It's Just A Matter Of Time

Canada could be headed for a housing and mortgage meltdown similar to the one that has devasted the U.S. economy, Merrill Lynch warned Wednesday.

Canadian households are more financially overextended than their counterparts in the United States or Britain, a report issued by Merrill Lynch Canada economists David Wolf and Carolyn Kwan says.

So it's revealed that Canadian home owners have more debt than their US or British peers. How comforting.

“What worries us is that Canadian households have been running a larger financial deficit than households in either the U.S. or the U.K.,” the Merrill report says. “... After 40 years of net saving, Canadian households moved into sustained deficit in 2002. In 2007, household net borrowing amounted to 6.3 per cent of disposable income, a wider deficit than in the U.K. and not far off the peak U.S. shortfall seen in 2005.”

But yet many still believe we are different.

To read David Wolf's full report, "The Tipping Point," click here.

Update:
Perhaps the Merrill Lynch report has ruffled a few feathers among other economists (are they speculators themselves?).

The nature of the decline in Canada is much different than that of the
U.S., said Benjamin Tal, senior economist at CIBC World Markets Inc.

"You need a trigger for a crash in the housing market. In 1989 to
1990, the trigger was double-digit interest rates that killed affordability in
Canada. In the U.S., the trigger was subprime, and a huge increase in default
rates when people who were not supposed to be in the business of owning a house
did, and that created artificial demand," he said. "Unless Canada goes into a
major economic recession ... I'm missing that trigger."

Let me do your job for you.

Falling house prices. That is the trigger. It's simple.

40 year mortgages, 0 downpayment, etc...all these new mortgage products introduced by the CHMC over the last two years force-fed false affordability on unsuspecting home buyers. These are the same home buyers that would not even qualify for a traditional 25 yr amortization period. People who have no business buying houses bought during the last two years. Just talk to my single hairdresser who owns 3 properties. A significant majority of homes bought in the last two years were bought with 40 year mortgages. Once can argue that affordability is now worse in 2008 than it was back in the 1990s as now the principle amounts of mortgages are astronomical.

In the US, the trigger was not subprime. Subprime would have never been an issue if house prices continued to rise or remained static. Those who were overextended once the teaser rates adjusted to higher rates could easily escape by either selling their property or refinancing their mortgage. When house prices fell in the US, those home buyers with subprime mortgages were trapped. They couldn't sell because there were no buyers. And they could no longer refinance their mortgages because their property was losing significant value. The only option was to default.

The same scenario is occurring in Calgary and other cities across Canada. Houses aren't selling under similar principles. I fear that sellers are unwilling to lower their prices because they will take a big loss. Intelligent buyers, are exercising their patience on the sidelines. Meanwhile, home prices which have risen exponentially over the last two years are starting to come crashing back down. Soon many Canadians will be in the same trap. Severely upside down on their mortgage they will be forced to either sell or refinance their mortgage. Both of which cannot be accomplished when asset values are decreasing. Skyrocketing inventory is a symptom and precursor of what is to come.

Reality check, as house prices slide in every major Canadian city - real estate is still unaffordable to the average wage earner. These include important people such as teachers, firefighters, nurses etc.

Even if our own meltdown is a fraction of what happened in the US, it will still have a significant impact on our own economy. Perhaps an in-house grown recession (pun intended).

To simply ignore all the warning signs and to discount what is happening in the US is complete ignorance.

SFH Market's Worst Nightmare/Enemy: the Condo Market

The simple physics of building implosion/demolition. Place highly powerful explosive charges to knock out supporting infrastructure and allow the building to cave in on itself.

One can argue that the condo market and the sfh market are two different markets but one must also make the realization that the two have a relationship. The condo market can be portrayed as supporting the sfh market. Does anyone notice how all of the realtor authored blogs avoid talking about the condo market?

Could the collapsing condo market in Calgary bring down the sfh market?

Remember that the condo market is seen as the easiest entry point into real estate especially when price hyperinflation occurs such as they did in Calgary in the last couple of years.

