Garth Turner - Real Estate in Canada

[rb]

I was researching Ontario political party platforms last night. Not surprisingly, pc party doesn't have a published platform. Although their public ramblings seem to suggest that they do not appreciate the recent regulation that may have tempered the Toronto prices.

 

They are doing very good in the polls. Could the animal spirits return to Toronto real estate if Ford wins? Or is this price slide caught in the downward spiral?

 

Disclosure: I rent in Toronto. I would like to buy at reasonable prices.

The short answer is that they're full of it and can't do nothing about it. I can elaborate if you wish.

 

As an aside if you rent in Toronto given the way things are now, you're actually getting a pretty good deal. (Deal goodness varies depending on what you rent). Prices would actually have to move quite a bit before you would get anything that seems "reasonable".

[obtuse_investor]

Looking south of the border, one can be "full of it" and yet can unleash animal spirits. People just have to believe the narrative and it's off to the races again.

 

Please do elaborate though. Isn't it a possibility? Or is my reasoning incorrect? I don't consume politics on a regular basis. I am not in touch.

 

 

As for renting, I agree. With the way rental yields are, I am happy to take the other side of the trade. Nothing lasts forever and I am extremely patient.

 

 

[SafetyinNumbers]

Looking south of the border, one can be "full of it" and yet can unleash animal spirits. People just have to believe the narrative and it's off to the races again.

 

Please do elaborate though. Isn't it a possibility? Or is my reasoning incorrect? I don't consume politics on a regular basis. I am not in touch.

 

 

As for renting, I agree. With the way rental yields are, I am happy to take the other side of the trade. Nothing lasts forever and I am extremely patient.

 

It might but I would think the changes in lending rules and the higher interest rates have changed the behaviour not any change in the way Torontonians think about buying vs renting.

[rb]

Looking south of the border, one can be "full of it" and yet can unleash animal spirits. People just have to believe the narrative and it's off to the races again.

 

Please do elaborate though. Isn't it a possibility? Or is my reasoning incorrect? I don't consume politics on a regular basis. I am not in touch.

 

As for renting, I agree. With the way rental yields are, I am happy to take the other side of the trade. Nothing lasts forever and I am extremely patient.

Ok, I won't go into the PC platform cause it's mostly nonsense. You can go through it on digest it on your own time.

 

But about the "animal spirits". In general you are correct that politicians can be full of it and unleash animal spirits - basically people doing dumb things with money. That has been happening for millennia. So it's not an unreasonable premise.

 

However, in this particular case I don't think it will work. Here's why. The main ingredient you need in order to unleash animal spirits, beside bs, is credit. And what regulation B20 does effectively is cut off credit from the animal spirits. You are a someone who makes a lot of money and can afford an overpriced house? No problem, here's a mortgage. You are a Chinese housewife who has a 25% down payment for million dollar home? Sorry, no credit for you. You're just a regular middle class dude that wants to dive in and own x number or properties? No can do.

 

B20 is the massive thing that didn't sink in yet. OSFI decided that the party's over and shut off the credit tap. Game over. I want to see the animal spirits that speculate with 100% down.

 

Disclosure: I know real estate investors that buy properties with 100% cash. But they're about as far from the animal spirit type as you can get.

[Liberty]

https://www.movesmartly.com/articles/the-mistake-that-cost-sellers-millions-when-torontos-housing-bubble-burst

[obtuse_investor]

Looking south of the border, one can be "full of it" and yet can unleash animal spirits. People just have to believe the narrative and it's off to the races again.

 

Please do elaborate though. Isn't it a possibility? Or is my reasoning incorrect? I don't consume politics on a regular basis. I am not in touch.

 

As for renting, I agree. With the way rental yields are, I am happy to take the other side of the trade. Nothing lasts forever and I am extremely patient.

Ok, I won't go into the PC platform cause it's mostly nonsense. You can go through it on digest it on your own time.

 

But about the "animal spirits". In general you are correct that politicians can be full of it and unleash animal spirits - basically people doing dumb things with money. That has been happening for millennia. So it's not an unreasonable premise.

 

However, in this particular case I don't think it will work. Here's why. The main ingredient you need in order to unleash animal spirits, beside bs, is credit. And what regulation B20 does effectively is cut off credit from the animal spirits. You are a someone who makes a lot of money and can afford an overpriced house? No problem, here's a mortgage. You are a Chinese housewife who has a 25% down payment for million dollar home? Sorry, no credit for you. You're just a regular middle class dude that wants to dive in and own x number or properties? No can do.

 

B20 is the massive thing that didn't sink in yet. OSFI decided that the party's over and shut off the credit tap. Game over. I want to see the animal spirits that speculate with 100% down.

