Reckoning day for the mortgage market?; More on the price/rent ratio

Reckoning day for the mortgage market?

Today’s the day that the axe falls on the 35 year amortization mortgage.  As of today, being approved for a mortgage gets just a little tougher.  In addition, the amount of home equity that can be pulled out is now limited to 85% from 90%.

February was the only full month that experienced the potential “rush to beat the new rules” as they were announced in mid January and take effect mid March.  That being the case, I predicted a fairly strong seasonally adjusted bounce in sales in February (seasonally adjusted simply means that it takes into consideration the fact that total sales volumes picks up as the weather warms).  Instead, the final February sales data from CREA, and the mid-month sales data from Toronto are nothing less than disappointing as both FELL year-over-year.   

So with all this in mind, it’s worth taking a minute and reviewing the big unanswered questions surrounding these rule changes:

1)  Just how significantly will this shrink the buyer pool?

I’m increasingly convinced that marginal buyers were providing the bulk of the  momentum in the current housing market.

For the past six years in Canada, real estate has been largely supported by a fairly continuous loosening of mortgage terms.  Sure Flaherty undid the 0/40 screw-up, but the fact remains that mortgage insurance went from a 10 percent 25 year am standard to 5/35 as of yesterday.  Add in the impact of emergency interest rates and you have a housing market that has the appearance of strength while at the same time relying on increasingly marginal buyers who only a few years ago would have been forced to sit on the sidelines until they could qualify for a taxpayer guarantee on their mortgage.

Without getting into a discussion about the incredible injustices involved in asking someone to put some of their own skin on the line before taxpayers guarantee the full loan, let’s just note that these policies have had the net effect of pulling demand forward by allowing people who otherwise would not qualify to suddenly be able to access a mortgage.

In some ways the average consumer shares the same mentality as water flowing down a hill.  They both look for the path of least resistance….the easiest route.  Taking a 35 year amortization does not necessarily imply that a buyer is marginal.  In many cases it’s just the easiest route.  It frees up a bit more cash over the short term while guaranteeing tens of thousands extra in interest payments.  They may not be wise, but they’re also not necessarily the buyers we’re concerned about.  Just how many of these marginal buyers have just been priced out is a huge question, but it may be more than we think.

Rob Carrick wrote about mortgage broker who fully supported the rule changes.  According to John Cocomile, a mortgage broker in Toronto, 90% of all new mortgages originated in his office were for amortizations of 35 years.  That option is now gone.

While I don’t at all suggest that Mr. Cocomile’s experience is necessarily representative of the rest of the country, I am also certain that CAAMP’s data does not represent reality.  By way of refresher, CAAMP calculated that 30% of all new mortgages were originated with 35 year ams.  As I pointed out, this is aggregate data representing all new mortgages.  The important data point would be the number of first time buyers accessing mortgages with 35 year ams, as pre-existing home owners who are ‘trading up’ would logically take lower amortization lengths on average.

So with the 35 year amortization option now gone, the maximum funding available to the average home buyer just shrank by 5-10% while the average mortgage payment just rose by over $100 a month.  BMO Nesbitt Burns deputy chief economist Douglas Porter suggested that resale prices could drop as much as 7 per cent within the next 12 months as a result of these new rules.

Pretty hard to disagree with Porter’s statement.  With stable demand and stable supply, all things being equal house prices in Canada will decline by about 5-10% just to compensate for the lack of new credit to keep prices buoyant.  But that’s a huge assumption that supply and demand will remain stable.  And that brings me to my next big unknown.

2)  How will the new mortgage changes affect supply and demand?

The last six months have been characterized by a joint buyer and seller strike as can be seen at the tail end of the following chart.

You’ll see that new listings have fallen at a rate only equalled by the miraculous 2009 emergency interest rate-induced market.  But unlike that market, which saw the return of widespread bidding wars for sparse properties, this market has not seen the same rebound in sales activity.  November stats held some promise as sales rebounded, but December was a different story.

