Garth Turner - Real Estate in Canada

[wisdom]

Privately borrowing for downpayment has been fairly common, but it comes at a price 12-14% plus fees. People were happy to pay it when the bubble was in full swing but the market for SFD houses has slowed dramatically  in Vancouver. People aren't going to pay 12% plus when they have come to believe that prices pay not continue rising. This bubble is done by the looks of it.

[TBW]

For borrow, MIC 4.7%, EQB 1.4% but that may have changed.  I don't really like being long any of the CAD banks so don't like the pair trade.  One I do like is long US banks and short cad.  Not as attractive as it has been, but I think still works.

 

Agree with Wisdom.  The second mortgage mkt will change a lot on this.  In the past you could borrow the downpayment and banks didn't care as mortgage was insured.  Now that they actually bear the risk, they don't want super expensive debt that hurts their borrowers debt servicing ability.  Also they would need to borrow to get to 20% down, big difference from borrowing to get 5% down.  Doing quick math borrowing 20% at 12% would cost as much as 3% mortgage on following 80%.  No one is going to do that.

 

A big part of all this is getting the risk to be born by the originating banks.  There may be further changes that make them face more risk when they do use insurance.  So we have a situation where less insurance is available, banks face higher risk and capital requirements are going up.  So less credit available and more expensive mortgage rates when available.  Therefore house prices are going lower.

[rb]

Wow, the borrow on MIC is large!

 

TBW, I understand your thinking. I like US banks as well. But in a pair trade you would try to match the characteristics of the underlyings mainly for downside protection. For example is the bubble is really stubborn and housing goes on a tear from here you don't loose your shirt. Bubbles are weird like that.

 

The reason why I brought up TD. Is because they indeed have a large US operation. They've also pulled back on residential lending years ago. I don't think they'll be spared if things go bad but I have more than a sneaky suspicion that they have the best RE loan portfolio out of CAD banks.

 

RE the secondary market I think  TBW is correct I don't see how you borrow tons of money at 14% if you can't borrow at 4%. But this market has been so crazy that nothing would surprise me.

[TBW]

One thing people forget about the big 5 is they are much more levered then their international peers.  If you look at Assets divided by tangible common equity and you strip out the insured mortgages you are still looking at levered ratios between 19 and 24.  TD is at 24 as they have a tonne of goodwill on their books.

 

So these banks don't have direct exposure to the riskier segments of the mort market.  They do have plenty of credit exposure to other riskier products like HELOC, credit cards, personal loans etc to the Canadian public.  This risk is then quite levered.

 

IMO they aren't the safe investments people think they are.

[Peregrine]

One thing people forget about the big 5 is they are much more levered then their international peers.  If you look at Assets divided by tangible common equity and you strip out the insured mortgages you are still looking at levered ratios between 19 and 24.  TD is at 24 as they have a tonne of goodwill on their books.

 

So these banks don't have direct exposure to the riskier segments of the mort market.  They do have plenty of credit exposure to other riskier products like HELOC, credit cards, personal loans etc to the Canadian public.  This risk is then quite levered.

 

IMO they aren't the safe investments people think they are.

 

Look at RWAs, not simple asset/equity calculations. There's a reason why A/E is way higher but their tier 1 common equity ratios are in line.

[Liberty]

http://www.theglobeandmail.com/globe-investor/personal-finance/household-finances/house-prices-will-not-rise-forever-base-your-financial-decisions-accordingly/article32219135/

[KCLarkin]

http://www.theglobeandmail.com/report-on-business/rob-commentary/the-intended-consequences-of-new-housing-policies/article32383166/

 

These changes will both reduce home buyers’ ability to borrow and increase lenders’ funding costs. We expect mortgage rates to increase modestly in response. Our government-backed mortgage funding has encouraged some unhelpful mortgage-lending activities. These business models will have to change since government should not be supporting lending that threatens our economic stability.

