Blessed by the Potato

“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.

It’s been another rough few weeks over here. I have revisions to make to my now-complete first draft, and though there aren’t that many, they’re taking me forever. I had hoped to be done these almost two weeks ago. I seem to have serious issues concentrating (also why there haven’t been many blog posts here), and my stress levels are once again through the roof. But it’ll be over soon (just months now!) and then I can worry about what to do with the rest of my life. To try to get my science groove on I’m even going out to give some rah-rah science! outreach talks at high schools soon, which I hope goes well.

Mother’s day seemed pretty hectic here, with dinners and brunches and last-minute shopping. I ended up getting a new pizza cutter for myself while I was at Caynes. I’m impressed enough with it that I had to give it a quick mini-review: it cuts through pizzas way better than my old ones. That might be because it’s new and sharp, but even then it seems to do a better job than they ever did: I’ve always had to go back-and-forth to get a clean cut, but this did the job in one swipe. It has a rather heavy handle (vs. the cheap plastic or wood handles of my other two), and the blade disc is held securely with no play: the other two both had fairly significant wobble in the roll of the cutter.

I was recently interviewed by a reporter from the Globe & Mail, and had a brief mention in an article as a result… but although it was my website and Potato identity that brought me to his attention, the article had no mention of either. So at least my quasi-secret identity remains safe, and I don’t have to write a tedious “welcome, G&M readers” post. However, if my understanding of comic-book lore is correct, this reporter is now in grave danger, as those who possess the information of a person’s secret identity — especially reporters with privileged sources — are abducted with uncanny regularity: whether by targeted schemes or pure evil happenstance. Fortunately, I believe the last time I updated my arch-nemesis page I selected “the geese who block the bike path by the river” and they are not the hostage-taking sort of villains.

Rob Carrick agrees with my earlier post that TD’s e-series funds are great, but hard to buy. I think it’s really weird that the fund you have to trade online requires faxing/mailing in an application to open an account, but weirder still that people like me have to write third-party user guides on how to actually manage the things.

CC weighed in before I got around to publishing this post, saying that he didn’t find the e-series that hard to set up. I don’t find it that hard from the instructions either, and have helped people set them up… but Wayfare did run into issues, mostly with the branch staff being clueless and trying to sell her on higher-MER funds, and with that conversion step not going through right away. Plus some of the other steps (like withdrawing under the HBP) are a little less clear, as Krystal found out. As much as I love the e-series funds for average investors, something’s not right when the best instruction sets and knowledgeable people are outside of TD. Anyway, I’ll repeat my best advice: use TD Waterhouse.

Deliquencies are rising in Alberta as the housing market there flattens out. I consider it more evidence that delinquencies are a trailing measure, so not very relevant in a discussion on the health of Canada’s housing market, but take it however you want (i.e.: too small to be meaningful at all is also a good way to take it).

A little article on Home Capital Group also points to some more warning signs: “He said the company is being cautious when considering loans that will go toward properties in Vancouver or downtown Toronto, because the markets are showing signs of overheating.”

Canadian Business revamped their website, breaking the RSS feeds and leading to many 404 errors for old links to their articles. The ability to comment also seems to have disappeared. But, I’ve found Larry MacDonald again, and now he seems to be moving towards believing that Vancouver at least, is in a bubble.

I’m a bit late on this, but Freddie Mac actually reported a profit this quarter. The preferreds I own (a very small speculative bet) are actually in the black now by over 30% (given the timeline though, still no better a performance relative than the index). I still don’t expect a final resolution for years yet, and this only suggests that rank insolvency is perhaps not as much of a risk — but political risk still looms large, as it didn’t look like the conservator allowed them to repay any significant portion of the bailout. Despite the recent run-up, they’re still only trading for 10 cents on the dollar, quite a reasonable discount given the return to profitability. Though I was tempted to buy more on the news, I figure I’d hold pat with my thimble-full of exposure. There’s still lots of risk here, and I don’t need to bet any more than I already have.

A short post by Saj Karsan on learning from your history, but not letting randomness influence that. I can’t dig it up now, but Michael James had a similar idea some time ago: a good decision is not necessarily the one that lead to the correct outcome in the way things played out, but one that made the most sense given the information available at the time.

A cute tongue-in-cheek site about the benefits of coal-fired electricity.

