wrote a very long amusing note critical of Hussman (he has long been critical of him for good reason - my point has nothing to do with Hussman really though) in that he (Hussman) referred to 1937 US stock market recently as a "bubble".  The poster then clarified that had you bought the "bubble" and held (assuming S&P / equivalent index like item at the time), you would have achieved 5.4% real return through until now, ending in 2008 to 2014 period only changed the results a moderate amount (say 0.4% real, from memory).

 

His post was mostly humorous snark about Hussman, but it was intended to say that if you call 1937 a bubble, how do you justify that given the returns achieved in the aftermath?

 

To me, this gets to some fundamental questions and assumptions that we as investors have to have a stake in, and often times the words we use "bubble" "intrinsic value" "overvalued" etc can detract from our discussions, because oftentimes our words make us seem further apart than we actually are (and of course, sometimes not).

 

I'll chatter a bit about some assumptions about asset prices that I think are commonly held, and try to address your point:

 

1) Real assets, generally speaking, increase in value over a long time - assuming the price paid was roughly in the realm of reasonable.  If the assets are productive in nature, generally this increase exceeds the rate of inflation, or the rate you can obtain holding T-bills.  Held long enough, your return on the asset will equal it's long term growth, almost completely independent of price paid (with enough time).

 

2) Asset prices in general (at least if held over a medium basis) feedback into behaviors in the economies they are in.  High house prices embolden home builders, owners, and lenders, low commodity prices discourage conservation, and eventually increase use (of course, all else equal, these are just two small examples), and of course high stock prices for a sector of the economy allow capital to flow toward endeavors in that industry more freely (through IPOs, debt raises, etc).

 

3) The long run return of different asset prices has some level of uncertainty.  For example, US stocks have provided real returns of 5.5-6% for 100 years, but perhaps 3% or 8% real would still be reasonable as we look forward - we don't "know".  Gold has kept with inflation pretty well, real estate has done inflation + 1% maybe, and land has done much better, although is very location specific.  All these returns can help us guide the future, but there are many uncertainties (call them real risks) about future legal developments, labor / capital relations, wars, tax impacts that make the outcome generally uncertain for investors.

 

To get back around to my point, there are a few things that feed into my half-answer of your comment above (which I think many rational people reading this thread would ask as well):

 

1) Canadian real estate, despite many who believe it to be overvalued (myself), may indeed turn out to be a good investment over a long time horizon, and even in the short horizon, there is no guarantee that it will even correct downward.

 

2) What Canadian real estate prices have done since some folks have been talking of a real estate bubble in Canada is in not particularly instructive.  We know two things: 1) Virtually every bubble / boom financial market in the past has had haters calling it overheated 3,4, and 5 years early... 2) Virtually every market that has unevenly risen higher over years and decades without a collapse also had probably similar number of haters. :)

 

2a) I think what this thread can teach us is to see what specific arguments were made by specific posters, and what the investment / economic implications were (by those posters)... so we can hold them accountable, and learn both the errors of and the bounds of the logic they have used.

 

3) Just because an asset price increases (or even is LIKELY to increase) well over a period of years or decades, may *or* may not mean the current price should be avoided.  We all have a fundamental assumption of what kinds of risks we want to accept (or what some would even consider "risk"): 

- Liquidity

- Volatility

- Permanent risk of loss

- Loss of opportunity

 

Circling back to my poster friend on the Fool, and 1937 not being a bubble... maybe we shouldn't use that loaded word.  Perhaps when something is bought and it drops 50% in short order, that's unacceptable risk to some?  Perhaps it's just part of the business?  Maybe it's the volatility price you pay (just a liquidity issue?) to own an asset class (equites) that outperforms all others when tax and inflation adjusted over time.  I don't know.

