Garth Turner - Real Estate in Canada

[Sunrider]

I live in Toronto, and this bubble is definitely insane, but I can't wrap my head around whether I can bet against it or not.

 

Because to me, the premise "this bubble must pop" is not good enough, obviously because of the timing aspect. In some sense, I need to identify potential catalysts for the bubble to pop, and be sure that the catalyst(s) would happen soon.

 

Here are some scenarios that I though about...

 

- Highly levered, speculative local investors default on mortgage payments or must sell the property for other reasons. This requires one of 1) interest rate rising fast, 2) cannot find tenants (or rental market tanks), or 3) the investors lose their sources of income / wealth. 1) is unlikely given that the government can control it to prevent popping the bubble, 2) is also unlikely looking at Toronto's rental market right now (no sign of population decline) and 3) likely means some sort of global financial melt down, which is hard to predict.

 

- Foreign investors suddenly need to sell, perhaps because they suddenly need the money, or they now have an incentive to sell (better investment opportunity elsewhere or maybe China says bring your money back now and you can legitimately keep it?) or they figure that the investments no longer meets their hurdle rates. I really don't know whether any one can predict timing of these events...

 

Anyone else can think of other catalysts and their estimated timing?

 

I agree with your logic - the timing and probability is uncertain and no one will know if this is a bubble that's gonna burst soon or a bull market run that's just beginning.

 

Other Catalysts:

- Capital control by the Chinese Government. (Usually ineffective as people will always find a way)

- Anti-immigration policy, Reduction of student permit/parents visa/work permit. by the Canadian Government - not likely given the current political environment

- New immigrants preferring other cities instead of Vancouver/Toronto - I dont see how that's probable

- Racism riots/Terrorist attack in Toronto/Vancouver - probability unknown, but that will be enough to scare off some immigrants who are here for their kids.

- increased capital gain tax of any kind on property. That will trigger short term selling - We will know today.

- Sudden jump in CAD - back to 1:1 USD?

- Government providing significantly more permits for condo development in the next few years

 

Valuation of housing is always relative. imagine a new Chinese immigrant from a major city come over and look at what $2MM can buy in Markham. And it comes with free English schools+free healthcare. Most would find it a steal. Our 35mm population just find it hard to understand what the 1.4B ppl are thinking.

 

True - although you then also need to take a view on how many Chinese with $2m to plop down (they won't get that as a mortgage without a job in Canadia) there are to come over as immigrants each year (since you're presumably saying that these are now the marginal buyer setting the price)?

[CalvinL]

from what I know.

 

- Financing, if needed, would have been done in China a few years ago, not here. It's harder today with all the capital control policies but not impossible.

- Most immigrants to Canada would be able to come up with 1M+ as a family. Selling any of their real estates in Beijing, shanghai, Guangzhou and of cos HK would generate that amount. (although most who had done that in the past few years would regret it now)

- Family buying: one child policy in the last few decade means a couple in their 30s today would have the financial backing of both their parents. Living with inlaw and parents is the expectation but that's also quickly changing.

 

of cos there are also mortgage packages designed for new comers in Canada from lenders like Genworth. Why would they do it - I have no idea. There is a rumour that's floating around - "in Canada you can get bankrupt and it does not affect your asset in China".  I'll stop here lol....

[mcliu]

capital gains taxes are lower and why should owners of real estate get an advantage over other forms of gains?

 

Assuming houses appreciate at roughly the same rate as inflation, you are taxing "phantom gains". At the end of 20 years, you own the exact same house as you bought (actually a bit worse for wear). It makes no sense that should also need to pay tax on this "gain".

 

Capital gains on stocks make some sense, since the retained earnings are taxed at a lower rate than dividends. So the real value of a company increases over time. There is still a stealth inflation tax though. Which is why capital gains taxes should be much lower than dividend or income taxes.

 

Mortgage deductibility subsidizes borrowers, not homeowners. So if I have paid of my house, I pay the stealth inflation tax. But I don't get to deduct interest.

 

Not sure if that's entirely true. I actually think houses should appreciate faster than inflation. (I could be wrong though.) If you look at it from a yield perspective. Price = Rent (or CF) / Cap Rate * (1 - Tax). The numerator would grow at something like nominal income growth (real income growth + inflation rate). The denominator would fluctuate based on interest rates. Also, certain prime locations are limited in supply and would appreciate more than those underlying factors due to scarcity.

