Garth Turner - Real Estate in Canada

[lessthaniv]

Real estate is a leveraged asset in most cases. Since 1981, the cost of borrowing money in Canada has fallen from the peak. Over the same period of time, many households moved from one income earner in the household to two. So, for 37 years the cost of borrowing money has been falling while household income was increasing. It's not surprising then that leveraged assets like real estate were driven up. Especially in a city like Vancouver where land supply is tight. Mountains in the North, water to the West, a border to the South with protected farmland to the East against the backdrop of more mountains. The building in Vancouver these days is up. Vertically. Assessed values are dominated by land values.

 

Looking forward, a change in interest rates increasing the cost of borrowing would likely create a shakeout for the overleveraged, but longer term the land will remain a valuable asset.

 

 

 

 

 

 

[rb]

Real estate is a leveraged asset in most cases. Since 1981, the cost of borrowing money in Canada has fallen from the peak. Over the same period of time, many households moved from one income earner in the household to two. So, for 37 years the cost of borrowing money has been falling while household income was increasing. It's not surprising then that leveraged assets like real estate were driven up. Especially in a city like Vancouver where land supply is tight. Mountains in the North, water to the West, a border to the South with protected farmland to the East against the backdrop of more mountains. The building in Vancouver these days is up. Vertically. Assessed values are dominated by land values.

 

Looking forward, a change in interest rates increasing the cost of borrowing would likely create a shakeout for the overleveraged, but longer term the land will remain a valuable asset.

Don't forget structurally weaker demand and more supply coming in the future as the baby boomers start to die off. Basically all the tail winds that real estate had over the past 30 years are basically turning into headwinds over the next 30.

[gary17]

if i rent in Vancouver the rent is $ 2500 for two bedroom

i can pay $700K mortgage with that, an amount of that goes into principal repayment and then i get to participate in future up side - i'm not flipping it tomorrow, but if i want to retire 15 years from now and move to the suburbs, it'll be good , and all that capital gain is tax-free.    why leave money on the table by renting ?    if you look at the history, major cities in Canada, US and many developed countries just tend to worth more over time than the less-developed 

 

Because rent for a 2 bedroom in Vancouver is less than $2,500, and because the cost of that condo isn't just the interest on the mortgage, but rather includes things like depreciation, insurance, and taxes. What's more, that $2,500 mortgage cost isn't fixed, but rather can increase dramatically with interest rates at the same time as the value of the assets decline. Plus, big, costly things can go wrong.  The risk of owning is far higher than renting, and ignoring those costs is a mistake.

 

So, if you actually care about the math, the math on renting in Vancouver is far superior to buying right now--I'm grateful that my landlord subsidizes my living expenses by hundreds of dollars a month (my two bedroom is $1,600).

 

OK - i don't need to be a math wizard to know those who rented when my dad started out vs those who bought - the latter are doing better now -   

 

OK just keep renting.  we'll know who is right in 30 years....   

 

Gary

 

 

[rb]

OK - i don't need to be a math wizard to know those who rented when my dad started out vs those who bought - the latter are doing better now -   

 

OK just keep renting.  we'll know who is right in 30 years....   

 

Gary

Ahhh... the great theory of value investing: go out and buy assets that have had very large run up in prices.

 

Maybe you should compare your dad's situation to a guy who rented and put his down payment, and savings from repairs, forced principal payments, prop tax etc into BRK and see how that latter guy did vs ur dad. You don't need to be a math wizard for that either.

[CalvinL]

Real estate is a leveraged asset in most cases. Since 1981, the cost of borrowing money in Canada has fallen from the peak. Over the same period of time, many households moved from one income earner in the household to two. So, for 37 years the cost of borrowing money has been falling while household income was increasing. It's not surprising then that leveraged assets like real estate were driven up. Especially in a city like Vancouver where land supply is tight. Mountains in the North, water to the West, a border to the South with protected farmland to the East against the backdrop of more mountains. The building in Vancouver these days is up. Vertically. Assessed values are dominated by land values.

 

Looking forward, a change in interest rates increasing the cost of borrowing would likely create a shakeout for the overleveraged, but longer term the land will remain a valuable asset.

Don't forget structurally weaker demand and more supply coming in the future as the baby boomers start to die off. Basically all the tail winds that real estate had over the past 30 years are basically turning into headwinds over the next 30.

 

It's true that the demand from baby boomers are dying out but I believe all projections point to an increase in population due to immigration, planning around 150k-300k per year. New immigrants likely won't find relatives, friends nor jobs beyond all the major cities.

 

Housing prices is a function of income and leverage applied. I can see how prices would come down if 1. unemployment rates go up 2. interest rates go up. both are actual factors that will make mortgage payment affordable and lower the demand for rental units.

1. is dependent on the economy, and no one has the crystal ball.