The big question is where did all this inventory go?  No doubt sellers have the memory of the last great government-induced rebound in demand in the back of their mind.  Perhaps they are anticipating another rebound in demand and price as the anomolous 2009-2010 housing market solidified the notion that short periods of turbulence in the housing market are to be followed by periods of great strength.

But this time is different.  Rather than bailing them out, the government has slapped them upside the head.  Rather than move to create additional demand, they’ve moved to destroy it.

This reality has probably not yet sunk in, but remember that mass psychology nearly assures that reversals in sentiment happen rapidly and can quickly ingrain in large swaths of the population.

3)  How will it affect credit conditions and the broader economy

One of the topics I discuss often is the role of real estate in generating massive amounts of credit that permeate our consumer-driven economy and give the illusion of prosperity and economic growth.  There is a powerful feedback mechanism between house price increase, consumer confidence, consumer spending, and economic growth.  I have written about this in detail on many occasions.

The bottom line is that lines of credit have become the drivers of a significant component of consumer spending in our economy.  CAAMP data suggests that home equity withdrawals have goosed the after-tax income of the average family by 9%.  This is money that flows directly into consumer spending.  This flow of money is now under threat.

Traditional HELOCs will come under pressure as house prices adjust to the reality of less credit entering the system and are repriced to the down side.  As I’ve shown many times, home equity withdrawal is highly correlated with house price movement.  Here is the American experience.  The bars show the amount of money withdrawn from home equity.  Can you guess where their home prices turned negative?

This is a huge concern for consumer spending, which accounts for 65% of GDP.  By extension, this is a huge concern for the broader economy.

The new rule changes don’t specifically target traditional, non-insured HELOCs.  Rather they target the CMHC-backed products.  While most institutions do not insure their HELOC portfolios, it doesn’t mean the impact will be negligible.  As this article in the Globe noted:

“Gerald Soloway…The head of Home Capital Group Inc., which has about 40,000 mortgages in Canada, says the mortgage-backed lines of credit were originally intended to help people make improvements to their homes. The reality, however, is “it became an ATM for weekend recreation.”

And by extension this excess credit creation has buoted segments of the labour market that would not otherwise have flourished.  Hence, unemployment is always low at the tail end of a credit bubble, but stubbornly high once it pops.

The new mortgage rule changes will not end the flow of insured LOCs, but it will strap them to an amortization schedule making them more burdensome for consumers.  If demand for lines of credit drop sharply as a direct or indirect result of these new rule changes, we’ll very quickly understand the significance of unintended consequences of government policy on the broader economy.

Frankly I’m quite surprised by the weak sales numbers from the past month.  They certainly give us clear indication of what the demand picture will look like going forward.  It’s the supply picture that remains in question.  Listings continue to be added at a relatively subdued pace.  Despite this, we saw the sales-to-new inventory ratio (the red line) actually take a surprising dive downwards in February while months of inventory actually rose.

This is not a good sign.  Expect the average house price to rise swiftly as the low end of the market is squeezed at the margins leaving more of the better financed buyers and trade-up buyers left to account for a larger proportion of purchases.  I fully expect April sales numbers, which we won’t get to glimpse until early May, to be extremely weak.

More on the Price/Rent ratio

The price/rent ratio is one of the major, fundamental determinants of house prices.  I wrote about this ratio at length in an earlier post:

Should everyone rent? When does it make sense to buy? A closer look at the price/rent ratio…

As a quick refresher, remember that we are at unprecedented highs in the price/rent ratio in Canada:

With this in mind, I read an interesting article from Standard & Poors from 2009 titled, “The Rent-Price Index in U.S Housing Markets“.

Note that the Rent-Price ratio is the inverse of the Price-Rent ratio.  It is represented as the rent received from a residence divided by the price of the residence.  Therefore, the rent-price ratio would be at historic lows in Canada while the price-rent is at historic highs.  They are the opposite of each other, but they both tell the identical story.

So what exactly is that story?  Here are a few snippets from the article:

Our analysis shows that low rent-price ratios are associated with
subsequent periods of low or negative house price changes. This
implies that house prices overshoot fundamental values associated
with capitalization of future rents, and revert to equilibrium through
subsequent price correction.

