Garth Turner - Real Estate in Canada

[mcliu]

Out of curiosity, how are people playing this? Short Canadian banks? Canadian development companies?

 

I struggled with that, unfortunately, there's no good instrument to short housing. It's hard to figure out the magnitude/timing and carrying costs for the trade is high. Nothing with attractive risk/reward trades like CDS.

Some possibilities but nothing really worthwhile:

1) Short mortgage insurance (Genworth MI), but carrying cost is high.

2) Short mortgage investment company. Only good candidate is ERM (Eclipse MIC, second tranche of first mortgage + uninsured mortgages), but liquidity is low, sub $30 million market cap, and also high carrying cost.

3) Short banks, but banks carry low LTV or insured mortgages.

 

Maybe the only option is to long government bonds, since a housing crisis will likely lead to big rate cuts. However, the bubble is centered around 2 cities, and US rates are rising.

 

If you live in these cities, maybe you can sell your house, or rent. Become a builder, but there's liquidity risks there if you don't complete in time.

 

Would love to hear if you guys have any ideas.

 

The biggest player from what I see -  a lot of people have become builders over the last decade or so. Depending on how big these guys are - each individual needs to buy at least 1 property each year if not 2. The slightly larger players are south Asians and iranians. The so called builders often own 10-20 properties. All these properties are financed and at different stages - i.e. some have just been bought as inventory for the  following year projects (20% or so), others have had plans submitted to the city another 20% as these will soon be demolished and construction will begin, another group of properties that are mid-way to being completed, and the last group that is completed and on the market.

 

Do you know what kind of financing they're getting and from where?

 

Gary - China has been trying to shut down outflows for a while. Initially it was $50k per person. Then Macau got shut down - was a major source. Then HK bank route got shut down.

 

People were playing with the $50k limit. So now there is a new $200k total limit. So now fake exports are the main source of funds leaving China.

 

What are the chances that authorities in China actually succeed. If that was the sole reason for Vancouver real estate market going up, I would be even more concerned.

 

Also, there's the fact that the amount of mortgage/consumer debt that's been added in the past 7 years in Canada/Australia is much larger than the possible capital outflow that China can inject into the foreign real estate..

[wisdom]

Mcliu - there are many sources of financing - all the way from traditional bank spec financing (Prime + 2.25%) to private financing (14%).

 

For smaller players most of the financing is done on HELOC's on their residence at prime + 0.5% plus a 50% land loan on the new property.

 

Larger players go to banks and are paying around prime + 2% plus fees of 1-1.5%.

 

A lot of pools have come up where  investors pool their funds and lend at 12-14%. They net around 7% after costs. Often the 20% down payment required by the regulators is in fact borrowed from these sources as well which I believe leads to under reporting of the real issue. Individuals are also active in this market. Everytime you hear an ad from a fund or broker that you will be approved as long as you have equity in real estate, this is the source. My understanding is no regulator has any idea about the size of this market.

 

The thing that scares me about these pools is that the money invested in them also includes individuals borrowing on their residences at 3% or so and earning a 4% net spread. This is a source of income for these individuals. If the market ever shuts down, not only  will these individuals lose their incomes and capital, but will owe the amount borrowed against their equity in their residence.

 

For private builders who are not sophisticated or are in a rush, this private financing is often a source of funds. These are usually few in number but the highest risk players. So far the ever increasing prices keep bailing them out.

 

One has to remember this works till the music is playing. The only source of payment on these projects is from the sale of property. If the music stops, the builders will not have the cash flow to even debt service as I believe most properties would not be cash flow positive today if people accounted for maintenance. Several of the properties are at different stages of development and there are no cashflows from them. That is when this market should get interesting.

 

The music has not stopped for 16 years now - the longest cycle so far.

 

The belief is absolute that we live in the only special place in the world and we are headed to having an average house valued at $2 mil now on median household incomes of $75, 000.

[Liberty]

Out of curiosity, how are people playing this? Short Canadian banks? Canadian development companies?

 

I'm renting.

[gary17]

Out of curiosity, how are people playing this? Short Canadian banks? Canadian development companies?

 

I'm renting.

 

Would you ever buy? 

Under what condition in this country would you enter the RE market?

[RichardGibbons]

Would you ever buy? 

Under what condition in this country would you enter the RE market?

 

For me, living in Vancouver, I'd buy a detached home when the cost to buy that detached home is negligible relative to my net worth.  So, I'd treat it like buying a luxury car--a depreciating asset I'd buy for fun, but expect to lose significant amounts of money on.

