Baby, we got a bubble!?

[redfirm]

Actually, the last recession within 9 months (by the end of March 2009 prices were down almost 15%.

Your point about the credit crisis never being over I think is totally a propos. I recall saying exactly this throughout 2009 and 2010. As in the Economist article KA1 refers to, the psyche of the American consumer has been damaged. For that matter, so has the psyche of the consumers in Europe and elsewhere. The Americans started to save. Great but this does not bode well for the economy in the short term. Long term, I have maintained (as have others) that deleveraging will have to occur (like anyone who has maxed out his credit cards, you can't keep adding more charges to it). So the painful bringing of household debt back into sustainable levels, i.e. austerity has to hit the World's largest economy ( and therefore side swipe the Canadian one). Add Europe's economy slowing, China already with inflation and a low peg Yuan not being able to sell, and the whole World could feel a massive shock. China, India, Brazil etc. lead us out somewhat of the last recession but this was also facilitated by massive easing by governments around the World. Now things are not better and most governments are far worse off than they were at the start of QE1. So, not to be doom and gloom, but just being logical, how can someone logically explain to me that real estate can continue to buck the obvious need to meet fundamentals at some point. I appreciate that governments may well "mess with the natural market" but in doing so, they simply postpone the eventual reality of the correction.

Fairly accurate analysis of the current situation. Canadian economy, including r/e sector, may be relatively strong, but it is not immune to the rest of the world. Too much bad news all around us ... Right now I'm much more concerned with TSX than r/e, but if this continues, leveraged r/e will be next.

KA1, it will be interesting to see what happens to August average prices. Hopefully not another 3.6% decline as that would be a real concern.

 

[cdr108]

and the chips come falling down:


U.S. triple-A debt rating cut by Standard & Poor’s

Aug. 5, 2011, 10:15 p.m. EDT

By Steve Goldstein, MarketWatch

WASHINGTON (MarketWatch) — The United States late Friday lost its triple-A debt rating from Standard & Poor’s for the first time in history, with the credit-rating agency saying the political system of the world’s top economy has become less stable and that budget cutting announced earlier this week didn’t go far enough.

S&P lowered its rating on the U.S. by a notch to AA+ and, to compound the embarrassment, said the outlook is negative as well, as it threatened another reduction in two years. The rating agency said the deal reached by lawmakers to cut the federal deficit by an estimated $2.1 trillion over a decade didn’t go far enough, and “America’s governance and policymaking [is] becoming less stable, less effective, and less predictable than what we previously believed.†Read text of downgrade.

S&P, a unit of McGraw-Hill MHP -3.43% , had said in July that $4 trillion in cuts over a decade would be required if the U.S. were to keep its triple-A rating. The U.S. has over $14 trillion in debt, and, even after the deal reached this week, is anticipated to add another $7 trillion over the next decade. Read more on debt-ceiling deal.

By S&P’s analysis, the U.S. debt-to-GDP ratio will hit 85% by 2021.

The move caps a wild day for markets and S&P itself. Multiple press reports indicated S&P had delayed downgrading U.S. debt after the White House — which had received a draft — spotted errors estimated to be worth $2 trillion.

The market impact of the S&P move is uncertain, but the wild 416-point swing in the Dow Jones Industrial Average DJIA +0.54% on Friday was in part influenced by rumors of such a move. The political ramifications also were explosive, with both sides quickly taking to cable news stations to blame each other for the U.S. downgrade.

Fellow rating agencies Moody’s MCO -2.03% and Fitch Ratings have not been as critical as S&P about U.S. finances, as both have affirmed their triple-A ratings. (Moody’s has warned that it may downgrade the U.S. in the future.)

Investors that are required by their mandates to invest only in triple-A-rated debt may still be able to own Treasury bonds if only one firm lowers its U.S. debt rating. It’s also unclear whether Treasurys pledged as collateral in various derivatives trades would be impacted.