If we reworded this to reflect the price-rent ratio in Canada, we would note that periods of high price-rent ratios are also followed by periods of low or negative house price appreciation.

Consistent with previous literature, we find evidence to support the view
that rent-price imbalances tend to be corrected more through subsequent price changes than through subsequent rent changes.

The experience of housing markets that have experienced significant variations in the rent-price (or price-rent) ratio is for the ratio to normalize primarily through an adjustment in prices, NOT an increase in rent.  Though both typically move back towards their mean, it is the change in prices that do most of the heavy lifting in the normalization process.  Further to that point, the authors note the following:

Our analysis also supports the view that house prices do most subsequent correcting, relative to rents, in the re-establishment of long-run fundamental equilibrium as measured by the rent-price index.

Once again we find ourselves as Canadians stuck as we try to explain away the unprecedented dislocation between house prices and the rents they would generate.  Is our experience likely to be different from the experience of other housing markets that experienced similar dislocations?  If so, why?

The five scariest words for any rational investor are “This time it is different”.

Cheers,

Ben 

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52 Responses to Reckoning day for the mortgage market?; More on the price/rent ratio

  1. Joe Q. says:

    Ben, a couple of points:

    1. I think you need to fix some italics tags in your post — too many italics are hard to read!

    2. There has been some confusion on-line between new mortgages (which would presumably include renewals by existing homeowners) and mortgages for first-time buyers (on new purchases). My understanding is that is the first-time buyers who overwhelmingly took 35-year amortizations with minimal down-payments. People who were renewing did too, but not to as great an extent. This may be the origin of the differences between Cocomile’s account and the CAAMP data.

    3. If you dig more closely into the latest TREB mid-month data, some interesting trends emerge — firstly that this was the first time in a while where we didn’t see a 10+% drop in sales from last year, and secondly that condo sales were actually up compared to last year (at least in Toronto proper). Semis and detached homes, though, were down around 10%, as before. This may truly be a sign of buyers at the margins trying to get into entry-level properties before 35-year amortizations die forever. Stats for all of March will tell a fuller story.

  2. John in Ottawa says:

    The problem I have with virtually every report I see that uses average home prices in Canada is that the average home price has been heavily distorted by home prices in the west, Vancouver in particular.

    Because the average home price is composed of only 6 centers, 2 in the west representing 33.6% of the index, and 4 in the east with Toronto alone making up 42% of the index, ratios based on the average home price are under reported in the west and over reported in the east.

    There is simply no meaningful way to discuss the average Canadian home price. It is a number that isn’t representative of any location in Canada. There is the average western home price and the average eastern home price. They are very different beasts.

    We also cannot look to Statistics Canada’s NHPI, which represents something like 30 markets, for help because it is “quality adjusted” and doesn’t in any way represent the houses that the vast majority of Canadian’s in fact purchase.

    Even statements such as X% of Canadians could not manage a 1 or 2% increase in interest rates are very suspect. First, as was mentioned just yesterday, Canadians have to qualify for a 5.4% interest rate to obtain a 3% rate. More importantly, when looking at measures of affordability, that is the percentage of household income that goes towards home upkeep, we do not know to what extent home owners are willing to make hedonic substitutions. Such decisions as foregoing the new car, or eating out less often, for instance. Affordability measures assume a certain lifestyle which may or may not be being maintained while house payments remain current. A systemic change in lifestyle would show up as a significant slowing in the consumer economy prior to any increase in the default rate. This is what we need to keep an eye on. However, again, I would expect major regional distortions.

    • Liam from Calgary says:

      good point, and well said

      • Liam, you do understand that Calgary is one of the Western cities that is wildly out of line with fundamentals?

        It is a good point though John. Aggregate data tends to be skewed by outliers. CMHC provides rental market updates but they tend to focus on larger cities and then on the condo markets within those cities. The easy to find data is difficult to track down.

