Blessed by the Potato

It’s been a rough few years to be a young adult in Canada and not own real estate. The media keeps firing off article after article about how it’s different here, how real estate always goes up, and how the systems and perverse incentives that lead to the bubble blowing up in the US totally don’t apply here.

Here’s a few recent ones to pick apart.

First up, CNBC asked around after the G20 in Toronto why our housing market didn’t crash. Amongst the silly answers given:

there are just six big Canadian banks that own the bulk of the mortgage market, and they don’t securitize and sell off loans at nearly the rate U.S. lenders do. They hold nearly three quarters of their loans on the books, and 80 percent of Canadian loans carry mortgage insurance.

In the same sentence they undermine their point. It doesn’t matter if the loans are securitized and sold to someone else, or insured, the effect is the same: for 80% of the loans made by Canadian banks, the risk has been offloaded (in our case, to the taxpayer, rather than AIG). The effect on behaviour is the same: sell sell sell full steam ahead, and damn the torpedoes. How many times have we heard of banks “helping” people find ways to borrow way more than they should qualify for, looking the other way on “creative” downpayments (that aren’t downpayments at all, but often other loans, sometimes even credit card cash advances). When they don’t bear the risk for making a bad loan, they make more bad loans.

Or this gem of misinformation and lawyering up the definitions:

Canadian banks also had and have no such thing as the Alt-A, or low-doc, no doc loans that fueled bad borrowing and consequent defaults. At the height of the Canadian housing boom barely 5 percent of loans were considered “subprime,” while a full third of U.S. loans were either subprime or Alt-A.

The CMHC will insure a person with a credit score of somewhere down in the 610-620 range, which is below Alt-A and into subprime in the states, but here AFAIK it doesn’t get a different name. It’s all good, baby. Not only that, but high loan-to-value mortgages (i.e.: CMHC insured) are rampant here. According to GT, the average downpayment on a new mortgage is now 6% (and since the minimum is 5%, that means a lot of people are not putting much equity in their homes). Small downpayments are almost as big a predictor of default as bad credit; combine the two risk factors and defaults rise exponentially. The difference in US and Canadian lending is not a difference of kind, just of degree (plus, our taxpayer bailout is built-in). Yes, there were fewer subprime mortgages issued, and the very worst dreck (negative amortization/interest only) was avoided, but just barely (40-year 0-down is not all that different).

Then this especially terrible article from the Toronto Sun was forwarded to me. In it, the author (a condo marketer and saleslady) recommends first-time buyers buy preconstruction condos because the builders aren’t as strict as the banks, and will let you create a payment plan for your downpayment, so you don’t need anything saved up. Spoiler alert: I’m going to recommend that people don’t buy condos (or pledge to buy condos at some unknown future date) when they don’t have any savings!

Recent statistics from BILD report that the typical high-rise condo suite price was up $25,108 in April, or 6.3% compared with April 2009. Where else can you get that kind of return-on-investment in this day and age?

Ouch, bad choice of timeframe. The TSX was up 28% in that period, not including dividends. And, it won’t cost you 10% in transaction fees to realize your profit. Of course, there is a logical reason for pre-construction to go up: your capital is locked up for 3+ years while your unit is built. And through all that despite real estate being an “investment you can touch/live in”, you can’t touch or live in or preview your pre-construction unit. How (and when!) it actually turns out can be a nasty deviation from what you were lead to believe in the sales pitch, and this is another risk pre-construction speculators are rewarded for. That this premium has now dropped to only ~5% is a statement on just how distorted the market has become.

Even if we weren’t tipping over the edge of our own housing crash, I’d almost always advise a first-time buyer to avoid pre-construction. A Tarion warranty is next to worthless, and as a first time buyer you’re probably keen to get out of whatever situation you’re in now (rental, parents’ basement) and don’t want to wait several years before your purchase is completed. Not to mention that you may not have the stability to effectively plan that far in advance plus a few years to know for sure that the imagined condo is where you’ll want to be living 10 years from now. No, leave pre-construction to the speculators and retirees, even if you do have to scrounge up a bit more for something you can inspect right now.

Then, on the same day in the Sun, “No bubble trouble to report here“:

We experienced a true bubble in the late 1980s and early 1990s, when mortgage rates skyrocketed and speculators flooded the market. Despite the fact that conditions are very different today, people continue to compare our current success in home sales to that time. I don’t understand why.

Look, no. Rates did not skyrocket in the late 80’s. Rates do not have to go up to pop a housing bubble — you just have to run out of buyers. In the early 80’s, there was a brewing bubble that was smashed by high rates (the 20% rates your parents still wake up in the middle of the night in a cold sweat thinking about). But the bubble that popped in ’89 was not fuelled by low rates or killed by high ones. Look them up yourself. Rates spiked all of maybe 2% (starting from ~12%, the equivalent of going up about 0.6% today) over the course of about 8 months in 1990, after the housing boom had already started to die. The late 80’s housing bubble can’t be laid at the feet of interest rates. Plus, we’re at rock-bottom interest rates now, so if conditions are different, it’s in a way that makes the current times look even more bubbly!

Speculation though, that’s a good measure of when things are getting bubbly. How much speculation was going on back then? Unfortunately, I don’t know of any good measures of that, but there is a heck of a lot going on now.

Then, after acknowledging that bubbles happen, this guy goes on to say:

Prices are only going to go up…

Unless, as they’ve done many times before, they go down. The Toronto Life article said that up to 40% of new condos are held by speculators. That’s a lot of future demand pulled forward, so we can easily keep putting roofs over the heads of families even as prices crash…

And again, in what must be the Sun’s G20 silly real estate report section:

Pricing is affordable, while construction-related job creation is averaging around 170,000 per year over the last five years in the GTA alone.

Do the math on that one. Average of 170k per year over 5 years. 850k. There is no way, absolutely no way that 850,000 new construction-related jobs were created in the GTA alone. That would mean that, of the ~5.6 million residents of the GTA, roughly 1 in 6 works in construction, and just started doing so in the last 5 years. If it is true, it’s terrifying, as a city of nothing but people building homes to sell to each other sounds like a frightening ponzi scheme to me, and will mean that when a downturn does come, there will be incredible positive feedback loops (where here, “positive” means “bad”).

And it’s not just the Sun, widely recognized as the paper with let’s say the least amount of journalistic prestige of the big 4 papers in Toronto. Even the Globe is making these goofs, such as “the little matter of affordability” which actually recognized that condos sold today can’t be rented for a profit. Rather than coming to the logical conclusion that a bubble exists and prices would come down, the author instead warns that rents are due to jump ~40-60% in the next few years. (And repeats the figure that up to half of all new condos are bought by speculators). Rents, of course, are constrained by wages to a much larger degree than owned housing prices, and can’t be leveraged up by low rates; we simply will not see rents jump ~50% just because that’s what’s needed to make the speculators’ numbers work. Not with an already healthy vacancy rate.

Kids, time to tune this shit out. The denials will continue to get stronger and more frequent as the wheels come off the market, and it won’t be until well after the decline has finally started before the majority of the stories turn into tales of woe and despair and talk of bubbles bursting.

Anyway, nobody listens to me these days because — despite the fact that I do research and am right — I’m not a “journalist” at a “respectable” paper. They can’t print this out and plunk it down in front of their parents to explain why they aren’t “building equity” like other kids their age.

Except for Julia, who is therefore awesome.