 

(Alternatively, I'd buy it when the math made sense, but that looks unlikely from here.)

[wisdom]

The way I look at it - why is there a compulsion to buy when things don't make sense. It is different if you understand the math, yet choose to buy because you feel it meets your emotional needs.

 

Upto an individual whether they believe the emotional benefits are greater than the potential risks.

[JBTC]

 

A lot of pools have come up where  investors pool their funds and lend at 12-14%. They net around 7% after costs. Often the 20% down payment required by the regulators is in fact borrowed from these sources as well which I believe leads to under reporting of the real issue. Individuals are also active in this market. Everytime you hear an ad from a fund or broker that you will be approved as long as you have equity in real estate, this is the source. My understanding is no regulator has any idea about the size of this market.

 

 

This is bad. These people will dump when the tide turns.

 

Would be good to know the size of this market indeed.

 

Out of curiosity - do they belong to certain ethic groups, or are they everybody?

 

[JBTC]

So we can't compare real estate prices across different countries, but it is OK to compare their debt levels?

 

I would prefer to compare with historical numbers - Canadian median houses have over the long run been $10k cheaper than the US. Today we are on average $200k higher.

 

Our median house used to be 2.5x income, today it is  lose to 6x.

 

Median house to median household income used to be under 5x in Vancouver and now it is over 12x.

 

Debt to gdp for Canada was 60%, today 100% and increasing faster than GDP.

 

Every single number you compare with historical stats, it is way off. It is always possible that Canada has solved a problem the Americans and Europeans were not able to = more leverage leads to ever inceasing prosperity or we have reached a higher plateau.

 

I remain a skeptic.

 

wisdom,

 

Thanks for pointing out a seeming inconsistency on my part. But let me make myself clear.

 

I don't encourage blind comparisons, not housing prices, not debt.

 

I listed the debt data to suggest one thing - just like Canada, many other countries also have the highest debt level now in their entire history. Not suggesting Canada is not bad; it's worse than most. But this fact helps think about what other factors than Canadian housing might also be at play.

 

Out of all countries, I cautiously mentioned we may need to look at Australia, because of the relative similarity. Australia is worse than Canada in ramping up debt and housing prices, and is holding up for now. But even they are different. For example, Australia allows negative gearing. But let's see.

 

I would not think Denmark is comparable to Canada. I have no clue about what's happening there. But it does us good when we are aware (not comparing) of such debt levels. Denmark and Sweden are among the most prosperous nations on the face of the planet. Maybe they collapse tomorrow, but how are they even sustaining their debt levels? Can some of you live in the Nordic countries help us out?

 

My general approach - the more data the better, generally respect the differences in the world, not in a hurry to conclude, but when data is overwhelming, conclude and invest accordingly.

 

Charlie Munger said it best - All reality must respect all other reality.

 

Our job is to gather these realities and make them respect each other.

 

[JBTC]

Hottest housing market in the world at the moment, according to the article below.

 

1) New Zealand

2) Australia

3) Sweden

4) Ireland

5) Canada

 

Somehow I am not very surprised.

 

http://www.valuewalk.com/2016/03/hottest-housing-market-world/?utm_source=mailchimp&utm_medium=email&utm_campaign=EMAIL_DAILY&utm_content=quick_link&utm_source=ValueWalk+Newsletter&utm_campaign=4549b8ca67-%3DUTMDaily&utm_medium=email&utm_term=0_299e40291b-4549b8ca67-50202589&mc_cid=4549b8ca67&mc_eid=afd3376b93

 

[wachtwoord]

I would not think Denmark is comparable to Canada. I have no clue about what's happening there. But it does us good when we are aware (not comparing) of such debt levels. Denmark and Sweden are among the most prosperous nations on the face of the planet. Maybe they collapse tomorrow, but how are they even sustaining their debt levels? Can some of you live in the Nordic countries help us out?

 

 

Especially Sweden is making the worst socio-economic choices imaginable and I'm expecting an enormous collapse. Norway is already writing contingency plans for closing the border with Sweden (and break the Geneva convention! something huge) if that happens.

[Liberty]

Out of curiosity, how are people playing this? Short Canadian banks? Canadian development companies?

 

I'm renting.

 

Would you ever buy? 

Under what condition in this country would you enter the RE market?

 

Sure. I'll buy when I find a house here at a price that I think makes sense. I'm just buying one house, so I'm not basing this on broad market indicators or anything like that.