        I am curious how you determined that the average home price is only 6 cities. Are you not confusing the TeraNet index with CREA stats? The graph I used above is using CREA statistics which include all centres. But your point is well taken that the averages are skewed by the bubblier centres, a fact that I don’t gloss over, though I’m not sure the effect is quite as substantial as you seem to suggest.

  3. Leo Lee says:

    You discussion on the Rent-Price Ratio is excellent. It is a topic that is still new to many commentators. And nobody is paying attention to it. It is just like the price-earning ratio in the stock market.

    You said: “I’m quite surprised by the weak sales numbers from the past month”. Not sure why you are. At any given period, the size of the home buyers market is finite. All low interest rate does is to skew the market, moved the buyers ahead of the normal curve. In the final analysis, for a given population and household formation, there are only that many buyers!

    “This time is different”? Wait till those first time home buyers who only marginally qualified with 35 &* 40-year amortization have to renew their five-yr mortgages in 2012 and the follow few years. I think we will see not just the economy will contract because consumption will be down, but foreclosure rate will go way up! The time may still be 12 months away, but it will arrive.

    • Thanks Leo.

      I suppose I was surprised since recent history suggests that people will try to rush to beat impending mortgage rule changes. I expected a similar bounce in sales. Now that the new mortgage rules are in effect, I’d be surprised to see much strength at all in sales over the next few months.

    • John in Ottawa says:

      Only because I don’t wish hardship on anyone, I’m going to cross my fingers that in the ensuing five years from taking out a 40 or 35 year to being forced into a 30 year, salaries have gone up significantly. This would be the case if the majority of the extended mortgage purchasers were new entries to the work force.

      Now, if their house ends up under water, all bets are off.

  4. triplenet says:

    February sales volumes are not down in every jurisdiction in Canada over last year.
    Get off your lazy ass and secure empirical data.

    price / rent ratios for single family residential housing – is a good analytical tool for what?
    Really, for what?

    • Find me where I said that they were down in every jurisdiction. Using CREA’s month-end numbers they were down on a national basis.

      Price/rent ratio is an excellent analytic tool for assessing the future price potential of residential real estate, as per the EMPIRICAL data outlined above. I can highlight other papers from peer-reviewed publications, but you can start with Shiller’s work.

    • Ian says:

      price / rent ratios for single family residential housing – is a good analytical tool for what?

      I rent a SFH on Vancouver’s west side – I pay $2200/month in rent for a house that would sell for $1.2M. For me, the price/rent ratio confirms that there is no rational reason to purchase the home instead of renting it. (Except for possible price appreciation, and I’m not a speculator). Expand this example to an entire market and the effect is the same – buying a home for a cost in excess of rental yield is inherently speculative unless you don’t care about losing money.

      And speaking of lazy, perhaps you could take the time to explain your opinion, and write complete sentences, before you accuse Ben of being so. A lot of people appreciate the time and effort he puts into his blog. Perhaps you’re angry because you know he’s right but it’s not good news for you?

      • jesse says:

        Price to rent for an older stock house in a neighbourhood that is slated for redevelopment won’t give you much of an answer. You need to use highest and best use when using price-rent ratios, including commensurate redevelopment costs.

        A detached bungalow in a gentrifying neighbourhood renting for $2200/month will have a high price/rent ratio but it will have a high ratio in “normal” times.

    • Aaron H says:

      What a rude, pompous, arrogant ***!

      Lazy?! This blog stands head and shoulders above most. Ben puts in a lot of thought, time and effort – and it shows! So how about you show a little respect and interact in a civilized manner (as best you can).

    • buff_butler says:

      price / rent ratios for single family residential housing – is a good analytical tool for what?

      yearly rent/price aka yeild (same calculation) is good for comparing against alternate investments including stocks/bonds/other property.

  5. triplenet says:

    Sorry girls, you are a collection of rookies that enjoy regurgitating data you don’t understand.

    Average price – so what?
    Do you have any data on how many homes sold for THE average price?
    The average price across Canada – means what?

    If you have the ability to predict the future price of real estate – then you may be an research analyst in Flaherty’s department. Of course your predictions change daily. They better!

