Real estate market to crash? correction due

[vultur]

Otherwise, as you point out yourself, many or most investments would not be made, as the operating return is usually less than the cost of capital, or sometimes less even than could be achieved in a risk-free Canada bond. In a scenario where only the operating income were considered, we would have very little rental real estate available!

Real estate investment analysis quite explicitly takes into account both components of the projected return, the operating income and the anticipated capital gain.

That's where we differ slightly OW. I submit that a stabilized real estate investment (ie where existing rent is at or close to market rent) must yield more than the cost of capital and thus produce positive leverage. In a market like Toronto where new condo rentals are free from regulation the going in rent is the market rent and given the enormous supply coming on stream in most areas of town you can bet the supply will more keep up with the demand in most locations. To assume higher than inflation rental price increases in the future would in my opinion be incorrect and given the high vacancy rate in Toronto in recent years I would argue that the trend is more towards a tougher rental market going forward. That is the way this game has been played as long as I've been involved and those are the rules that I was taught by my predecessors. The higher than bond yield is effectively a benefit that should rightfully be bestowed on the owner for assuming a higher risk activity than parking his capital in a low risk debt instrument (ABCP meltdown notwithstanding).

The recent wave of negative leverage purchases by individuals and syndicate groups who I personally characterize as specuvestors is to me indicative of a trend that was formed under the false assumption that real estate cannot lose value. The fallout from that erroneous assumption is being felt very hard in markets like San Diego, Miami and Los Vegas. In effect, it is a ponzi scheme mentality and not a true investor mentality. Blame the enormous amount of excess capital floating around in the world for this trend of underpricing risk in the market. I recognize that buyers of condos in Toronto in the past several years have seen a reasonable amount of appreciation but I submit that has been more a function of the self-perpetuating trend that can be unwound quite easily than a function of sound investment strategy.

 

[TrickyRicky]

I think we are due for a correction but this may only manifest itself in stagnant price appreciation. The most vulnerable market is the new condo market in my opinion where I would suspect the biggest risk for depreciation might be. Also, someone mentioned the high end market being vulnerable. I don't believe this is the case. High end usually does well in a down-turn. I doubt prices will moderate in either new or resale low-rise homes. Unfortunately for young home buyers I think much of the price appreciation in single-family homes in the city is real and here to stay.

 

[vultur]

You were saying?

Thorpe: Condos Are A Lofty Concern

Jacqueline Thorpe
Financial Post

Tuesday, September 04, 2007

The Bank of Canada is universally expected to hold its interest rates steady at 4.5% tomorrow.

Although the unemployment rate is at a 33-year-low of 6.0%, wages are rising at a 3.7% annual clip, the economy expanded 3.4% in the second quarter and core inflation has been above its 2% target for an entire year, the sludge dripping from North American debt markets is expected to persuade the bank to stay its hand for now.

It will take time to see whether this sludge will contaminate broader lending, mingle with the U.S. housing slump and cause the United States and Canadian economies to slow. Canada also has some sludge of its own to absorb from the asset-backed commercial paper blow-up here.

It is ironic that as the bank holds rates in response to the slump in U.S. housing, it may further stoke a Canadian housing market still on a tear and vulnerable to risks of its own -- like the rising labour and materials costs the bank was previously trying to restrain.

While U.S. building and sales have cratered and prices have dipped 3.2% on the year, Canadian resales rose nearly 10% in July to a new record and average prices jumped 12.6% to a record $311,495.

Toronto high-rise sales, meanwhile, are in their second year of 24% increases year-to-date. The luxury hotel-condo -- usually commanding the top floors of some architectural jewel and bearing a marquee name like Ritz or Four Seasons -- is the latest boom's must-have.

"It is now common to see 2,000-to 2,500-square-foot condos selling for $2-million or more with property taxes and condo fees to match," Sherry Cooper, chief economist at BMO Capital Markets, said in a recent note. "Per square foot, condo prices are now higher than single-family home prices of similar quality and location."

At the Four Seasons hotel-condo in Yorkville for example, a 2,500-square foot condo sells for more than $4-million; a 3,900-square-foot penthouse has a $7.4-million price tag.

