Canada's Housing Bubble

Jun 04, 2010 Garth Turner greaterfool.ca

Some have asked what happens when a bubble ruptures.

Well, handily enough, we have an example right here in the bag. It’s called America. Let me pull it out for you…

The US housing market hit its zenith in the autumn of 2005 when the average house price reached 4.6 times the average income (houses here now sell for five times income). It took two seasons – until the Spring of 2006 – for price reductions to become apparent in markets which had experienced big increases.

Lesson one: Sellers disbelieve what’s happening. Lower asking prices take months to materialize.

Then, for the next four years (until now), the price of US real estate continued to drop. The Case-Shiller S&P Index faithfully recorded a grinding descent as it became apparent to potential homebuyers and investors that a great deflation was occurring. So, why buy when it would be cheaper in a few months?

Lesson two: Real estate gains are rapid. Losses are slow-mo torture.

In America, the sunbelt cities which had grown like weeds during the housing boom – Miami, Phoenix, Vegas and most of southern California – were the first to buckle. It took more than two full years for anti-real estate sentiment to spread to the economic heartland of New York City, Baltimore, Washington, Boston and Seattle. But spread it did.

Lesson three: Anyone saying ‘it’s different here’ isn’t paying attention. In fact, those cities believed to be the most desirable can suffer the greatest damage.

In America, incentives to try to breathe life back into the housing market didn’t. Washington tried giving $8,000 to every new homebuyer, and even paid people cash to move up. In addition, mortgage rates were kept at emergency levels, while US taxpayers continued to deduct mortgage interest and property taxes from their taxable income. Once the cash handouts ended – last month – sales collapsed by a third. Meanwhile prices continued to fall.

Lesson four: Real estate is the most emotional of assets. When the emotion is fear, no sale.

In America, the appetite for houses was insatiable, as relaxed mortgage lending rules (as in Canada) allowed people without savings to gobble up new homes. As a result, homebuilders could hardly pace demand, and new suburbs marched across former farm fields. Today, there are too many houses. Fannie Mae’s chief economist is on record this week saying entire new developments in California and Florida should be bulldozed, as they no longer make financial sense.

Lesson five: Houses can go to zero.

In America the greatest issue turned out not to be foreclosures for the few who never should have bought homes, but negative equity for the many. Today over a quarter of families have mortgages of greater value than their homes, and it’s estimated this could grow to half of all homeowners. As far as anyone knows, it’s an unprecedented historical event. In some markets homes have declined 40% to 70% from their peak value, taking valuations back to levels of the late Nineties. Anyone buying in the last decade, and who had the bulk of their net worth in a home, could well have lost it.

Lesson six: Real estate’s no sure storehouse of value.

In America, almost 40% of sellers dropped their asking prices in the last 90 days. Proportionately, the greatest number were the owners of expensive homes – in the million dollar range. Believed to be crash-proof in the first couple of years after the bubble burst, high-end houses are now suffering far greater price declines (in percentage and actual terms) than more modest ones. In Baltimore, for example, a developer is about to auction off 11 waterfront luxury homes which were recently offered at $1 million each. Prices now start at $300,000.

Lesson seven: When the storms sets in, everyone’s hit.

In America, recent polling showed that over 70% of people now feel real estate is dangerous, a poor place to invest, and likely to decline further in value. And so it will.

Lesson last: Read this post again. Share it. And get your house in order.