    A SFD is not an investment. Therefore only the uninformed apply financial tests to determine value.
    1.2M for a house on the west side? Are you sure you’re not renting a garage?
    $2,200 per month – it’s a basement suite then.

    • Ian says:

      It’s assessed at $1.2M so I’ll let you decide what it would sell for. Rent is $2200 for the whole 2 story house in a nice neighborhood – yard, garage, basement and everything. Market rent may be closer to $3000 for the area since we haven’t had an increase in years. If I’m a rookie then explain to me why I would buy the place over renting it. I ask that question a lot but I’ve never heard a good reason.

      A SFD is not an investment. Therefore only the uninformed apply financial tests to determine value.

      Of course it’s an investment, even if you’re living in it. You’re collecting rent, either from someone else or yourself. Are you advocating that someone should not try to determine the true value of a house before purchasing it?

  6. triplenet says:

    Assessed value vs. market value – know the difference!
    Look up the definition of an appraisal – Appraisal Institute of Canada.
    The reason you cannot get an answer for rent vs. purchase of a SFD is because its a moot analysis.
    An investment offers financial returns. That is the primary consideration in the aquisition. It is the core function. A return on and of investment.

    A home is just that – a home. Something that provides ammenities and benefits that are not based on financial realization. Of course 20 years hence, in the right cycle, I sell and purchase another home that will provide the same/similar benefits that I need or want. Would be nice if there was cash left over… that’s a bonus.
    Too bad so many Canadians (and surely Americans) do not understand this.

    • Ian says:

      I have a very nice home, I just don’t own a house. So I get the benefits of owning without the increased financial risk associated with owning.

      I think the analysis is worthwhile. Renting a house is currently cheaper than the interest portion of a mortgage (at historically low interest rates) and I don’t have the risk of additional costs such as unexpected maintenance and tax increases. And since rents correlate to incomes there is a limit to how quickly they can rise. Granted, I miss out on any price appreciation (with leverage!), but I also miss out on any price depreciation (with leverage!). The last five years have had lots of the former, but I’m not so sure about the next five years.

      Your house is an investment – even if you’re living in it. The financial return is the rent you would otherwise be paying someone else. But if your costs (mortgage) are higher than your return (rent equivalent) then I don’t think it’s a very good one.

    • jesse says:

      “A home is just that – a home”

      Price-rent is important when looking at a market space that has a large portion of its participants interested in financial returns ex intangible benefits. When there are no significant data for rentals in certain markets, price-income and imputed rent data are substituted.

      The real key for price-rent is to look at a condo/apartment market where there are significant numbers of investors. They will be mostly interested in the “price-earnings” calculations because, like all investors, they look at returns and prices (unless they’re speculating…). Owner-occupiers compete in this space and will be willing to pay a premium over investors because of intangible benefits of ownership. So the question is, why would investors want to compete with owner-occupiers? (I’ve heard it put as follows: the owner’s premium is the renter’s discount.)

      The crux of the argument for price-rent (price-earnings) is that, eventually, investors solely interested in earnings set the price. It may take a long time for this to happen but it will.

    • Tw says:

      If you were to calculate all of the expenses associated with your dwelling, you hope to sell and breakmeven on all expenses and walk away without a tax bill. I think if people were actually told in real dollars how much they will have paid by the end of their mortgage….plus all associated expenses, they would stunned at how much appreciation would be needed to break even….especially in the current market.

      A home in an investment by any measure, and a liability until sold. Value whether market or appraised is a function of perception.

  7. Pingback: Reckoning day for the mortgage market?; More on the price/rent … | Mortgage info

  8. Sams Mango says:

    I don’t see how any rule change is going to stop young/old folks to continue to pile into homes and pay increased prices. PRICES WILL CONTINUE TO RAISE this year, maybe we get a blip after this….

    Jobs, economy, commodity prices are booming! Canada has a very strong balance sheet. Canada doesn’t need anyone. People need Canada. Break out the maple syrup and get involved.

    • ATP says:

      “Jobs, economy, commodity prices are booming! Canada has a very strong balance sheet. Canada doesn’t need anyone. People need Canada. Break out the maple syrup and get involved.”

