Blessed by the Potato

In looking for descriptions of what happened in Japan’s economy, and what lead to the sustained low interest rates there, and why the same things don’t apply to Canada, I relied fairly heavily on some posts by John Hempton of Bronte Capital.

One thing that really struck me was his post on the difference between the banking crises of Japan and Korea. Critical to the story of the Japanese banks and the low rates was the tradition, the deeply held psychology that families (especially women) should have large, cash savings.

“The reason is the different banking structure. Korea started its Chaebol industrialisation later than Japan – and the one multi-generational part of the formula (educating young women that they should save and save and save) was just not done as well. This is a multi-generational process.”

That idea of indoctrination is interesting, because I suspect I see something similar in Canada and the US, except our young women are being indoctrinated not to save, but to buy real estate. Think about all the irrational opposition you face whenever you talk with people about even the possibility of a housing correction (or, if you’re one of the ones who just can’t believe me on that point, think about how viscerally you oppose me!). The same sayings/rules of thumb will get thrown out, and when you hear them enough you realize they’re not just rules of thumb, but mantras. “Safe as houses”, “they’re not making any more land”, “why pay someone else’s mortgage”, “renting is throwing your money away”, “you need to own a house to be secure/raise a family”, “it’s different here, real estate is local”, “investments you can touch/live in”. For most of the time (e.g., 1991 – 2004) they’re perfectly valid, but rules of thumb are just that — quick guidelines that aren’t true in all situations.

So armed with these mantras and innovative financing (0%/5% down, long amortizations, plus the gamut of sub-prime dreck dreamed up in the states), our society appeared to be indoctrinating people, young women especially, into puffing up the real estate market. Indeed, all considerations of bubble-like valuations aside, you know things have gotten ridiculous when single 20-somethings are buying places on their own (often sized for just one person). What happens when they find someone that they want to live with, or want to start a family? Ah, but that was just their way of getting “on the property ladder”. My sister, who can’t even buy a bicycle on her own, wanted to buy a place while she’s at school in Kingston to “get on the property ladder” (thankfully, not even the bank of Dad would lend her money to tilt at that windmill). Worried about how high the costs are getting? Don’t be: “buy now, or be priced out forever”. Not so very long ago it would have been very strange for a young person to buy a house/condo on their own — it was almost an admission of spinsterhood, locking yourself into the single condo lifestyle like that. An additional rule of thumb, that you should want to live in a place for 7+ years to make buying worthwhile, seems to have been lost along the way.

Now though there’s a cult of homeownership. Even after explaining the math to them* many people still give me that look when I say I’m looking for a rental when I move back to Toronto. It took months of repeating the explanations to Wayfare before she finally started to agree with me, and even then I can see it’s a tenuous hold, as the irrational hormonal part of her still wants to build and feather a nest of her very own. I was talking to a friend about the preliminary parts of the search for a rental in Toronto. With some places over $2000 per month, it seemed unfathomably expensive to him (to me as well — that much would pay for a very nice detached home in London, inclusive of utilities). “So why aren’t you just buying then?” he asked. Ah, that was easy: if you remember the very simple (though long-winded*) post earlier about the rent vs. buy decision, $2400 per month costs about as much as a $375k house in the medium term, and the places we were looking at were not selling for anywhere close to $375k. The landlords would basically be subsidizing us by taking on the risk of owning a $500-600k house while we lived there.

“Ah,” he says “well there are a lot of nice places along the Danforth for around $400k.” Of course, those places tend to rent for under $2k, so again, renting makes more sense.

“And that area is going up.” he says.

Ah. I see.

That area is going up.

Now, I don’t want to poke too much fun at my good friend, but here’s the thing when people tell me “that area’s going up/gentrifying/turning around”: if that was certain, it would already be up.

Ok, clearly I don’t believe 100% in efficient markets, but nonetheless, I don’t think my friend has a special knowledge of that area that all the other buyers, real estate agents, and investors lack. Given that the rental yields are really not any better than the rest of Toronto, it looks like some measure of gentrification is already priced into the area — and it’s not like the already packed 14′ wide houses can be torn down with more density built in their place. Plus what part of Toronto haven’t you heard someone say is “going up”? Everywhere is either “an exclusive with great schools that will always be in demand” or “a trendy area that’s finally getting the attention it deserves”.

* – very verbosely I must admit, so there’s always the risk of “TLDR” that the mantras don’t face.