Garth Turner is a very polarizing figure. He was a controversial politician, and was one of the early voices to raise a warning about a Canadian housing bubble, getting a book and blog out of the deal. Indeed, I have to credit him for first bringing the idea to my attention; of course, I went out and did my own homework to come to the same conclusion, a step that is not to be skipped. I read his blog Greater Fool pretty much every day, but yet I don’t have it linked in the blog roll on the sidebar. That’s because it’s hard to recommend him: he’s crass, vain, evasive at times, confrontational at others. I read it, but it’s certainly not for everyone. Often, I find myself providing Garth-to-English translations as he glosses over crucial details or makes up his own slang that accumulates after years of daily posts.

Garth is not a personal financial blogger, out to rationally lay out the details of a plan and analyze the ways to optimize it. He’s not some student out to cheerfully converse and debate with the denizens of the internet all hours of the night. He provides brief glimpses of possibilities, and then tells people to go get a qualified financial advisor for details. When pressed, he’s fond of various terse two-word answers: get lost, get real, grow up, come on. I remember about two years ago he had one of those open forum sessions with the Globe where readers send in questions and he answers for an hour and the whole transcript goes up on their website, and he answered someone’s question with a two-word brush-off and I was appalled: it’s one thing to do that on your own site, quite another in a Q&A with the Globe!

But that’s just who Garth is. He talks about the housing situation in emotional terms, and provides some good anecdotes from his readers, but he’s not a details guy. So earlier this week Garth suggested to one reader that he borrow against his paid-off house to invest in a “balanced portfolio (my fav is 40% fixed, 60% growth) making 8% or so […] This is called diversification. It mitigates against having the bulk of your net worth in one asset alone. […] And it’s something nine in ten Canadians would never dream of doing. Which is why only one in a hundred of us have a net worth of a million, while seven in ten own houses.”

Others jumped on this particular advice, the most prominent being Canadian Capitalist saying “This advice is so bad that I don’t even know where to begin.” In the comments, Michael James (who by now you show all recognize as another PF blogger I link to a lot and have great respect for) said: “I’m tired of hearing recommendations to leverage a house for “diversification”. After borrowing against a home to invest in other assets, the home represents exactly the same percentage of net worth that it represented before borrowing. Changes in the home’s value affect net worth in exactly the same proportions whether you have a mortgage or not. The only difference from a risk point of view is the added risk from the new assets. This may or may not be a good strategy, but it is not diversification in the sense of reducing risk.”

And that’s well said. It’s not diversification in the usual sense of reducing risk: borrowing against the house is not the same as selling it, you still have exposure to it if the price goes down. But, as he says, you do get exposure to the new assets, which is part way towards diversification (but with increasing risk because you’re leveraging to do it). I don’t think it’s bad advice in Al’s case, but the issues of leverage — and other details like what a balanced portfolio should be and the issue of whether it makes sense to hold bonds when borrowing to invest — are lacking from Garth’s post. It’s harsh, but not entirely unwarranted criticism.

Then in today’s post, Garth comes out swinging: “Which brings me to this. It’s a column trashing me on the wimpy MoneySense site, written by a young father of three brave enough to be anonymous.”

That brings up a very good question of what it means to be anonymous these days. Is Lady Gaga anonymous? Madonna, Mark Twain, Prince, Robin Hobb? Canadian Capitalist, first off, isn’t anonymous: Ram has had several articles written about him (which are not hard to find on his website), his actual face is his forum avatar. But even if that weren’t the case, is “Canadian Capitalist” anonymous, in this sense? Is “Potato”? Sure, we don’t use our real names, but how much would our “real names” mean, anyway? There’s definitely a distinction between the fleeting anonymity of user213 leaving a comment on Garth’s blog with a dummy email address and then disappearing into the ether never to be seen again, and the pseudo-anonymity of CC or Potato, Gabe or Tycho, Yahtzee: established personas on the intertubes, with consistent messages, accountability (at least as much as if I was blogging with my real name), the ability to be contacted and engaged in dialog with. I publish under both my real name and Potato, and I daresay I’m better known and more widely read as Potato, with a longer track record (going on what, 13 years now of BbtP?). I would be more anonymous if I used my real name.

A name-brand source of information, opinion, ranting, and hilarity.

So I don’t think the “brave enough to be anonymous” ad hominen is warranted or fair. The internet seems to be growing up and moving away from pseudo-anonymity, but it’s still there (just as it is in “real” publishing) and I think it’s important to distinguish between actual anonymity and a nom de plume.

