Interesting article in The Economist: ‘Bricks and Slaughter’

I’m just compiling the real estate data from the various boards for the monthly ‘Tour through the board stats’ feature.  Should be done later today.

In the meantime, I enjoyed this interesting read courtesy of The Economist:

Bricks and Slaughter

It is part of a series by the economist exploring the lessons to be learned from the global property bubble.  Yes… was not just the US housing market that burst. While the article is not dealing specifically with the Canadian property market, some lessons nevertheless jump off the pages.

Some key quotes that jumped out at me, though the entire article is worth reading.

“Property is widely seen as a safe asset. It is arguably the most dangerous of all…”

“(The property market) is so big that when credit conditions loosen it is likely to absorb a lot of the extra liquidity; and when something goes wrong the effects will be serious.”

…Like when CMHC loosens lending requirements drastically over the course of several years…..or when new credit products like mortgage-backed securities provide tons of liquidity to the Canadian lending environment (so prevalent in fact is securitization via MBS issuances that it consumes over 100% of new mortgages).  Rampant securitization in the US, which removed risk from the bank sheets (as it does in Canada) is one factor nearly universally accepted to have played a part in blowing their bubble.  Despite the fact that some in the mainstream media assert that this process is not active here in Canada, this could not be further from the truth.

An even bigger reason to beware of property is the amount of debt it involves. Most people do not borrow to buy shares and bonds, and if they do, the degree of leverage usually hovers around half the value of the investment. Moreover, when stock prices fall, borrowers can usually get their loan-to-value ratios back into balance by selling some of the shares. By contrast, in many pre-crisis housing markets buyers routinely took on loans worth 90% or more of the value of the property. Most had no way of bringing down their debt short of selling the whole house.

Property bubbles almost always start because fundamentals such as population growth, interest rates and economic expansion are benign….These fundamentals explain why many market participants are able to persuade themselves that huge price rises are justified and sustainable.

On bubble psychology

This part of the article is fantastic.  As faithful readers know, the psychological element of our current housing boom, and the associated change in consumer expectations fascinate me.

…If housing were simply a financial investment, buyers might be clearer-eyed in their decision-making. People generally do not fall in love with government bonds, and Treasuries have no other use to compensate for a fall in value. Housing is different. Greg Davies, a behavioural-finance expert at Barclays Wealth, says the experience of buying a home is a largely emotional one, similar to that of buying art. That makes it likelier that people will pay over the odds.

Once house prices start to rise, the momentum can build up quickly….The price of residential property is set locally by the latest transactions….One absurd bid can push up prices for lots of people.

As prices rise, property is arguably more likely than many other asset classes to encourage speculation. One reason is that property is so much part of everyday life. People do not gossip about the value of copper and tin, but they like to talk about how much the neighbour’s house went for. They watch endless TV shows about houses and fancy themselves as interior designers, able to raise the price of their home with a new sofa and artful lighting.

This last quote is bang on.  As expansions in house prices beyond their fundamentals continues for some time, the justification for rising house prices becomes rising house prices.  Greed over the outsized gains made by friends and family and the fear caused by the ‘buy now or be priced out forever’ mantra encourage more people to jump in.  Home ownership rates soar.

…Homeowners overestimate the value of their homes by an average of 5-10%. Those who had bought during good times tended to be more optimistic in their valuations, whereas those who had bought during a downturn were more realistic. Expectations of higher prices explain why bubble-era buyers were more willing to buy risky mortgage products and take on ever greater quantities of debt.

Indeed our made-in-Canada credit bubble has overwhelmingly been fueled by real estate (70% of all outstanding debt) and the home equity line of credit (up to 12% of outstanding debt).  Without an expansion in credit availability and new “innovations” in the mortgage market, property prices would be far lower than they are currently.  People (wisely) would not have embraced zero down and then 5% down mortgages ammortized over 35 or 40 years.  Alas, all good things come to an end.  The credit binge is arguably set to cool with consumer debt at all-time highs and new moves by the government to tighten mortgage rules.  Without this availability of abundant credit and a never-ending supply of buyers in the buyer pool, the property market looks far different from the one of the past decade….as we will soon see.