Permalink.

“You can’t time the market” is a statement that’s generally true for the stock market — it’s a highly liquid, fairly efficient market full of professionals who all have roughly the same access to information about the future of the market. The shares traded are identical, so as soon as one is traded at a new price, effectively they’re all re-priced, and they’re only traded with the goal of making money — nobody hangs onto a share because it’s what they owned when their daughter took her first steps or because it’s customized just for them. The theory says that any information that could affect the future value of stocks is priced in in short order, so you can’t successfully time the market — getting out before a crash, or in before a surge. At least, not consistently enough to make money. And for the stock market, I think that’s probably true.

The housing market is a different beast entirely. It’s composed of units which are not 100% interchangeable. It’s highly illiquid. The participants are to a very large extent non-professionals who are poorly or even mis-informed about the state and future of the market, and have emotional entanglements to their properties on top of that. Each transaction is negotiated in secret, with pricing details only released some time later — so when one is traded at a new price that incorporates information about the future, it doesn’t necessarily affect other sales.

So when I come on here and piss and moan about how the housing market is getting ridiculous, and how I really fear that there will be a crash/correction to come in the next few years, and people say “you can’t time the market”, well, that’s not entirely true for the housing market, since it’s not as efficient as the stock market. It is true that I can’t say “next June, a month before the BoC’s promise to keep rates low runs out, the market is going to tank 8.53%”. It’s true that I’ve been bearish for over 2 years now, and aside from the beginnings of a correction last fall (a tailspin broken by the low rates), Armageddon has not visited Canadian homes. So in that sense the timing is hard. Getting the exact “when” down is very difficult. It’s certainly not precise. But it’s enough to know that we’re near the “top”, even if we don’t know when the “bottom” will come — the “when” is often not as important as the “how much”.

For the stock market, there is no “renting” of stocks. There’s no set of metrics that tell you reliably when the market is over- or under-valued. P/E ratios, bond yields vs dividend yields, these might be useful clues, but nowhere near as handy as the rent-vs-buy calculation. If a landlord can’t buy a place and rent it out at a profit, then something has to change. It’s also hard to come across telegraphed messages like this:

But if home prices keep bubbling, the central bank might raise rates

If the real estate market momentum does not moderate in the coming year – “or worse still, if price growth accelerates – it could lead to an earlier and more substantial tightening in policy than currently anticipated,”

Not often you’ll see hints from that the central bank is out to keep a bubble under control.

Of course, interest rates are a blunt instrument. There are many interconnecting factors: the dollar is already getting too high vs the USD, hurting our exports in a tenuous recovery. The central bank wouldn’t want to start raising rates to control the over-heated housing sector just to doom the business sector. Even within the housing sector, urban areas have the fever the worst; the Maritimes and more rural areas aren’t too far off of realistic valuations. There are more precise ways to throw water on the housing market, such as taking away 5%-down 35-year insurance.

In all seriousness, I don’t think people have to worry about the BoC jacking rates before their self-imposed timepoint of next summer, unless non-house inflation also takes off. However, the fact that this is on the BoC’s radar at all should be troubling. We are, IMHO, near the top of the market, even if the “when” of the peak may still be another year or two down the road.

Permalink

Everybody’s moving to Toronto it seems lately, and with that comes the inevitable realization that Toronto has a really high cost of living. What’s a cash-strapped recent grad to do? Rent, of course… which always (no matter how many times it’s debunked) brings about the lament that “renting is just throwing money away.”

Of course money is equally thrown away when buying: interest you pay the bank you’ll never see again, likewise property taxes, transaction fees, condo fees, and maintenance. That’s just the cost of putting a roof over your head. The question is, which option will give you the quality of life you want? If one costs less, or offers more freedom, or has fewer risks, or some compromise combination of those, then which you go for might not be all that simple.

I’ve mentioned before the rule-of-thumb that if a place costs more than 150X the monthly rent to buy, then you’re probably better off just renting that. Today as I was explaining this concept I realized it might be easier to understand in reverse:

So, let’s say that you have a place you want to buy. You get a mortgage that is for all intents and purposes approximately the same as the purchase price (that is to say, we’ll assume the opportunity cost on your downpayment is the same as your mortgage rate, or that 80% — or 95% if you’re a first-time buyer in today’s market — is close enough to 100% for our approximation). Every year that is going to cost you your mortgage rate: right now that might be ~3%, but it could easily go back up to 5-7% within just a few years, especially as the economy recovers and the low, stimulatory rates aren’t as necessary. Just look at how quickly the rates came down.