With the announcement of construction being halted on the Gateway Midtown towers yesterday, it indicates that there is substantial trouble in the condo market in Calgary. Right now there is severely low demand for condo units and there will be soon a enormous influx of product coming onto the market. Inner city fundamentals are out of touch with reality.

With a severe reduction in demand and record high inventories, prices will have to come way down.

As Radley77 has beautifully composed graphs comparing the two markets and levels of construction, we can see that the quantity of multi-family units continues to increase outstripping single family units.

For the bulls out there who remain, seeing the quantity of condos being built in the future should be concerning because the element of inventory will not be manageable.

I believe that there is a relationship between the condo market and the sfh market.

If inventories continue to skyrocket, prices will come down as they have now. Because condos have a price point much lower than a sfh, they will become more attractive to the first time home buyer looking to enter into the real estate market.
Once that buyer is removed from the pool of buyers then the sfh inventory will be stagnant and will continue to increase if prices in that market are not lowered (in accordance) to attract buyers.

Once the new mortgage rules come into effect in October, the pool of buyers will be reduced even more.

The reality may be that the condo market may be the first go, followed then shortly by the sfh market.

Here Is What $320k Will Get You

Real Estate Type : Single Family
Building Type : House
Bedrooms : 1
Bathrooms : 1
Interior Floor Space : 925.70 sqft
Storeys : Bungalow
Built in : 1926
Land Size : W:8.840m D:36.580m Shape:REC
Title : Freehold
Location : 112 9 Av NECalgary, AB T2E 0V2
MLS®: C3322995

Aren't post grow-op properties supposed to be a good deal?

This is more evidence that the Calgary real estate market is out of touch with reality. The seller of this property is looking for $320k for a post grow-op establishment. The house is most likely extensively damaged and is currently being evaluated by the Calgary Health Region. The MLS listing makes reference that the purchase would be more land motivated (even though the lot is in an ambiguous location).

It's still astonishing to see the level of denial that still exists in the marketplace.

False Sense Of Affordability

This might be old elementary news, but over the last couple of years during the inflation of the Calgary real estate bubble many home buyers were "tricked" (yes, I dare say it) into affordability.

A conventional and financially rational mortgage would follow a 25 year amortization period. A down payment requirement of 25% would be a solid foundation. In addition, a single income stream would the norm.

Since February 2006, CHMC has introduced 30, 35 and 40 year mortgages to allow prospective buyers a chance into the real estate market. In conjunction to low interest rates, a well oiled real estate marketing machine, and a booming economy this created the present bubble dynamic.

Recently, the essence of 40 year mortgages has been questioned.

"Canadians are flocking to 40-year mortgages, often without a down payment, and the rapidly developing trend is beginning to ring alarm bells for policy makers in Ottawa.

Both the Finance Minister and the Governor of the Bank of Canada are expressing concern about the situation, as the U.S. economy continues to reel from a crisis triggered by mortgage holders who were in over their heads."

The shocking statistic found in the article is that around 40% of new mortgages are of longer than conventional 25 year periods. Furthermore, 15%-20% of first time home buyers are opting for no down payments and 40 year mortgages. Since Calgary lead the sudden incline in prices, unconventional lending practices may be more pronounced in the market.

Instant applications to a life of serfdom and financial tight rope walking. Longer term mortgages cost thousands more just in paying interest and last much longer. They are only beneficial to your bank, mortgage broker and anyone in the real estate "money supply chain."

"The bigger question is what happens as you go off two, three, four, five years from now, and it's no longer just a significant share of the new applications, but it's a significant share of the outstanding market," said Derek Holt, an economist at Bank of Nova Scotia. "I think we'll be in uncharted waters as to the sensitivity to shocks that most households will find themselves facing." If there is a shock in jobs, interest rates or commodity prices, "unless you see the arrival of 60-year mortgages, then you've got a household sector that's really backed itself up against the wall."

If the current state of affordability is defined as minimal down payment on a mortgage longer than 25 years, the cold reality is much different. You can't afford the house (wait for the price correction).