[clutch]

of cos there are also mortgage packages designed for new comers in Canada from lenders like Genworth. Why would they do it - I have no idea.

 

Interesting. Could you point to any websites or materials that talk about these mortgage packages for new comers?

 

(edit) Nevermind, I found this:

http://genworth.ca/en/products/new-to-canada-program.aspx

[Liberty]

A little too rustic for my taste..

 

[Spekulatius]

I don't think you can really time these things..

 

If the bubble is as big as it looks like and the popping of the RE bubble in the US is any guide, than you don't need to time this perfectly, in fact t is probably better to wait after the prices have turned down for a while. US RE went from red hot to cold in fall/winter 2005 and it took until 2007 to play out.

[clutch]

I don't think you can really time these things..

 

If the bubble is as big as it looks like and the popping of the RE bubble in the US is any guide, than you don't need to time this perfectly, in fact t is probably better to wait after the prices have turned down for a while. US RE went from red hot to cold in fall/winter 2005 and it took until 2007 to play out.

 

Can't generalize from one data point

[mcliu]

There's also no good vehicles to short like CDS in Canada.

 

Saw this today:

 

http://torontolife.com/real-estate/houses/toronto-house-for-sale-252-macpherson-avenue/

 

Semi-detached bought for $1.4M in 2015, renovated and is listing for $3.3M today  :o That IRR though.  ;D

[cwericb]

Timing the housing market does not work. Want proof? This thread was started five years ago. Think about it.

 

Had someone deferred buying in 2012 expecting a collapse, that same home could now be 50% more expensive. 

 

Purchasing in 2012 instead of renting, one would would have by now:

  1) paid down a percentage of his mortgage

  2) experienced a substantial gain in the value of his equity

  3) had a very nice tax free increase in his net worth

 

On the other hand, the renter would have:

  1) helped his landlord pay off his mortgage

  2) probably experienced, or will experience an increase in rent payments.

 

Yes this is hindsight. Yes housing prices may take a dip. But investing in a house cannot be compared to buying shares in the stock market.

 

A share is a share. A house is a home. If your shares drop 30% you just lost 30%. If the housing market drops 30% you still have 100% of your home.

 

Also. Comparing the 2007 American housing market with the Canadian housing market is not an equal comparison. There are major differences, and there is much more to the Canadian housing market than two or three cities.

[TorontoRaptorsFan]

The last Garth Turner blog talked about the Real Estate Expo in Toronto...

 

:o

 

http://torontolife.com/real-estate/think-going-go-even-sky-high-wealth-expo-attendees-talk-torontos-housing-market/

 

 

[clutch]

Had someone deferred buying in 2012 expecting a collapse, that same home could now be 50% more expensive. 

 

Purchasing in 2012 instead of renting, one would would have by now:

  1) paid down a percentage of his mortgage

  2) experienced a substantial gain in the value of his equity

  3) had a very nice tax free increase in his net worth

 

On the other hand, the renter would have:

  1) helped his landlord pay off his mortgage

  2) probably experienced, or will experience an increase in rent payments.

 

Yes this is hindsight. Yes housing prices may take a dip. But investing in a house cannot be compared to buying shares in the stock market.

 

A share is a share. A house is a home. If your shares drop 30% you just lost 30%. If the housing market drops 30% you still have 100% of your home.

 

That's an appropriate argument for buying vs. renting. But if you consider real estate as pure investment, why can't we compare it to stock market?

 

Although for Toronto in the past 5 years, you'd come out ahead investing in a house (if you took any leverage) vs. investing in S&P500. No leverage, I think it's a wash, ~100% for both investments. But could anyone have predicted this outcome (not just predicting non-collapse, but skyrocketing of hosue prices)?

 

p.s. If your share drop 30% you might still have same intrinsic value of the business. ;)

 

 

[rb]

Timing the housing market does not work. Want proof? This thread was started five years ago. Think about it.

 

Had someone deferred buying in 2012 expecting a collapse, that same home could now be 50% more expensive. 