On top of that, you’ll have property taxes: roughly 0.8% in Toronto. A general rule of thumb is that maintenance and repairs will run about 1% per year (condo owners will likely have fewer repairs to pay for on their own unit, but instead will see this vanish as a condo fee; TANSTAAFL). So let’s say 1.8% per year from this stuff.

Real estate is not liquid, and you’ll likely have to pay an agent something like 5% when you move, and lawyers and the governments will take another 2% as well (especially in the Toronto land transfer tax area). If the average person moves around every 5-7 years, we’re looking at a little over 1% per year when we spread things out over the 5-7 years owning the place. Let’s call it 1.2% so that we sum up to an even 3% with the fees above.

A mortgage rate of 5% + 3% of other “throwing money away” costs is 8% per year. 8%/12 = 0.667% per month. If your rent is costing you 0.667% of the purchase price per month, it probably doesn’t matter whether you buy or rent, financially — flip that around and you’ll see that 1/0.00667 is 150, so that’s where the 150X monthly rent rule-of-thumb comes from. And of course that’s really the upper limit; if you instead take 7% as your average interest rate, plus 3% for the other costs, you’re looking at 120X monthly rent, which pretty much defines the “grey zone” where choosing to buy or rent basically hinges on how long you plan to live somewhere and what you anticipate the average interest rate to be (below 100X, and you’re generally staring at a decent investment that you can snatch up and rent out).

Surf MLS for a while and you’ll find that in Toronto places are selling for over 200X rent — go the other way now, 1/200 = .5% per month, or 6% per year is what the cost of shelter is. The only way that makes sense is if your mortgage is at <3%.

And rates are there… for now. And that explains why the housing market came back from the land of the zombies this spring. Things were crashing out as people finally hit the breaking point with the prices the way they were last fall, combined with the general financial panic. Then as rates hit bottom (and they are at bottom — there is no room left for rates to go lower; it’s only up from here) the affordability didn’t look so bad, so prices have been treading water the past few months, much to the dismay of bears such as myself. But I can’t bring myself to believe that prime rate will hover at just over 2% for more than a year; and buying is barely a breakeven proposition at these rates; much higher and we’re back to real estate being overvalued and due for a crash/correction, eventually.

So, what do I mean when I talk about the costs and quality of life? Well, I’m saying that when you look at the money that goes out the door and is lost completely, the cost of shelter, it’s a fairly significant sum — it is the largest component of pretty much every person’s budget. If a place that rents for $1500/mo sells for $300k right now, that’s just about break-even at an interest rate of 3%. At 5% for the mortgage (plus ~3% for your other lost expenses) that place will cost you $24000 per year to own — over six years, you’re looking at $144k down the drain. Not an insignificant amount of money by any stretch of the imagination, and not an implausible rate (in fact, you’d have to pay about that now to lock in for 5 years rather than play the variable rate game). The rent that’s gone will total $108k over those six years, still not easy for some people to accept, but that’s $36k that you’d have extra: you could get an apartment and a car, or just a condo. Housing and a $6k European vacation every year, or just housing. Throw the savings in your RRSP and retire 5 years sooner. This is enough money that it does affect your quality of life, so it’s a decision that should be made with all due diligence. Or, if you find your quality of life best improved by more housing, and you’re able to pay $144k over six years anyway then instead of renting a similar place, you can find a better one and afford to spend $1900/mo in your first year — enough to upgrade from a 1+den to a 2-bedroom with a second bathroom, or into a building with better amenities, or a better neighbourhood, etc.

Note especially that in this scenario the renter is building exactly as much equity as the owner since we haven’t considered the principal repayment portion of the mortgage to be an expense — that’s considered forced savings here (though again, “actually saving” is a better savings plan). Also remember that I am talking about apples-to-apples comparisons: with condos or townhouses I’m comparing as much as possible to the identical units within the same building.