As for the debate itself, I think by now you can see I’m somewhere in the middle: I think that with what we know about Al and his interest in leverage and diversification, borrowing against his home to invest is perhaps a good plan for him (though if he wants to move up and is concerned about a real estate correction, selling and renting a larger place would be an even better plan). Expecting 8% on a diversified portfolio is maybe a little optimistic (and past returns are no guarantee of future outcome), being able to secure a HELOC at 3% will require some good negotiating skills, and it may not make sense to include the safer spectrum of bonds while also borrowing at the same time, but nothing is out of the ballpark there. However, Garth didn’t fully discuss the risks, the limits of the diversification, what he meant by balanced portfolio, etc. Greater Fool is where you go to get the kernel of an idea, an emotional appeal about not shunning risky assets entirely for the illusory safety of a house, or a fun cautionary tale about a couple with ridiculous exposure to real estate. It’s not the place for a detailed financial plan and a rational discussion of the trade-offs involved.

And a final note: I’m generally slightly opposed to leverage, and the bizarre case of holding low-yield fixed income like a savings account or government bonds while also having debt. But it can make sense in some cases. For instance, recently one poster at CMF wanted to try to find a way to maximize her mortgage over-payments to finish it off, but noted that income could be unpredictable and needed a long amortization just in case. To me, that’s an excellent case where it’s safer to maintain the leverage of the mortgage and keep some money in a savings account: if you do run into a rough patch, it’s very difficult to get that overpayment back, you still have to make your regular mortgage payments to keep from facing foreclosure, and you can’t eat your principal. An emergency fund, even if it costs you a bit in interest spread, can be a very handy thing (and in this particular case, she was looking for an open mortgage to really go nuts with the prepayments, but a closed mortgage is so much cheaper that to keep the emergency fund and just pay it at the end wouldn’t cost anything).

I like the note in this story about the advisor making clients check the box “I want to buy low and sell high” or “I want to buy high and sell low.”

Michael Geist had a tonne of UBB-related posts up this last week or two. I haven’t had a chance to read any yet, but I’ll get around to it (and likely posting on it) soon. If you can’t wait, go ahead and read him yourself!

Last time around I briefly mentioned Tokyo Electric Power, with a pointer to Financial Uproar’s take. After that little bump I mentioned, it just tanked. I was surprised by that: my take was that the cleanup costs would be several billion (let’s say $10B), and the liabilities were capped by Japanese law. What transpired was that that last part looks like it may not be true: though there is a law in place to limit liability for “exceptional” natural disasters, and that it would be a no-brainer that the worst quake/tsunami to ever hit Japan would count as “exceptional”, that’s not automatic, and the government is apparently not going to make that declaration. I don’t have expertise in Japanese law to say one way or the other, but I’m anxious to see what happens in court down the road.

Supposedly the reason for that is that, because of the public scrutiny, etc., the politics wouldn’t be very good of letting them partially/mostly off the hook. But no matter what, the lay public is going to have a bee in its bonnet about nuclear plants for some time to come now. If the Japanese government leaves TEPCO out to dry on the liability thing, despite the unprecedented size of the natural disaster and the existing laws, that could send a chill down corporate spines, and that would really sink nuclear power in the country (and possibly, everywhere).

Be sure to check out the comments section of my previous post on REITs vs Condos. Rachelle had some good points about the risks of REITs, and I realized that though I much prefer REITs to condos, I didn’t quite emphasize enough that I’m not hugely keen on either. After all, REITs are only 3% of my portfolio now. I’m not sure under what circumstances I’d go to zero allocation — even in my active portfolio, passive thinking on asset allocation means that, to some extent, I’m willing to risk losses to get exposure to a sector. I also explain further what I meant by “somewhat” interest-rate sensitive (TLDR: less leverage than retail condos, and the effective rates today aren’t as far below “normal” 2007 as CMHC-insured residential rates are, so the correction shouldn’t be as bad).

The Globe had an op-ed on the housing bubble here, saying “signs point to a severe housing correction.” Nothing new to BbtP readers (though he does trot out the hot asian money meme). I think the most remarkable thing about this article is not what it says but the very fact that it not only got published as-is in the Globe, but it was featured prominently rather than buried (or in a point-counter-point pair). If I was in a more optimistic mood, I might say that the big drop-off in sales volume for the 2nd half of March and the uptick in such articles in the MSM finally marked the top… but we’ll have to have passed it by months/years before we can really say where the top was. As always, patience.

A good TED talk on apathy in politics. I like his proposed zoning notice for Toronto. The topic of apathy and politics is perhaps particularly apropos with the current federal election.

Oh, humans, can I ever get you to stop relying so much on your limbic system? On the internet today: “nothing is more horrifying or ignorant than to hear the pro-nuke faction rushing forward to boast, as they are doing these days, that nobody-has-died-yet-from-radiation-at-fukushima.” Yes! Damn them for trying to inject facts and rationality into our Fukushima fear and outrage orgy!