[gary17]

It will be interesting if any of this will lead to some break on the rapidly accelerating bubble lol

 

http://www.theglobeandmail.com/news/british-columbia/bc-premier-vows-to-end-shadow-flipping/article29289313/

[wisdom]

Impossible to know what will be the trigger. Be prepared for things to stay irrational for longer than anyone can imagine. Have no expectations and it is far easier to deal with any outcome.

[JBTC]

It will be interesting if any of this will lead to some break on the rapidly accelerating bubble lol

 

http://www.theglobeandmail.com/news/british-columbia/bc-premier-vows-to-end-shadow-flipping/article29289313/

 

The governments can always do plenty. It's curious why they haven't done much. Maybe they are not worried enough.

 

In other hot markets, government actions can often slow the market meaningfully.

 

But for anyone hoping for a crash, it's best to let the speculators run wild and prices go as high as possible.

 

[scorpioncapital]

It's very hard to have major bubbles in a highly regulated economy (Canada may be in the middle of the socialism spectrum but it leans more that way than say the US). This is because pretty much the only thing you can do is squeeze your citizens and most times they just take it.

 

 

 

 

[JBTC]

"Sydney home values fell the most in seven years in the December quarter as a regulatory crackdown amid record prices pushed up mortgage rates and sapped demand.

 

The residential property index in Australia’s biggest city dropped 1.6 percent, the first decline in 13 quarters, according to government statistics released Tuesday. Sydney prices have, however, recovered in the first two months of the year, more recent data from research firm CoreLogic Inc. showed March 1.

 

Home-price growth in Australia’s biggest cities is expected to slow as mortgage-rate increases and tightening lending standards, introduced as prices climbed to a record, hurt buyer affordability. Sydney home values have climbed about 70 percent since the end of 2007, while in Melbourne they have risen about 50 percent, data from the statistics bureau show.

 

Home values across the largest cities in the country expanded 0.2 percent in the December quarter, according to the data. The total value of Australia’s 9.6 million residential dwellings increased A$31.6 billion ($24 billion) to A$5.9 trillion, the data show."

 

[Liberty]

The governments can always do plenty. It's curious why they haven't done much. Maybe they are not worried enough.

 

It's because when 3/4 of people own homes/mortgages, and most of these people have their whole net worth tied to those assets (even when the net worth is deeply negative), you don't win votes by doing anything that might stop the rapid inflation of that asset. All the timid measures are to hope for a slow leveling off and plateauing, but the longer they kick the can down the road (hopefully to the next government, is their thinking), the more delicate things become.

 

A few more years of this and the median house in Canada will be $600k+, an then what? A few more years and it's $800k? $1m? How fast are incomes rising? How fast are debt levels rising? I'd say that over 98% of home owners in Canada are decidedly not wealthy chinese princelings, so what next?

[KCLarkin]

The governments can always do plenty. It's curious why they haven't done much. Maybe they are not worried enough.

 

It's because when 3/4 of people own homes/mortgages, and most of these people have their whole net worth tied to those assets (even when the net worth is deeply negative), you don't win votes by doing anything that might stop the rapid inflation of that asset. All the timid measures are to hope for a slow leveling off and plateauing, but the longer they kick the can down the road (hopefully to the next government, is their thinking), the more delicate things become.

 

A few more years of this and the median house in Canada will be $600k+, an then what? A few more years and it's $800k? $1m? How fast are incomes rising? How fast are debt levels rising? I'd say that over 98% of home owners in Canada are decidedly not wealthy chinese princelings, so what next?

 

Politics is less an issue in Canada than it was in the U.S. The bigger worry is that they will cause a hard-landing by tightening too quickly.

 

The main problem is that the tools that would be most effective (higher interest rates) would have a broader impact on the economy. It would also hurt weak markets like Alberta.

The other problem is that most of the really nasty shenanigans are happening outside the federal regulatory regime.

[Liberty]

Politicians could make the market way more rational by regulating the RE industry so that there's more transparency and realtors are prevented from at least the worst kind of shenanigans (some of what goes on would put those in the financial industry in jail). RE in Canada is super opaque, anti-competitive and anti-consumer (I guess it's like many other industries in Canada..).

 

In fact, it's so opaque that most people don't even realize how opaque it is. You have to go see how it is in some other countries to realize that buyers and sellers have a lot more info about what's going on and don't get all their info funneled through salespeople organizations.

[scorpioncapital]

Transparency usually comes after the bubble is pricked because it helps to prevent the next one, but when in the middle of the bubble, politicians want the opposite since going from opaque to transparent could very well burst it.