Now, there are of course more “depending on…” factors. For example, people who buy, especially in my recent-graduate-and-fertile age bracket tend to buy more than they need for the immediate few years so they don’t have to move and waste the transaction fees. That is, they skip the “starter house” and go straight to their “forever house”, but have to pay more for that for the first few years when they don’t need the space (that is to say, if they did decide to rent, they’d rent a smaller place because the only cost of moving up in a rental is the stress, the truck rental, and possibly one month of rental overlap — fairly trivial compared to the direct costs and risks of being house poor by overreaching early on). In favour of the home buyer is the fact that the house price gets “locked in” (though IMHO, that’s not a good thing in this market), whereas the renter is subjected to the ~2% yearly increase in rents (although as my experience has shown, this is negotiable). Still, that’s a fairly minor factor: sapping just $360 of the $6k renters benefit in the second year, and up to $2k in the last year, which again is peanuts compared to the risk of interest rates spiking, having your condo levy a special consideration, or some other major repair. For people with poor financial discipline, the principal portion of the mortgage payments are a form of forced savings; for those who don’t need that structure, only paying the “lost” fees gives you freedom for those situations (job loss/paycut, emergency, etc) to not save if you need to use the money, i.e. it’s easier to manage your cashflow, and you can expect a higher return on those savings to boot.

One peculiar trait that I find baffling is that people who are seemingly allergic to debt and leverage seem to not give a second-thought to leveraging up to 95% on an illiquid asset that then in many cases also becomes their only asset (talk about under-diversification!). Indeed, the run-up in prices over the last few years has been fuelled by increasing amounts of leverage (due in no small part to the relaxing of minimum down payments and increasing amortization times). With great leverage comes great sensitivity to interest rates, so listen well to the words of Carney:

“…over time, things will normalize – interest rates will normalize. And the way to think about managing your personal affairs, I would submit, is can I borrow at what would be a normal rate?” Carney said.

Instead of first-time buyers soberly pondering that question after a good night’s sleep, a hot cup of tea, and a spreadsheet, we get people desperately buying something so that they can “take advantage of historic affordability”. Indeed, it is truly baffling how little independent thought people put into the biggest decision of their lives.

Finally, as was pointed out in the RL discussion that prompted this post, nowhere have I mentioned “property appreciation”. And that’s for the simple reason that if you need to rely on the housing market going up at some ridiculous rate (or I should say, continue going up at some ridiculous rate) just to make your purchase make sense, then you are speculating. Plus, while people seem to think housing prices going up is a good thing (and I suppose for buyers it is better than the alternative), what do you do then? Once prices go up do you sell your home and start renting to realize the gains? It seems that while people want to buy something to get in on the boom, they haven’t really thought through what might happen if they’re right: “I’m like a dog chasing cars, I wouldn’t know what to do with one if I caught it!”. Even less do they consider what might happen if they’re wrong: just look at the rest of the world, or even Toronto’s market during the meltdown last fall: housing prices do not always go up. What happens if they go down and you find yourself needing to sell? You’re a typical Torontonian first-time buyer, so you only scrapped together 5% down, and after a few years of living in your house you have maybe 10% equity — the bank owns the other 90%, and unlike in the US there is no jingle mail, you have to service your debts. But, a small made-in-Canada correction has occurred: only a 10% decline in house prices, nothing like what the subprime meltdown in the States was like… but now you have no equity left; no downpayment to buy your next place, yet your psychological biases may nevertheless prevent you from “selling at a loss”. Since you “locked in” your price when things were high, you can’t even just hold on to the place and rent it out, since you’ll be losing money every month (especially when you consider that beyond the “thrown away” money in the above comparison, as a landlord you need to add a vacancy provision, etc.). It’s not a happy scenario… where’s the downside protection?

So now you get to the bottom of this giant rant and you ask yourself: “Why is Potato ranting about this again? He’s made his point very clearly before, how is just working at the valuation in reverse worth a new 1500-word post?” The answer is two-fold: first, as I explained at the top, I was trying to dispell the “throwing your money away” myth with a co-worker, and found the bottom-up rates approach to be a little clearer and help show where the 150X rule-of-thumb came from. The second is that this morning Wayfare sent me a dozen links to Toronto houses. I’m about a year away from finishing my PhD: we are in no position to buy a house — even it was fairly valued — and yet the grip of housing mania, the emotionality of the whole thing is so surreal that I can’t even convince my own wife of the truth of this. Fortunately, with her being self-employed, and myself being a grad student (and I’ll have no job history when we first move back to Toronto even if I do manage to land a job right away), no lender in their right mind will give us the mortgage to hang ourselves with… but I try very hard to not depend on the rationality of 3rd parties to keep myself out of trouble; after all, while lending standards have tightened up a bit recently, lenders still don’t have a reputation for being terribly rational this decade. Still, it’s hard to fight decades of indoctrination and tradition that buying a house — no matter the cost — is just something you do when you get married and graduate. Like putting on funny hats and having old men in colourful robs hood you, it’s just a tradition that may not make any sense, but you do it anyway because that’s what society expects of you. Of course, the one graduation tradition is a lot less costly than the other.

