Canada's Housing Bubble

November 24th, 2009 Garth Turner greaterfool.ca

Bubble talk continues. The latest contribution is from Scotia economist Derek Holt in a paper entitled, “Is there a Canadian Housing Bubble?” Like most highly trained economists, he doesn’t answer the question, but he does have a lot of cool charts (the one above is amended, as I’ll explain in a moment).

Mr. Holt’s a guy I know well from my time on Bay Street. He’s always been a real estate bull, and changing banks (he was formerly with RBC) hasn’t changed him much. But his report does contain a nugget of info I’ve been digging for (and only a banker would have access to) – the number of people taking long amortizations, which usually corresponds with low down payments.

Bubbles1

Does history repeat? Only if human nature does.

Says he, 47% of new mortgages taken out in the last three years have had ams of more than 25 years, and 60% of those have been 35 or 40-year jobs. Hmmm.

Why does this matter?

Because it gives some bones to the flesh we see flailing around the market these days – young buyers who have been the principal combatants in bidding wars driving prices higher and helping make housing unaffordable for everybody. If half the new loans are for greater than 25 years, and the bulk of those are 35 or 40, then it’s a fair assumption these folks went that route to achieve lower monthly payments.

As we all know, the longer the am, the more a mortgage debt swells. Those who opt for 35 or 40-year repayments get rid of virtually no principle in their early years, with all their monthlies going towards interest. That’s why they are so loved by the banks and are financial muggings for homeowners. Add in the CMHC insurance money, and it’s a recipe for zero equity gains for several years – unless the market keeps rising.

In other words, no rational homeowner would opt for a 35-year loan. Only those who were buying at the end of their leash, looking for a way to swing the deal. As we know, the key question in real estate today is not, “How much does it cost?” but rather, “How much does it cost a month?”

So I’m thinking, this preponderance of long-am, irrational, cash-strapped new homebuyers is not the best news an economist could hear. It sure would not be welcome if the conclusion were that, yes, we do have an asset bubble – because bubbles always burst. And when they do, people bleed. Especially those who bought in last, paid too much and have no equity behind which to hide.

This info comes to us, by the way, at the same time we hear that one in four Americans with a mortgage and a house is in negative equity – owing more in debt than the property is worth. Interestingly, it seems most of them were not subprime borrowers, just folks who got caught in the real estate trap when house valuations took a dump.

Such a good thing we’re Canadians. No twitchy mortgages here.

Got two interesting emails today (actually I got buried in them). Here ya go.

This is from a professional real estate guy in Winnipeg:

I am not sure what you are espousing with your doom and gloom predictions for Real Estate in Canada….Real Estate is cyclical, largely dependant on interest rate movements, new supply coming on to the market and inflation.  It goes up, it goes down. However, in most part, interest rates rise as an economic response, usually a lagging economic response to inflation. Inflation has a large component dealing with real estate prices so it appears we may have a period of time of rising real estate prices until interest rates rise appreciably.

Will real estate go down at some point…YES….could it continue up another 10-20 percent YES….I don’t know….and after getting two calls today about your interview on the Globe website and then viewing it, I am amazed that someone who goes by another name than God can be so sure.

This is from a professional mortgage broker in Toronto:

I check into your blog sporadically.  Daily reading has been bad for my business as a mortgage broker as I found myself spending a lot of time advising my clients not to do things.

It seems well established that a lot of decisions to buy a family home are based on emotion.  The lenders play on this emotion.   It seems everyone writing to you is about to succumb to the female “nester” in the relationship and plunge into homeownership.  It’s timely to report the human side of the consequences….not my clients but friends of my kids.

House purchase summer of 08 – 100% financing 40 year amortization.  Husband a carpenter, wife at home with the new baby.  November of 2008, husband laid off, wife goes back to work for minimum wage. Still not enough family income to pay the mortgage and buy groceries.

Value of house has dropped 10% – Payout of mortgage was higher than the purchase price the day they completed. by virtue of 100% financing and the CMHC fee.  Real Estate commission 7% on the first $100,000, 3.5% on the balance.  Shortfall would be $49,000.

Couples’ families want to help.  Daughter and baby move home with her parents.  Son moves home to his parents.  Duplex is rented out to cover the mortgage payment. This doesn’t work.  Husband moves in with wife and her parents.  This doesn’t work.  Couple rent cheap apartment. This doesn’t work.  Mother and child leave after 8 year relationship.

There hasn’t been a lot of time spent on discussing the human side of this recession or investing in a real estate bubble but it is important to note the consequences are not just a loss of money or investment.

The chart at the top of this post came from Derek Holt’s report (the economist). I have modified it to include the bubble real estate market of 1989, and the one we are in now. I’ve also indicated how long it took for prices to recover from the last one – 13 years.

I hope Mr. Holt’s bank tells the kids.