The New Road to Serfdom

I have decided to no longer continue maintaining this blog. I would like to thank all of those who have contributed to the discussion over the past year. Last week, we brought a new baby girl into our family. Between that, and more extensive travel for work, I have decided that I don’t have the time necessary to contribute significant amounts of energy to this endeavor.

I will leave you with 2 thoughts:

1. The liquidity bubble is world-wide and still going strong. This has manifested itself in many ways, and caused a rolling housing bubble around the world. It appears the Canadian version of the bubble has now rolled into Saskatchewan.

I guess they are running out of land in Saskatchewan.

2. The long term economic impacts of excessive debt loads will be felt long after the market slows down and the torrent of easy credit dissipates. If you haven’t already read this piece, I suggest you read the whole thing. It was written last year before the US market started to slow, and I feel it is more relevant for us now, as we reach the pinnacle of our mega-boom and the temptation to borrow vast sums of money is huge.

Some quotes:

“Never before have so many Americans gone so deeply into debt so willingly. Housing prices have swollen to the point that we've taken to calling a mortgage–by far the largest debt most of us will ever incur–an "investment." Sure, the thinking goes, $100,000 borrowed today will cost more than $200,000 to pay back over the next thirty years, but land, which they are not making any more of, will appreciate even faster. In the odd logic of the real estate bubble, debt has come to equal wealth.

And not only wealth but freedom–an even stranger paradox.

After all, debt throughout most of history has been little more than a slight variation on slavery. Debtors were medieval peons or Indians bonded to Spanish plantations or the sharecropping children of slaves in the postbellum South. Few Americans today would volunteer for such an arrangement, and therefore would-be lords and barons have been forced to develop more sophisticated enticements.

The solution they found is brilliant, and although it is complex, it can be reduced to a single word–rent. Not the rent that apartment dwellers pay the landlord but economic rent, which is the profit one earns simply by owning something. Economic rent can take the form of licensing fees for the radio spectrum, interest on a savings account, dividends from a stock, or the capital gain from selling a home or vacant lot. The distinguishing characteristic of economic rent is that earning it requires no effort whatsoever. Indeed, the regular rent tenants pay landlords becomes economic rent only after subtracting whatever amount the landlord actually spent to keep the place standing.

Most members of the rentier class are very rich. One might like to join that class.

And so our paradox (seemingly) is resolved. With the real estate boom, the great mass of Americans can take on colossal debt today and realize colossal capital gains—and the concomitant rentier life of leisure—tomorrow. If you have the wherewithal to fill out a mortgage application, then you need never work again. What could be more inviting—or, for that matter, more egalitarian?

That’s the pitch, anyway. The reality is that, although home ownership may be a wise choice for many people, this particular real estate bubble has been carefully engineered to lure home buyers into circumstances detrimental to their own best interests. The bait is easy money. The trap is a modern equivalent to peonage, a lifetime spent working to pay off debt on an asset of rapidly dwindling value.

Most everyone involved in the real estate bubble thus far has made at least a few dollars. But that is about to change. The bubble will burst, and when it does, the people who thought they would be living the easy life of a landlord will soon find that what they really signed up for was the hard servitude of debt serfdom.”

Globe and Mail: Worries grow as hammers fall silent

I know that what happens in the United States and the rest of Canada has little to no effect on the Alberta economy. We are not prone to speculative excess like the rest of the world and there is no affordability issue here because most people's incomes have doubled or tripled over the last 2 years allowing Calgary's citizens to pay higher and higher prices for the same homes without increasing debt loads like they have in other parts of Canada or the United States.

Still, it's sometimes amusing to here the blasphemy that comes from other opinions...

Interesting article in today's Globe and Mail.

Some Quotes:

"Construction on new U.S. homes has hit the lowest level in almost a decade, boding ill for the Canadian factories and lumber companies that rely on the industry.

New home and apartment construction plunged a greater-than-expected 14.3 per cent last month, the Commerce Department said Friday. It was the fewest number of new houses since August, 1997.

The report raised questions about whether the plunge represents one bad month, or a more prolonged slump in the housing industry. Canadian exporters fear that a lingering slowdown in their biggest market could still spread to lower consumer spending, leading to a broad weakness in demand.

“This is not good news,” said Jayson Myers, chief economist at the Canadian Manufacturers & Exporters. “The big question is, is it really bottoming out, because the housing market will be a very important factor in driving the overall health of the U.S. economy in the coming year.”

Lumber and building materials companies, which account for about a tenth of Canadian exports, will be most directly affected, he said. But all manufacturers that rely on U.S. demand are at risk, he cautioned.

The lumber sector is already facing hard times. Forestry exports fell 8.6 per cent last year from 2005 levels amid a U.S. slowdown, government figures showed this week.

By region of the country, housing construction fell 28.5 per cent in the West, 15.2 per cent in the Midwest and 11.8 per cent in the South. Construction starts rose 8.9 per cent in the Northeast.

The overall housing decline was much sharper than the 2.6-per-cent drop that analysts had been expecting and raised concerns that the steep slide in housing has yet to run its course.

On Thursday, the National Association of Realtors said that sales of existing homes fell in 40 states in the fourth quarter of last year and home prices dropped in 49 per cent of the metropolitan areas surveyed, the widest price decline in the history of the Realtors' survey.

Many economists are worried that the housing bust, which followed a five-year boom, could be a prolonged one as sellers struggle to reduce record levels of unsold homes."

One thing that is always true is that every single month during the decline, the RE organizations assure us that we have reached the trough and that it will be smooth sailing from here.

USA house prices falling during period of low interest rates, low unemployment, and a growing economy.

Read this article from CNN Money

Long time readers of this blog will know that it's my position that while current prices need high employment, low interest rates, and low employment to continue, home prices can and do drop due to high prices and a bubble-like investment mania.

Now, due to the housing mania in the United States over the past few years, many markets are experiencing deflation not seen in real terms since the great depression, despite all the factors which should be positive for housing (low interest rates, high employment, expanding economy). Prices just got too high for whole segments of the population to afford, and the markets started to stall, and some are collapsing under the weight of massive debt loads.

I know people will tell me that "it's different here", but I believe that like many formerly hot markets in the US, Calgary has many speculators, increasing personal debt loads, and large portions of the working population that are having trouble affording housing here... and not just poor people.

Some Quotes:

Fourth-quarter report from National Association of Realtors shows largest price drop on record as markets with price declines now outpace those with gains.

The slump in home prices was both deeper and more widespread than ever in the fourth quarter, according to a trade group report Thursday.

Prices slumped 2.7 percent in the fourth quarter compared to the fourth quarter a year earlier, according to the report from the National Association of Realtors (NAR). That's the biggest year-over-year drop on record and follows a 1.0 percent year-over-year decline in the third quarter.

And from Yahoo:

Formerly red-hot areas were among the hardest hit as the five-year housing boom cooled considerably in 2006.

Mark Zandi, chief economist for Moody's Economy.com, predicted that home prices in many parts of the country would continue to be under pressure for the rest of this year as the market works through still large inventories of unsold homes.

He said this process will be made more difficult with banks raising lending standards because of concerns about rising mortgage default rates.

"The price declines we are seeing are extraordinarily broad-based and just symbolize how significant a price correction we are in," Zandi said.

Reader predictions for this hot market

I think it’s quite clear that the market has heated up considerably since the beginning of the year. Sales levels broke the record for January and looks like it will again for February. Both average and median prices are up significantly, and it even appears that there are bidding wars again for certain properties. This could last another month, or it could last another 6 months, in a repeat of 2006.

What we know from other markets is this, prices can and will rise until the “entry level” homes get priced out of reach of the 1st time home buyer. This is due to the market's need to have an ever increasing number of homebuyers to outpace the new supply that gets added.

My question is this: What do you think is that price level for this city?