 

This is a long way of saying that what happens in 2012-2015 doesn't matter to me personally (other than learning as I mentioned above) because my (financial) bet on the Canadian housing market didn't start until right at the end of 2014.  But just because other's were wrong in 2012, doesn't mean avoiding CA RE wasn't prudent (I don't have a strong opinion).  But also, if CA RE is  a good long term asset class, perhaps all the short term chattering is irrelevant to long term investors (in fact I would virtually GUARANTEE that is the case... long term being >10 years).  Paying a 50-100% premium for an asset class that will return 5% real, still means you are a winner with a long enough timeframe.

 

However, I would only caution that the #1 mistake I see (and have seen) people make is to forget the simple fact I covered about asset prices up thread... that asset prices do actually feedback into the real economy.  The psychology of booms and busts is real and based on human nature, high prices beget competition, loosening of downside scenario testing (which makes it worse when it does come).  I like Canada, and I think long term it's a good bet, and that would include real estate.  But based on every data point I see, forgoing investment now (in RE), will likely leave buyers with better opportunities later after the sheen wears off and reality sets in.  I may be wrong, and if it takes long enough for my view to bear itself out, I *will* be wrong, even if someday I get to say "told you so" because time is not on the side of someone betting against the prices of real assets in well run countries.

 

I just personally think that those buying into CA RE are using way rosier assumptions than others elsewhere investing in similar assets.  To me I'm guessing that they will be disappointed, mostly because they are taking on heightened risks (volatility, liquidity, and loss of opportunity... but probably not risk of permanent loss if held for a good period of time) for the compensation they are getting.  However, I am man enough to admit, that my estimate on the compensation for holding CA RE long term may simply not be as optimistic as reality, or the market may be ok with the long term rate of return from today's prices, and thus no adjustment is needed.

 

There is of course a different implication of your question if we invert it:

 

If prices were extremely elevated in CA RE 3 years ago, and the natural increase in value is less than markets have appreciated since then... doesn't that just mean we have much further to fall now?  I don't know which is right... but I feel like the market tend to hurt the most people it can... I know several people (in Oregon in the US) invested in Toronto Condos and they are all quite happy with themselves.  When the CA RE boom reaches Portland OR, I have trouble thinking this time will be different.  But again, it's a good asset long term, so it may not be a huge deal.

 

And of course those sitting out a boom or betting against don't necessary leave their proceeds in cash... that is not the appropriate measuring stick.  Saying a CA RE investor is worse off in cash, isn't really an argument, cash is crap long term, but that doesn't mean they shouldn't spend their money on a better opportunity.  When I short a stock, I use most / if not all of the proceeds to buy another stock I like better... the same is true with all life's decisions... not buying CA RE, doesn't mean you can't buy a Greek hotel, or a Florida swamp, or an Argentinian stock, or...

 

We'll see.

 

Ben  (wish I knew the future, and sorry for the ramble)

[KCLarkin]

Why are houses almost twice as expensive in Canada as in the US?

 

Do you really think you could sell a house in Toronto and buy something similar in NYC for half the price?

 

 

 

 

 

[Liberty]

Why are houses almost twice as expensive in Canada as in the US?

 

Do you really think you could sell a house in Toronto and buy something similar in NYC for half the price?

 

No, but that's not what I said either.

 

[cwericb]

Ben, I am playing devil’s advocate with many of my comments. I also agree with much of what you write. None of us have a crystal ball - unfortunately - the best we can do is make educated guesses.

 

However, I would point out one unique point in investing in a house. Unlike most investments, it is an investment that you can use, enjoy and live in as the market settles out.

 

What I don't understand is why people seem to assume that Canada consists of just Vancouver, Calgary, Toronto and Montreal. Prices in those cities are very high and while some or all of those cities may see a housing correction, that does not mean that the same correction will necessarily take place in all of Canada. Remember that those cities only represent about one third of the population of Canada. Two thirds of Canadians live elsewhere.

