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Shorting the Housing Bubble in Canada


txitxo
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For the Canadians in the forum: which do you think is the best practical way of shorting housing in Canada? It may take some time to burst, but you have all the symptoms of a housing bubble forming, same as in Spain 6-7 years ago. The Canadian banking system looks very solid (as Spanish banks did 6 years ago). Which Canadian banks are more exposed to housing? Which are the weakest construction or construction-related companies (suppliers, etc.)?

 

 

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I don't short, but I rent. That's my way to play this one. We'll only look at buying a house after a significant correction in prices.

 

That's what we did in 2004. It was so obvious that there was a huge bubble in Spain that we sold our apartment after doubling the money we paid for it, rented a nice villa (paying a 1% rental yield), read a bunch on books on value investing and started managing the money from the sale. We've done pretty well since then, despite this being the worst environment for investing since the Great Depression. House prices have gone down by almost 50% in our area in real terms, but they still have a long way to go (rental yields are still ~3%, I am pretty sure they will eventually get close to 10%, as it happened in the 80's ) so we keep renting and enjoying life. 

 

As a value investor I am reluctant to short anything. But since 2007, the stock prices of Spanish banks and real state companies heavily  involved in the housing bubble have gone down by a huge amount. The pattern in Canada (and for instance in Brazil) is starting to look the same. So I am trying identify the Canadian equivalents of Metrovacesa and Banco de Sabadell to keep an eye on them.

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Home Capital Group is probably one of the best run lenders in Canada trading at 8x earnings (20-25 ROE for the last 15 years) for the you very reason your thinking of shorting.  You should question if you coming late to the short party on that one.  Their Loan to value has been decreasing in major bubble areas because they know.  They are requiring 50% down on some Toronto homes.

 

P.s.- Canada's debt figures don't take amortization into consideration.  90% of Canada's loans are insured by CMHC.  Genworth would be worth a look as they are an alternative to CMHC.  Toronto Condo's are the biggest bubble around.  If you exclude Vancouver, Calgary, and Toronto, Canada is not that overvalued IMO.

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If you exclude Vancouver, Calgary, and Toronto, Canada is not that overvalued IMO.

 

If you excluded California, Arizona, Florida etc the US didn't look too bad either, that didn't prevent prices from falling everywhere.  Some of the Rust Belt was the worst, no appreciation and large price drops, Detroit, Buffalo, Cleveland.

 

I hope for your sake there is no bubble in Canada, but if there is it's unlikely other areas will escape especially if all the major metros are affected.

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If you exclude Vancouver, Calgary, and Toronto, Canada is not that overvalued IMO.

 

If you excluded California, Arizona, Florida etc the US didn't look too bad either, that didn't prevent prices from falling everywhere.  Some of the Rust Belt was the worst, no appreciation and large price drops, Detroit, Buffalo, Cleveland.

 

I hope for your sake there is no bubble in Canada, but if there is it's unlikely other areas will escape especially if all the major metros are affected.

 

That's my thinking too. Real estate is such an emotional investment, when things go south, it'll go down way past "fair" in the panic.

 

And I live in an area that is generally not considered one of the most overvalued places, yet that's only a relative term. Prices still went up by almost 100% in the past decade, while incomes have stayed almost flat and the price of everything (food, fuel..) has gone up. Yet everybody I know's buying a house with very little down... How do people make the difference? Debt, of course. That's not sustainable.

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I don't short, but I rent. That's my way to play this one. We'll only look at buying a house after a significant correction in prices.

 

That's what we did in 2004. It was so obvious that there was a huge bubble in Spain that we sold our apartment after doubling the money we paid for it, rented a nice villa (paying a 1% rental yield), read a bunch on books on value investing and started managing the money from the sale. We've done pretty well since then, despite this being the worst environment for investing since the Great Depression. House prices have gone down by almost 50% in our area in real terms, but they still have a long way to go (rental yields are still ~3%, I am pretty sure they will eventually get close to 10%, as it happened in the 80's ) so we keep renting and enjoying life. 

 

As a value investor I am reluctant to short anything. But since 2007, the stock prices of Spanish banks and real state companies heavily  involved in the housing bubble have gone down by a huge amount. The pattern in Canada (and for instance in Brazil) is starting to look the same. So I am trying identify the Canadian equivalents of Metrovacesa and Banco de Sabadell to keep an eye on them.