The Federal Reserve and the Federal Deposit Insurance Corp. quickly issued a statement saying banks would not have to increase bank capital that was backed by Treasury or other federal-government-backed obligations. The Fed also said discount-window borrowing would not be impacted.

In any case, investors have flocked to Treasurys this week, with government-bond prices seeing their biggest gains in two years, which indicates investors have brushed off concerns that they won’t be paid back.

China effectively has no other option but to buy U.S. Treasury obligations to keep the value of the yuan artificially low.

The rating agencies have been heavily criticized for their role in the credit crisis for not downgrading mortgage-backed securities, but there are few alternatives to their role.

Early Saturday Tokyo time, the Wall Street Journal reported that an unnamed senior Japanese official had said the S&P downgrade wouldn’t affect Japan’s investment policy.

 

[KA1]

Fairly accurate analysis of the current situation. Canadian economy, including r/e sector, may be relatively strong, but it is not immune to the rest of the world. Too much bad news all around us ... Right now I'm much more concerned with TSX than r/e, but if this continues, leveraged r/e will be next.

KA1, it will be interesting to see what happens to August average prices. Hopefully not another 3.6% decline as that would be a real concern.

That will be a great opportunity for the vultures to swoop down and pick up the prize?

 

[KA1]

... Right now I'm much more concerned with TSX than r/e, but if this continues, leveraged r/e will be next.

KA1, it will be interesting to see what happens to August average prices. Hopefully not another 3.6% decline as that would be a real concern.

Earlier, I had made a post half jokingly and half seriously about vultures swooping down. Now a serious post.

I would appreciate Redfirm, Interested, Daveto, Cdr108 and my favourite, CN Tower, to give their opinions as to what happens if the prices keep going down,month by month, slowly and slowly.

What do the individuals, rather investors, do who have committed to buy units, sometime in the future, with a minimum down payment? If you walk away from the commitment, then, you run the risk of developer suing you for breach of contract. Go bankrupt?

Slowing economy would mean, perhaps, loss of jobs. That, in turn, would mean that investors who hope to pay for the mortgage with rental income would be in trouble. If you try to sell the property, then, there will be no market unless you are willing to sell it to the vultures at a deep discount. What do you do? Lick your wounds, if you have the financial means?

I have a unit coming up for possession in AURA, at higher floor, sometime in 2013. I can't away from closing the deal even if the estimated fair market value of the unit might be lower than I agreed to buy at. Similarly for other individuals who have purchased units in various other developments.

I see the scenario as 'split' into 2 parts -- individuals who have the means to face the storm holding on to their investments with the market value lower than the peak but perhaps higher than the cost and individuals who bought the unit, on leverage' suffering financially.

Any other thoughts?

 

[interested]

Ka1, in response.

I believe others as well as myself addressed our views in the past on outcomes:

As I said, I do not believe that even if properties go under and say go 5%-10% below what people have paid, that they will "walk away" since as you point out that does not let them off the hook (unlike US states that had non recourse mortgages).

People who bought 1-5 years ago have already some paper equity (such as yourself in Aura) so even a 5-30% drop drop will simply mean that the price owed is the price paid in 2006-2010. However, the premium of new over existing may narrow accelerating the drop. However, the most recent purchases are likely 2-3 years at least away from completion.

That said, those at the margin; ie, poorly capitalized investors will be stretched. Big time speculators (buying more than 1 property who may be doing so based on 15% but cannot close multiple properties if having too) will be in a different position. The big unknown is what percentage of all the real estate market is borderline at the margin. Of course with decreasing prices that continue, it engulfs even properly capitalized investors/owners eventually. Witness the ongoing spiral in the US that occurred.

People buying to live if they can afford will stay almost certainly ( no walk away mortgage possibility). Investors will initially try to hold on unless it continues a downward decline and can't. Speculators who relied solely on price appreciation and especially if they are stretched will eventually default if prices continuously decrease.

The question I believe will be: if a downward correction starts, will it be saved by relatively low interest rates or will inflation have hit at the same time, thereby driving up costs as prices drop, effectively a double whammy. Or will it be higher interest rates that trigger the decline.