 

Disclosure: I know real estate investors that buy properties with 100% cash. But they're about as far from the animal spirit type as you can get.

 

Thanks for your thoughts rb.

 

I agree with you. The supply of credit has "suddenly" dried up and fear has set in. Something major has to happen to reverse that. Ont PC party could reverse some local provincial rules, but OSFI is out of their reach.

 

 

[Sunrider]

Hmm ... I’m wondering whether we’re getting close to the point where this becomes shortable?

 

From my time in Canada, I recall that there is government and private mortgage insurance, and they should be the first loss tranche, after the borrower, of course.

 

Does anyone know if the insureres are obligated to immediately pay off the entire loan amount to the lender in case of borrower default or are they able to pay obligations as they arise (as is the case with MBI and OCN for bonds)?

 

In the latter case one would expect that the insureres will be hit less hard - they still have premia coming in and can pay obligations from those ... there would be dividend cuts, but it may not be catastrophic.

 

If the banks can immediately recover their principal then that would be a bloodbath for the insurers given that insurance is taken out where people don’t have a 20% cushion, and a lot of people should be dead in the water with a 12% drop as that chart on the prior page indicates.

 

Of course not all of those will be unable to pay their obligations, and I think those mortgages aren’t non-recourse ... but I thought I’d tap into the wisdom of this board to see what people think.

Thank you.

[Cigarbutt]

Interesting thread.

 

Personal perspective: We bought our house in 1996 (Montreal metropolitan area) and the CAGR on the value (appraised/market) has been 3,4/3,9%, pretty much in line with our region of the country. Not particularly impressive but still about double the average inflation rate over the period. So? When I include the "value" of the house into net worth calculations, I discount 30 to 40% of the market value. Why? Because, from 1900 to 2000, it was expected that, in the main, the value of a well maintained piece of real estate would keep pace with inflation. Our real estate market is comparable to Ottawa but the environment of other urban centers in BC or Ontario and in the aggregate leaves me perplexed.

 

Some stats for the Canadian market (in the aggregate):

 

-Price trends

 

From Q1 2000 to Q1 2009, house prices rose by 79% (49% inflation-adjusted)

From Q2 2009 to Q3 2012, house prices increased by another 24% (17% inflation-adjusted)

From Q4 2012 to Q4 2015, tighter mortgage rules implemented in July 2012 helped calm the market, but house prices still rose by around 15.7% (10.8% inflation-adjusted)

From 2016 to 2017, house prices surged by 22.5% (18.5% inflation-adjusted)

 

-Size of the mortgage market versus GDP

 

1990-2000: 40-45%

2008: 54%

2014: 65%

2017: 71%

 

Reflecting on what Sunrider just wrote, wondering now how to benefit or to protect from the downside. Need to do more work.

 

There is definitely some kind of disconnect but timing is always hard especially with residential real estate.

On a personal level, if I would live in Toronto or Vancouver, I would now consider selling even if the house has sentimental/practical value.

 

The Bank of Canada has produced a lot of interesting work in the area. They are trying to navigate the disconnect, hope for a soft landing and do not want to look like the people taking the punch bowl away. Maybe an impossible task?

 

Here's a link that shows an interesting tool that they have come up with, the vulnerabilities barometer:

http://news.buzzbuzzhome.com/2018/03/heres-canadas-housing-market-cause-banking-crisis-hint-debt.html

The title is sensational but the only public comment may be a sign of the times:

"The plan is to die with as much debt as possible while living life's best."

 

The graph should be taken as a picture is worth a thousand words but for those interested, here's the more official reference:

https://www.bankofcanada.ca/wp-content/uploads/2017/12/san2017-24.pdf

 

What I find fascinating is that, despite what seems to be an incredibly high vulnerability, uncharacteristically, many measures of financial stress are very low in the context of an unprecedented interest rate environment.

 

Where is the margin of safety?

 

Interesting times.

 

 

 

[TBW]

Sunrider, I did this presentation on Genworth MI Canada that answers most of your questions https://onbeyondinvesting.com/blogs/blog/ira-sohn-2018-investment-contest-finalist-short-genworth-mi-canada

 

Couple quick points, they get paid upfront in one lump sum payment so there isn't a steady flow of premiums coming in.  They also recognize most premiums as revenues in first 5 years, so they are really susceptible to slowing market as insurance written decreases.

 

The pay the bank upfront for lost interest, they then take possession of the house and sell through power of sale to recover their losses.  So losses are taken immediately, and they have to hold, maintain, repair houses when a bankruptcy occurs, which is an expensive process.