2. is something that would likely be artificially kept low. The government both left and right have every incentive to keep the housing market up. I find it hard to imagine a scenario where the government keeps rate high as housing prices come down.

[gary17]

OK - i don't need to be a math wizard to know those who rented when my dad started out vs those who bought - the latter are doing better now -   

 

OK just keep renting.  we'll know who is right in 30 years....   

 

Gary

Ahhh... the great theory of value investing: go out and buy assets that have had very large run up in prices.

 

Maybe you should compare your dad's situation to a guy who rented and put his down payment, and savings from repairs, forced principal payments, prop tax etc into BRK and see how that latter guy did vs ur dad. You don't need to be a math wizard for that either.

 

you assume we didn't own BRK and you assume that everyone knew about BRK 30 / 40 years ago -  i think many BRK owners then also did buy a house    the diff is likely immaterial if BRK is the main driver of wealth.

 

anyway, wish you guys luck and happiness :)  it's just a number game... i can careless lol

[wisdom]

What about other tail winds such as:

1) tighter lending rules - money is getting harder to get.

2) you actually need income now to buy in Vancouver - you did not until recently - asset value or rental income was all that was needed.

3) As a new Canadian you could put down 35% and you needed no Canadian income or credit to borrow 65%. eg. you needed only $500k as an immigrant to buy a $1.5 mil home without income. Not any longer.

4) higher income taxes, property taxes and capital gains on the way. How much does this decrease the NPV?

5) businesses are struggling in Vancouver because of high overheads - real estate prices.

6) Younger families and people moving out thus the city is being hollowed out - schools closing in Vancouver. How long is this sustainable?

7) Government finally starting to crack down on principal residence fraud used to avoid taxes - many builders in Vancouver reported houses that they sold as principal residences and instances of couples reporting 2 separate principal residences to avoid capital gains.

 

Add up all these steps and try adjusting the values for all these factors. We haven't even looked at psychology or that 30% of Vancouver's GDP is real estate or that 25-30% of the households with mortgages in Vancouver have mortgages over 450% of household income or at some point interest rates could rise.

 

But, none of these matter because Canada is nearly out of land, Vancouver is special and all the rich are moving here. Apparently, the same arguments are being made in GTA from what I hear.

[CalvinL]

OK - i don't need to be a math wizard to know those who rented when my dad started out vs those who bought - the latter are doing better now -   

 

OK just keep renting.  we'll know who is right in 30 years....   

 

Gary

Ahhh... the great theory of value investing: go out and buy assets that have had very large run up in prices.

 

Maybe you should compare your dad's situation to a guy who rented and put his down payment, and savings from repairs, forced principal payments, prop tax etc into BRK and see how that latter guy did vs ur dad. You don't need to be a math wizard for that either.

 

If we value a house like a business, how would that look like to you?

 

If people buy property with all cash and then try to rent it out, the rental return is at around 2-3%. Might as well just buy government bonds. The trick right now is to leverage up at low interest cost and magnify that return. 

 

Relative to the current mortgage rate and assuming 2% increase in rent every year, the current prices seem to be in reasonable range - If downpayment is at 20%, deduct all fees/maint/interest/tax the rental income could come in at around 8-15% on the downpayment depending on the building.

 

Of cos, big assumptions: is the current rental price sustainable? what would be the mortgage rate/cost of capital in 5 years after the fixed term? Recent price run up right have deteriorate that return rate further and added risk to the investment, but a big run-up doesn't always mean an asset is already at overvalued category.

 

 

[Peregrine]

What about other tail winds such as:

1) tighter lending rules - money is getting harder to get.

2) you actually need income now to buy in Vancouver - you did not until recently - asset value or rental income was all that was needed.

3) As a new Canadian you could put down 35% and you needed no Canadian income or credit to borrow 65%. eg. you needed only $500k as an immigrant to buy a $1.5 mil home without income. Not any longer.

4) higher income taxes, property taxes and capital gains on the way. How much does this decrease the NPV?

5) businesses are struggling in Vancouver because of high overheads - real estate prices.

6) Younger families and people moving out thus the city is being hollowed out - schools closing in Vancouver. How long is this sustainable?

7) Government finally starting to crack down on principal residence fraud used to avoid taxes - many builders in Vancouver reported houses that they sold as principal residences and instances of couples reporting 2 separate principal residences to avoid capital gains.

 

Add up all these steps and try adjusting the values for all these factors. We haven't even looked at psychology or that 30% of Vancouver's GDP is real estate or that 25-30% of the households with mortgages in Vancouver have mortgages over 450% of household income or interest rates could rise.

 

But, none of these matter because Canada is nearly out of land, Vancouver is special and all the rich are moving here. Apparently, the same arguments are being made in GTA from what I hear.