Let’s use 2 benchmarks:

A small single family home in a far flung new subdivision. (approx 1200 sq feet)
A small 2 bedroom condo in the inner city (approx 800-900 sq feet)

A second question: Now that its become quite clear that home prices are flat or falling in most of North America, at what price levels do you think that young people will start to decide that it’s not worth it to come here and build a career? Do young people care about house prices when deciding to move to a new city?

Circular Logic: The market is strong so it can’t be a “bubble”

One of my main reasons for starting this blog, was to point to some fallacies which I had noticed were becoming “common wisdom.” Among these fallacies were of course the notion that “real estate only goes up”, “we’re running out of land” and that price didn’t really matter, because somebody would always come along to pay more…

I’ve noticed that the strong sales numbers of the past few weeks has caused another round of housing perma-bull types to come here and say basically, “it can’t be a bubble, because look how strong the market is and look how much people are willing to pay/borrow.”

To me, it’s circular logic. In any market, the buyers HAVE TO BELIEVE THAT THERE IS NO bubble, in order to buy at high prices. The very nature of a financial or asset bubble requires that the majority of the masses buy at high prices. Therefore, the fact that many people ARE buying at high prices, does not mean that a bubble does not exist, all it means is that if there is a bubble, it hasn’t ended yet.

When both amateurs and professional fund managers bought Nortel at $100 / share, they did not believe it was a bubble or they would not have bought at that price and the price would have been much lower. When people bought real estate in Japan in 1989, they did not believe there was a bubble, or else prices would not have been high and there would have been no bubble. When people bought condos in Miami in 2004 for double what they paid for it 2 years before, they did so believing that the market was justified.

Clearly what the market action over the past month shows, is that the masses in Calgary still believe that prices are justified and going higher. This however, does not mean that sooner or later the high debt loads and rapid housing supply growth will not create a different perception amongst the masses, which would cause the market to turn. Markets are driven by psychology, and mass psychology is not permanent.

Canadian home prices unchanged for first time since 2000

Read this article from CTV. It is based on only new houses and only looks at month over month chages, so it is basically meaningless. However, I think it's interesting in that public perception can be changed by headlines, if the headlines continue over a long period of time.

I have a theory that once prices basically flatten out for a year or so, panic in the market disappears and people are left doing old-fashioned financial analysis when purchasing an investment, whether it be real estate or anything else. During a boom time, people ignore fundamentals because they can always find someone to buy thier investment for more than they paid. During a period of flat or even down prices, one again needs to look at price/rent ratios, price/income and other factors before jumping into a large purchase.

It's like during the dot-com days, who cared about PE ratios when you could buy Nortel for $60 and sell it for $80 in a few weeks? Analysts would invent reasons why the price should go higher. Did you ever hear about the earning to PhDs employed multiple? That was my favorite retarded multiple being banding around by analysts who couldn't value things based on zero earning. Once the market collapsed, all of a sudden investors pay attention to valuation again.

On another note, more bad news about the US sub-prime mortgage market today. Renegade bloggers have been warning about this for about a year, but most simply dismissed them as chicken littles and losers. Turns out they were on to something. Read this article in today's Bloomberg. Turns out that the banks who originated and bought lots of this mortgage paper are starting to show significant losses. HSBC announced that they have lost over $1,000,000,000 in this space. Expect similar annoucments from others in the future.

They're not making any more land

Interesting article today in Bloomberg about how real estate pros (the large US homebuilders) got caught up in the frenzy with amateurs in the mad land rush over the past few year. It appears that the conventional wisdom is that real estate prices can only rise.

I know this is from the United States and it's different here, but I thought this is a good read anyway as a potential warning to what could happen once a real estate frenzy subsides.

Read this article.

Some quotes:

Brian Tuttle owns so much land that he paid $3.6 million to get rid of 125 acres ready for development in the middle of Florida's Palm Beach County.

``In 2005, I was a brain surgeon, and in 2006, I was a moron,'' said Tuttle, who walked away from his deposit on the land rather than lose even more money buying it and building homes on it. ``The only good news is that I'm not alone.''

The worst housing slump in 16 years made a lot of smart money vanish. D.R. Horton Inc., Pulte Homes Inc., Lennar Corp., Centex Corp. and Toll Brothers Inc., the five biggest U.S. homebuilders, said plummeting land prices cost them a combined $1.47 billion in the fourth quarter.

Builders paid more for land during the boom because home prices were rising, too. They didn't realize speculators were pumping up demand by buying houses to sell quickly. When prices reached a point where speculators quit buying, homebuilders were forced to abandon so much property they helped create a glut that drove down land prices more than 9 percent last year, according to data compiled by New York-based research firm Real Capital Analytics Inc.

``Homebuilders allowed their own enthusiasm for price increases on houses to affect their decisions on what they would pay for land,'' said Mike Inselmann, president of Metrostudy, a real estate research firm in Houston.
The decline in land values reveals the role short-term buyers played in the housing boom, when the median U.S. home price rose to $276,000 last June from $177,000 in February 2001.

Industry executives, including Toll Brothers Chief Executive Officer Robert Toll, estimated that about a quarter of their houses were bought by people interested only in flipping them -- buying and selling quickly rather than moving in.
`Dried Up'

Louis Genuario Jr., a regional builder in Alexandria, Virginia, said speculators may have made up about 40 percent of housing customers. In some new condominium complexes in suburban Washington, every buyer was a speculator, Genuario said.

``When land came on the market, you competed against national homebuilders who were flush with money and speculators who were jumping into the market and trying to resell it immediately,'' Genuario said. ``The price was high and the supply became limited. Then the market stopped when you couldn't get people to buy because it exceeded their ability to pay. Now we see land that's been on the market for months.''

These days, the speculators are looking foolish, too. In Florida, where they helped inflate land values as much as 10-fold from 2000 to 2005, prices have dropped by as much as 50 percent.

``The land market has dried up,'' said Alex Barron, an analyst at San Francisco-based JMP Securities LLC. ``Most builders are on the sidelines because they expect prices to go down another 30 percent.''

Pent up Demand at These Prices?

There seems to be a common theme in much of the mainstream press talking about “pent up demand” when explaining why home prices will continue to rise far above historical rates.

There is clearly pent up demand for homes among people who cannot afford the price level in Calgary. There must be lots of people who would qualify for a $200,000 house and would happily buy tomorrow if they could. The problem that I see, is that this type of “pent up” demand cannot continue to drive price increases from current levels. In fact, as price levels rise, a smaller and smaller percentage of the population can afford to add to this “demand”.

We’ve seen other markets where demand should be strong based on traditional fundamentals (low interest rates, low unemployment, strong economy), where housing just got too expensive and the market essentially collapsed (liquidity at first, prices only later).

My question to you is this:

Is there tons of pent up demand in Calgary for a $400,000 + SFH in a far-flung suburb or a $300,000 + condo?

Or, is the pent up demand for housing mostly with people who cannot or will not buy at current price levels?

Sub Prime Mortgages and Re-pricing in the Bond Market

Last year I read an interesting book called The Tipping Point, by Malcolm Gladwell. Its general thesis is that small changes at certain times can change the world. Some of you may not agree with the thesis, but I thought it was a unique way of describing changes such as how the crime rate in New York dropped in the 1990s, or how certain products reach a “tipping point” where they catapult from years of relative obscurity to mass adoption in a short period of time.

Financial markets also can experience tipping points. The dot-com bust looked like it was correcting in 2000, only to bounce back for a year. The major crash occurred in 2001, as people started selling for tax purposes, which led to panic selling of clearly over-priced assets, which led to a major rout. The Nasdaq index then spent the next couple years dropping from over 4000 to under 1500. The crash was due to the overvalued equities, not the tax-related selling. However, the tax selling provided the trigger, or “tipping point” which led to the entire house of cards crumpling down.

Check out the chart here:

There has been lots of chatter on this site about interest rates and various amateur prophets have declared that interest rates are at the top, and will decline from here. Perhaps this is true.