 

Purchasing in 2012 instead of renting, one would would have by now:

  1) paid down a percentage of his mortgage

  2) experienced a substantial gain in the value of his equity

  3) had a very nice tax free increase in his net worth

 

On the other hand, the renter would have:

  1) helped his landlord pay off his mortgage

  2) probably experienced, or will experience an increase in rent payments.

 

Yes this is hindsight. Yes housing prices may take a dip. But investing in a house cannot be compared to buying shares in the stock market.

 

A share is a share. A house is a home. If your shares drop 30% you just lost 30%. If the housing market drops 30% you still have 100% of your home.

 

Also. Comparing the 2007 American housing market with the Canadian housing market is not an equal comparison. There are major differences, and there is much more to the Canadian housing market than two or three cities.

That's why all of you should just go out there and buy a house. Don't look at the price and don't think. Price doesn't matter in real estate.

[cwericb]

 

That's an appropriate argument for buying vs. renting. But if you consider real estate as pure investment, why can't we compare it to stock market?

 

Ever trying to live in your portfolio?

 

Although for Toronto in the past 5 years, you'd come out ahead investing in a house (if you took any leverage) vs. investing in S&P500. No leverage, I think it's a wash, ~100% for both investments.

 

While you will pay income tax on 50% of that investment gain,  but 0% on the gain on your principal residence. That's no wash.

 

But could anyone have predicted this outcome (not just predicting non-collapse, but skyrocketing of hosue prices)?

 

This is similar to the situation with home computers years ago. A home computer would drop in price drastically as new technology came out almost monthly. Some people went for years with out a computer because it would be cheaper next month. Others simply bought the computer that would do what they needed it to do and ignored the fact that it might be half that price in a couple of months.

 

p.s. If your share drop 30% you might still have same intrinsic value of the business

 

Perhaps, but what actual use is that share to you. Can you live in it? House prices can drop or increase by 90% and you still have the house to live in.

 

 

 

 

[rukawa]

That's why all of you should just go out there and buy a house. Don't look at the price and don't think. Price doesn't matter in real estate.

 

I had a friend who argued that you should never time the market in real estate and it always made sense to buy. I remember asking him, what if the average price were 10,000,000 for 2000 square feet, would you still buy. His claim was that this could not happen since the real estate market was in some sense efficient and prices could never go this high since people would not be able to afford it.

 

The implication here is that there is a level at which it does not make sense to buy real estate. Even cwericb would have to admit this number exists even though it might be some platonic idea that is never reached in practice. So the real debate is about three things:

 

1) Some ballpark estimate of the upper bound on real estate after which prices are no longer sane

2) The question of whether its possible for the market to ever breach this number

3) And whether the market has already breached the number

 

For 1) assuming that household income is around 78k (typical for Toronto), my view is that a sane price would have to reflect what people could pay off by retirement. Here is my breakdown:

 

Household income: 78k

After tax: 60k

non-house Living expenses for two people: 30k

Money available to pay for house: 60k-30k = 30k

 

I assume the average Torontonian has 30 years from ages 30-60 to payoff their house. The rest of the time they are either saving for retirement (60-65) or getting their shit together (23-30). Then the total possible upper limit is: 30k*30years = $900,000. No of course there are interest costs but there are also GDP per capita increases which should translate to salary increases. I assume these balance out (probably a bad assumption since interest costs are paid early and gdp increases come later).

 

I am curious as to what cwericb number would be for a sane upper limit to house prices? And how he would change the analysis above.

[clutch]

 

That's an appropriate argument for buying vs. renting. But if you consider real estate as pure investment, why can't we compare it to stock market?

 

Ever trying to live in your portfolio?

 

Although for Toronto in the past 5 years, you'd come out ahead investing in a house (if you took any leverage) vs. investing in S&P500. No leverage, I think it's a wash, ~100% for both investments.

 

While you will pay income tax on 50% of that investment gain,  but 0% on the gain on your principal residence. That's no wash.

 

But could anyone have predicted this outcome (not just predicting non-collapse, but skyrocketing of hosue prices)?

 

This is similar to the situation with home computers years ago. A home computer would drop in price drastically as new technology came out almost monthly. Some people went for years with out a computer because it would be cheaper next month. Others simply bought the computer that would do what they needed it to do and ignored the fact that it might be half that price in a couple of months.