Although the prices may not be quite so lofty, they are racing across the country, too, with Saskatoon joining Calgary as the latest hot spot.

Analysts are at pains to point out how the Canadian market is in much better health than the United States.

"The current subprime default rate in Canada is less than 3% compared with 13% and growing for the United States," Warren Lovely, economist at CIBC World Markets said in recent note. And there isn't much subprime debt in Canada anyway. It accounted for barely 5% of mortgage originations during 2005-06, well below the 20%-plus share in the United States, Mr. Lovely said.

As well, Canadians have taken out fewer mortgages with teaser or adjustable rates and they have traditionally relied less on home lines of credit to fuel consumption.

Builders and lenders in Toronto, burnt by the 1990 real estate bust, are smarter too.

"There's a healthy amount of discipline that has been inserted into the Canadian system that was a direct result of the problems of '89, '90, '91," said George Carras, vice-president at RealNet Canada Inc. Typically a project is 60% to 70% sold before a shovel breaks ground. Deposits are also quite significant and required at various milestones over the course of construction.

At the Four Seasons for example, the buyer must put down a $50,000 deposit, followed by additional deposits equal to 25% down at the end of the first year after signing -- with still more than two years to go before occupancy, Ms. Cooper notes.

"There is an incredible rigour around the interim financing, which is typically done after a minimum pre-sales target has been met and enough due diligence is in place -- there is enough money to get their loan back on the completed building," Mr. Carras said.

Yet trouble can come rumbling out of nowhere, as the Canadian ABCP market storm has shown.

Instead of buyers walking away from deposits as prices slid in the United States, Canadian developers might run into trouble grappling with runaway costs, especially if borrowing costs become stickier north of the boarder.

Canada is at, or very near full employment in the construction industry, and competition for labour has become fierce, Mr. Lovely said. Material costs have also soared.

Under a supply-side crunch, a developer might go bust before he can bring his project to completion, leaving buyers hanging.

Mr. Carras agrees the biggest risk for the Toronto market now appears to be execution risk, especially with some 60 of the 160 or so developers building new homes in the Greater Toronto Area having operated for five years or less.

"The things to watch are in the execution risk--being able to deliver the units that are sold, within budget to people that will be closing when they are supposed to be closing," Mr. Carras said. "That's the risk profile of this marketplace because there are a number of people in this space that have not been in this space before."

So far though, the market appears to be functioning smoothly and the condos are flying off the shelves.

But as the U.S. market shows, sentiment can sometimes turn on a dime -- all the more reason for the Bank of Canada to hope this subprime mess sorts itself out and it can get back to raising rates.
© National Post 2007

 

[Observer Walt]

The Toronto Real Estate Board posted August sales figures today. There were 8,059 sales of resale residential properties during the month, a record for August and well above 6,976 for August of last year. Sales year-to-date (YTD) are 67,146, also well ahead of 59,488 at this point last year. The median price year-to-date is $316,000, and the average is $371,022, up from $300,000 and $352,766 YTD respectively as of the August month end last year.

A statistic which is a good indicator of the market trend is "days on the market", the length of time for an average sale to occur. This year, YTD, it is 32 days, compared to 33 at this time last year. It is not taking any longer to market the average property.

It's limited evidence, to be sure, but there is no sign of any "crash" yet. I continue to feel that we'll see some weakening in the "high-end" product, but I think the market volume overall will not drop much, and prices will not decline at all, in the foreseeable future. Some of the recent nervousness in the financial markets will be offset by the unlikelihood of an interest rate increase.

 

[Pep'rJack]

.
Soaring house prices 'unsustainable'

September 13, 2007
Canadian Press

http://www.thestar.com/Business/article/256186


TORONTO – Canadian home price increases are not sustainable in the long term, a report from the Bank of Nova Scotia economics department says.

The fundamentals of Canada's housing market are solid, with little evidence of overbuilding or speculative buying, and a low volume of subprime mortgage lending to risky borrowers, Scotiabank economist Adrienne Warren said today.

"Yet, there is little doubt that current trends are unsustainable," she said.

