Blessed by the Potato

Wayfare saw an interesting ad for a house recently, claiming among other things, that there were 5 new appliances.

Now, this listing was very familiar: it was the house we’re renting now (and leaving soon). The thing is, we can’t figure out what the 5 new appliances could possibly be. What counts as an appliance? I guess we’ve got the dishwasher, stove, fridge, washer, dryer, and maybe the mini bar fridge in the basement. So 6 potential appliances that could make up the advertised 5. Except, only 2 of those are actually less than 3 years old (what I might consider “new” without stretching the truth too much): the dishwasher and the mini bar fridge. Maybe the fridge and stove are new-ish: they’re still in decent shape, but even though I haven’t searched too hard for a date of manufacture, I’d guess with a fair bit of confidence that they’re at least 5 years old, and likely more than 10. Not exactly new.

Even then, that only brings us to 4 (mini-fridge, fridge, stove, dishwasher). Neither the washer or dryer can count by any rational use of the word “new” — they’re possibly older than I am.

So what’s the 5th appliance? We’re trying to figure it out. There are some straightforward answers: perhaps the landlord is planning on replacing some of those appliances so they will be new for the next tenants. Maybe he’s counting the air conditioner, or the new doors we installed. Perhaps the medicine cabinet? More troubling answers might be if he just recently counted appliances when visiting, and is including our stuff like the microwave, storage freezer, or toaster oven that we bought for ourselves (and will be taking with us). Perhaps he’s confusing “new” with “working” and is counting the ancient washer and dryer.

Or maybe it’s just an honest error, which reinforces the need to take ads with a grain of salt.

We’re back at it: looking to move again, just two short years after the last go-round. A strange smell has been coming out of the A/C the last few months, which has driven Wayfare into an allergic/asthmatic reaction (my nose also gets runny when the A/C is blowing, but I don’t mind it if I get cool air in exchange). Unlike our previous house, there’s no visible mould, and no visible water getting in, either. It might not be mould — it could be some other allergen like mouse dander, or asbestos, but mould’s the working hypothesis*.

Our best guess as to the source involved the clogged/mis-levelled gutters, which created an uncontrolled waterfall right on the side of the house where the A/C is every time it rained. But after getting that fixed the problem has only gotten worse. While we’re pretty sure our landlord would fix it if we asked (like he fixed the gutter and the water leak on the other side of the house last year) — which is a trait very much unlike our last landlord — we just don’t have any idea what the problem might be, and if we can’t keep him focused on specifics, nothing will get done.

I’m loathe to move: the location is perfect, and we (or more properly, Wayfare and her parents) have put a tonne of work into the house fixing all the minor things that were wrong with it. But if you can’t breathe the air, well, that’s no good. The final straw though was when sewage backed up into our washing machine. I don’t think that any blame can be ascribed to the house or the landlord for that one, but it was just enough to make us throw our hands up in the air and decide that yes, we should move.

Once again, we dove into the housing search. We found a lot of houses were listed with realtors this time around, though we had a bit better luck with getting them to return calls and set up appointments. Still, some disappointments: a few that never called back, one that called back and didn’t seem to know how paging and calling back worked (“Who is this?!” “Umm… you just called me.”). Overall communications were quite poor, which I still find surprising since a realtor’s job is basically to communicate with people. There was one townhouse complex I was curious to see: it’s a small complex, I’d guess no more than 10 units total, and 3 of them were on the market at the same time — made me think we’d have a good chance of low-balling a bit. Yet we couldn’t get in to see any of them: one realtor just didn’t return our calls and emails, another returned my email but then took a few messages to get the concept of wanting to set up an appointment to see the place, by which time a few days had passed and my visit to Toronto was at an end… and he wouldn’t set up an appointment with less than 24 hours notice. At least 3 places went off the market before we could get in to see them.

For the houses that we did see, we were pretty disappointed: one with obvious black mould, another that wasn’t in very good shape (carpet in the basement that could not have been more recent than the mid-70’s, a really bad paint job, and what looked like booby-trapping: toothpaste on the handle of the bathroom drawer, a sanitary napkin in the storage area of one of the bedrooms… ick), and one that we think maybe someone died in (reeked of mothballs and possibly mould as well; tiny kitchen, smaller than many apartments; 6 bedrooms, but each was tiny, and no living room; and the new wood/laminate flooring in the basement had been laid down incorrectly, so it dipped and sagged with every step).