The dichotomy of course is that if real estate is melting and the stock market melting and other asset classes decreasing, how can interest rates go up and stay up if the "real economy" is also doing poorly. The answer I guess is a repeat of the stagflation in the 70's and KA1, based on your posts, you are old enough to remember the tough 70's and also the decline in prices in the late 1970's and 1980's; though granted interest rates where much higher at those times.

I think there will be renters as people cannot afford the homes they bought (as is occuring in the US now). However, clearly again it is a balance question that I do not claim to know the answer to; of whether there is excess renter demand which would support rents, or excess "investor/speculator" supply in which case rents will decrease. Again the decrease may not be too great here since in reverse, the increase in rents at least in the core over the last 10 years has not reflected the increase in prices.

 

[TrickyRicky]

My understanding is that most owners and small investors just eat it during a contraction.

If long and drawn out many over stretched individuals, often realtors have a hard time not going under. Realtors get double hit because not only do they over-leverage themselves and carry larger volumes of units, they also loose their income stream because a) there are too many realtors after the boom cycle b) there are significantly less buy and sell transactions.

Also, the development industry contracts with many small renovators and new agressive developers going under.

I don't predict any of these outcomes. It is just my understanding of contraction scenerios.

P.S. I'm still calling it, May 17th 2011 real estate market peak.

 

[redfirm]

KA1,
I think its too early to panic. Markets go up and down ... nothing new there. Different circumstances will require different actions - well capitalized investors will
hold and weather the storm. It's the ones who "swam naked" and went "all in" that will be exposed. Same goes for r/e. As you know I was sceptical of TO condo market over the last 6 months given that fundamentals were just not there. But suprisingly, I'm not all doom and gloom right now. Still have the same opinion I had before this new round of disturbances started.
Low interest rates, greed and lack of understanding of basic concepts led some people to borrow more than they should. The size of this population will determine the % we go down, maybe a bit of temporary overshoot beyond that...

 

[KA1]

KA1,
I think its too early to panic.

I was sceptical of TO condo market over the last 6 months given that fundamentals were just not there. But suprisingly, I'm not all doom and gloom right now.

I am not at all in panic.

About 10 years ago, a client had given me 1oz of gold wafer, with official receipt from BNS. I am hanging to that 'investment'. As you can see, I am fully diversified -- a finger in the gold and a fist in fully paid r/e and not at all any exposure to stock market. I have no mortgage on any of the properties. 2013 is too far away to worry. I was just asking you and the others to paint a picture if prices keep going down 2/3% month by month.

Can you tell us your reasons as to why you are not all doom and gloom right now. Are you now on my side -- a bull, over long term?

 

[cdr108]

given figures floating around that 70% of the population has bought, that seems to be the limit of any peak.
as the ratio of owners:renters increases beyond that point, it doesn't make any more logical sense as who will rent?

TREB and R/E agents have said investors make up 50-60% of condo buyers, and if there are less renters out there, then that results in excess inventory of rental units ===> rental rates and prices stagnate or drop.

because Ontario does not have non-recourse mortgages, i believe most end-users and small investors will try to wait it out as one typically doesn't want to realize a loss/acknowledge they've made a bad decision/have to declare bankruptcy, plus end-users need a place to live and small investors tend not be over-capitalized.

depending how quickly and dramatic the market corrects, over stretched individuals might either sell some and minimize their exposure; or believe that it'll only be minimal or rebound a-la 2008 so they'll stay put and suffer the consequences.

I know of a few realtors who were flying high in the 1980's and crashed badly losing everything and had to declare bankruptcy.

One of the misconceptions is that Canada will have a flood of foreclosures for it to be bad.
That's not the case because our mortgages are Full Recourse, so end-users will typically be obligated (forced) to continue with their obligations.

Even during the bust of the 1990's our foreclosure rates were very low compared to the current US percentages.