"Affordability is becoming increasingly stretched for many would-be buyers after almost a decade of rising home prices. More recently, economic risks have increased in the wake of the intensifying financial market turmoil stemming from the U.S. subprime mortgage problems."

Additionally, "from a long-term perspective," there is growing overvaluation in some parts of the country, "a precursor to a period of softening conditions," the report says.

Scotiabank surveyed 15 cities, and all except St. John's, N.L., have inflation-adjusted prices above their long-term trend. The national average deviation was eight per cent, ranging from one per cent in Ottawa to 25 per cent in Edmonton.

"Some deviation from underlying trends is to be expected at the late stage of a housing boom," Warren observed.

"At the peak of the prior two housing cycles in 1976 and 1989, national home prices were 12 per cent and 18 per cent, respectively, above their long-term trend. The smaller degree of overshooting this time around, and the sustainability of price appreciation, may reflect in part an undervaluation of Canadian real estate prices in the late 1990s and into the early part of this decade."

Warren added that Canada's overvaluation is small compared with other countries such as the United States, and price growth ``remains consistent with short-term supply-demand dynamics."

However, she cautioned: "The further domestic home prices climb above underlying economic fundamentals, the greater the risk of an eventual correction."
.

 

[lordmandeep]

so really Toronto will not be hurt to much, while Edmonton will be devastated if the market crashes,

 

[beaconer]

New data show (US) housing market 'in freefall'

http://www.theglobeandmail.com/servlet/story/LAC.20071003.IBHOUSING03/TPStory/Business

WASHINGTON -- The number of Americans signing contracts to buy previously owned homes dropped to the lowest level on record in August as the housing recession deepened.

"The existing homes market is now in freefall," said Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd., in Valhalla, N.Y. "The downside from here is still substantial."

The National Association of Realtors' index of signed purchase agreements fell 6.5 per cent from the previous month, the group said yesterday. The decline was more than economists anticipated and pushed the measure to the lowest level since the organization began tracking purchases in 2001. The gauge plunged 11 per cent in July.

Higher credit costs and lending restrictions after the collapse in subprime mortgages may push the industry downturn well into 2008. Market futures contracts show the Federal Reserve will probably cut rates later this month to avert spillover from the credit squeeze and keep the broader economy expanding.
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The Globe and Mail

Compared with a year earlier, pending home sales were down 22 per cent. Purchases declined in all four regions of the country, led by a slide of 9.5 per cent in the South. The smallest drop was in the West, which notched a fall of 2.7 per cent.

So far, the Fed's half-point rate cut on Sept. 18 has failed to lower mortgage rates and boost demand. Buyers have been further constrained by the tighter lending standards and the shutdown of mortgage lenders such as American Home Mortgage Investment Corp. in early August that closed off access to credit.

"Fewer contracts were being written because of mortgage-availability issues," said Lawrence Yun, a senior economist at the real estate agents group. "More than 10 per cent of sales contracts fell through at the last moment in August, primarily the result of cancelled loan commitments" from lenders.

"There is still no bottom in sight," said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., a New York forecasting firm. "Sales will continue to fall until there is a greater price capitulation by sellers. It still appears that we have not reached market-clearing prices to reduce the inventories of unsold existing homes."

Other housing market indicators have pointed to a second leg down after concerns over subprime mortgage defaults caused credit markets to seize up in mid-August. Sales of previously owned homes fell in August to the lowest level in five years, the Realtors group reported Sept. 25. Two days later, the Commerce Department said new-home sales declined to a seven-year low and median prices dropped the most since 1970.

The stock of unsold homes rose to a record of 5.1 million in August, forcing builders to further scale back projects. Housing will continue to hinder the expansion after already reducing growth for the last six quarters, economists say.

As stockpiles climbed and sales fell, home prices in 20 U.S. metropolitan areas dropped 3.9 per cent in the 12 months through July, according to the S&P/Case-Shiller index. The decline was the biggest since record keeping began in 2001. Lower home values threaten to hurt consumer spending by preventing owners from tapping equity for extra cash.

Mounting foreclosures are adding to the problem. The number of Americans who may lose their homes more than doubled in August from a year earlier, according to a Sept. 18 report by Irvine, Calif.-based RealtyTrac Inc.