 

I am happy to find a value investor in Spain. I too have a connection to your country, having recently bought a piece of development land outside of Puerto Banus (Pedro de Alcantara playa) for about 10% of the market value of land in central Toronto, on a square metre equivalent basis. At least I think I bought it, I am still waiting for the registry. All the local and Euro problems have created a buyers' market like I have never seen. One can successfully name their own price in such inefficiency. My offer was 40% of the ask (which was already down 40% from 2009 ask) and I had to wait only 4 months for the seller to acquiesce. Rental yields are helpful when the market is functioning but probably somewhat limited in a market like Spain's today.

 

Toronto condos are overdone and I too would like to find a way to exploit the over-supply. On Wednesday, I am out with a condo developer. I will try to see where the weaknesses are. I suspect, like in the last real estate correction (1990-95), it will be the developers themselves. The large financials in this country have a tendency of gliding through these things.

 

Questions from boardmembers for the developer are welcome but I will not be pen-in-hand. More like putter-in-hand.

 

 

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If you exclude Vancouver, Calgary, and Toronto, Canada is not that overvalued IMO.

Aren't those 3 housing most of Canada's population though? Edmonton is not too far from Calgary in terms of real estate prices.

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Questions from boardmembers for the developer are welcome but I will not be pen-in-hand. More like putter-in-hand.

 

I watch my local Vancouver RE market very closely.  I see sales activity freezing up quickly.  One example: a townhome in burnaby has had 3 $20k price drops in a month, going from $620k to $560k.  From the agent, the seller has bought a place elsewhere and so he's motivated to sell.

 

I guess my question for your TO developer friend is, given the frenzy of condo developments in the MTA (I read somewhere that there are more condos in development than 15 other top North American cities combined), what's their exit strategy if their inventories don't sell: 1) Hold for better time (turn into rental apt), 2) Slash prices, 3) Demolish them!

 

Seems like in Vancouver, I am seeing some #2s, although #3 (by fire "accidents") is not unheard of.

 

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I guess my question for your TO developer friend is, given the frenzy of condo developments in the MTA (I read somewhere that there are more condos in development than 15 other top North American cities combined), what's their exit strategy if their inventories don't sell: 1) Hold for better time (turn into rental apt), 2) Slash prices, 3) Demolish them!

 

Of #4, no exit strategy ;)

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I am happy to find a value investor in Spain. I too have a connection to your country, having recently bought a piece of development land outside of Puerto Banus (Pedro de Alcantara playa) for about 10% of the market value of land in central Toronto, on a square metre equivalent basis. At least I think I bought it, I am still waiting for the registry. All the local and Euro problems have created a buyers' market like I have never seen. One can successfully name their own price in such inefficiency. My offer was 40% of the ask (which was already down 40% from 2009 ask) and I had to wait only 4 months for the seller to acquiesce. Rental yields are helpful when the market is functioning but probably somewhat limited in a market like Spain's today.

 

Toronto condos are overdone and I too would like to find a way to exploit the over-supply. On Wednesday, I am out with a condo developer. I will try to see where the weaknesses are. I suspect, like in the last real estate correction (1990-95), it will be the developers themselves. The large financials in this country have a tendency of gliding through these things.

 

Questions from boardmembers for the developer are welcome but I will not be pen-in-hand. More like putter-in-hand.

 

  Spain's property market is still expensive, generally speaking.  Of course you can find good deals if you know how to look for them. Some people are using a "shotgun" approach, they look for 20-30 properties similar to what they'd like to buy and make extremely low offers to all the owners. In some cases they receive replies which illustrate how powerful the Spanish language is for cursing, but almost always one or two of the owners are so desperate that they will sell at prices well below official valuations.

 

  I think rental yields are useful to give you a sense of where prices should go. In the last "big crisis" in Spain the price/ gross rental ratio  was  P/E ~30 in 1974 and it reached P/E~11 in 1984 (just before we entered the European Union). We also started with a P/E~30 in 2006. Rents have gone down by 25% since then, and although it is difficult to gather good information, it seems that real market prices for housing are down by at least ~45%. So we are still at P/E ~25, and to get to P/E~11 we need an additional 50% drop from today's prices. And that's assuming that we don't go below P/E 10, this crisis is already much worse than the one in the 70's.

 

Now, when you feed these prices into the bank balances (where housing is only down by 25%) you'll realize why Egan-Jones says that 100.000M€ is not enough to bail out Spanish cajas, and that you probably need 4 times that amount...

