Canada's Housing Bubble

Jun 30, 2010 EdmontonHousingBust.com

This past week I’ve been digging through some newspaper archives, mainly I was looking for stats and possible story ideas (and did pretty good on both fronts), but also found it fascinating reading through the articles and getting a sense for the flavor of the time.

The further I went back, the less and less that became available, but there was multitudes there from the 90’s, and looking back at the time in hindsight knowing what we do today it was rather remarkable, as even though it was very stable compared to either the 80’s before it, or the 00’s, the high and lows within it were no less celebrated or bemoaned by those living it.

But I’ll save discussing the 90’s for another day, today I’m going to discuss another article I stumbled across… actually, just one item from it. It was an article that appeared in the Globe and Mail on July 7th, 1982, titled “Vancouver house prices plunge” and actually discusses the various markets around the country. This was a very tumultuous time as the title suggests.

Interest rates after years of slow but steady increases just months earlier had spiked to levels previously thought unimaginable (5-yr Fixed Mortgage rates in September ‘81 hit their all time high of 21.43%, up almost 7% from just a year earlier) and while off the peak were still extremely high, this of course had a cooling effect on housing in several markets.

For those needing a refresher, consult the graphs in this post. Towards the end they get to Edmonton, and the Edmonton Real Estate Board happily touted that while price increases had slowed, they were still going up as of June, even in spite of interest rates. Then there was this paragraph.

The number of sales last month for residential property on the multiple listing service in Edmonton was off by more than half from what it was a year ago. There were 373 houses sold in June compared to 802 in June, 1981. The number of places up for sale was nearly the same in both periods – about 1,800. ”Be positive. Now is a good time to buy. If people can hang on for a year or two (with high mortgage interest rates), real estate will be a good long-term investment,” said Bob Weist, an administrator with the Edmonton Real Estate Board.

Yeah… be positive! It’s a good time to buy! Just ignore those interest rates, real estate only goes up!

As it turns out… not so much.

Now, it’s easy to look back now and nit-pick knowing that after those June ‘82 numbers it was all down hill of real estate in the city of Edmonton. And, this is also coming from an industry flack whose job it is to pump the stuff, so we still have to take it with a grain of salt considering the source. But what really takes such a statement from being merely bad, to being spectacularly bad, is that it was just weeks later that interest rates also fell off the cliff. So not did this turn out to be the absolute worst possible moment lock in price wise… but you double it up by locking in at a horrendous interest rate.

Rather than a great investment, it’s more like financial hara-kiri.

Just for example, to finance an amount equivalent to the average home, $94,042, with a 25 yr amortization at 19.1% interest, would cost $1510 a month. That may not sound all that bad to us today, but remember this is 1982, and the median family income in Edmonton is $26,680… thus the cost to service such a mortgage would cost a staggering 68% of a households annual salary. Forget about eating, you’d be lucky to pay your taxes… which is probably why sales had already slowed to a crawl, no one could buy anymore.

And after 5 years, and over $90,000 worth of payments, you will be the proud owner of a whole $1,313 in equity… or you would have that much if the house wasn’t worth just $80,000 ($14,000 less than you paid for it)… leaving you about $12,700 underwater. In other words you’ve spent over $90,000, and all for the privilege to still owe the bank $92,700, on a property now only worth $80,000. I don’t know about your guys, but that would be the last time I went to the EREB for investment advice.

Over the entire life of that mortgage (using actual numbers and 5yr terms), it would cost just over $300,000 over the 25 years to pay that off… and adjusting for inflation it comes out to $447,000 in current dollars. So you’re probably saying to yourself at this point, that seems steep, but you’re not sure what to make of it. Well, lets compare to a few other scenarios.

Lets say, instead of buying immediately in the wake of Bob’s statement, you wait six months. At this point prices have dropped off a little over 4K, but the biggie is interest rates have dropped almost 5%, to 14.34%. Your monthly payments (for the next 5 years) are now down to $1104… a saving of over $400 a month for the exact same place, that’s HUGE. Over the life the mortgage this would cost you $257,000 to pay off nominally (or $371,000 in real dollars)…. a savings of 16% (or 20% in real terms) just for sitting on your wallet for a mere six months.

Not bad, but lets say you waited a whole year. By now prices are down 9K, and interest rates have settled in at 12.98%… now it’d only cost you $957 a month to carry the debt. So, you’re already not only paying a whopping $553 less per month, but more of what you are paying is going towards equity rather than debt servicing. And the savings you’d have over the life of the loan are now 27% nominally, and 33% inflation adjusted.

And it only gets better as time goes on as prices continue to soften and interest rates drop. Lets go four years out to the summer of ‘86. Average price now is $78,500, interest rates are now below 11%, and you’re monthly payment would be mere $762, almost half of what it would have been if you foolishly bought when Bobbo and the EREB told you it would be a good idea… and over the life of your loan it would cost $201,500 nominally, and $260,000 inflation adjusted. Some mammoth savings.

(I’m sure some of you smart cookies wondered to yourself just how can I have projections for the entire 25yr life inflation adjusted of a mortgage started in 1986 as it wouldn’t have expired just yet and we don’t know what going to happen with inflation through 2011. Good catch. The answer is, I assumed a continuance of our current 1.8% year-over-year inflation to continue through expiration. I assume that will be close enough to actual, and even if things did go completely crazy any impact would be negligible at this point anyway).

Maybe you’re wondering, what if I was just that genius and/or lucky to hit absolute bottom price wise. Well, that would have been February ‘86 when prices dipped to $68,253… and in that case you could have skated away with an interest rate at 11.94% and a monthly carrying cost of $716. Less than half what it could have been. And over the life of your mortgage it would have cost you $184,000 nominally, or $241,000 inflation adjusted. In other words, buying that “good long-term investment” would have cost you 63% more nominally, or a whopping 86% in real dollars.

Not my idea of a good investment… but it’s not my job to sell houses…

Again, it’s easy to sit back and take pot shots and normally I don’t bother (though I do enjoy it more than a little)… but just looking back at that statement, and knowing the timing of not just prices, but interest rates, and how they were both literally on the cusp of collapsing, makes it not just a bad call, but an epically bad call. One for the ages. One that probably even makes the likes of Jim Joyce or Jorge Larrionda feel a little bit better… probably doesn’t do much for England, but at least Armando Galarraga got a ‘vette out of it all.

I guess the point I’m trying to make is that when locking into decisions that are going to play out over decades, we need to be aware of the dangers up front. The future is uncertain, hell, right now the current is uncertain, and incorrect assumptions can have disastrous consequences.

We may not be facing the risk of high interest rates right up front like they were in 1982, but we must recognize the danger of locking into high levels of debt while rates are low… cause they can go up, and if they do your level of debt remains… and high leverage and high interest rates are a lethal combination. Heck, even just buying assets at inflated prices in the absence of interest rate considerations can be a financial life sentence.

To paraphrase someone much brighter than I, our economic cycles are long, but our memories are short.