Many others have argued that mortgage interest rates are currently at historical lows, and are not correctly pricing in the real risk due to 5 straight years of the boom and very low default rates. Most of the new mortgages taken out in the hottest US markets over the past few years were in a category known as sub-prime. This is basically the type of loans that go to people with less than 20% to put down, and also others with less than perfect credit scores. Because of the boom, these mortgages had very few defaults since 2002, and so rates continued to decline as investors in the bonds backed by these mortgages believed that the reduced risk premium would be sustained. In turn, these mortgages also helped prop up demand and prices in hot markets as buyers were able to use these cheap mortgages to increase the amount they could borrow. (In Canada this has not been as large a problem, however over the past year at the margin there has been a move towards interest only and 35 yr mortgages to extend demand).

Interestingly, housing prices basically stopped appreciating in many of the hot markets during 2006 and consequently defaults started to rise. This occurred slowly and first, and now at an accelerating pace. Only now (about 18 months after the peak in the housing market), are we starting to see stress on these investments. Some renegade analysts are even saying that this could be the “tipping point” which will cause defaults to spread from sub-prime to less risky bonds down the mortgage food chain. This, in turn, may lead to widespread increased mortgage rates (regardless of what the Fed does). This is due to mortgage investors beginning to add back risk premium into these products. Even if the problems are contained in the sub-prime segment, this could still cause a major contraction in the housing market as in many places such as California, the majority of new mortgages over the past year were in this category. As the spigot runs dry, a major source of new demand will contract. If you look at how this type of credit contraction has taken place over previous cycles, you could probably say we are still in the 2nd inning of a 9 inning game.

Good article here in the Financial Times that you should read if you are interested in this topic.

Will mortgage rates rise or fall over the next 5 years? I have no idea. What I do know is that those who are making a prediction with absolute certainty do not really understand how interest rates are set or the global bond markets, which effect mortgage rates all over the world. If the MBS market decides that mortgages are more risky in the future, mortgage rates can rise even as central banks decide to lower overnight rates.

Market Resurgence or Dead Cat Bounce?

Looking at the preliminary data for January, a few things are clear. The housing market has surged back considerably from the weakness in the second half of 2006.

• Since October 30, inventories have dropped 45%
• Days inventory has dropped from 96 in October to 45 in January
• Sales have been very strong (about 19% above Jan 2006 and slightly above January 2005 levels).
• Prices are back up to the Oct 2006 level, which was the all time high.

The question remains, is January the start of a new resurgent market, which will propel prices far higher?

Or, is January a small bounce of what will be a much weaker market (year over year from 2006). Are buyers simply trying to buy before the “spring rally”, which may or may not occur?

There is lots of evidence that could support either theory. What’s your opinion?

100 Bottles of Beer on the Wall.

For those of you interested in macro-economic trends, it can be very difficult to deciphering the usual garbage spewn out by the financial media. Even a reputable organization like Bloomberg, will have on any given day contradictory articles about events. For example, it is not unusual to read an article in the morning about how there is a shortage of oil and therefore prices should rise, only to read an article 2 hours later about how there is a surplus of oil and therefore prices should fall.

Once in a while I come across really well thought-out pieces that take a step back and try to explain recent financial history. Most people agree that decreasing interest rates over the past 10 years have significantly led to asset inflation across the world, including home prices. This is a great article trying to explain some of the global phenomena that has caused this to happen, and what we could see in the future.


Click here to read.

Some quotes:

“The twin barrels of financial innovation and globalization have significantly complicated the forecasting of asset returns in recent years. Two domestic bubbles in the last decade are testimony to the power of levered money and the recirculation of price insensitive reserves back into U.S. financial markets. While the late 1990s equity bubble had its roots in bonafide technological innovation, peak prices were driven by credit creation fed by globalized repatriation of Asian reserves following its financial crisis in 1997/1998. Similarly, what now appears to be confirmed as a housing bubble, was substantially inflated by nearly $1 trillion of annual reserve flowing back into U.S. Treasury and mortgage markets at subsidized yields, as well as innovative funny money mortgage creation which allowed anyone to buy a house at escalating and insupportable prices. Bond, stock, and real estate trends then, have recently been increasingly at the mercy of relatively price insensitive and levered financial flows as opposed to historical models of value or the growth of the real economy itself. An exorbitant P/E of 25x meant nothing in 1999 as unforeseen flows and investor mania drove them to 35x at the peak in 2001. An unchanged 10-year yield range centered around 4½% mystified the Fed, but not cash rich foreign central bank buyers as short term rates were aggressively raised by 425 basis points from 2003 to mid-2006. This foreign repatriation produced artificially low yields, (perhaps 50-100 basis points confirmed in numerous Federal Reserve staff reports and speeches in recent years) which in turn drove housing values to unsustainable levels as recently as six months ago – the estimated peak in national home prices."

Will high prices affect migration?

It's good to take a step back at times and think about the long term implications of our current economic boom. There is no question that the boom has attracted an incredible level of migration over the past few years. This has led to a severe shortage in housing and has contributed significantly to the recent run-up in prices in Calgary.

My question is this: Do you think that the high cost of living in Calgary, will start to have a deterrent effect on current and future migration to the city?

One of the incredible consequences of the home price boom in the United States is that areas that recently led the nation for in-migration, all of a sudden started having net outflows of population. This is certainly the case in parts of South Florida and also in areas of California, including San Diego. Businesses in those areas are reporting that the most difficult problem for them in filling jobs is the high cost of housing. Click here for an interesting article about this from San Diego.

"The high cost of housing has become the biggest hurdle for employers to overcome in recruiting new employees, said Michael Schuerman, director of research for the San Diego Regional Economic Development Corp.

In a 2006 survey of local companies, 90 percent of the employers and 100 percent of the employees identified the high cost of housing as their top local business challenge.

As a result, far more people are leaving San Diego County than are moving here."

I have a theory that until about a year ago in Calgary, this was not an issue. People would happily leave other parts of Canada to take advantage of the Alberta economic boom. Over the past 6 months however, I have noticed a distinct change in the attitude of many of the people I have spoken with, both in terms of people already living here, and other that I've spoken to about moving here to fill jobs. I have even now heard of people that have decided to leave Calgary, because their increased earnings here do not make up for the higher cost of living.

A friend of mine, who recently moved back to Toronto, told me that the problem in Calgary, is that there is no affordable housing anywhere. He compared it to Toronto, where while the inner city areas are very pricey, as you get farther outside the city, there are lots of areas where a middle class family can still afford a home that they like. He told me that so much of the economic activity in Toronto is in the suburbs (Mississauga, Vaughan, Richmond Hill...), that lots of people easily live outside the city and can still be close to work. This is just one example, but I'm sure there are others.


What do you think? Will newcomers continue to brush off the higher living costs in order to move here? Or will the migration rate begin to decrease do to this?

Fundamental Values

What is the fundamental value of a home? How is it measured?

In the stock market, one looks at various ratios of companies to compare them, including price to earnings & price to book. One also looks at discounted cash flow over the life of an asset or company and can derive a "fundamental" value that way. Many times the market price is higher or lower that what you determine to be the "fundamental" value.

Historically, when looking at commercial real estate, one uses a cap rate, which is roughly measure the rate of return based on rents.

In residential housing, it's difficult to determine fundamental value, because a house is part investment and part consumption. To get a general idea of what a house is worth, it is useful to look at price/rent ratios. In other words, for a particular home, how much can it be rented out for? It is sort of like looking at cap rates for residential properties.

One of the arguments world wide about the recent huge increase in home prices, is that they are not justified by fundamentals because rents have not risen as much. Looking back, I don't have accurate rental data for Calgary. I'm not sure if the aggregate data is that meaningful anyway, because there is no "standard" home that is easy to compare. Therefore, it is useful to look at least at anecdotal evidence to see what the current price/rent ratios are in the city.