 

 

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Now, when you feed these prices into the bank balances (where housing is only down by 25%) you'll realize why Egan-Jones says that 100.000M€ is not enough to bail out Spanish cajas, and that you probably need 4 times that amount...

 

You have to balance the balance sheet with the profit effect. Anyway, real estate is not the main problem in Spain as we in Latin America very well know.

 

Krugman recognizes mistake: http://krugman.blogs.nytimes.com/2010/04/14/the-secret-of-the-banks-success/

 

 

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Now, when you feed these prices into the bank balances (where housing is only down by 25%) you'll realize why Egan-Jones says that 100.000M€ is not enough to bail out Spanish cajas, and that you probably need 4 times that amount...

 

You have to balance the balance sheet with the profit effect. Anyway, real estate is not the main problem in Spain as we in Latin America very well know.

 

Krugman recognizes mistake: http://krugman.blogs.nytimes.com/2010/04/14/the-secret-of-the-banks-success/

 

  My impression is that the big Banks, that is, Santander and BBVA, should be OK. They saw what was coming, they were much more conservative giving out mortgages (young couples used to complain) and, as it has been discussed in the STD thread, they have  large and profitable operations outside Spain. But that is not the case for the rest of the financial system, which barely has any international presence and is full of toxic assets. Bancaja (one of the banks which merged into Bankia) had a ballet dancer on the Board. She of course couldn't read a balance sheet and just signed whatever they put in front of her. The Board of CAM falsified the accounts to get bonuses. The public banks were run by politicians, often for their personal profit. There are at least 1.5M of new, empty housing units in Spain which either belong to financial institutions or are financed by them and which will have to be sold at 1/3 of the price they had when built.

 

  We have a functioning state and tax system, and with a reasonable amount of cuts and reforms we could repay our public debt. It would be hard, but we have killed worse bulls. However, it is arithmetically impossible to bail out our banks. The total hole is probably 30-40% of our GDP. That debt has default written all over it, and it will be eventually paid by the ECB printer or not paid at all.

 

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The total hole is probably 30-40% of our GDP. That debt has default written all over it, and it will be eventually paid by the ECB printer or not paid at all.

 

30-40% of GDP and government debt to GDP of around 70%. That is more than OK. Plus you can nationalize the banks, take some profits and privatize them later to soften the blow. Spain's problem is not fiscal, that is just a symptom.

 

And please, if you nationalize the Cajas could you make those German bondholders suffer converting their stakes to equity? I have heard that Bankia was sold retail in Spain but not the others I think.

 

Fuerza España.

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I recommend anyone who wants to short the Canadian housing market do their DD......

 

-Start with CMHC

-The fact our mortgages are full recourse

-Loan to values

-Down payment rules

-NPL trends with the majors- which I think are the best play on this (BMO, TD, Royal, Scotia), other than selling your condo in Toronto and renting.

 

 

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30-40% of GDP and government debt to GDP of around 70%. That is more than OK. Plus you can nationalize the banks, take some profits and and privatize them later to soften the blow. Spain's problem is not fiscal, that is just a symptom.

 

And please, if you nationalize the Cajas could you make those German bondholders suffer converting their stakes to equity? I have heard that Bankia was sold retail in Spain but not the others I think.

 

Fuerza España.

 

Thanks for the good wishes, Plan. But the debt/GDP ratio is more 90% than 70% once you take into account all the hidden liabilities. Providers have not been paid in many months, there are many off the balance sheet public companies which are bankrupt. Today's front pages are filled with news that many regional governments have stopped payments to hospitals. Add ~7% deficit  more this year and probably 5% the next, and we are already over 100% at the end of 2013. That, we could manage. In fact we are already negotiating a full bailout with the Troika. But having to pay a bank debt  of >30% of the GDP is like getting a big boulder dropped on your head when you are barely managing to stay afloat. No easy way out of this. Either Germany truly accepts direct recapitalization of banks (which will be sorely needed for Italy and France further down the road), with the ECB printing a couple trillions, or the euro is toast.

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Here are a couple of relevant articles.

 

http://www.valuewalk.com/2012/05/dialectic-capital-short-cast-hlf-bam-china-and-canadian-housing/

http://seekingalpha.com/article/697261-the-way-to-play-canadian-housing-market-bust

 

They both mention BAM as a short candidate, while BAM is probably in portfolios of a few value investors.

 

Thanks! Very useful information.

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