 

Mortgages are recourse, but that matters far less in recovery than people think (like companies get 52% vs 50% recovery due to recourse).  The reason is once a person loses their house its hard to get blood from a stone, there is also the PR implications of being aggressively collecting from people in dire straits.

 

Hope this helps.  Let me know if you have any further questions.

[Viking]

When Calculated Risk called the top of the US real estate market (I think he did this in 2005 or 2006) one of the key stats he was following was housing inventory. Significantly growing inventory was key to calling to turn.

 

I have not been following the real estate market super close but I did take a look at my region recently (Fraser Valley, Greater Vancouver). Inventory for all property types is starting to climb year over year. http://www.fvreb.bc.ca/statistics/Package201804.pdf

 

I still believe interest rates are key. If interest rates (and mortgage rates) in Canada continue to move higher something will have to give.

 

Housing is such a large part of the Canadian economy any slowdown will not be good.

 

The million dollar question is what can a Canadian (in a high priced market) do to protect themselves?

1.) sell. This is not an option for me today (my family would lynch me). Fortunately our mortgage is small and, if prices crash, our loss would be a fall in the equity of our residence. (Easy come easy go?)

2.) ?

 

I have one strategy that I been executing is I have all of my investments in US $. If I sell a position and raise cash I leave it in US$. My thinking is if housing in Canada tanks then our economy will also tank. In this scenario I would expect the US economy to out perform the Canadian economy and US$ to out perform the CAN $. Not very sophisticated but it has worked very well the past 5 years.

[Cigarbutt]

1-When Calculated Risk called the top of the US real estate market (I think he did this in 2005 or 2006) one of the key stats he was following was housing inventory. Significantly growing inventory was key to calling to turn.

 

2-I have one strategy that I been executing is I have all of my investments in US $. If I sell a position and raise cash I leave it in US$. My thinking is if housing in Canada tanks then our economy will also tank. In this scenario I would expect the US economy to out perform the Canadian economy and US$ to out perform the CAN $. Not very sophisticated but it has worked very well the past 5 years.

 

For 1-

Calculated Risk made many useful observations during that time frame. The author focused on a few key housing variables. Interestingly, mortgage debt to GDP was one of them and he has updated the analysis recently (for the US):

http://www.calculatedriskblog.com/2018/02/the-housing-bubble-mortgage-debt-as.html

This is one of these graphs that suggest that the US is back to its long term trend. But who said that this trend should be upward?

I understand that the avg 5-yr fixed mortgage rate has come down since 1980 but who cares about the debt/equity ratio when your home value keeps going up?

Even without the pendulum swinging the other way however, if the US pattern can serve as a potential template for the Canadian outlook, then we should fasten our seat belts.

 

Avg 5yr mortgage rate (Canada):

2000: about 8%

2008: about 7%

now:  about 5,5%

Diamonds are forever but 5yr fixed mortgages and variable ones are not.

 

For 2-

I agree with the "hedge" that you describe. For the real estate reason mentioned and other reasons, I have brought up the USD based portion of the portfolios to about 75% with most of the currency change happening during the recovery after the financial crisis when the CDN $ was close to par. So far, this has been a positive move and because of the expected relative outperformance of the US, I will keep the same currency profile for now.

 

 

 

 

[Sunrider]

Sunrider, I did this presentation on Genworth MI Canada that answers most of your questions https://onbeyondinvesting.com/blogs/blog/ira-sohn-2018-investment-contest-finalist-short-genworth-mi-canada

 

Couple quick points, they get paid upfront in one lump sum payment so there isn't a steady flow of premiums coming in.  They also recognize most premiums as revenues in first 5 years, so they are really susceptible to slowing market as insurance written decreases.

 

The pay the bank upfront for lost interest, they then take possession of the house and sell through power of sale to recover their losses.  So losses are taken immediately, and they have to hold, maintain, repair houses when a bankruptcy occurs, which is an expensive process.

 

Mortgages are recourse, but that matters far less in recovery than people think (like companies get 52% vs 50% recovery due to recourse).  The reason is once a person loses their house its hard to get blood from a stone, there is also the PR implications of being aggressively collecting from people in dire straits.

 

Hope this helps.  Let me know if you have any further questions.

 

Awesome thank you. So lgd = 50% and loss to mortgage insurer 50% less equity, so call that 31% of principal assuming everyone is at just 19% equity. Now all we need is a good estimate of the default rate over the next years.

[TBW]

Losses are actually higher, costs of repossessing house, fixing selling is 15%.  So equity is closer to 3% on the last 97bil of insurance underwritten.