Permalink.

First off, a series of disclaimers.

1. I’m sick at the moment with a nasty hacking chest cold and I just chipped another tooth, so I’ll be looking at another stupid thousand-dollar crown in the near future. I didn’t even bite down on a tic-tac or anything like that: it was just that an old filling was starting to come apart, and I lost part of the tooth as the decay got in and there was only a small bit of natural, healthy enamel left holding the back quarter on. So it would be fair to say that I’m a little grouchy at the moment, so take anything you find offensive in the rant with that in mind.

2. Wayfare has accused me of wanting a housing crash and moreover of wanting reasons to delay buying a home for a few more years and having a case of confirmation bias where I seek out evidence and articles that support a crash coming to Canada. Likewise, I accuse her of the same thing, of wanting to fulfil the dream of homeownership right now so badly that she ignores the doom-and-gloomers and focuses on anything that indicates that now is the best time to buy (or better yet, that January 2010 will be). I hope that the downturn will be quick, like ripping off a bandaid, and that we’ll be back to decent values by then, but I fear it’ll take a few years, like it has in the States. Of course, our respective confirmation biases don’t really help the discussion one way or the other, but it’s important to acknowledge that I do look at the data with an eye to how that housing downturn is coming along.

3. I’ve ranted a few times before about the real estate market, so some of this may seem like a repeat. Hey, what can I say, I just don’t have that much new material, and it’s not that fast-moving a market.

On to the rant, which is really a series of interconnected mini-rants.

Rant #1: the Rent vs Buy rant. I talked a bit about the rent vs. buy calculations before, and discussed the merits of the two ways of finding shelter. In a comment at Bad Money Advice this was put even more plainly: you can rent your dwelling from your landlord, or rent the money for your dwelling from the bank. Anyhow, after talking with a few people (homeowners or hopeful homeowners) about how renting is not blindly throwing your money away some of them came back somewhat vehemently with two points: that you need to own so you can have control over the property, and the forced savings. For the latter a real-world example was used of several people (no one I know closely) who are unable to save unless forced to by a mortgage. Even though they knew owning would cost more than renting (thus depriving them of money they so love to spend) they would rather own because then they build equity. Now this is unfortunately the fault of the CMHC and zero-down mortgages, but someone who can’t save doesn’t need a house, they need help. Whether it’s a shrink or an inappropriately starchy friend with a calculator and some graphing paper, a mortgage is not the answer. For the near term, for the good times they will build equity by having to pay down that mortgage, but that isn’t enough. And, it puts them at risk: if they lose their job and can’t pay the mortgage and have no other savings they could get foreclosed on, lose their house, and their life savings along with it! Whereas someone with actual savings would just dip into that to pay the rent…

The other reason for needing to buy, to personalize your space, is way overstated. People don’t seem to appreciate both how much freedom you do have as a tenant and how little most people actually renovate. Heck, for the first three years after I moved out I had white, barren walls because I didn’t dare paint or put any holes in them. But you can paint however you want, the only stipulation in your lease agreement is usually that you have to paint back to white (or whatever it was) when you leave. Hell, look at my bedroom: the last tenant painted bugs on the walls for her daughter! (they were awesome, so we chose to keep them, which also let us take over the place a week earlier since they didn’t need to repaint, which made moving much easier) Likewise, you can put holes in the walls to hang pictures or install shelves, but you can’t get too ridiculous (I don’t have a legal definition on “ridiculous” though). Moreover, nearly anything is negotiable with your landlord: want a new fridge or stove? Heck, want a natural gas fireplace in the living room? If you’re going to stay there a while and were willing to pay for it anyway, why not discuss it with the landlord? Now of course it’s harder to bring yourself to spring for a full kitchen remodel, or to convince the landlord to bang out a wall to open things up, but those sorts of renovations are much rarer than people seem to feel they might be when they need to have that control — and vice-versa, people looking at condos will find they have much less control over radical renovations than they might think. Sure, at some point in your life you’ll probably want your dream home kitted out just the way you want, but you don’t necessarily need to get into that with the first place you move into after your parents’ basement.