I know of a few examples personally:

1. A friend of mine rents a condo. Recent sale price $325,000, rental rate $1250 /month. Price/Rent ratio = 260x

2. Co-worker rents an 800 sq foot older apartment for $800 per month. Last sale price was $240,000. Price/Rent Ratio = 300x

3. Friend bought a old house in Inglewood for $370,000. Rents out the place at $1300. Price/Rent Ratio = 285x

What are you seeing in the market? Any examples which show much lower multiples? Much higher?

Home values see annual double-digit rises: Re/Max

If you want to read about a real estate study to convince you to buy a house at any price, look no further than this article in the CBC. It discusses a study released by ReMax.

Some quotes:

"Conventional wisdom used to be that real estate was a relatively safe, long-term investment that typically appreciates at a rate of five per cent annually," Michael Polzler, regional director of Re/Max Ontario-Atlantic Canada, said Wednesday in a release.

"These statistics clearly tell a different tale. In the top 10 markets, real estate values rose at least eight per cent or more on an annual basis. Even the worst-performing market in the country experienced an increase of close to six per cent annually since 1981."

There is so much flawed logic in this study I don't even know where to begin, even setting aside the obvious the ReMax does the study.

First, they pick the starting point. As with any investment that goes through cycles, timing is everything. Buy at a low point in the cycle and sell at the high point, and you make money.

Second, they only talk about nominal terms, ignoring inflation. This is not a good way to measure returns, because during much of this period inflation was eating up most of the gains.

Third. Since the early 80s, interest rates have gradually come down to the current levels. This has been a huge factor in nominal prices rising. The problem is in looking forward, interest rates cannot drop than much any more, as they are already very low. Mortgage rates dropping from 20% to 5% will be a huge boost to the market, whereas a potential drop from 5% to perhaps 3.5% or 4% is unlikely to spur huge asset appreciation in the future.

Forth, the price of a house is only one outlay. Most Canadians use debt to purchase homes, and therefore the debt servicing costs must be included (along with other costs and benefits) to do a true analysis of rate of return. This study completely ignores this, and assumes a house is like a stock, buy it at one price, and sell at another, without taking into account any of the carrying costs. Any moron in a first year finance course can tell you that you must take into account all cash inflows and outflows over the life of the investment to measure return.

For a typical home buyer the costs include a downpayment, interest payments, principal payments, property taxes, maintenance expenses, utilities, and then transaction costs when buying and selling the home. The benefits include imputed rent (the rent you save by living in your house). Without calculating these, any study attempting to measure rate of return on a real estate investment is simply nonsense, designed to mislead and misinform.

I'm glad the CBC spent some time questioning the study so as not to merely be a mouthpiece to industry propaganda. (sarcasm)

Herald: Calgary, Toronto both 'seriously unaffordable'

Interesting article in the Herald.

Lots of denial by the local real estate folks. Interesting reaction to the survey.

Some Quotes:

Calgary's skyrocketing housing prices have pushed this city into the same league as Toronto, with both cities described as "seriously unaffordable," in an international survey released Monday.

The third annual international survey of housing affordability conducted by Demographia International said Calgary and Toronto were tied for 14th in Canada while Regina was ranked as the most affordable city in the nation followed by Winnipeg and Quebec City. Edmonton was 10th. Vancouver was at the bottom of the list as the least affordable.

Only a year ago, the survey described the Calgary market as "moderately unaffordable."
Ron Stanners, president of the Calgary Real Estate Board, disagreed with the survey's description of the city's real estate market and said the average family in Calgary can afford to purchase a home -- "not necessarily what they would like but it is there and they may have to accept a little less to get started."

Bank of Canada Blindsided

This is an interesting article I saw over the weekend about David Dodge, the chief of the Bank of Canada. What I found interesting about it, was that the bank of Canada appears to have been blindsided by the slowdown in the USA and subsequent spread to Eastern Canada.

I guess I’m surprised by this, because when I started this blog in May of 2006, the number one risk that I identified was the a housing bust in the US could lead to a general economic slowdown, which would then spread elsewhere, including Canada.

Our central bank has downgraded it’s economic forecast 3 times during the past few months, but ensures us that the slowdown in the US will be very short-lived and that we should expect a quick economic rebound. We shall see….


Some quotes:

Bank of Canada Governor David Dodge didn't see Canada's steep economic slowdown coming, but he maintains he still made all the right decisions on interest rates.

Mr. Dodge slashed his growth estimate for the fourth quarter of 2006, and notched down his expectations for 2007 yesterday, repeating a pattern that has dogged the central bank for many months. The bank has repeatedly been too optimistic about the U.S. economy and its spillover effects on Canada.

"To me, it just stands as remarkable that the central bank can get the economy as wrong as it has and still maintain the same view on interest rates as it did before," said David Wolf, chief economist at Merrill Lynch Canada Inc.

But Mr. Dodge said yesterday that the revisions are minor, and he had no regrets about any of his interest rate decisions.

"We think that the level of the policy rate is absolutely appropriate at this point in time," he told reporters yesterday after issuing the bank's quarterly outlook.

While on the surface, an economy in a slump normally dictates interest rate cuts, the central bank made it clear yesterday that it is comfortable with keeping rates at their current level of 4.25 per cent indefinitely.

But that's mainly because not only has the Bank of Canada been too optimistic about the growth of the Canadian economy, it has also been too optimistic about the economy's ability to produce efficiently.

CREB: Condos will be king in 2007

Interesting analysis in today's herald. They claim that demand for single family homes will be down due to high prices and less buyers, but then say that prices will rise. Could one of those much smarter than myself explain to me the logic here? Demand down, supply up ... Prices up?

Some quotes:

The Calgary Real Estate Board, in its annual forecast Wednesday, predicted the average sale price for condos to rise by nine per cent this year and total sales to increase by three per cent. And while single-family home prices will jump by seven per cent, total sales in that market will drop by four per cent, it said.

"I expect there to be more interest in the condo market in 2007 because it continues to be more affordable than the single-family housing market which means that more first-time homebuyers, more families and potentially more seniors will take a closer look at condos as an alternative," said Ron Stanners, CREB president.

The organization said the single-family average sale price will hit $411,948 this year, while the average sale price for condos in 2007 will rise to $284,175. In 2006, the single-family average sale price was $384,998. The condo price was $260,711.

The CREB forecast also has condo and single-family home listings each rising by three per cent this year.

"In 2006, condos represented 27.42 per cent of residential sales," said Stanners. "With single-family prices where they are, we expect condos to become more popular and we expect sales to increase to 30.85 per cent of the residential market."

Lai Sing Louie, senior market analyst for Canada Mortgage and Housing Corp. in Calgary, said the real estate board's forecast of sales in the condo market "jives with our forecast. Overall, condo prices are more affordable than single-detached so demand in that area will be strong,"
said Louie.

"And with that prices should rise. We have a similar understanding that inventory should sort of wind itself through by the second quarter and then prices will probably be moving around then."

CREB: A third of condos and houses on the market in Calgary are vacant

Thanks to the readers who sent this link from the CBC.

If this data from the CREB is accurate, it leads me to question the notion that there was little to no speculation in the local market.

All along lots of my friends, acquaintances, and co-workers who were speculating in the market ensured me that there was very little speculation in the market.

Some quotes:

At least a third of condos and houses on the market in Calgary are vacant, prompting concern from a real estate agent that sellers aren't being realistic about the price they hope to get for their properties.

"Sellers are having a hard time grasping that we are not in early last year's market," said Kristen McNaughton, a Calgary real estate agent.

"In the fall, we definitely saw a dip, and it cooled down to more of a balanced market and that's what needed to happen."

Housing prices soared 38 per cent in Calgary in 2006, with the average price for a single-family home at $396,870. In 2005, prices went up 18 per cent.

But as a new year begins, the Calgary Real Estate Board said the vacancy rate in listed houses has reached 33 per cent, while in condos it is at 40 per cent.