 

p.s. If your share drop 30% you might still have same intrinsic value of the business

 

Perhaps, but what actual use is that share to you. Can you live in it? House prices can drop or increase by 90% and you still have the house to live in.

 

I said "But if you consider real estate as pure investment". I was considering a scenario when you already own a house and looking to buy additional properties for investment. Hence, I didn't consider about living in it nor the capital gain tax exemption. And this assumption is very valid in Toronto where you have an increase number of people buying houses as pure investment, not to live in them.

[Viking]

Timing the housing market does not work. Want proof? This thread was started five years ago. Think about it.

 

Had someone deferred buying in 2012 expecting a collapse, that same home could now be 50% more expensive. 

 

Purchasing in 2012 instead of renting, one would would have by now:

  1) paid down a percentage of his mortgage

  2) experienced a substantial gain in the value of his equity

  3) had a very nice tax free increase in his net worth

 

On the other hand, the renter would have:

  1) helped his landlord pay off his mortgage

  2) probably experienced, or will experience an increase in rent payments.

 

Yes this is hindsight. Yes housing prices may take a dip. But investing in a house cannot be compared to buying shares in the stock market.

 

A share is a share. A house is a home. If your shares drop 30% you just lost 30%. If the housing market drops 30% you still have 100% of your home.

 

Also. Comparing the 2007 American housing market with the Canadian housing market is not an equal comparison. There are major differences, and there is much more to the Canadian housing market than two or three cities.

 

You perfectly outline the dilemma facing first time buyers in Canada today. The recent past has taught that waiting was the wrong decision (and spectacularly so). The other side of the coin is 'if' we are in a bubble of historic proportions and it pops and prices move back to 2012 levels (not that crazy) first time buyers will be wiped out financially. Yes, if they remain in their house prices will rise over the following 10-20 years; however, they will be scarred financially.

 

I remember the dot com bubble in the late '90's. It was clearly a bubble in 1996 but it did not pop until 2000. I remember people being called stupid for being sceptical of the permanence of the gains in 1997, 1998, 1999 because the dot com stocks just kept going higher... in 2001 people had a very different view of reality.

 

The big difference between a stock bubble and a housing bubble is leverage. First time housing buyers today are highly leveraged. IF we get a correction of 20-30% first time buyers will get cleaned out.

 

Psychologically, investors react very differently to gains and losses. A 30% gain feels great; however a 30% loss feels much, much worse. My point is the two are not symmetric. Crazy times for those first time buyers itching to use real estate to get rich (like their parents did). Good luck!

[rb]

 

For 1) assuming that household income is around 78k (typical for Toronto), my view is that a sane price would have to reflect what people could pay off by retirement. Here is my breakdown:

 

Household income: 78k

After tax: 60k

non-house Living expenses for two people: 30k

Money available to pay for house: 60k-30k = 30k

 

I assume the average Torontonian has 30 years from ages 30-60 to payoff their house. The rest of the time they are either saving for retirement (60-65) or getting their shit together (23-30). Then the total possible upper limit is: 30k*30years = $900,000. No of course there are interest costs but there are also GDP per capita increases which should translate to salary increases. I assume these balance out (probably a bad assumption since interest costs are paid early and gdp increases come later).

 

I am curious as to what cwericb number would be for a sane upper limit to house prices? And how he would change the analysis above.

I'm now cwericb but I do have some issues with the analysis.

 

1. 30K non house living expenses in Toronto? That's really optimistic but ok.

2. You assume that all the other funds (30k) goes to mortgage payment. That ignores carry costs: property tax, insurance, maintenance, repairs, etc. Everyone who owns a house knows that those add up to a surprisingly large amount.

3. Only 5 years of retirement savings. So at retirement the couple has a house and 150k (30x5) in savings.

[rb]

You perfectly outline the dilemma facing first time buyers in Canada today. The recent past has taught that waiting was the wrong decision (and spectacularly so). The other side of the coin is 'if' we are in a bubble of historic proportions and it pops and prices move back to 2012 levels (not that crazy) first time buyers will be wiped out financially. Yes, if they remain in their house prices will rise over the following 10-20 years; however, they will be scarred financially.