 

Not many defaults need to occur for the $3.9bil equity to get hit, as they only have 100mil in loss reserves.  Regulatory capital is $400mil, that doesn't take much at all to be impaired.

 

Historically defaults in Canada have been low.  Suspect they won't be this time.

[Cigarbutt]

Had an interesting discussion recently with a member of the preceding generation (boomer) who was explaining how lucky people are these days when comparing mortgage rates that "they" had to deal with (rates at more than 20%...) in the early 80's.

I guess it's a question of perspective:

 

https://www.nbc.ca/content/dam/bnc/en/rates-and-analysis/economic-analysis/housing-affordability.pdf

 

Need to worry?

Not to worry according to official sources because the economy is robust, real estate is sticky and people have developed a "slower mentality".

https://www.bloomberg.com/news/articles/2018-05-29/why-canada-s-big-banks-aren-t-too-worried-about-household-debt

[Liberty]

Had an interesting discussion recently with a member of the preceding generation (boomer) who was explaining how lucky people are these days when comparing mortgage rates that "they" had to deal with (rates at more than 20%...) in the early 80's.

I guess it's a question of perspective:

 

https://www.nbc.ca/content/dam/bnc/en/rates-and-analysis/economic-analysis/housing-affordability.pdf

 

I'd rather pay 15-20% rates for a few years, while wages are also inflating relatively rapidly, and then be left to pay the rest of the principal over a couple decades at much lower rates, than sign up for a gigantic amount of debt at almost zero interest rates, knowing that rates will likely rise over a couple decades and the principal will still have to be paid.

[SharperDingaan]

Had an interesting discussion recently with a member of the preceding generation (boomer) who was explaining how lucky people are these days when comparing mortgage rates that "they" had to deal with (rates at more than 20%...) in the early 80's.

I guess it's a question of perspective:

 

https://www.nbc.ca/content/dam/bnc/en/rates-and-analysis/economic-analysis/housing-affordability.pdf

 

I'd rather pay 15-20% rates for a few years, while wages are also inflating relatively rapidly, and then be left to pay the rest of the principal over a couple decades at much lower rates, than sign up for a gigantic amount of debt at almost zero interest rates, knowing that rates will likely rise over a couple decades and the principal will still have to be paid.

 

Mortgage rates in the high teens are incredibly destructive.

You don't try to buy a house, you just try to hang on to what you have and hope that rates will be lower when you have to renew. If it means renewing at 5-6% above your previous rate, there is a very real chance that you will have to sell the house.

 

If your mortgage is floating you need (a lot of) renters to help cover the interest. As an additional 25bp on your mortgage every quarter costs an additional $250/yr per 100K of mortggage. IE: Extra $250 for Q1, extra $500 for Q2, extra $750 for Q3, extra $1000 for Q4. Yes, an extra $1000/yr is only $83.33/month (1-2 coffee's/day) - but if your mortgage is $500K its $416.67/month ABOVE what you are already paying. Give up that 2nd car or find a renter, and be prepared to give up MORE next year.

 

SD

 

 

 

 

[Viking]

Real estate moves in very long slow cycles. Boomer generation experienced one end of the extreme with interest rates at +20%. The flip side of this is house prices were low and size of total debt was also low.

 

In the past 35 years interest rates have fallen from +20% to sub 2%. And (no surprise) house prices have skyrocketed. Boomers who owned a house have hit a financial home run. First time buyers today are getting generationally low interest rates but they also are paying historically high prices and taking on record amounts of debt.

 

As interest rates now normalize higher to 4 or 5% many first time buyers with massive mortgages (and little equity) are going to see their payments skyrocket. This is all after tax dollars.

 

There likely will be a number of lessons that will be learned by the current generation of first time buyers. The lesson will be total amount of debt matters. Interest rates matter. And housing is not a sure fire road to riches (as it was for the boomer generation). Leverage is a wonderful thing when the trade is moving your way like it has for the past 35 years); however, leverage can also be financially devastating when it moves against you.

 

 

[jobyts]

Real estate moves in very long slow cycles. Boomer generation experienced one end of the extreme with interest rates at +20%. The flip side of this is house prices were low and size of total debt was also low.

 

In the past 35 years interest rates have fallen from +20% to sub 2%. And (no surprise) house prices have skyrocketed. Boomers who owned a house have hit a financial home run. First time buyers today are getting generationally low interest rates but they also are paying historically high prices and taking on record amounts of debt.

 

As interest rates now normalize higher to 4 or 5% many first time buyers with massive mortgages (and little equity) are going to see their payments skyrocket. This is all after tax dollars.