[Liberty]

What I don't understand is why people seem to assume that Canada consists of just Vancouver, Calgary, Toronto and Montreal. Prices in those cities are very high and while some or all of those cities may see a housing correction, that does not mean that the same correction will necessarily take place in all of Canada. Remember that those cities only represent about one third of the population of Canada. Two thirds of Canadians live elsewhere.

 

That's a good point. Obvious, you don't buy the average price in the country. If I lived somewhere where houses were selling for a reasonable price (some little town in New Scotia or something), I'd buy. But where I am, I don't think they are, and I look at the behavior of everyone around me, how they think about RE, not giving any thought to risk, expecting things to keep going exactly as they have for the past 10-15 years, and how they are buying based on what they can afford to pay per month (without much margin of safety, at these super low rates), and I know that this is not a sustainable thing. And where I live is a lot less expensive than the big cities. Still, too expensive is too expensive; a Toyota Corolla might be a good deal at $20k, but it's overpriced at $40k regardless of the arguments the salesperson has.

 

The argument that you live in your house, so it doesn't matter if you overpay might be convincing if buying a house was the only option apart from a cardboard box, but I can rent and get a nice subsidy from my landlord (ie. to live in equivalent comfort, while putting aside as much as I'm putting aside now (in house equity vs savings/investing), would cost me significantly more).

[KCLarkin]

No, but that's not what I said either.

 

That's what you are implicitly saying when you use averages. The "average" means there is no difference between a condo in Detroit and a 6 bedroom house in Toronto.

 

So there are a few plausible answers to why house prices are twice as expensive in Canada:

- the average does not normalize for differences in locations, house sizes, or house types

- the methodology used by NAR/CREA is based on transactions. This can skew averages (for example there might be a lot of distressed foreclosure sales but very few sales of high end homes)

- the averages in Canada might be skewed by Vancouver and Toronto

- the averages in the US might be skewed by Detroit and other distressed markets

- the mortgage market in the US is seized up as a result of the financial crisis

- US real estate is a bargain

- Canada is in a speculative real estate bubble

 

When you look at the international data I posted, the safe conclusion is that real estate prices are elevated almost everywhere relative to historical prices. Certain markets in the US seam to be the outlier.

 

 

[wisdom]

Prices are elevated everywhere from long term averages - it seems there is agreement on this.

 

The only question is:

the risk/reward still good, or

do we keep dancing till the music is playing.

 

[gary17]

Remember also all the gains from your primary residence in Canada is tax FREE.... so if you can make $1M 30 years later on a piece of real estate, it is as if you made $2M in income.... or something like that. 

 

I think there are definitely a few players in the market.... but I know for most Chinese buyers, they are buying 1 house for the long term to raise their kids...  They aren't buying multiple houses/ condos.  And I believe most are buying with cash -  and I believe they are buying in London, LA, San Fran, Singapore, etc., not just Vancouver / Toronto.

 

I should also mention the Chinese RMB is pegged to the USD... so relative to people from China / Taiwan / HK --- Canadian real estate just dropped 25% compare to a year ago...  so it is on sale

 

It's a tough decision for sure...   

[Liberty]

That's what you are implicitly saying when you use averages. The "average" means there is no difference between a condo in Detroit and a 6 bedroom house in Toronto.

 

Um. No.

 

So there are a few plausible answers to why house prices are twice as expensive in Canada:

- the average does not normalize for differences in locations, house sizes, or house types

- the methodology used by NAR/CREA is based on transactions. This can skew averages (for example there might be a lot of distressed foreclosure sales but very few sales of high end homes)

- the averages in Canada might be skewed by Vancouver and Toronto

- the averages in the US might be skewed by Detroit and other distressed markets

- the mortgage market in the US is seized up as a result of the financial crisis

- US real estate is a bargain

- Canada is in a speculative real estate bubble

 

When you look at the international data I posted, the safe conclusion is that real estate prices are elevated almost everywhere relative to historical prices. Certain markets in the US seam to be the outlier.