      Well said. Now all you have to do is start a cult and order followers to keep chanting the above.

      • Sams Mango says:

        One story that was missed is how debt to income ratio has been coming down in Canada which peaked at ~160 to ~140 X

        Anyway, I am bullish and am not going to push my views. I will stay focused on making money while the good times last. Who knows when they will come back again. Record low rates, I will enjoy, leverage and invest.

      • Sams Mango says:

        thanks for starting the chant.

    • Joe Q. says:

      I don’t see how any rule change is going to stop young/old folks to continue to pile into homes and pay increased prices.

      Don’t know about old folks, but in 2009-2010 the vast majority of first-time home buyers (around 90%, according to several mortgage brokers interviewed in the media) put down 5% on their purchases and amortized over 35 years.

      • Sams Mango says:

        Even better, they have long life balance sheets and chip away at it for longer.

        The problem will be the shift from – cool closer pad, BF/GF living with me and end at family pad

        From me, I always invest in the larger places in the city for people who want to stay in the city and have kids (near schools and parks) and the same with houses. The human movement/life cycle never changes.

      • Joe Q. says:

        I think you missed my point, Sam / Mango.

        The “young folks” and a substantial number of investors / speculators were buying into the market with 5%-down, 35-year amortizations, based on just making the monthly payment.

        “Going to the max” on their monthly payment now buys them a lot less house (about 7% less).

        The impact of the end of 35-year amortizations on the entry-level market will be significant.

  9. Ralph Powers says:

    Good post over at Garth’s site http://www.greaterfool.com
    _____________________________________________________________
    Do you have no savings, low income, live in social housing and have a crappy credit rating? If you do you’re in luck and can qualify for a mortgage for hundreds of thousands of dollars!

    Thank goodness Canada didn’t get into subprime lending, and we have only conservative lending here with our financial institutions.

    https://www.vancity.com/MortgagesRenos/CustomFit/SpringboardHomeownership/

    This can only end well…….

  10. Alex says:

    Wow. Lots of anger here today from bull extremists. A byproduct of March 18?

    “A SFD is not an investment. Therefore only the uninformed apply financial tests to determine value.” WTF? Value is not determined by a “financial test”? What does that even mean? That the price of a house means squat? Interesting – sounds like the incoherent ramblings of a few realtors I’ve met.

    And dude, addressing those who disagree with you as “girls”? Listen up – save that crap for your therapist, OK?

    And Mango – who could forget about you? Your nonsensical claims have been part of this blog for a little while now, haven’t they? “I don’t see how any rule change is going to stop young/old folks to continue to pile into homes and pay increased prices. PRICES WILL CONTINUE TO RAISE…” (I assume you meant “rise.”)

    Why? We’re in debt as a nation up to our proverbial eyeballs. Prices in POCKETS of a FEW major centers are higher than they’ve ever been, yet prices everywhere else are trending downwards – the epitome of a deflating bubble. Measures are being put into place to stop the insanity. The across-the-board cost of living is escalting everywhere. And most importantly, unless you’re so incredibly wealthy that you don’t give a sh*t, renting is currently a far more viable route for many than owning.

    As for appreciation, what appreciation? How can anything, even in the areas that are already down, appreciate given the fact that NOBODY CAN AFFORD A FREAKING HOUSE anymore. And that’s at the core of it. Prices have been artificially jacked to a place where they’re totally and completely unaffordable. How do you not see that?

    Ben is clearly too much of a gentleman to tell you brainiacs to get stuffed. Don’t know how he does it…

    • Sams Mango says:

      LOL, how is your rant vs the corporates going about “news” you questioned?
      You need to relax, rent and get angry birds on your iphone.

  11. Liam from Calgary says:

    Ben’s reply:
    Liam, you do understand that Calgary is one of the Western cities that is wildly out of line with fundamentals?

    If you mean, Calgary has lots of jobs, a highly educated employee base, increasing immigration, and finally fiscally responsible home owners.
    Your right

  12. jesse says:

    a highly educated employee base, increasing immigration, and finally fiscally responsible home owners.
    Your right”

    Yeah hes right. Its all about the educated employee base.