Rant #2: the Silly Real Estate Agents rant. It should be said that there are a number of real estate agents that just need to be taken out behind the shed and put down. It’s a field with very little repeat business, low barriers to entry, oh, and it’s commission-based. So there’s a lot of incentive for agents to be greasy sharks, and to be constitutionally unable to see past their own efforts to rationalize that now is always the best time to buy. They pass off their failures to properly price the market as victories, but the thing that really cheeses my nachos is that they charge tens of thousands of dollars for their services, the most important of which is access to their exclusive listing system, and they can’t even take a minute to proof-read, or spend the $5 to have a high-school student do it for them. That’s leaving alone the issue of not taking advantage of the ability to post pictures to MLS.

Of course, not all agents are all bad, but they can have a silly side. One has a blog that I just found and read a few posts on. He’s a decent writer, and for the most part has his head on his shoulders, but still says a few silly things about property values. In one post he talks about the difficulties of assuming a tenant can pose to selling a property. The points he makes are valid, but he ignores the elephant in the room: that the condo in question is flaberghastingly over-valued (and what rosy realtor(TM) glasses he must be wearing to call it “a very attractive price”). While it can be a pain to deal with a tenant if you just want to just live somewhere, having one who wants to stay can make the life of someone looking for an investment property much easier. In this case a potential investor can’t fool themselves about what market rent might be, it’s right there in the listing that this unit screams overpriced. The asking price of $575k is 230X the monthly rent of $2.5k. At a generous 5% interest rate/opportunity cost on the purchase, the cash flow is already down to about $100/mo, easily coming to a loss with just the condo fee, let alone maintenance or vacancy allowances. Yet just two weeks later this guy talks about a four-plex being overvalued and having poor cap-rates, and at the current rents it is rough, at 270 times rent — but if he’s right and the rent could be $1600/mo for each of the four units, then it’s just 203X, a better buy than the very attractively priced condo he talked about two weeks previously! (and it could be better yet since they added a 5th unit to the basement!) One more example with a price-to-rent of 260X, yet the conclusion is “I’m shocked that this house is available at a ‘paltry’ $1,299,000. But I’m not so shocked that nobody is banging down the door to rent it for $5,000 a month…” Yet again he doesn’t see the buy vs rent logic: if the interest cost alone is closing in on $5000 per month, why wouldn’t someone who wants to live there consider renting it at that price? The only reason I can think of is conspicuous consumption/pride — people don’t rent million-dollar mansions.

There are other factors to consider, of course, not the least of which being the cracked foundation mentioned. But one distinction is that one was a luxury condo, and the other was just a regular brick four-plex. For some reason condos make people in this city stupid. You’d be hardpressed to convince a group of homeowners to band together to pay monthly for services they didn’t really need, like having a surly security guard patrol the neighbourhood at night. But, call him a concierge and have him nap behind a desk and you’ll get condo owners springing for it in their monthly condo fees every time.

To give credit where credit is due, I think anyone thinking of buying a pre-construction condo (if any still exist, as many pre-construction projects have been cancelled) should read his post on why that ship has sailed.

Rant #3: A Conversation With My Dad: In the mid-80’s, my dad left a small job at a major accounting firm to start his own company. His financial consulting business covered a lot of bases, but developed a focus on assisting clients through bankruptcy (or skating around it). In the late 80’s and early 90’s this part of his business took off, and one thing he had to do a lot of was evaluate and dispose of properties. I knew he had been all over Ontario and parts of Alberta looking at houses and to a lesser extent, office buildings, helping to arrange for hundreds to be sold, but I was just a kid at the time and there wasn’t really much call to talk about it since. With the downturn in real estate coming though, it’s looking like old times to him, with the first sign being the freeze in sales, especially at the higher end (and around their house there are dozens of listings that are now closing in on over a year for sale; others that spent months on the markets and were delisted, but still don’t have drapes in the windows).

We took a walk around the neighbourhood one day with the dog pointing out houses for sale, and ones that obviously weren’t lived in. The beginnings of the end could be seen in some, for example one house a builder obviously ran out of money and has been sitting with the inside unfinished. For sale, as-is 1.2M, or 1.46M if finished, and over a year on the market (in another realtor blooper, the picture with the for-sale sign and snow on the ground has a date of February 2008).