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9 Responses to Interesting article in The Economist: ‘Bricks and Slaughter’

  1. Brett says:

    You guys might find this interesting, following along the lines of the BMO report released yesterday showing Saskatchewan among the most overvalued compared to long term trends.

    Compare this quote from the Economist article:
    “According to Andrew Lawrence of Barclays Capital, the construction of exceptionally tall buildings is a reliable indicator of economic crises in the making.”

    Now this from Regina’s Leaderpost

    “$100-million hotel-and-condo project, launched last summer by a local developer, has received a much-needed boost from an out-of-province company.

    Westgate Developments Ltd. of Regina has joined forces with BrightStar Corp. of Toronto to get the stalled project at Albert Street and Victoria Avenue— **touted as the tallest building in the province** — back on track.”

    Draw what conclusions you will.

  2. data junkie says:

    Where did you get that stat about 70% of all debt being mortgages and 12% being HELOCs?

  3. Sams Mango says:

    Ben, I thought I would let you in a great data comp, because I know you love this stuff.

    Whistler, I think you will make the MSM with this comp

    Whistler real estate is currently trading at 50% of 2002 prices, it is basically in the dumps. Back in the boom, PE deals took over, etc….now we have WB.TO.

    So an investor can hold real estate even at these terrible prices and still earn a negative yield, or own the stock and get a positive yield of 4.5%. Both investments should ride the ups/downs of the local market. I would also add that you would still need to earn a further 20% in gains to adjust for liquidity and broker fees on the real estate leg.

    This is after getting the Olympics and the largest real estate boom in the country and just 1.5 hours away in Vancouver, condo sleep fests. What happened? Here you can get into your marsh mellow thinking….

    Why is this happening?
    – Is it because not many Asians ski or support sports?
    – Has the international market left and only local day trippers are left?
    -Are whistler costs so high, that real estate investors are just financing the market basically?

    I believe this example is an excellent one for you and your readers to explore – you have the exact some risk exposure from two angles – Stock Market and Real Estate Market. Then you have the non quant stuff mentioned above to try to understand why this is happening. A real Canadian Example, two investable assets – why the large divergence?

    Good Luck.

    • pricedoutfornow says:

      I was in Whistler last week (where SO’s sister owns a cash flow negative condo, has been this for almost ten years), and read an article in the Pique which had realtors admitting that they never thought that international investors would come to Whistler in droves looking for real estate after the Olympics. Turns out most real estate in Whistler is owned by Canadians (Vancouverites), with a few Americans and 6 Chinese (yes! 6!) So much for SO’s sister’s comment that “I won’t sell until after the Olympics!” Had no effect whatsoever, and actually I’m pretty sure her property wouldn’t sell for any more than what they paid for it in 2001 (and now she’s $100k poorer for financing the negative cash flow). Jeez.
      I can’t wait till this bubble is over and people regain their senses….

    • jesse says:

      Whistler condos can look like their prices are stagnant but look at the maintenance fees. Some are above $600/month. That doesn’t leave a heck of a lot of room for a mortgage.

      Plus lift tix are on the pricey side. Add it all up. Not looking good…

      Also look at inventory in the Okanagan. They’re measuring in years, not months. That’s going to be a big drain on prices very soon.

  4. Vince says:

    Hey Ben, was wondering if you would be interested in writing an article on the Toronto “luxury” condo market. It is set to explode this year and next with all the new projects like Trump, Shangra-La, Ritz… Toronto has apparently an accute shortage of $5mln. condos. This issue will be rectified with all the new properties. Unlike Miami, we have a great climate, nightlife, the ocean and are situated between North and South America.

  5. Vince says:–condos-on-the-market

    I can’t understand why just a few think the condo market in TO is in trouble. Thats a lot of supply, in one zone and for the most part, at really high price points.

    • Sams Mango says:

      1 . These have been already paid for
      2. Investor class is really unknown
      3. If 100% spec – they won’t all default at once, thus is takes time
      4. If 100% owner occupied, nothing will happen.

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