  13. triplenet says:

    Join the girls club Alex. You know absolutely nothing about real estate.

  14. Don says:

    triplenet, and sams mango. Ages please

  15. pathrik says:

    Being from Alberta myself it is not unusual to hear boasts about the impenetrability of housing due to immigration, a booming economy and blah, blah, blah. Alternatively in the east we talk about the bubble being isolated to western Canada.

    There is another line that is as equally dangerous as “this time its different”.

    That line is “we’re different here”. Call me a cynic but when I hear that from policymakers and public officials I think it should be interpreted as ‘we’re all pretty much the same’.

    All that being said, Ben asked if the fallout will be different here. While its hard to say it seems to be more closely tied to commodities here than in other markets (as Shiller, Ben’s blog and other blogs have noted). This makes me a little worried because the bull trend in commodities could go on a while and that might mean our housing sector does not fully deflate as much as we might think it will in the next year – assuming commodities can keep going up for awhile. In other words the housing market will only really deflate when the prices of commodities fall. Which means Canada is going to be facing a double whammy when it does.

    I have seen commodities busts in western canada before (as a kid albeit). Trust me when I say this – they are rude awakenings and humbling experiences for many who get caught up in mania, and that describes a lot of people in western Canada. We hear a lot of talk that the west is the new engine of growth in Canada etc. Read history books, this kind of talk has been given from the time of confederation during different commodity booms.

    I cant fathom what a commodities bust would be like in Canada, but especially in western Canada, if it coincided with the mother of all housing busts.

    • Liam from Calgary says:

      SO your predicting a world wide depression to cause a major decrease in oil prices.
      What do you base this on?

      • Liam

        If the housing market in Alberta is entirely driven by oil and nat gas, why has it fallen over the past two years while oil prices have tripled? There’s no doubt that a booming oil and gas market is good for Alberta, but only if it raises wages accordingly. This is what you seem to be missing. You can have the world’s most intelligent workforce in Alberta (as per your earlier comment), a booming oil and gas sector, jobs galore, and still have a falling real estate market if you are starting from a point of overvaluation based on measures of fundamental value.

        This is what you are missing. There are qualitative factors that drive real estate and then there are quantitative factors. You are focusing primarily on the qualitative factors, which can win out for several years or even a decade or longer, but they cannot prevent prices from realigning with the quantitative measures of fundamental value. They will eventually win out. Unfortunately for Alberta, it appears that the ‘eventually’ began two years ago. Sorry man!

      • LightsOut says:

        Oil prices look set to rise substantially from here looks to me as we are in another oil crisis…..

        The arab thing is not going away anytime soon….
        Japan is going to need lots as their nuclear strategy is in shambles……
        China is going to need ever increasing amounts…
        If we ever get a recovery usage will shoot up here…

        The oil supply is under serious threat short term and medium ..no meaningful increases in production for 5 years now and big supply gaps on the horizon……

    • pathrik says:

      Commodities sectors have historically followed boom and bust cycles. Is it different this time? Maybe, as some believe the ‘rise of China’ will lift commodities for years to come.

      However China could also go into a recession which would trigger a fall in commodities prices. That is one possible trigger. Oil prices declined in 2009 after the Wall Street bailout. I seem to recollect the Alberta budget going from a big surplus to a very serious deficit shortly thereafter. A bear market in commodities would not be good for incomes.

      It wouldn’t be the apocalypse. But by it wouldn’t be pretty either.

      Time will tell I guess.

  16. @Sam/Mango
    “One story that was missed is how debt to income ratio has been coming down in Canada which peaked at ~160 to ~140 X”

    This is categorically false.

  17. Lumpen says:

    OT, but thought this was an interesting quote from across the Pacific:

    http://www.straitstimes.com/BreakingNews/Singapore/Story/STIStory_647217.html

    FYI, Lee Kuan Yew was PM of Singapore for 30 years. The source is the major newspaper in Singapore.