Oh, that listing I linked to above with the spelling errors? It’s actually been relisted with a new price and a new host of spelling mistakes (and oops, he also forgot to take the old listing down). $600k to $520k, a 13% decrease. Still more than I’d pay for that house, but getting there. An improvement over the 2% drop for the other pair of houses that have have been sitting for over a year just down the street from that one, and it might actually move.

Back in the very beginning of the 90’s he was faced with a client’s home to dispose of. It was in a small town north of Toronto, and there were a dozen nearly-identical houses all sitting for about the same price — their 1988 price. And some of them had been on the market for over two years without entertaining an offer. But since the last completed sale in that small, illiquid market might have been in 1988, that was the only set of comparables the agents had to work from. It was clear at that point that the only way to get things to move was to “lead the market lower”. So they put the house up at 15% less than all the other homes were at, and they got a buyer. That got the whole market for that town moving again — generally lower and lower each sale until it bottomed out, but at least people who needed to sell could.

This time around it is a bit different. Things are still fairly seized up, and sellers are hoping that the nice weather of spring will make it all better and they can get what their house is “worth”, but the buyers aren’t buying. Someone will probably start leading the market lower before the volume picks up again, but the low interest rates are confounding that, making things appear affordable because the monthly payments are lower.*

We also had a long, painful discussion about what to do about the family cottage in northern Ontario. Last October the stock market was crashing, and it was looking like we would have to sell the cottage; Wayfare and I were up there on our honeymoon, and we very nearly had to hang the for sale shingle on our way out. When things stabilized (however temporarily) and my dad’s heart stopped racing, we were thrilled that, while things were not as good as they were last year, they were not so dire that we would be forced to give up things like the cottage just to keep my parents in retirement. However, over the winter we had some really nasty weather, with snow squalls pretty much every week. My parents didn’t make it up there even once a month, and with my dad’s poor health it’s not like they snowmobile or go boating anymore anyway.

So the issue went from having to sell the cottage to one of maybe we should. On the one hand the cottage costs a fair bit every month to keep up, money that’s just wasted if my parents are only going up once or twice a month now (they used to spend more time at the cottage than in the city, when they did snowmobile and swim and paint the deck or cut down a tree just for the sheer hell of it). They could spend a few months in South Carolina every winter just on the money saved in property tax and energy, let alone the opportunity cost of the equity in it. While they used to sometimes go up just for a few hours and drive back the same night, the cost of gas is not negligible anymore, and not getting cheaper. Plus as painful as it would be to sell now, as frozen as the market is, it’s not likely going to get better in my estimation. We could be the ones to lead the market in that area down, since it’s still frozen for now, and get a decent price (even if it is ~20% less than what we could have got last year). I figure if they’re not enjoying it like they used to, my parents might as well sell it. Being down in London I only make it up there once a year, and my brother only goes a few times a year himself, despite still living in Toronto. However, the other issue is the long-term destiny of the cottage. Despite the expenses, might it be worthwhile to hold onto through the next few years of limited use so it’s still in the family when us kids have the opportunity to go more, when my sister and I finish school and move back to the city?

* – I drafted this in London before leaving for my dentist appointment, but after arriving in Toronto I see that the market, bewilderingly, isn’t completely frozen. There are a half dozen “sold” signs up, and the place across the street from Wayfare’s parents, that had been up for so long the paint on the for sale sign was fading also finally sold (though we have no idea how much any of the properties sold for). Of course, in some cases I have to wonder if the agents weren’t just putting sold stickers up on houses that were merely delisted: one had Re/Max (I think) sign up for 6 months that now has “sold” plastered on it, and right beside it a new for sale sign from another brokerage has cropped up. Either someone is taking this house-flipping thing a little too seriously, or the representation changed after no action was had and a misleading sold sticker was put up (I kind of doubt CREA regulates the use of sold stickers). While I’m a big believer in the rent-vs-buy calculation and price-to-rent ratios for determining when things are overheated, which to me points to at least a 25% downturn needed in Toronto, perhaps 10-15% is all we’re going to get if that’s all the price reduction it took to get these properties moving again… I still feel it’s probably a “bear market rally” driven by low interest rates, nearly meaningless tax credits, and buyers that couldn’t out-wait the sellers… but I’m not as sure of it any more.