 

No one argues that recent price increases in the GVA or GTA are sustainable. What prices will do in the future is anyone's guess. In my view, real estate is not likely to be a great investment in the long run for the average person. But I don't think it ever has.

 

Whether housing prices will crash, who knows? But the factors in play in Canada right now are vastly different than what happened in the US a decade ago despite the fact that the two situations often get conflated.

[wisdom]

Banks may have a higher ability to absorb losses, but, the rest of it is the same or worse.

 

Can you explain to me mathematically how does this work:

Americans were too leveraged and had sub-prime thus they ended up with 69% home ownership and $1.5 in debt for every $1 of disposable income.

 

Yet, the risk averse Canadians have 70% home ownership and $1.67 in debt for every $1 of disposable income.

 

How does  a $1 in income earned in CAD allow one to be prudent and risk averse yet carry more debt?

 

And the 70% home ownership is not including all those rich foreigners buying up Canadian real estate with all cash.

 

PS. I would argue that the risk in Canada is concentrated in 2 spots with an economy that is not as diversified as the US.

[rb]

It's true that the demand from baby boomers are dying out but I believe all projections point to an increase in population due to immigration, planning around 150k-300k per year. New immigrants likely won't find relatives, friends nor jobs beyond all the major cities.

 

Housing prices is a function of income and leverage applied. I can see how prices would come down if 1. unemployment rates go up 2. interest rates go up. both are actual factors that will make mortgage payment affordable and lower the demand for rental units.

1. is dependent on the economy, and no one has the crystal ball.

2. is something that would likely be artificially kept low. The government both left and right have every incentive to keep the housing market up. I find it hard to imagine a scenario where the government keeps rate high as housing prices come down.

Yes immigration will continue but the fact is that immigration is nothing new. Canada has had immigration for decades. During that time house prices went up, house prices went down, and house prices went sideways.

 

The idea that the government will prop up real estate with low rates sounds good in theory. Except that interest rates are low right now and real estate ownership is already expensive at current rate levels.

 

In addition I don't understand the arguments that Canada cannot have a US style crash. If prices take a 30% hit they would be down to the level they were roughly one and a half years ago and real estate wasn't exactly a bargain back then.

[rb]

Banks may have a higher ability to absorb losses, but, the rest of it is the same or worse.

 

Can you explain to me mathematically how does this work:

Americans were too leveraged and had sub-prime thus they ended up with 69% home ownership and $1.5 in debt for every $1 of disposable income.

 

Yet, the risk averse Canadians have 70% home ownership and $1.67 in debt for every $1 of disposable income.

 

How does  a $1 in income earned in CAD allow one to be prudent and risk averse yet carry more debt?

 

And the 70% home ownership is not including all those rich foreigners buying up Canadian real estate with all cash.

 

PS. I would argue that the risk in Canada is concentrated in 2 spots with an economy that is not as diversified as the US.

In addition there's the distribution of the debt that isn't covered by overall statistics. In Canada the % of mortgage free households is in the 40s. Pre-crash in the US it was in the 20s. So debt in Canada is more concentrated than it was in the US and thus the indebted households are more levered and vulnerable.

[CalvinL]

On a seperate note:

 

If we are calling things "overvalued" or "undervalued" purely based on historical prices, how's that different from stock price chartists and speculators? To me the intrinsic value of a property is all the future rental income minus all cost discounted to present value.

 

Have anyone crunch the numbers with a model (DCF etc) for their own situation in Canada? Rent vs Purchase, with different rate, rental prices, in dfferent location etc. What are your findings and what surprises you? if current pricing is "too high" or "too low", what would be the right pricing and what's the rationale?

 

It would be interesting to see the assumptions behind certain model that lead to your stand on housing market valuation.

[Peregrine]

Banks may have a higher ability to absorb losses, but, the rest of it is the same or worse.

 

Can you explain to me mathematically how does this work:

Americans were too leveraged and had sub-prime thus they ended up with 69% home ownership and $1.5 in debt for every $1 of disposable income.

 

Yet, the risk averse Canadians have 70% home ownership and $1.67 in debt for every $1 of disposable income.

 

How does  a $1 in income earned in CAD allow one to be prudent and risk averse yet carry more debt?

 

And the 70% home ownership is not including all those rich foreigners buying up Canadian real estate with all cash.

 

PS. I would argue that the risk in Canada is concentrated in 2 spots with an economy that is not as diversified as the US.

 

Without getting into specifics, I would say that the mortgage underwriting in Canada is substantially different than what took place in the US. In fact, I would say that the whole system is entirely different from that of the US. Comparing the two, in my view, is a major false equivalence that has been repeated ad nauseum by some economists.

 

Soundness cannot be solely evaluated on debt-to-income ratios. For one, Canadians have a lot more equity in their homes. And second, the cost to service that $1 in debt has declined substantially.