McNaughton said sellers with vacant properties may have bought in hopes of reselling, or recently moved to newly built homes. The next two weeks will say a lot about the 2007 market, she said, with sellers either pulling their properties off the market to rent them, or lowering their prices.

I personally think that lots of the homes that will come onto the market over the next few months are not pure speculators exactly, but rather buyers who acted like speculators, by purchasing a new home and not selling their old one to take advantage of the perpetually rising market. It is this type of behavior which has caused sudden inventory spikes in other markets as new buyers get gradually priced out of the market and new construction continues to add to the total stock of homes.

Back in Business

I leave for one month and look what happens. I can’t even trust you guys to keep the oil price up... in the winter!

I must admit that I have been far removed from what is going on in the markets. I had the opportunity to visit the far east, and got to spend some time in China. I purposely did not check the web regularly to try and refresh my thoughts and enjoy my holiday. I came back last yesterday and saw this chart of the Feb Crude contract:



What is going on? Seems that from what I can gather, there is no real shift in the energy markets, except that the sentiment has changed. The winter has been unusually warm, and investors are coming round to the idea that the US housing market downturn is not a 6 month phenomenon to be followed by a resurgent boom, but rather the start of what is likely a multi-year decline, which is likely to have far reaching economic consequences. A slowdown in world economic growth will likely ease the recent tight supply in the oil markets. Hence we are seeing OPEC once again talking about cutting.

I kind of see OPEC as being damned if they do, and damned if they don’t. If they do manage to cut production to reduce the excess supply of crude in the market, they are basically showing the world that there is indeed excess spare capacity, thereby reducing the “fear premium” in the market as any small disruption in supply due to geopolitical events can be met by increasing production. A large part of the story over the past few years was that there was essentially little and shrinking excess oil production capacity in the world, and so any minor disruption (a strike in Nigeria for example) could cause the oil market to soar.

If they don’t cut in the face of slowing demand, then likely global inventories will continue to rise, causing more downward pressure on prices.

My view is by no means universal. The bulls will happily counter that it doesn’t really matter if the US economy slows, because the continued growth in China and India and Brazil will counter that, causing global demand for crude to continue rising.

Maybe.

One interesting thing about my visit to China this winter was the ability to talk to lots of the people living and working there. I was lucky in that during my time in grad school, I had the opportunity to study with many quite well-off mainland Chinese who came to Canada to study. Two of my friends now occupy quite high positions, one in the government and another who works for Lehman Brothers in Hong Kong. What’s interesting to me is that both of these locals were far more scared of slowing Chinese growth than we in the West are. The government publicly admits that that the growth rate is unsustainable. The economy is unhealthily dependent on surging exports, largely to the United States, and is mired in problems like a corrupt banking system that is hiding hundreds of billions in bad loans. They have so much spare capacity in many sectors due to this. For example, many factories have been build that essentially are idle. This continues as corrupt local government officials take bribes to continue the flow of bad loans to inefficient ventures.

Most educated people in China are extremely worried about what a recession would do to their social system, and hundreds of millions of people depend on a quickly growing economy just so they can find low wage employment. In the west, we tend to view China’s growth rate as an unstoppable high speed train. In China, many see it as a train that is out of control, that could easily become derailed.

I don’t have any great insight as to when Chinese growth will hit a snag, all I’m saying is that there is tremendous risk to that growth. This is widely recognized in China, but largely ignored by both analysts and lay people here.

I will have more thoughts on this in the future. I will need a few days to reacclimatize myself to what is going on in the local housing market.

What are your observations about what has been going on in the Calgary housing market?

Shifting Supply Curve and the Illusion of Permanence

As we head deeper into December, the housing market tends to slow down. Therefore, it is really difficult to get a gauge as to what is happening. Most of the stories in the media seem as meaningless as ever. I find this a good time to sit back and take the time to really think about things from a big picture perspective. The contrarian inside of me is reminding me to continually question my own assumptions. What have I been right about over the past few months? What have I missed? There are lots of naysayers out there, people who like to tell me I’m essentially on crack. Are they seeing something that I’m not?

When I started this blog back in May, we were essentially at the height of the buying frenzy in Calgary. I saw family members, friends, and co-workers acting with absolute hysteria about houses. Some were buying houses sight unseen. Others were agreeing to purchase a pre-construction townhouse, without having a contract for the final price. Most were waiving the usual inspection conditions that you would think are quite necessary when making a large purchase. Many were actively engaged in bidding wars over what were essentially sub-par homes in not very desirable areas.

Being a student of both economics and history, it was fascinating to me to watch this behavior in light of what I was witnessing in the United States, which at the time was the start of a Real Estate meltdown after a long period of “irrational exuberance.” I travel lots to the US and work with many Americans, so I saw a eerie similarity to what people were starting to say in Calgary, and all the BS that I had heard over the previous year from friends and co-workers down in Florida, Arizona, and other spots. “I must buy now or be priced out forever”, “they’re not making any more land”, “Calgary will be the next Toronto/Vancouver…”, just like, “Florida will be the next California”, “California will be the next Europe”, etc. “The old rules don’t apply, historical valuation methods are meaningless”, “Price/Income ratios don’t matter anymore, Price/Rent ratios are irrelevant”, “RE only goes up, so it doesn’t matter what you pay”.

Turns out that every financial mania in history has ended quite badly. By May of 2006, we were only starting to see that occur in many housing markets in the US. When talking to people in Calgary however, I realized that most people here didn’t even know that the US had a housing bonanza over the past few years, never mind that they didn’t know it was at the point of busting. Most people believed that the boom we were experiencing in Calgary was unique, do to all of the unusual local factors at play here.

I started this blog as a way of trying to connect some of the dots that I saw. The main ones being that housing booms were occurring world-wide, enabled at first by a dramatic drop in interest rates and increased ability to borrow, but then continued as a mania developed and people were willing to use greater and greater leverage to buy into this “low risk, high reward investment.” As more and more people piled in, demand outstripped supply, and prices started rising at rates far above historical norms. When people started witnessing this high level of appreciation, speculators started piling in, effectively driving up demand further increasing the gap between supply.

In a market like housing, supply is always much slower to respond than demand, for all of the obvious reasons. It takes time, people, and large financing to build an extra home. But demand for that extra home can increase over-night.

Nobody would participate in a financial mania without a solid story, to help them believe that the prices they were paying were rational, and not a result of temporary conditions. In Calgary, we had the perfect such story, due to the booming energy sector. Since oil prices bottomed after the Asian crisis in the late 1990s, they have been on essentially a 8 year bull run. At first, most analysts thought that the price rise was fundamental but perhaps temporary. When oil hit $35, many analysts said “it might drop, but it won’t go back to 25”. When it hit $40, analysts said, “it might drop, but won’t again go below $30”. When it hit $50, the analysts told us that “it might drop, but won’t again go below $40.” When it hit $70, the analysts told us that there is no way it will drop ever again below $50, and that likely it was going to $100 and beyond.

My question is this, what has changed in the world so much since 2004, when oil was below $40, that has caused the new “floor” to be $50?

For the record, I am not an oil bear. For all of the reasons discussed here and through my own research, I am a believer that over the long run, oil will continue to be an important resource for the world, which will support the energy sector world-wide. However, I also believed this in 2004 and in 1998, when oil prices were much lower. This is why when people tell me that the price can’t go below $50, I really think they are wrong. Why can’t it? 50 is just a nice even number, but that level is meaningless.

I think the reason people give us these artificial levels as “floors”, is because of the perception of permanence. It is difficult for us as human beings to imagine a future that is very different from the present. Think about past situations. When the world was in recession, it felt like the recession would never end. When the world has been booming as it has the last 5 years, it feels like the boom will never end.