Then we came across what was basically the perfect house: a bit bigger than what we had now, and newly renovated so we wouldn’t have to do any of the crazy work we did on the current house to get it livable. The main issues were the location (further from the subway than we’d like, but nothing can be done about that) and the price (quite pricey for the size and location, and at the absolute top-end of our “we’ll just never eat out again” rent budget). For the price we could attempt negotiations, which I did. In the end, we only got 2% off the price, but that’s still better than nothing. What was interesting though is that we also offered for a November 1 possession — we hadn’t yet given our 60 days notice to the old landlord, so even then we’re going to have a month of overlap. The new landlord though fired back initially at the negotiation attempt, saying that she was already “giving” us the equivalent of 2 months rent by letting us wait until November to take possession. That point didn’t fly with me though: first off, it was already mid-September, so there was zero chance she was going to get someone to take it for Sept 1 (maybe a mid-month possession of Sept 15). And even then, for a detached house the renter pool tends to be like us: looking for more time before moving in (though on the flip side, perhaps to stay for longer), so I don’t think she can even count “giving” us October as a loss — it was very unlikely (but not impossible) that she’d ever find someone for an October 1 possession.

For the obligatory rent-vs-buy analysis, this house last sold at $X, and then was significantly improved by the landlord (new kitchen, a few new windows, upgraded electrical, new washer/dryer, new A/C). So if we were to buy it in the current condition, it would likely cost $1.2*X. Yet the price-to-rent is 225 times X (270 times the estimated current “value”!). If we assume that we took a fixed-rate mortgage at 3.5% and never had rates increase on us, that rent increases 3% every year, that we stay there for 10 years (for calculating transaction costs), no CMHC req’d, and that zero maintenance needs to be done over that 10 years (since almost everything is new now) — in other words, assumptions that are about as favourable to the owning case as I can make them without having to rely on boom-times price appreciation — it would still cost about as much to rent as if we managed to buy it for $X — it’s like getting the renos for free. And of course, the actual cash flow impact is less (the mortgage payment alone would be more than rent; even though some is principal repayment, there’s less flexibility there). If I assume what is, IMHO, a more realistic scenario (rent only increases 2%, and the mortgage rate averages 4.5%), then opting to rent is like getting this house for 30% less than what we’d have to pay to buy it now.

So yeah, we’re happy to take the rental option and not have to deal with owning in this market.

And one other source of savings for the renter we haven’t discussed before: life insurance. Since we don’t have a mortgage or dependants, we don’t really need life insurance at the moment, but would if we borrowed. Oh, and: lawn care is included. That’s like another $700/year benefit.

Here are the before/after pictures of the kitchen, to give you an idea of how thoroughly renovated the house is:

* – Yep, it’s mould. The work guys just had the wall boards off, and I’m told it’s back there.

As soon as I heard that the mortgage brokers behind ratesupermarket were pushing a first time house buyer’s guide, I thought “I’m gonna hate that. Tearing it apart should make for a fun blog post.”

A novel idea was that you’d sign up for a 2-week guide that would send you one part of the lesson by email each day. Kind of gimmicky, why spread out 14 already-short pages over a full two weeks? Anyway, it’s short, there are cartoony graphics, and there are quizzes so it’s apparently aimed at getting the school-age crowd to buy homes.

Much to its credit, it does start the series off with the question of whether one should rent or buy. But of course, I have to take issue with the nonsense in the rent vs. buy comparison. They create a simple pro/con list for buying and renting. Unsurprisingly, they dig up the tired old half-truth “Money paid towards rent disappears forever” and stick it under the con column for renting. Yet under the pro column for buying is the flip side of that half-truth “Mortgage payments go towards your home’s equity” with no mention that interest also disappears forever.

“Restricting rules regarding guests, noise, pets, yard space, etc.” also appears as a con for renting, though most of that is not true (or applies equally to owners in condos or other situations with rules regarding noise, pets, etc.).