I’ve had a number of only vaguely related thoughts on real estate lately, so let’s see if I can string them together into a coherent post:

A report recently came out from UBC asking the question “Are Canadian Housing Markets Over-priced?” The answer was not quite what I expected: the paper figured that Toronto was at equilibrium, Vancouver was 11% overpriced, and Ottawa 25% overpriced. If I were to rearranged those numbers based on my current understanding of the housing market, I would say that Toronto was 11% over, Vancouver 25% over, and Ottawa at equilibrium.

Some people have, naturally, been tearing the paper apart, especially since they rely on ads on Craigslist and in the newspaper to determine the market rent. While this will tend to give a higher rent than might perhaps be the true market rent (since those are the asks and not the actual agreed-upon market rent), I’m ok with using that as a tool to get an estimate. Others complained about how they figured the average (SFH, detached) home price.

My big issue with the paper is how they get to their equilibrium. It understates what the equilibrium yield should be. They include the cost of the capital (mortgage costs), maintenance, taxes, insurance, and then takes out the anticipated capital gains. They say that the market would be in equilibrium when the rental rates equal that net cost of owning. However, that leaves zero profit for taking on the risk and effort of owning/landlording. IMHO, there can’t really be an equilibrium until there’s at least some kind of profit/risk premium margin. If we were to put in even a 2% premium to where equilibrium should be, then the Toronto market for example goes from being balanced at ~$420k for the typical house to being over-valued, with a target of ~$308k to get to equilibrium, a drop of over 25%. Heck, just adding in the amortized transfer costs for owning real estate vs renting (taxes, closing costs, commissions) would up the equilibrium by a percent or two, again indicating that house prices should fall and are not at equilibrium.

That would also bring it more in line with the rules of thumb I’ve read about: for instance, that a house is overvalued when the price is more than 200X monthly rent; a 5% yield (as for the balanced Toronto market in the paper) translates to about 240X, whereas using my arbitrary 7% is a more reasonable 171X. ~125X should be the buy range, which is a gross yield in this sense of 9.6%.

Of course, the more pressing issue is perhaps how they managed to figure in anticipated appreciation into their return. Leaving aside the validity of attempting that at what they admit might be the top of a cycle, it leads to positive feedback and chasing performance: the markets that have gone up a lot then have more anticipated appreciation, so they’re not considered overvalued, whereas the markets that might be in equilibrium are considered overvalued because they didn’t have the price run-up, and so don’t have the same amount of anticipated appreciation to offset high house-to-rent values.

—

The days of bidding wars seem to be coming to an end, but I’ve always wondered about that mispricing. It’s often newsworthy when a house sells for significantly over asking price (sometimes 20% or more). My question/revelation is: how could the house have been so mispriced to begin with? Shouldn’t the selling agent take a drubbing for that one for being so off on setting the asking price? Shouldn’t the buyer’s agent take a drubbing for letting things get so out of hand that a bidding war sent things up that far above the asking/market price? I never see any such issues for the realesnake agents…

—

A recent New York Times op-ed says that the subprime mess wasn’t all bad. After all, “only” ~15% of subprime borrowers defaulted, so those subprime loans helped 85% of people who took them buy their own home, and that’s a good thing… right?

I don’t necessarily see it as good that some of these sub-prime borrowers got to become home owners. Everyone needs an (affordable) place to live, but not everyone needs to be a homeowner. Should young single people be homeowners? It was never really something I thought of single people doing, but there are a lot of condo projects out there with a lot of bachelor/1bedroom units, and a lot of young people jumping into the market earlier in their lives thanks to loose lending. Especially when they’re buying on zero-down — home ownership carries risks and potentially costly maintenance, so these people should have been showing that they could save and budget by coming up with a down payment.

Plus the rampant home inflation/bubble prices caused by suddenly opening the floodgates and letting everyone get credit to buy meant that people who would have been traditional prime buyers suddenly found that housing costs were going up faster than their downpayments were growing, and that they needed to become subprime borrowers themselves in order to “get in before they were priced out forever”.

—

By its illiquid nature and the way the data is kept and tracked, it’s difficult to say what the health of the real estate market is until months after the fact. The anecdotal evidence is not looking too good: it may not be a subprime wasteland in Ontario, but things definitely look to have slowed down. Of course, anecdotal evidence is so unreliable it almost isn’t evidence at all… but that said, I saw my first set of houses up for auction here in London today. They were all student rentals near the university that had been on the market for a while (I think — hard to say if it’s the same houses when I only bike by every couple of weeks). I can’t tell if it’s a bank/foreclosure auction, or if the seller is auctioning themselves just to get things moving.