 

I remember the dot com bubble in the late '90's. It was clearly a bubble in 1996 but it did not pop until 2000. I remember people being called stupid for being sceptical of the permanence of the gains in 1997, 1998, 1999 because the dot com stocks just kept going higher... in 2001 people had a very different view of reality.

 

The big difference between a stock bubble and a housing bubble is leverage. First time housing buyers today are highly leveraged. IF we get a correction of 20-30% first time buyers will get cleaned out.

 

Psychologically, investors react very differently to gains and losses. A 30% gain feels great; however a 30% loss feels much, much worse. My point is the two are not symmetric. Crazy times for those first time buyers itching to use real estate to get rich (like their parents did). Good luck!

You're right the big difference is leverage. I'd add a little to that. Everyone ignores second order effects and assumes that you can still live in your house.

 

But in reality, house price declines come with long and bone crushing recessions. So if the house price drops you get wiped out financially and you loose your house because you can't afford the huge mortgage payments anymore because you're suddenly out of a job.

[cwericb]

rukawa:

“The implication here is that there is a level at which it does not make sense to buy real estate. Even cwericb would have to admit this number exists even though it might be some platonic idea that is never reached in practice.

 

I am curious as to what cwericb number would be for a sane upper limit to house prices? And how he would change the analysis above.”

 

Well don't forget that essentially there is a certain correlation between housing prices and rent and you have to live somewhere.

 

Clutch:

No argument. Buying a property other than your principal residence is an entirely different matter. But never forget the fact that gain on one's primary residence is tax free.

 

Viking:

“First time housing buyers today are highly leveraged. IF we get a correction of 20-30% first time buyers will get cleaned out.”

 

Not necessarily. First you need a 20% down payment or insurance from CMHC and when push comes to shove, those guys will probably work with you. Second, if my house drops in value by 20% the house doesn’t go away. I still have to live somewhere and either pay a mortgage or rent.

 

Rb

“But in reality, house price declines come with long and bone crushing recessions. So if the house price drops you get wiped out financially and you loose your house because you can't afford the huge mortgage payments anymore because you're suddenly out of a job.”

 

If that happens you are probably screwed anyway.

 

Funny, but everyone on this board is a risk taker. Otherwise you wouldn't be investing in the markets which, who knows, could all be a house of cards. But when it comes to your home its right there, its where you and you family live. There is little risk to that aspect and to a certain extent its value is not what it would bring on the market, but how it provides a place for you and your family a place to live. Most certainly we would like to see it escalate in value, and yes, there are risks associated.

 

Sorry but I gotta go

[Hoodlum]

The big difference between a stock bubble and a housing bubble is leverage. First time housing buyers today are highly leveraged. IF we get a correction of 20-30% first time buyers will get cleaned out.

 

The scary thing is that a 20-30% drop just brings us back to Jan 2016 in Toronto.  We would need a 50% drop just to get back to 2012 levels. 

[rukawa]

I'm now cwericb but I do have some issues with the analysis.

 

The better way to deal with this is to post your own analysis with your own numbers. We are conducting a debate with words. I am trying to pin people down with numbers.

 

“The implication here is that there is a level at which it does not make sense to buy real estate. Even cwericb would have to admit this number exists even though it might be some platonic idea that is never reached in practice.

 

I am curious as to what cwericb number would be for a sane upper limit to house prices? And how he would change the analysis above.”

 

Well don't forget that essentially there is a certain correlation between housing prices and rent and you have to live somewhere.

 

I asked for a number. You haven't given me one. What is your number for an upper limit? A trillion per thousand square feet, a billion? I'm trying to pin you down. You do have to live somewhere...but you also have to pay for things in your life and given that you only make a certain amount of money there is a limit to how much you can pay.

 

We argue with words...we should be arguing about numbers. Otherwise this debate is largely rhetorical and emotional. My argument is that there is an upper limit for housing prices and that limit is based on affordability. So please give me a number and justification for the number.

[rb]

I asked for a number. You haven't given me one. What is your number for an upper limit? A trillion per thousand square feet, a billion? I'm trying to pin you down. You do have to live somewhere...but you also have to pay for things in your life and given that you only make a certain amount of money there is a limit to how much you can pay.