 

Cities don't grow overnight. The historical average of house prices in Canada and the US can be compared over time. Why did they diverge recently but not before? Why was 2006 considered to be an overpriced market in the US but not in Canada?

 

Nobody said that prices were the same everywhere, but this phenomenon is a country-wide thing, just like it was in the US in 2006. Some places are worse than others, but most of the factors that have caused this (federal housing policies, interest rates, media psychology, busts in other asset classes driving people away, etc) were country-wide factors. This isn't like the Toronto bubble in the late 80s. You can look at price trends in almost any city in the country and see it happening, not just in Vancouver and Toronto -- prices might not be as high, but in a small city where houses used to cost 175k, the fact that they now cost 300k barely a decade later is still telling.

 

In any case, this comparison between two very close and similar countries is just one of many factors. Even if that didn't exist, there would still be price ratios to incomes, price ratios to rents, price ratios to replacement costs, growth in prices vs inflation, growth in prices vs historical, debt levels vs historical, buying psychology, lack of good data about the market (the US is way ahead of us there), etc.

[KCLarkin]

The historical average of house prices in Canada and the US can be compared over time. Why did they diverge recently but not before? Why was 2006 considered to be an overpriced market in the US but not in Canada?

 

I'm going to step aside from this conversation. I will suggest that:

- the starting point of that graph was probably deliberate and things might look different if you looked at a longer time period

- the NAR/CREA data is not a great methodology for tracking housing prices. Case-Schiller is not perfect but addresses most of the flaws.

[alertmeipp]

Liberty,  I used to think exactly like you.

 

  In Toronto,

Rent ratio is properly 30 40x.  1m house rent for 2.5k.

 

Income ratio is over 7x. And I am talking

about become tax income...

 

Very high ratios no matter how u cut in.

 

But i still see multiple ppl bidding on the offer night.  Heard stories about  guys out bidding  pretty  himself just to get in.

 

U check out the houses in Scarborough. They don't even look as nice as those in Phoneix.

 

But if this bubble continues on for few more years, why not jump in and take advantage of it.

 

Only if I know the future.

 

. 

[alertmeipp]

Remember also all the gains from your primary residence in Canada is tax FREE.... so if you can make $1M 30 years later on a piece of real estate, it is as if you made $2M in income.... or something like that. 

 

I think there are definitely a few players in the market.... but I know for most Chinese buyers, they are buying 1 house for the long term to raise their kids...  They aren't buying multiple houses/ condos.  And I believe most are buying with cash -  and I believe they are buying in London, LA, San Fran, Singapore, etc., not just Vancouver / Toronto.

 

I should also mention the Chinese RMB is pegged to the USD... so relative to people from China / Taiwan / HK --- Canadian real estate just dropped 25% compare to a year ago...  so it is on sale

 

It's a tough decision for sure... 

 

Gary,

 

The areas I witness the steepest raise in RE generally have high ratio of ppl from mainland China.

 

It's not uncommon to see a huge house in Toronto and Vancouver  either being empty most of the time or just have the mom and son live there.

 

I don't even think thry care about the forex rate.

They just want to get the money out in case something bad happen back home.

 

Canada is a much smaller market than US. so the impact will be way more visible.

 

 

 

 

[alertmeipp]

Say if I l am renting my place for 2.5k, if I buy it will cost me 1m

 

And I need to pay 8k annually for taxes, maybe 4k for maintenance.

 

So spend 1m saves me 20k... So it does not make sense to buy unless u are betting on house price to go up fast.

 

 

Of coz,  I do realize house is not pure investment.

[Liberty]

Liberty,  I used to think exactly like you.

 

  In Toronto,

Rent ratio is properly 30 40x.  1m house rent for 2.5k.

 

Income ratio is over 7x. And I am talking

about become tax income...

 

Very high ratios no matter how u cut in.

 

But i still see multiple ppl bidding on the offer night.  Heard stories about  guys out bidding  pretty  himself just to get in.

 

U check out the houses in Scarborough. They don't even look as nice as those in Phoneix.