[Liberty]

Transparency usually comes after the bubble is pricked because it helps to prevent the next one, but when in the middle of the bubble, politicians want the opposite since going from opaque to transparent could very well burst it.

 

Agreed.

[Liberty]

Anecdote from Vancouver, FWIW, shows some of the mindset going on and the way people get houses they can't really afford:

 

“There is mass hysteria here as people rush to buy now or be priced out forever. I thought things were crazy before, now they are just beyond absurd. It seems like people are doing whatever they can do buy now, including (probably) pledging their firstborn children. Some have this mentality that they must buy to ensure the future of their children, otherwise their kids will never be able to afford a place years down the road, since people seem to have forgotten that Vancouver isn’t the only city in Canada, or the world, that has houses.

 

“A friend of ours has been looking to buy for months, to no success. Outbid on many properties, until they finally found one that had no other offers. Bad location, they made an offer and it was accepted. Price is $800k for a 3 bed townhouse. The bank gave them the bad news: they didn’t qualify for the mortgage. No s**t sherlock, hard to justify a $750k mortgage when the family income is only $70k per year. Following some fancy footwork by the broker (something that seemed to involve kiting cheques between family members)-voila! The deal is done, townhouse is theirs. It seems outrageous to me but this seems like a fact of life these days that it’s an any-price type of game….doesn’t matter what the price is, the broker can help you get the place you want. If the bank doesn’t follow through, private lenders can step in too.

[wisdom]

Another interesting anecdote - a lot of investors/speculators are buying with closing dates out a year or so. They are hoping to flip the property before the closing so that they do not have to qualify for a mortgage. And earn a large return on their deposit on the contract (which can be less than 5% of the purchase price).

 

This can get interesting if they fail in their bid to flip and have no plan B (can not qualify for financing to complete the purchase). The seller may have already signed up on a new purchase. When the buyer does not complete on the initial sale, what happens to the seller? Can they carry 2 mortgages? Where do they get the funds to put down 20% on the their purchase?

 

How long will this game of musical chairs continue?

 

 

[Liberty]

Another interesting anecdote - a lot of investors/speculators are buying with closing dates out a year or so. They are hoping to flip the property before the closing so that they do not have to qualify for a mortgage. And earn a large return on their deposit on the contract (which can be less than 5% of the purchase price).

 

This can get interesting if they fail in their bid to flip and have no plan B (can not qualify for financing to complete the purchase). The seller may have already signed up on a new purchase. When the buyer does not complete on the initial sale, what happens to the seller? Can they carry 2 mortgages? Where do they get the funds to put down 20% on the their purchase?

 

How long will this game of musical chairs continue?

 

Reminds me of the Globe & Mail article a few months ago about how some agents can flip a house 2-3 times before closing, taking a cut each time.

 

Here it is, fascinating stuff:

 

http://www.theglobeandmail.com/news/investigations/the-real-estate-technique-fuelling-vancouvers-housing-market/article28634868/

 

http://www.theglobeandmail.com/news/national/article28634862.ece/BINARY/w940/image.jpg

[JBTC]

The governments can always do plenty. It's curious why they haven't done much. Maybe they are not worried enough.

 

It's because when 3/4 of people own homes/mortgages, and most of these people have their whole net worth tied to those assets (even when the net worth is deeply negative), you don't win votes by doing anything that might stop the rapid inflation of that asset. All the timid measures are to hope for a slow leveling off and plateauing, but the longer they kick the can down the road (hopefully to the next government, is their thinking), the more delicate things become.

 

A few more years of this and the median house in Canada will be $600k+, an then what? A few more years and it's $800k? $1m? How fast are incomes rising? How fast are debt levels rising? I'd say that over 98% of home owners in Canada are decidedly not wealthy chinese princelings, so what next?

 

You are absolutely right the government has an enormous self-interest in maintaining high housing prices. This is partly why most of time owning a house is a rational choice for most people.

 

Here the issue is if the prices are going up too quickly, they make a reversal more likely. Therefore, if the authorities are wise and experienced, it's better to intervene early, and then back off when prices soften. In high-priced markets such as HK, Singapore, Australia, and New Zealand, the authorities do that often.

 

In the news article I sent earlier about Australia, it says prices weakened due to regulatory crackdown. There are numerous things the government can do and they will be effective.

 

My guess is the Canadian government is still not too worried. And with weak commodity prices, they probably want housing to support the economy.

 

In terms of how much more prices can run, although Canada has done a great job catching up, Australian home prices are still 30% higher. I hope Canada doesn't get there soon.