 

There likely will be a number of lessons that will be learned by the current generation of first time buyers. The lesson will be total amount of debt matters. Interest rates matter. And housing is not a sure fire road to riches (as it was for the boomer generation). Leverage is a wonderful thing when the trade is moving your way like it has for the past 35 years); however, leverage can also be financially devastating when it moves against you.

 

Does that mean the total cost of ownership of a house (with 30Y mortgage) is more or less the same now compared to the boomer generation?

[Liberty]

Does that mean the total cost of ownership of a house (with 30Y mortgage) is more or less the same now compared to the boomer generation?

 

Guessing you're asking about the US, since there are no 30y mortgages (with locked rates) in Canada..?

 

I don't know, but it would certainly have helped some people if we could have locked rates for 30y here..

[scorpioncapital]

It's amazing, I didn't know this but there's a faq you can see that if you have a government debt you can choose to serve time! yes go to jail if you can't pay the debt. Personally I would just skip the country, but I didn't know debtor's prisons still exist in Canada. Shocking indeed!

 

[Liberty]

https://overcast.fm/+JCDbMlqZ8

 

Haven't listened yet, but saw that Jim Grant had a new podcast on Canadian housing.

 

Update: Had a chance to listen. Good overview, some updated stats, nothing too new.

[Libs]

https://overcast.fm/+JCDbMlqZ8

 

Haven't listened yet, but saw that Jim Grant had a new podcast on Canadian housing.

 

That was good. There was a stat to behold: real estate commissions, in the aggregate, are 3 X what Canada is spending on R & D. That's seriously messed up, if true.

 

I guess it is:

 

http://www.cbc.ca/news/business/real-estate-fees-home-sales-1.4226630

 

 

 

[Liberty]

https://www.theglobeandmail.com/real-estate/toronto/article-supreme-court-wont-hear-long-running-toronto-home-sale-data-case/

[Cigarbutt]

Anecdotal

Neighbours on my street put their house for sale (not eager to sell and tagged with a full price) on the market and sold it (papers signed) within 3 (three) hours.

 

Context

Reading shalab's recurrent threads that suggest Canadians are wealthy (and implicitly implying that the wealth is owed...) and wondering if the house is built on sand. From 1990 to today, both household assets and household debt (and so household net worth) have grown at an annual compound rate of 6,9% and I continue to be haunted by the divergence (US-CDN) that occurred in 2008-9. Understanding the evolution is difficult and short term forecasts are impossible but the real estate sector in Canada is one of those non-linear equilibriums marred by perhaps an illusory sense of stability and fraught with linear extrapolation risks.

 

Conclusion

There is a significant amount of discomfort that is at least based on some rationality. Maybe we will muddle through somehow but painful adjustments are possible and, thinking of creep mechanics, there is the possibility of sudden collapse with a sea of red ink. To "explain" the evolving real estate conundrum, some suggest that households simply react rationally to the underlying incentives supported by financial innovation while others suggest that there are deep deficiencies in financial literacy. I still believe in cycles. Preparing for all scenarios.

 

https://www.weforum.org/agenda/2017/12/canada-s-household-debt-levels-are-the-highest-in-the-world/

https://www.nbc.ca/content/dam/bnc/en/rates-and-analysis/economic-analysis/economic-news-teranet.pdf

https://eppdscrmssa01.blob.core.windows.net/cmhcprodcontainer/sf/project/cmhc/pubsandreports/housing-market-assessment/2018/q3/canada/housing-market-assessment-canada-68456-2018-q03-en.pdf?sv=2017-07-29&ss=b&srt=sco&sp=r&se=2019-05-09T06:10:51Z&st=2018-03-11T22:10:51Z&spr=https,http&sig=0Ketq0sPGtnokWOe66BpqguDljVgBRH9wLOCg8HfE3w%3D

 

 

[bizaro86]

Real estate is a weird mash-up of mostly local factors, with some national ones mixed in. I'm pretty sure that anecdote isn't from Calgary, for example. I think you had mentioned once you're in Quebec?

 

Local factors (local economy, net-migration, investment demand, animal spirits, etc) can combine with national factors (interest rates, mortgage policy changes).

 

Interestingly, in Calgary the local economy has been weak for some time, combined with federal tightening which have both hurt local real estate. Now the local economy has green shoots from $65-70 WTI, but real estate isn't improving much if at all.

 

Part of that is foreclosures from a year or two ago finally hitting the market and part of it is sentiment hasn't turned yet.

 

I'd be a buyer in size right now except for concern that a national price decline will hit here in the form of reduced buyer sentiment and tighter lending standards. Price declines have finally caught up with rent declines in my areas.