Even more strange though is this one: “Cosmetic renovations typically come out of your own pocket” as a con for renting. Huh? Whose pocket do they come out of for owners? For that matter, aside from Wayfare and I, who does renovations as a renter?

Considering the site is owned by mortgage brokers, who only make money when someone buys and takes out a mortgage, I was expecting it to be much more strongly biased towards rushing in to buy (e.g., to not even have a section on rent, and to focus more on stretching to get the maximum mortgage possible). The budgeting section didn’t stress that their calculations would give the upper end of affordability, but that was to be expected.

Interestingly, they have another rent vs buy table on their site. I’m not sure how I stumbled on it, but it’s not part of the cartoony first time buyer’s guide. It also looks to perhaps be a rough draft, since they get away with saying things like “Affordable: in some cities renting is the only option for people because of high housing prices; Low Risk: If house prices start to drop (as some people are predicting), you’ll be glad you didn’t buy” under renting pros, it’s not as nicely formatted, and has the common loose/lose mistake.

“He’s been predicting that for years and it hasn’t happened yet.” It’s a common refrain heard as a housing bear, or indeed, a brush-off argument used against someone making predictions in a wide variety of other areas (e.g.: global warming). There’s a certain comforting logic to “it hasn’t happened yet.” After all, at some point you have to consider the possibility that your prediction was wrong and isn’t going to happen.

But the thing is, “it hasn’t happened yet” was true at the time the prediction was made, too. So one needs to try to estimate how much time is needed before you need to start worrying about events not unfolding as planned. It’s not a stand-alone argument.

When I first started getting bearish on real estate around 2007, I told Wayfare the time to buy wouldn’t come until 2010-2012. Here we are in 2011 and it’s still going to be years yet. The recent market troubles leading to a prolonged ZIRP in the states is not going to help matters on that front. While rising rates are not a necessary condition for the market to start to correct, they sure would help.

While I sometimes make some (small) speculative investment moves when going long, the extra risk factors of shorting have kept me away, even when I had some good reasons to be short. But if I could, I would be short Toronto RE now — no matter how I try and look at it, it looks over-valued unless I assume crazy things like ZIRP forever (a few more years, sure — but 25 more?). One issue with that though is timing: RE cycles are long, and can take years to play out. It’s very tough to have any manner of certainty when it comes to crowd psychology. I do have to stop every now and then and look back at the data and my analysis to wonder if I’m wrong, since it does keep defying gravity, and I keep coming back to the same conclusions. Assuming people do any math at all before making their purchase decision (and everything I’ve seen suggests they don’t), the current prices are factoring in continued price growth of at least 3-4%/year, with rates at basically nothing going out forever. Yet even many of the bull-inclined analysts and real estate associations are calling for a plateau as a kind of best-case scenario.

I went and re-read the story of Mike Burry, one of the few genius hedge fund managers that caught on to the brewing US real estate bubble in the early years. The problem was that by being early by several years, he strained the relationship with his investors as they constantly doubted him and his unpopular bets; he ended up closing his hedge fund as soon as he could (though not before making hundreds of millions of dollars by betting against subprime loans). It looks like being right but early seems to be every bit as bad as being wrong, at least as far as interpersonal relationships are concerned.

It’s tough because my cohort is of the home buying age. I feel like I have a responsibility to warn them of the dangers, that the “pride of ownership” is currently a several hundred dollar per month expense. I worry not only for my friends’ sake that they might in the not-too-distant future find themselves trapped and house poor, but also for my own guilty conscience over my inability to prevent a predictable loss. I’m haunted by visions of when the dinner party conversations inevitably switch from “we could add forty thou in value by putting in a second washroom” to “can you believe interest rates these days? We had to cancel our vacation this year to keep the house. I don’t know what we’ll do next year if they keep going up.”

But, what’s a socially acceptable warning? I’ve blogged about the matter enough that if they follow my writings, they probably already know my arguments and don’t care: I sometimes worry that maybe they don’t read my blog (though everyone, of course, should). Even if they’re not BbtP readers, surely they’ve at some point heard about the crash in the US (and around the world), which should have delivered the message that real estate doesn’t always go up. It is their money to lose; maybe they do have a few thousand a year to spend and value pride-of-ownership that highly — just because my pride is cheap doesn’t mean everyone’s is. Maybe the other assumptions don’t apply (like that they would actually save and invest the difference). Plus that timing issue keeps rearing its head: not many people think on 5 or 10 year timescales, so it’s hard to counsel patience on that level when people are making decisions for next month.