Students of economic history will know that at the latter stages of booms, players are willing to take on greater and greater risks, because the last recession has essentially been wiped from memory, and they become convinced that we are now in a new economic era, where it is all high reward and very low/no risk. This unfortunately is a big part of what contributes to business cycles. Near the end of cycles, people take larger and larger risks, while believing that the risks are getting smaller and smaller. How many times have you heard “RE may not appreciate at the same rate as the past few years, but it will at least flatten out and grow slowly; it never or rarely goes down in value.”

The flip side to this is that recessions are generally prolonged by the opposite behavior. People are willing to take less risk that they probably should. It is during these times when asset values tend to drop below long term “fundamental” value. Not only are people willing to borrow less, but banks and other financiers are less willing to lend, due to the recent memory of past losses.

In Calgary, it seems to me that many people have bought into the notion that we are in a new economic era, and that the current boom will last for a very long time. One girl at work told me that it will last for the next 30 years. I asked her why she thought that. She just responded that “that is what everyone is saying.” How’s that for sound economic analysis!

Because the economy is currently so strong in Calgary, people become wedded to the idea that this situation is a permanent one. In the housing market, we’ve seen prices stall since about the summer. Why? From what I can tell, demand remains very robust, but new supply has essentially caught up with it. Housing starts broke that record this year; a record that has stood since the 1970s. Of course developers have responded to high prices and increased building capacity. This has taken time, and was not without it’s headaches, but it has been accomplished.

Some people on this blog have derided some of the “flippers” out there. I actually think that these speculators are good for the long run prospects of the market. In an economic sense, what they have done is transferred some of the risk of new construction from the developers to themselves. This has allowed more houses to be built than otherwise would have had they not been part of the market. Sure, in the short run, it has contributed to the run-up in prices, as demand was larger than it would have been. But over the long term, it is this extra construction that has helped supply levels ramp up, and eventually this will bring the market quicker towards a sustainable equilibrium when builders can produce enough homes per year that are wanted by end-users of all income types.

Every housing markets needs to create homes affordable to all income levels. It is not sustainable that the market is unaffordable to vast segments of our society, including people who work in middle-class professions like teachers, nurses, policemen…
I’ve run into many relatively new Calgarians over the past few months who have told me they are thinking about going back to where they came from, whether it be Toronto, Saskatchewan, or elsewhere. We have a huge labor shortage in the city, but there is no hope of filling the lower end of the job spectrum at this time due to the housing affordability issue. Lots of bulls out there are convinced that everyone in Calgary earns 100K+ and gets huge bonuses and stock options. Sure there are lots of these people, but they are a minority. Many others in the city, had they not bought a home prior to 2006, have essentially been completely priced out of the market (with traditional financing). This is an issue for the long run sustainability of these price levels.

An analogous situation to this is Florida, where for many years the population was growing substantially. Over the past 3-4 years, people started to believe that this was going to continue forever, and that was a major justification for the huge price increases during the RE boom. The problem was that once prices got to such a high level, the migration rate slowed dramatically, and many younger families started leaving the state. This was happening in the background while building was ramping up. For the first time in many years, many school districts started reported drops in enrollment this year in Florida. What happened to all the people that were supposed to continue migrating to Florida justifying ever increasing housing prices? Turns out that high housing prices started to drive people from the State, and prevent others from moving there. I think this is a very real possibility for Calgary. We need people to come here to fill all of the jobs and also to continue to support the housing market, however current housing prices are starting to give many people second thoughts about moving here.

Most “normal” cities have a wide variety of neighborhoods and prices for homes. Usually the far flung suburbs are quite cheap, and allow for people who have good steady jobs to buy a home at a price that’s affordable to them. I think what’s happened in Calgary is that even the “cheap” areas have become extremely expensive. This is likely to be a deterrent for many people moving to the city. This is not New York or London or California. Nobody comes to Calgary for the “culture” or weather. They come to have a good life, good job or business, and have a better standard of living. If that standard of living advantage is reduced or erased by the high cost of living, I am not convinced that the projections of massive in-migration can be accomplished over the near term. There will always be an incentive for the oil executive or petroleum engineer to move here for a very high salary, but the city also needs people to come and be nurses, teachers, and Tim Horton’s workers, and it is these people that will probably choose to stay elsewhere.

Where are we now? Are we at an inflection point in the market? These are the types of questions that I’ve been trying to figure out, and the evidence is largely mixed. I really believe that a lot will depend on the world economy over the next year. When I started talking about the possibility of the US led world recession back in May, most people thought I was smoking something really nice and they wanted some of it. Now people are starting to see that this is a real possibility. Will the next recession be very short lived (aka 2001) or will it be long and protracted, like most in history. What will happen to oil demand and prices during the next recession? I don’t know, but I can tell you I wouldn’t be betting on some magical $50 floor price. The last time I checked, oil was still a commodity, and commodities have historically performed quite poorly during period of slowing or negative economic growth.

I guess in summary what I’m trying to say is that there is lots of risk to the Calgary housing market out there, but most people feel that there is little to no risk. I think 2007 will be an interesting year.

I will be away for a month from Mid December to Mid January in Asia, and will not be adding to the Blog over that period. This is probably fine as there will likely be little market activity to comment on. Everyone have a great Christmas and New Year. Thanks to everyone who has contributed to this Blog over the past 7 months. I know I have learned a lot from you and hopefully you have also learned some things that you’d not thought about before. I will be back online in the second half of January, and hopefully can continue to add value to the debate.

Sooner or later you will pay

I just saw this article from the Sun from Wednesday. I thought it was different in that it actually questions the conventional wisdom, so I will reprint the whole article here:

"Word on the street is foreclosures are on the rise.

And it begs the question: Are we encouraging people to take on more debt than they can afford?

Gone are the days when you scrimped and saved for a 25% downpayment, then religiously paid off the mortgage over 25 years.

Now it's 0% down mortgages and interest-only payments, with buyers given 40 years to pay it off.

Even Canada Mortgage and Housing Corp. (CMHC) is offering 40-year amortization on interest-only deals, after a number of new private insurers gave Ottawa's crown agency a run for its money.

But it was done in a cloak of secrecy, after Bank of Canada Governor David Dodge grilled CMHC over insuring 35-year mortgages.

There was no public announcement, just a posting on CMHC's website -- after private insurer Genworth Financial made headlines with its 40-year deals.

"To avoid another tongue lashing from the Bank of Canada, CMHC neglected to make this announcement public," complained tax crusader John Williamson, federal director of the Canadian Taxpayers Federation (CTF).

The CTF, through freedom of information, was able to get a copy of a harshly worded letter Dodge sent to CMHC.

It said: "I read with interest and dismay ... that CMHC would offer mortgage insurance for interest-only loans and for amortization of up to 35 years."

Williamson says with two new players coming to town for a total of four private home insurers competing for business, it's time Ottawa sold CMHC, which is sitting on sweet profits of more than $1 billion.

"There is no longer a compelling reason for the federal government to be involved in mortgage insurance," said Williamson, who points out Australia sold its version of CMHC in 1997.

Meanwhile, a new Statistics Canada report shows many Canadians are spending an unusually large proportion of their incomes to keep a roof over their heads.

The golden rule is no more than 30% of a household's pre-tax income should go towards housing costs -- yet in 2004, 1.7 million Canadians spent 30% or more on shelter costs.

A breakdown shows 12% spent 30% to 50%, and 2% spent 50% or more.
Renters, though, were more likely to experience affordability problems.

And now we're seeing signs of a slowdown in our housing market, though Canada won't likely suffer the declines seen in the U.S., according to Century 21 president Don Lawby.
And one of the reasons is Canada is just now getting interest-only mortgages, while the U.S. has had them for years.

"In the U.S., because they can deduct mortgage interest from income tax, people use their homes like an ATM," said Lawby.

"Once you start doing that, you treat your home as a different vehicle than a place to live. It becomes your cash machine.

"So people try to make money off the value of their homes, and that pushes up the value of homes faster."

Sooner or later, the day of reckoning arrives with price corrections in over-baked markets.
With total household debt in Canada approaching the $1 trillion red-alert zone, it's time for reality check.