The most dangerous lifetime financial decision is "force feeding" affordability in a bubble real estate market.

Offending Economists Around The World

The preceding graphic was the housing market in the US where prices eventually crashed. Early symptoms included a decrease in sales and high inventory levels.

Notice the very "shocking" similarities to the trend of the Calgary real estate market. In Calgary, home sales are plummeting 30%-40% YOY. Inventory has risen to all time record highs (~7000 city SFH, ~3200 city condos). By exhibiting the same symtoms, it seems that the Calgary real estate market will suffer the same illness.

According to this article, CREA is forecasting the resale market in the province will drop by 18.9 per cent to 57,900 units this year and experience a further five per cent drop in 2009 to 55,000 MLS sales. Interesting to note, the report says the average sale price in Alberta will rise by 4.7 per cent to $373,000 while it will only go up by 2.8 per cent in 2009 to $383,300.

So how exactly does retracting sales contribute to rising prices?

As a commodity, real estate is rather complex. But don't be fooled, real estate is still bound by the same simple economic fundamentals of supply and demand. The price function isn't perfectly elastic (but rather "sticky"), therefore price fluctuations will take more time to develop.

This type of reporting should be insulting to any economist. By CREA's estimation, economists around the world should be going back to their post secondary institutions and demand for refunds on their educations. Adam Smith is rolling twice over in his grave. Insulting the intelligence of the common person will only cause CREA and its members to further lose credibility.

Contrary to real estate perma-positive pumping reports, increasing inventory and decreasing sales will reduce property prices.

It's inevitable.

More Negative Equity On The Horizon

The much anticipated "spring rush" has been a complete disaster in Calgary's real estate market. This is well documented in the MSM these days. It was during this period that sellers were hoping to unload their anvils of debt to unsuspecting greater fools. The hope and anticipation were met with retreating buyers. In analyzing historical trends, sales should dwindle further during the next coming summer months propagating further price declines.

In July 2007 we saw the peak for Calgary SFH market hit an average price of $505,920 and median price of $439,000 (achieved in June 2007). This was followed by months of declining prices. The year ended in December 2007 with an average price of $444,769 and a median price of $406,788. Summer buyers would already owe more on their mortgage loans than the value of their homes.

Suffice to say, we may start seeing month-over-month price declines as early as this month. This means the price declines will be longer and more painful for sellers this time around. With inventory at record levels and low sales, the price declines this year will be magnified.

By the end of this year, there is potential that a high percentage of home buyers during the last two years will in a negative equity position. Negative equity, an element in the real estate game that your friendly real estate "professional" did not address during the frenzied buying hysteria. But is has now become a reality for most home owners in Calgary. In combination with being "house poor," many bubble buyers will be in a constant state of financial duress. This may mean not having enough money to send your real estate "professional" a Christmas card this year.

As negative equity builds, market exit strategies for sellers are minimized and financial losses will be greater.

Those who are overextended could possibly tip the rest of the market into a severe correction.

...

A new reality in Calgary. Overextended homeowners will use creative ways to find tenants to help cover mortgage costs on multiple homes.

City Vacancy Rates Jump to 4%

The once white-hot Calgary real estate market boasted a vacancy rate of 0.5% back in 2006. According to this article, alot has changed in the past 2 years. Inventory has slowly built up to uncontrollable levels and property sales have dissipated. This has resulted in rising vacancy rates in Calgary to as high as 4%. Earlier this month, CHMC had forecasted the vacancy rate to be at 2%. It's currently double the forecasted level. With so much inventory available, the "bitter" renter has more options to choose from.

The pendulum is clearly swinging the other way. With vacancy rates much higher than anticipated, many landlords will have to be competitive (ie. lower rents) in order to attract tenants. By lowering rates, their carrying costs are adversely increased with reduced rent revenue. A quick peak at rentfaster.ca/calgary.php will reveal a plethora of rental listings.

The augementing vacancy rate is simply just another symptom of the real estate market heading into a (severe) correction.

Stay tuned.

To read previous posts, please click http://crebb.wordpress.com. Thanks!