Plus, if I’m wrong (though this is one of my “highest conviction” long-term predictions), they’ll fucking hate my guts because real estate is so very emotional.

David Fleming at Toronto Realty Blog recently tried to get that across with a little anecdote, but got the moral of the story backwards. He describes, in a very round-about post designed to stir the pot (I know I shouldn’t give in), a place he liked to visit called Park City, Utah. This place like many others got caught up in the buying frenzy in the states, despite the fact that it was this little artificial town surrounded by empty land. There was no land scarcity, and no one should have bid up the prices of existing RE since you could just go a half mile down the road and build a new place on an empty lot. Yet they did anyway. It wasn’t a logical investment based on the fundamentals, it was emotion-driven. A frenzy. David then tries to spin that as being evidence that Toronto doesn’t have a bubble brewing: Park City had no land scarcity and prices crashed; Toronto does have land scarcity, so prices won’t crash.

But the true take-home message is that land scarcity has very little to do with short-term valuations. Was land any more or less scarce in 1989 in Toronto than it was in 1992? Yet prices dropped 30% in those 3 years. Is it any more scarce today than it was in 2001? Yet prices have roughly doubled. And of course in the US, the cities with equal land scarcity to Toronto also experienced run-ups in price and subsequent crashes.

Even in places like Park City, Utah — with abundant land for development all around — prices got over-heated and later corrected, even though it should have been obvious that a bubble was brewing and those rapid price increases didn’t make sense. How much easier then is it to then inflate prices beyond fundamentals in a place like Toronto, where the fundamentals aren’t quite staring you in the face so dramatically as the cornfield next-door?

Yet we come full circle: it hasn’t happened yet. Prices may be too high, having leap-frogged ahead of the fundamentals. Indeed, I’ve been arguing that it is highly likely that that’s the case. I figured that the most likely way such a large imbalance could be corrected was through a decline in prices, i.e.: a crash. It’s a very unstable position to be in for the speculators at the margin: losing money or at best breaking even on rental properties purchased recently with maximum leverage. It was always possible that the corrective action could instead be a long period of stagnation while inflation helps the fundamentals catch up to the price. The banks and the housing pundits pushed that theory, but I always thought that was very unlikely: we’re dealing with the madness of crowds, so exact timing is difficult, and long periods of stability are rare. But without the pressure of rising rates, that unlikely solution to the problem is looking well, a fair bit less unlikely.

Oh, and just before I hit publish I saw the news that the TREB stats for the first two weeks of August were released, and detached homes in the 416 were down something like 15% in price. While I would love to call that as the beginning of the end, I don’t think it means much at all. Prices were down about 15% last summer too, only to rebound in the fall. Plus there are very few transactions in the detached home segment, particularly in the summer doldrums, so it’s possible that the price decline is just a shift in the sales mix and not a legitimate decrease in prices. I wouldn’t get too excited just yet: see what the Teranet numbers have to say, or better yet, see if October brings a rebound. If it’s still weak by October I’ll start letting my hopes get high, and hold my breath through the spring that ZIRP be damned, buyer exhaustion has finally hit. But for now, I’m still a patient, sad bear.

“So is it a bubble? Glancing at popular metrics such as the price-to-income ratio or the price-to-rent ratio, it is tempting to conclude that the housing market is already in clear bubble territory and a huge crash is inevitable. Tempting, but probably wrong. When it comes to the Canadian real estate market at this stage of the cycle, any statement based on average numbers can be hugely misleading. The truth is buried in the details—and there the picture is still not pretty, but much less alarming.

The average house price is still rising by 8.6% on a year-over-year basis. However, take Vancouver out of the picture and this rate slows to 5.6%. Exclude both Vancouver and Toronto and the price increase is only 3.7%.”

So if the country as a whole is close enough to be a bubble that it’s tempting to conclude such, but is really only being driven by Toronto and Vancouver, left unsaid is the conclusion that Vancouver and Toronto are in bubbles — bubbles large enough to skew the averages for the entire country.