    I took a look around some of the online RE sites to get a benchmark for relative pricing. Assuming 100% of earnings were spent on RE (no interest, food, utilities, etc), the mean worker could afford to buy between 3 and 11 square feet per month. The 11 sqft number was HDB housing, and seemed to be between $350 and $500/sqft based upon the two sites I looked at.

    Mean wages:
    http://www.mom.gov.sg/statistics-publications/national-labour-market-information/statistics/Pages/earnings-wages.aspx

    • Sams Mango says:

      Lee Kuan Yew

      This man wrote an excellent book – From third to first, I would advise people to read it. Excellent.

  18. Sams Mango says:

    I will find it Ben. It was in the globe a week or so.

    War and stock markets. That is next phase for the world now. Not one middle eastern riot burned an american flag. Now we are bombing them. Oil higher and markets higher will be the end result. Off course low rates

    Ben. I think home price collapse down trade will on hold now. Focusing now on next trade

    • Any luck with that bogus stat?

      • Well…..?…….Still waiting…..

        Sorry Mango…..that stat is bunk. Canada has not experienced any sort of debt deleveraging yet.

      • Lumpen says:

        If I might put words in Mango’s mouth, I believe he/she is referring to the following based upon publication date:

        http://www.statcan.gc.ca/daily-quotidien/110314/dq110314a-eng.htm

        It shows a marginal decline in the debt/disposable income ratio (but not to the extent noted above). I can’t conclude anything from the flatness of the ratio, but the components were more interesting (to me anyway).

        Per capita debt grew roughly at the same pace as in the prior quarters ($600 sequentially), yet personal income growth was strong. PDI is lumpier though, and takes into account capital gains. Equity markets were strong in Q4. Probably a greater influence – highly unlikely wages grew 2% sequentially. So far, Q1’11’s not as promising on the PDI front.

        Reference:
        Statcan definition of PI & PDI:
        Personal income is the sum of all incomes received by residents of each province, including returns for labour and investments, and transfers from the government and other sectors (including old age security payments and employment insurance). Personal disposable income is the amount left over after payment of personal direct taxes, including income taxes, contributions to social insurance plans (such as the Canada Pension Plan contributions and Employment Insurance premiums) and other fees.
        http://www.statcan.gc.ca/pub/13-605-x/2003001/chrono/2003prov/4151911-eng.htm

  19. MB says:

    Here’s an example from a condo in midtown Toronto:
    New building, 1 bedroom plus den on 8th floor, 1 bathroom, $449,000, condo fees $360 and taxes ~$200/month, parking included.
    The same condo is being offered for rent for $1,800 per month.

    Assuming someone just buys the place with cash, not including sales taxes, fees and commissions, and rents it, their cash flow is 1,800-360-200= $1,240/month or $14,880 per year. That is an annual yield of 3.31%, or a Price/Earnings ratio of 30.17. The numbers are pretty bad even with this example which doesn’t use any leverage. For comparison, Canadian bonds’ total return was more than 6% last year (XBB). And the P/E ratio is very high indicating that either the condo price is too high or that rent should rise in the future. At least with stocks that have high P/E ratios, there are expectations that earnings will increase substantially in the future, but with rents that is next to impossible since they usually follow the inflation rate.

    Let’s assume someone buys the condo with a 20% down payment ($90,000) and a 5/25 year mortgage @ 4%. Mortgage payment is $1,888. Cash flow is $1,800-1,888-360-200= -$648 per month.
    On a 30 year amortization the monthly payment is $1,707. Cash flow is negative $467 per month.
    With a variable rate @ 2.25% and 30 years, cash flow is negative $130.

    This is a horrible investment no matter how you look at it. It’s cash flow negative if we use any leverage, future rent growth might increase but not much more than inflation, taxes will increase, condo fees will increase, and the principal is not protected or guaranteed.

    So, why would someone buy this condo at this price?

    I live across the street from this building and at night only 30% of the apartments have light in them. My guess is most investors bought the condos pre-construction 4 years ago and are now waiting for more speculative buyers.

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