 

[KA1]

TREB and R/E agents have said investors make up 50-60% of condo buyers, and if there are less renters out there, then that results in excess inventory of rental units ===> rental rates and prices stagnate or drop.

depending how quickly and dramatic the market corrects, over stretched individuals might either sell some and minimize their exposure;

What I understand is that if you are an end user and can make mortgage payments, then, over the long term, you can ride out any decline in the prices. Same for the investors with some financial depth. There will be no bubble bust for these individuals.

It is the 'marginal' investors/flippers, with not much ability to stay put, will suffer -- just like the real estate agent(s) that you knew. Correct?

 

[wang888]

looks like low interest environment will continue ... surely means that the housing market wiill be okay right???

its beginning to look like a simple supply/demand issue now since the low interest is here to stay!

 

[Kenny]

looks like low interest environment will continue ... surely means that the housing market wiill be okay right???

its beginning to look like a simple supply/demand issue now since the low interest is here to stay!

A low interest rate is no guarantee against housing price erosion. Just look at the U.S. for a prime example of this fallacy.

IMHO, the recent volatility of the markets will have a substantial impact on Canadian real estate. If the markets shoot up (unlikely), investors may think about moving towards equities instead of real estate. If the markets tank, the average person will be much more leveraged and will be less likely to buy a new house.

The only scenario which will cause real estate prices to remain the same is if the markets beat along in the middle. Uncertainty is keeping people in real estate. Your home has practical value. It feels safe as an investment because it provides safety. Why stick your future into your investment portfolio when most companies are keeping their money in cash reserves? Look at Apple and their $76 billion.

Uncertainty cannot last forever. Eventually someone smarter than everybody else will figure out what the future will hold, and they'll start leading in a particular direction. Then the rest of us will follow like sheep.

 

[interested]

looks like low interest environment will continue ... surely means that the housing market wiill be okay right???

its beginning to look like a simple supply/demand issue now since the low interest is here to stay!

this is exactly what I meant when I said before that government meddling will alter the market. Probably means that the next 2 years things will be stable now that Bernanke has said no interest rate hikes for 2 years. However, again, this is because things are not better. There is no plan. There will likely be more easing if things get rockier. Again, all things pointing to more money and therefore more asset erosion due to inflation.

the longer we go, the worse the pain when things finally unwind. Classic postponing of paying the piper in the hope that somehow we eventually won't have to.

 

[redfirm]

I am not at all in panic.

About 10 years ago, a client had given me 1oz of gold wafer, with official receipt from BNS. I am hanging to that 'investment'. As you can see, I am fully diversified -- a finger in the gold and a fist in fully paid r/e and not at all any exposure to stock market. I have no mortgage on any of the properties. 2013 is too far away to worry. I was just asking you and the others to paint a picture if prices keep going down 2/3% month by month.

Can you tell us your reasons as to why you are not all doom and gloom right now. Are you now on my side -- a bull, over long term?

Sorry, I was not clear in my previous post. All I wanted to say is that I didn't change my opinion one bit over the last two weeks. Still think there'll be correction in the mid term horizon (but not immediate is what I wanted to say!). Long term we'll probably see what we always see: ups and downs. Basic rules apply in long term: buy low, sell high, do not borrow beyond your means, fundamentals!

Interesting to hear that you have no exposure to stock market ... pension? RRSPs, RESPs?

 

[KA1]

Sorry, I was not clear in my previous post. All I wanted to say is that I didn't change my opinion one bit over the last two weeks. Still think there'll be correction in the mid term horizon (but not immediate is what I wanted to say!). Long term we'll probably see what we always see: ups and downs. Basic rules apply in long term: buy low, sell high, do not borrow beyond your means, fundamentals!

Interesting to hear that you have no exposure to stock market ... pension? RRSPs, RESPs?

Thanks for the clarification.

Yeap. No exposure to stock market. Zilch.

Pension is from wasting my youth -- at least a major part of it -- with the Federal government (CRA) before I woke up and started my own bean counting business. Had cleaned my RRSPs to invest in r/e quite a few years ago -- one of the few best decisions I have ever made.