 

[Liberty]

Also: http://www.theglobeandmail.com/real-estate/the-market/cmhc-to-issue-first-red-warning-for-canadas-housing-market/article32386112/

 

Canada Mortgage and Housing Corp. will increase the risk rating in its overall assessment of the country's residential market to "strong" from "moderate" when it issues a new report on Oct. 26.

 

"CMHC has recently observed spillover effects from Vancouver and Toronto into nearby markets," CMHC chief executive officer Evan Siddall said in an opinion column in The Globe and Mail. "These factors will be reflected in our forthcoming Housing Market Assessment on Oct. 26. They will cause us to issue our first 'red' warning for the Canadian housing market as a whole."

[Liberty]

http://www.bloomberg.com/news/articles/2016-10-24/canada-s-swelling-debt-pile-raises-questions-over-future-growth

 

While Canada boasts the lowest government debt load among Group-of-Seven countries, household debt is the highest of its peers, the Basel, Switzerland-based BIS said last month in its quarterly report. In September, Statistics Canada reported household liabilities rose to 100.5 percent of GDP, exceeding the size of its economy for the first time.

[Liberty]

http://www.macleans.ca/economy/economicanalysis/when-it-comes-to-canadas-housing-market-were-in-the-dark-here/

 

What other information gaps do we have? There are almost too many to count, but one of the largest, as far as homebuyers are concerned, is the continued lack of transparency around sales and pricing in the resale market. For all the efforts by Canada’s competition watchdog to open up access to basic real estate data, it remains firmly under the control of a self-interested monopoly of realtors.

 

[...]

 

It’s all a depressing reminder that in Canada, transparency remains a dirty word and paternalistic attitudes about protecting the public from information prevail.

[TBW]

http://www.bnn.ca/video/cohodes-still-shorting-home-capital~981334

 

This is a good watch.  I totally agree with him and have been short EQB since 2014.  The amount of fraud that will come out after this bubble bursts will be shocking imo. 

 

[TBW]

Liberty, thanks for posting that Macleans article.  Its a great read.  Why we don't have the free information that he suggested is beyond me.  From what I understand the realtor groups have been legally required to share info but for some reason they still aren't.

[wisdom]

SFD right across the board is down 20% in Vancouver and suburbs. Financing is drying up. Time to hold on, it is about to get ugly.

[TBW]

Hey Wisdom, do you have any idea who the main (publically traded) mortgage providers have been?  I think CWB and CM have disproportionate exposures but from being on the ground who would you think has been dominant in the market?

 

The credit unions must be really nervous...

[KCLarkin]

SFD right across the board is down 20% in Vancouver and suburbs.

 

Do you have a reliable source on this? The benchmarks/indices I have seen do not corroborate this. Teranet had Vancouver prices up 0.18% MoM in September. And up 24% YoY.

 

Or are you referring to volumes? Or are you referring to "average prices" (which are skewed by sales mix)?

 

 

[wisdom]

Speaking to realtors and developers. I had started hearing that prices were down 15% by September end but was waiting for more people to confirm. Now I have spoken to enough people and I am confident in what I am saying.

 

Banks that used to do 65% financing for foreign nationals with no income and credit in canada. I am hearing from internal sources that has stopped. Earlier a foreigner could land with $5 million and the banks would give them a $10 million mortgage. Thus, the top of the market has been taken out.

 

Even for locals getting 65% financing is tightening up.

 

You could live at home with low networth and low income and still buy a revenue property using rental income. Now it isn't consider prudent.

 

FI's have started hitting their caps on lending to developers because the cities had slowed down approvals. Thus, they are unable to lend to these developers even though they have several homes that they purchased earlier this year during the frenzy and need to close on them in the near future.

 

At the Same time, the demand has disappeared because of the tightening. So not sure who will buy the completed homes. And if they can't sell their completed homes, I am unable to figure out how they pay their mortgages on properties they own.

 

Shadow banking was handled by brokers. Their money came from investors who had borrowed against their homes and their earning was the spread. If prices continue dropping, this capital could be written off and individuals who thought this was easy money will be left with no income on the capital but will have their outstanding mortgage/HELOC against their primary residence.