 

But if this bubble continues on for few more years, why not jump in and take advantage of it.

 

Only if I know the future.

 

.

 

Best of luck with that.

[Liberty]

The historical average of house prices in Canada and the US can be compared over time. Why did they diverge recently but not before? Why was 2006 considered to be an overpriced market in the US but not in Canada?

 

I'm going to step aside from this conversation. I will suggest that:

- the starting point of that graph was probably deliberate and things might look different if you looked at a longer time period

 

Found these which goes back to 1980:

 

http://www.theglobeandmail.com/globe-investor/personal-finance/mortgages/home-buying/article11502773.ece/BINARY/w620/Real+house+prices%3A+Canada+vs.+the+U.S.

 

http://www.theglobeandmail.com/globe-investor/personal-finance/mortgages/home-buying/article11502650.ece/BINARY/w620/Ben+Chart+1

[cwericb]

That graph shows the Canadian house prices went through a period of 10 years where housing prices were stagnant -all during the 1990's? Boy I don't remember that - (edit) I guess that depended on where you lived.

 

[merkhet]

Liberty,  I used to think exactly like you.

 

  In Toronto,

Rent ratio is properly 30 40x.  1m house rent for 2.5k.

 

Income ratio is over 7x. And I am talking

about become tax income...

 

Very high ratios no matter how u cut in.

 

But i still see multiple ppl bidding on the offer night.  Heard stories about  guys out bidding  pretty  himself just to get in.

 

U check out the houses in Scarborough. They don't even look as nice as those in Phoneix.

 

But if this bubble continues on for few more years, why not jump in and take advantage of it.

 

Only if I know the future.

 

.

 

Best of luck with that.

 

Many of my relatives said the same thing about China's housing market... (multiple bids, etc.)

[Uccmal]

Does it make sense to short canadian banks based on this insight?

 

In a word... No. 

 

I just went through two separate processes in the last 7 months.  One was remortgaging our house at lower rates with First National Lp (Canada's biggest mortgage lender).  The other was setting up a new Heloc with TD Bank. 

 

First National required proof of wage, employment, and assessed the house for its value before approving the remortgage.  The house was assessed for 950k, my estimate on its resale is 1050 to 1100 k.  They cap the amount they will lend at 80%.  We remortgaged with room to spare. 

 

I like to operate with a Heloc to smooth my investment income that I rely on.  We went to Td to get a Heloc set up.  Again, we had to provide full income verification, and TD sent their own house assessor.  It was again assessed for 950 k, within seven months of the last assessment.  The capped the total borrowable at 80% including First National's portion. 

 

My Wife and I have Equifax credit scores of 800 and 854.  900 is a perfect score.  90 plus Defaults among those with higher than 800 run at less than 1%.  We had to go through alot of hoops to get this all done. 

 

My conclusion:

The big 5/6 Canadian Banks are unlikely to get stung very much in a real estate crash, if there is one.  First National is also unlikely to get stung very much either.  If housing does crash their stocks will get very cheap for no reason.  Ry, TD, BMO, BNs, CM, and Fn are all on my long term watch list. 

 

I have even dipped my toes in the water buying some First National and Ry recently.  This is part of my strategy of shifting some of my assets to Canadian dividend paying companies to generate income.

 

If I were going to short something in relation to a Real Estate crash I would look at mortgage lenders who work the subprime space.  There are some smaller publicly traded ones.  I dont have any suggestions in particular as I dont short as a rule, and I am not looking in this space for watch list candidates - I suspect some of these will get wiped out but cant say which.  In part of my due diligence For Fn, I googled under numerous search terms for Canadian Housing lenders for people with weak credit and came up with a few names - First National did not appear.  Incidentally, I have been a customer of First National for 11 years since they were a smaller outfit, and they sailed right through 2008/2009 unscathed.  It only took me 7 years or so to pull the trigger and start paying myself back on my mortgage.