 

We argue with words...we should be arguing about numbers. Otherwise this debate is largely rhetorical and emotional. My argument is that there is an upper limit for housing prices and that limit is based on affordability. So please give me a number and justification for the number.

 

I kinda did if you read post 1331.

 

Ok, so on my street in a Toronto suburb 2 semis sold in the past week. Both listed and sold withing the week for about 870k. They were about 1250 sqft and 33 years old.

 

Let's now look closer at what this means. According to the rules, the minimum payment for these houses would be 62K. On top of that you'd have to pay around 14k in land transfer tax and 29k for mortgage insurance. Add in a couple of extra closing costs and you need about 110k upfront.

 

Now if you get a 5 year variable mortgage (25 year amortization) at 2.45% the mortgage payment is about $3,600 per month. Add in $100 for insurance and $300 for property tax and you would need $4,000 after tax per month just to carry the minimums for there house. This is without utilities, or any maintenance/repairs which any homeowner knows are more than you'd expect. However you have to quality for a 5 year fixed @4.64%. Which means that you need pretax family income of about 180k - and you can't have payments on other debt larger than 14k.

 

All of this for a small semi at current interest rates. Totally reasonable and affordable right?

 

But let's unpack that even more. To get the the great "pin down" number. One way to figure out the maximum paid is to see what's the maximum you can qualify for under CMHC rules. I believe that current rules do allow for reasonable expenses outside the home. Lets assume $3,600 in property tax, $1,200 insurance, and $500 for 1/2 heating costs.

 

You're right that the median family income in Toronto is 75K. But screw them if they're not smart to make real coin they should be homeless. Let's go with $120k annual income. 32% of that is $38.4K. Take out expenses and you're left with $33.1k for mortgage payments or $2,758 per month. At 5% down payment that's 516K max for the house. At 20% it is 613K.

 

So I would go with the max pin down number as 613K for say a 1,500 sqft place. I believe we blew through that number a while back.

[Cardboard]

"You perfectly outline the dilemma facing first time buyers in Canada today. The recent past has taught that waiting was the wrong decision (and spectacularly so)."

 

This is exactly the cause of the bubble. People do some logical math as some are here, they look around and at some point they think "what the heck?" and they jump in. When the cost of property taxes with insurance is higher than renting, you know that people are buying based on property appreciation and not common sense.

 

Stop paying your municipal taxes for fun and then tell me if you are truly owning your home, condo or property.

 

And I don't think that you will find a number on what makes sense or doesn't. It will likely go well above what the median income can afford for a variety of reasons including assets to back up purchases, shaddy loans, rich immigrants, 2nd home buying as investments, etc.

 

However, I can guarantee you that the highest price will come when the last one wanting or be able to afford a home in a certain district will have bought.

 

Cardboard

[rukawa]

But let's unpack that even more. To get the the great "pin down" number. One way to figure out the maximum paid is to see what's the maximum you can qualify for under CMHC rules. I believe that current rules do allow for reasonable expenses outside the home. Lets assume $3,600 in property tax, $1,200 insurance, and $500 for 1/2 heating costs.

 

You're right that the median family income in Toronto is 75K. But screw them if they're not smart to make real coin they should be homeless. Let's go with $120k annual income. 32% of that is $38.4K. Take out expenses and you're left with $33.1k for mortgage payments or $2,758 per month. At 5% down payment that's 516K max for the house. At 20% it is 613K.

 

So I would go with the max pin down number as 613K for say a 1,500 sqft place. I believe we blew through that number a while back.

 

I believe average house price in Toronto is around mid 700's. Average detached is above 1m.

 

Your analysis is interesting and much better than mine. How are people even getting CMHC insurance? I don't get it. CMHC require that you can spend no more than 32% of your gross income on Principal, Interest, property taxes and heating on housing.

https://www.cmhc-schl.gc.ca/en/co/moloin/moloin_003.cfm

 

So with the median household making around 76k, you can only service your house with 76k*0.32/12 = 2k per month. Heating is 100 a month. Property tax is 300 a month. So you are left with 1600 to service the house. I've plugged that into the TD mortgage payment calculator and I get that the most you can afford is $400,000 of principal for the mortgage.

 

 

[scorpioncapital]

The difference between renting and owning is that in one, the government is your landlord, and in the other, your fellow citizen. You can decide which you feel is the better option.