Scrimp and save, then buy. It's common sense. "

Leverage: Interest Rates and RE appreciation over time

One thing that has been difficult to comprehend about the recent housing boom is the cavalier nature that many buyers have taken to debt. It almost seems that we have been taught that the more debt you have, the better off you will be, because the bigger asset you will own. This almost seems counter-intuitive, but it is indeed the attitude that many people have. "I bought the most house I could afford", many times actually means, "I bought the most house the bank would lend me."

I spent some time thinking about this tonight. Why are people willing to borrow as much as they possibly can?

The answer is strikingly simple.

In a period of rapid price appreciation, as long as the asset appreciation rate is greater than the interest rate on the mortgage, you win! If your mortgage rate is 6%, but the house is appreciating > 6%, you are better off having more leverage. Not only that, but when the appreciation rate is greater than the mortgage rate, the more expensive your house, the more you win! When people believe that appreciation rates in the future will be greater than mortgage rates, they are willing to borrow vast sums of money to buy a house.

I decided to look back historically at the Calgary RE market to see if this is normal (appreciation > interest rates) or is it an aberration in the current market. With mortgage data from Stats Can in hand ($3 later) and Calgary avg pricing since 1973, I charted the two:

The first graph shows annual house appreciation plotted against the 5 year mortgage rate.


The second graph shows the difference between the appreciation rate and the mortgage rate. If the value is positive, it means appreciation is higher, and it is a good time to leverage up. If the value is negative, it means the interest rate is higher, and leverage will hurt.



It turns out that since 1974, on average mortgage rates have been 1.64% higher than RE appreciation rates, meaning you are better off using large down-payments and paying off your house as fast as you can.

However, there are periods where the appreciation rate trumps the mortgage rates. In Calgary, this most notably occurred in the mid to late 1970s and again since 2004.

To me, these charts show exactly why people have been viewing large mortgages as assets: because during the last 2 years, leverage has been a huge benefit. Leverage will not truly begin to hurt, until the appreciation rate drops below the interest rate as it tends to do over time. This is why during a period of flat house prices, you usually see defaults rise substantially. People who are over-leveraged begin to drown.

This brings me to another question:

Are Calgarians using this unique time of prosperity, no unemployment, and rising wages to reduce debt?
Or
Are they using it as an opportunity to borrow more (as the bank will lend you more as your salary increases)?

Calgary Herald: Housing prices fall with the leaves

Read this article from today's herald: Not much news in my opinion, lots of Realtorspeak about how now is a great time to buy or sell. I guess for brokers, now is always a great time to buy or sell...

Some quotes:

For only the second time this year, the average resale price of a Calgary home has dropped from the previous month.

And the average price of a single-family home has fallen below the $400,000 mark after being above that level for five straight months.

The Calgary Real Estate Board reported Tuesday the average residential sale price for November was $360,674 -- a 3.58 per cent drop from $374,067 in October.

Residential real estate prices have shown steady and at times impressive increases throughout the year in Calgary. The only other time the average sale price dropped this year was in July ($357,831) compared to June ($367,033).

But despite the slight dip in November, the average residential combined sale price was still 36.4 per cent higher than a year ago when it was $264,432 in November 2005.

The overall average price was down because of a decline in the single-family home market. The average price there dropped to $394,712 from the $413,712 in October.
Kevin Clark, president of the Calgary Real Estate Board, said "prudent buyers" are keeping real estate agents busy "trying to buy while inventories remain strong." "The opportunity does remain strong on both sides of the fence," Clark said. "The buyers are staying in the marketplace, which is . . . what we've encouraged.
"It's in fact almost a little pickup. There was only a small window there in September when it kind of really got a little quiet and it was almost like the end of summer and early fall marketplace.

Since then, sales have remained strong for houses that are "priced and presented well," Clark said.

November combined residential sales totaled 2,313, an increase of nine per cent from last month's sales of 2,122, and a decrease of 11.45 per cent from November 2005 when the sales were 2,612.

The combined sales in November included 1,632 single-family residences, 670 condominiums and 11 mobile homes.

In November of 2005, 1,837 single-family residences, 764 condominiums, and 11 mobile homes were sold.

Lai Sing Louie, senior market analyst for Canada Mortgage and Housing Corporation in Calgary, said the housing market traditionally slows down a bit at this time of year.
"You usually see in price patterns that there's a little easing until the end of the year," Louie said.

"But in terms of the whole market, the market is still very strong. There's a lot of active listings out there. . . .

"We're in a sort of consolidation process right now where you have lots of people sitting on large potential capital gains that if they sell for a little bit less it's not a big issue to them."

Calling a Top

We’ve had some good (and not so good) debate on this site for a while. Some of the bulls have even argued that they agree that housing is over-valued, but think it will continue to be over-valued for a long period, so it makes sense to buy now and benefit before the “bubble” bursts. The argument usually goes that the bears are simply nit-picking whiners, who don’t know how to make money and are just upset, jealous, or regretful for not buying property before the run-up, and wouldn’t know a good deal if it slapped them in the face. They would rather argue “theories” rather than make a bet to make money in this market.

Fair enough.

My question is: are most of these type of bulls (I’ll call them informed bulls, because at least they understand the risks), going to be smart and/or lucky enough to unload at or close to the top, and not ride investments all the way down to the next trough?

Some would argue that the tops of markets can be identified when all of the good news is priced in, and all of the risk is ignored. It is also the time when the uninformed and unthinking masses pile into an investment because it is a “can’t lose” proposition. My argument all along has been that 2006 looks a whole lot like this scenario in the Calgary residential real estate market.

One thing we’ve learned from other cities, is that unlike stock markets, when real estate markets turn, prices don’t fall immediately, it is the liquidity that dries up, making it very difficult to sell. Only after a period of 12-18 months of an illiquid market do prices begin to drop. Usually they drop slowly over quite a few years in a situation of low liquidity making exiting difficult or painful the entire time, (“I’m not going to give my house away!!”)
When the turn happens, all of the media and “experts” will tell us that it is simply a blip before the market roars back. Will the bulls out there be able to ignore the conventional wisdom of the day and sell, before it gets bad? In many US markets, sellers had a year after the peak (summer 2005) to sell at close to peak values before prices really started to slide. How many did?

US Update: Housing Slowdown Spreads to Manufacturers

Read this article from the Globe and Mail.

Despite the expected cheerleading from the mainstream financial press in the US (CNBC, Marketwatch…) it appears as though the unavoidable has begun to not be avoided. Despite the media’s assurance last year that there was no housing bubble, the bubble has begun to leak. Despite assurance from the press that the housing slowdown would last only 6 or 9 months before the mega-boom continued, the market is continuing to decline. Despite the economists’ predictions that the slowdown in housing would only be contained to a few coastal markets and would not affect the greater economy, it now is becoming more and more apparent that the housing slowdown is worse than “expected,” and affecting many non-coastal markets as well.

Long term interest rates in the US remain at their historical lows (30 year fixed mortgage at 5.61% this morning, down from 5.8% one year ago). The press likes to blame high interest rates for the housing market decline, but I think that is a bunch of BS. The market was a mania, and all mania’s eventually become exhausted.

We are only now starting to get reports that the housing slowdown is spreading to other sectors in the economy. I expect the news to remain overly optimistic in the near term, with every “bad” report followed by an economist prediction that “this is just a blip, a short term phenomenon before the rally continues next year” or something to that effect. We shall see…

November Stats and Trends

Another month has passed, and I have compiled the stats for November. None of the data is official yet, so there may still be some tweaking around the edges. I also don't have the final sales and listing volume numbers, so I will add those charts when I get them.

The biggest change for November was that inventories began to shrink after 5 straight months of increases. This is partially seasonal, as you can see from the chart below, but the drop was quite rapid, so there must be other explanations as well. Average sale prices dipped 3.6% month over month, which may help explain why sales volume was up. Are sellers slowly becoming more realistic with prices? Are they willing to negotiate? While there has been lots of chopiness in average prices over the past few months, the average prices have been flat since about May, where the average used home sold for 358K.