 

New rules that start to role out next week will require banks to hold more capital against mortgages. I expect this to make mortgages unprofitable unless rates are increased. Thus, I expect banks to start pulling back even more starting next month.

 

Realtors, etc believe this to be temporary because they can not  believe the government will let things collapse.

 

All this is happening in a economy that has a very high reliance on real estate.

 

Any business that is housing related will have a tough time going forward -Reits, banks, retail sales (no home equity as ATM), etc. In my opinion, this is the last pillar holding up the Canadian economy and it too is on the the way down. We should feel the ripple effect right across. Not sure if there will be any safe place to hide other then exporters and businesses that benefit from a low loonie.

[wisdom]

The 20% drop is from the peak in June. Thus, it will not show up in the YoY numbers until next year. But it is coming.

 

I am not sure most people understand the gravity. They are really in denial or are so used to it bouncing back everytime over the last 16 years, they think they just have to wait a few months and it will be back to the good old days.

[TBW]

Awesome stuff Wisdom! Thank you. Agree not many places to hide for investors in Canada. Also think currency goes a lot lower vs usd than people think.

[KCLarkin]

The 20% drop is from the peak in June. Thus, it will not show up in the YoY numbers until next year. But it is coming.

 

I think it is fair to say that Vancouver house prices might drop 20% over the next year. Even though I agree with everything you said, I highly doubt house prices have dropped 20% across the board in a single month. The anchoring effect makes it very difficult for moves that big. Usually, volume dries up as sellers refuse to lower their prices even as buyers disappear. After re-listing their houses a few times, the sellers eventually find a market-clearing price. Or else distressed sellers come into the market.

 

A much more likely scenario is that sales of high-end homes have dried up. So the mix shifts to condos. This causes the "average" price to drop 20%. Teranet uses a fairly sophisticated process to track price moves to avoid this skewing effect. I doubt the realtors and developers are as scientific.

 

[wisdom]

I am talking about SFD. So yes houses. They are clearing at 20% below what they would have sold at earlier this year. I am not talking averages here.

 

In a city where the average single family house was in the $1.2-1.5 mil range with median household income of $72,000, what isn't high end?

[KCLarkin]

I am talking about SFD. So yes houses. They are clearing at 20% below what they would have sold at earlier this year. I am not talking averages here.

 

I know that's what you are saying. And I know that's what you believe. I'm simply saying that the method you are using is not reliable.

[bbarberayr]

http://www.macleans.ca/economy/economicanalysis/canadas-housing-market-looks-a-lot-like-the-u-s-did-in-2006/

 

Good Maclean's article summarizing housing in Canada.

[Liberty]

http://www.macleans.ca/economy/economicanalysis/canadas-housing-market-looks-a-lot-like-the-u-s-did-in-2006/

 

Good Maclean's article summarizing housing in Canada.

 

Thanks for posting.

[KCLarkin]

The 20% drop is from the peak in June. Thus, it will not show up in the YoY numbers until next year. But it is coming.

 

Sales of detached properties in October 2016 reached 652, a decrease of 54.6 per cent from the 1,437 detached sales recorded in October 2015. The benchmark price for detached properties is $1,545,800. This represents a 28.9 per cent increase compared to October 2015 and a 1.4 per cent decrease compared to September 2016.

 

Sales of detached properties in June 2016 reached 1,562, a decrease of 18.6 per cent from the 1,920 detached sales recorded in June 2015. The benchmark price for detached properties increased 38.7 per cent from June 2015 to $1,561,500.

 

The benchmark is down 1% from June to October.

 

 

[wisdom]

SFD is not the benchmark.

 

Where has the largest drop in sales been? SFD, townhomes, condos?

 

I have so far only talked about SFD.

 

Dig through the numbers and you will realize what I am saying could potentially be true even if the benchmark number is what it is.

 

PS. I don't need anyone to agree or believe me. I am writing what I see. Do with it what you choose.