Clearly lots of listings were taken off the MLS without a sale. Are these listings coming back in the spring? Or are they gone for good?

Click on any of the images below to enlarge:

Financial Media: My Opinion

I’d like to make a personal commentary on the financial media. It is quite good at telling you what happened last week, but absolutely dreadful at helping you invest for the future.

To any students of this and past housing booms like myself, it is clear that the cycles happen over multiple years. You typically have a multiple year expansion in prices. In the last few of years of the boom, the population and media forget that housing, just like other commodities, goes through cycles. We are fed with a steady chorus from friends, family, and the media as to why “this time it’s different.” During these last couple of years of a multi-year boom, prices rise at an even great rate, as the people that were thinking of buying a home in the next few years, pile in quickly so as to not be “priced out forever.” In addition, it is during these last few years when amateurs pile into housing as an “investment.” During normal times, there is always a sub-set of the market that are investors who make a living in the real estate business. It is near the end of a multi-year expansion that your local bus driver, secretary, and construction worker are getting in the game.

The final years of excessively high price increases inevitably lead to different allocation of resources in an economy. Real estate construction and related businesses (mortgage brokers, furniture stores, home depot) will grow to be a larger and larger share of GDP. A building boom occurs due to demand spiking not just due to end user purchasers, but also due to investors, flippers, and speculators. As long as there are enough people willing to buy at ever increasing prices, and enough banks willing to loan the money, the boom can and does continue.

If history is any guide, during these last years of the boom, 2 things happen which bring about the end of the multi-year price expansion.

1. The excessive capital allocated to housing construction, leads to an oversupply in the marketplace. Because of the staggered nature of construction and long lead times, this takes time, and only becomes apparent 2-3 years after the building boom reaches it’s pinnacle.

2. At the same time, as prices rise higher and higher, there are fewer and fewer first time buyers that are able to purchase or finance an entry level home. This constant supply of new buyers into a marketplace are needed to continually push up prices. In many places, a “starter” condo that used to cost 100K now requires $250K. The pool of eligible buyers naturally shrinks because it requires a higher income or higher savings to purchase exactly the same product. In a market where wages rise by 7% and home prices rise by 40%, you have a whole lot of people that become “priced out.” In order to for the market not to stall, banks need to begin to offer “creative financing” in order so that the same person who was priced out at the new higher price, can still afford to buy, thereby allowing the market a last final gasp. These types of loans have been prevalent in the United States since about 2004, and have recently become a growing percentage of the Canadian mortgage market, with many first time buyers now resorting to 35, 40, and interest only loans. At some price level, even the banks start to refuse riskier and riskier mortgages, and this is what causes the market to run out of steam.

After past multi-year booms that have ended with incredible rates of appreciation, the market entered into prolonged multi-year declines in real prices. At times of low inflation, you see significant nominal price declines (See Calgary 1982; Japan 1990-2005). At times of higher inflation, much of the gains get wiped out through high inflation. Either way, in the past, the downturns have lasted over a few years (1930s, early 1980s, 1990-1995 in California, 15 years in Japan after RE market bust in 1990)

By most measures, the scale and scope of this boom has been far larger and widespread than any in history. This is what brings me to my original point: The media keeps reporting like it is expecting the longest and largest boom in history, to be followed by a 6-12 month quick mild correction before the market booms again. When news comes out to the contrary, the media is “surprised”.

Read this article today in Bloomberg.

"Sales of new homes in the U.S. fell more than forecast in October, dashing expectations that the worst of the housing slump is over.

Purchases declined 3.2 percent to an annual pace of 1.004 million last month from a 1.037 million rate in September that was lower than previously reported, the Commerce Department said today in Washington. The supply of unsold homes at the current sales pace rose to 7 months' worth."

Why are expectations that the worst is over? Whose expectations? Why does the media not ask difficult questions, like “wouldn’t this downturn be at least as long as past downturns and last more than 6 months?”

Herald: Lots of choice means price break for home buyers

Check out this article in the Herald. No real news, but some of the usual spin to keep me interested.

Some quotes:

"New listings continue to trend higher in British Columbia and Alberta, which is taking some of the steam out of many local housing markets in those provinces, says a report released Tuesday by the Canadian Real Estate Association.

“A more balanced market gives buyers more negotiating power and time to make purchase decisions. This trend is forecast to continue and result in smaller price increases in 2007,” said CREA Chief Economist Gregory Klump."

I wonder if there is a law against real estate spokespeople mentioning the possibility of actual price decreases?

Does weather matter?

While enjoying the -25 degree weather today on my walk to work this morning, I started to ask myself, "Why do people live in this place?" I started to think about how real estate boosters from other cities used to justify the never ending price increases by explaining that the weather is terrific (i.e. California, Florida, Vancouver...) Even some readers on this site have claimed that Calgary prices are sustainable due to the nice climate...

I'm not saying they're wrong, but days like today remind me that there is probably little correlation between nice climates and cost of living. Some of the best climates of the world have very cheap costs of living (Northern Thailand for example), while some of the crappier climates have high costs of living (see London, England).

Cost of living in general and home prices in particular are much more correlated with the local economy and all the usual factors, supply of land and new housing, demand, interest rates...

Sorry for ranting today, but when it warms up I'm sure I'll be in a better mood! :)

Friday Inventory Update

Inventories have declined substantially since the end of October. Sales have picked up while listings have fallen quite dramatically. Some of this could be seasonal. Average selling prices have declined slightly, although I don't make too much of month over month price changes, as it takes a few months to confirm a trend.

My best guess is that as the market has calmed down since the summer, lots of the people listing their homes for "wishing prices" have either taken them off the market, or lowered the prices to more realistic levels. These lower prices are helping increase sales, as demand remains incredibly strong and there seems to be no tightening of credit. In fact, anecdotally, credit is loosening, as a mortgage broker friend of mine told me that she is selling lots of 35 and 40 year mortgages now. It's about half of her business.

I believe that the bears out there who have called the top in Calgary have spoken prematurely. We might have reached a top in prices, but demand is proving to be very robust at this point.

Century 21: Housing market crash not in the cards for Canada

Don't worry be happy. We can be assured that Canada is different from the United States. Century 21 told us so.

Check out this article.

Some quotes:

Canada's hottest housing markets will not suffer the price crashes seen in some U.S. regions, in part because the speculation and high-risk mortgages that fueled the activity south of the border are not rampant in this country.

A survey by realtor Century 21 Canada found the massive price increases seen across Canada over the last five years have slowed in all but a few areas. Meanwhile, the U.S. housing situation is dire. U.S. home prices have dropped drastically in recent months, with popular markets such as Florida, California, Nevada and Arizona experiencing the steepest downturn.

Don Lawby, the president of Century 21 in Canada, says there are economic and financial factors that differentiate the housing markets in the two countries.

“There is more speculation in the U.S. than we have seen in Canada,” Mr. Lawby said. “Lenders in Canada don't have the same lending policy as the U.S. For the first time in history we have interest-only mortgages. In the U.S., they've had them for years.”

Some Canadians are using non-conventional or riskier mortgages — such as interest-only financing — to buy their homes. However, a recent study by CIBC World Markets found that non-conventional mortgages make up about 5 per cent of the Canadian market, a small amount when compared with about 20 per cent in the U.S.

Because Americans can deduct mortgage interest from their income tax, people are using their houses like cash machines, Mr. Lawby said. “Once you start doing that, you treat your home as a different vehicle rather than as a place to live,” he said. “So people try to make money off the value of their homes, and that pushes up the value of homes faster.”

Over the last six months the median price of all existing U.S. homes dropped 11.5 per cent to $200,000 (U.S.) from $223,000, according to the U.S. National Association of Realtors.