 

Also, you're painting the US with a broad brush when in fact the US housing collapse was particularly prominent in a few locations. Moreover, it's not the average home buyer that caused the most damage - it was the marginal buyer. So using simple average measures to gauge safety can be misleading.

[Liberty]

OK - i don't need to be a math wizard to know those who rented when my dad started out vs those who bought - the latter are doing better now -   

 

OK just keep renting.  we'll know who is right in 30 years....   

 

Gary

 

If they invested the money that they saved by renting, they probably did better, as RE over long periods doesn't do much better than inflation and equities over time have a nice premium over that. If they decided to spend it instead, that's a different choice, the same as those who are now taking equity out of their houses via HELOCs and spending it on luxury SUVs or downpayments for their kids.

 

Ask the people who bought in Toronto in 1989 how long it took them to get back to where they started. I'll give you a hint: The year starts with a 2.

 

Most people do better  owning their home because it forces them to save, but that's not  really a thing of owning homes, you can save my while renting too. Sometimes one approach makes more sense than the other, houses are not worth owning at any price.

[rb]

Without getting into specifics, I would say that the mortgage underwriting in Canada is substantially different than what took place in the US. In fact, I would say that the whole system is entirely different from that of the US. Comparing the two, in my view, is a major false equivalence that has been repeated ad nauseum by some economists.

 

Soundness cannot be solely evaluated on debt-to-income ratios. For one, Canadians have a lot more equity in their homes. And second, the cost to service that $1 in debt has declined substantially.

 

Also, you're painting the US with a broad brush when in fact the US housing collapse was particularly prominent in a few locations. Moreover, it's not the average home buyer that caused the most damage - it was the marginal buyer. So using simple average measures to gauge safety can be misleading.

This is unbelievable.

 

So debt-to-income rations now don't matter in lending. And Canadian mortgage underwriting is substantially different from the US..... because it's driven mainly by income ratios. <head scratch>. In addition banks don't really have a way to independently verify borrower income and there have been lots documented cases of doctored income.

 

Also as you said average figures don't matter and in the US the marginal buyer was the problem. So Canada is ok because on average Canadians have more equity in their homes and the marginal buyer until recently was able to buy property with 2% down and thanks to a new program in BC they can buy with 0% down over there. Got it.

 

 

[Viking]

Real estate prices in Vancouver are clearly in bubble territory. Prices are up 50% in my area (Langley) in the past 6 years. A 2,400 square foot house (no basement) is worth about $900-$950,0000. This same house might rent for $2,500 per month.

 

Prices have been driven up primarily as interest rates have fallen to historic lows. It is possible to get a 5 year closed mortgage for 2.5%. If you have a $1 million dollar mortgage your interest costs are only $25,000 per year (about $2,000 per month); this is 'cheaper' than what it costs to rent ($2,500) per month. I think this is how many people do the math. My guess is until interest rates move higher (north of 4%) house prices will continue higher.

 

A second factor, especially in greater Vancouver, is the Chinese buyer. This has added to demand. However, with the new capital controls the Chinese government put in place in December it appears demand from offshore Chinese buyers has slowed.

 

Should interest rate jump higher at the same time demand from Offshore Chinses buyers contracts then Vancouver real estate will likely have a hard landing. As with any bubble popping it is impossible to predict the timing.

 

I would not want to be a first time buyer leveraged to the hilt today. Buffett has taught us that you get rich by buying when quality is out of favour (margin of safety); and when quality gets really cheap you lever up and concentrate. In Vancouver today first time buyers are buying at the extreme high and they are using maximum leverage. Sounds like a recipe for disaster to me.

[Peregrine]

Without getting into specifics, I would say that the mortgage underwriting in Canada is substantially different than what took place in the US. In fact, I would say that the whole system is entirely different from that of the US. Comparing the two, in my view, is a major false equivalence that has been repeated ad nauseum by some economists.

 

Soundness cannot be solely evaluated on debt-to-income ratios. For one, Canadians have a lot more equity in their homes. And second, the cost to service that $1 in debt has declined substantially.

 

Also, you're painting the US with a broad brush when in fact the US housing collapse was particularly prominent in a few locations. Moreover, it's not the average home buyer that caused the most damage - it was the marginal buyer. So using simple average measures to gauge safety can be misleading.

This is unbelievable.

 

So debt-to-income rations now don't matter in lending. And Canadian mortgage underwriting is substantially different from the US..... because it's driven mainly by income ratios. <head scratch>. In addition banks don't really have a way to independently verify borrower income and there have been lots documented cases of doctored income.

 

Also as you said average figures don't matter and in the US the marginal buyer was the problem. So Canada is ok because on average Canadians have more equity in their homes and the marginal buyer until recently was able to buy property with 2% down and thanks to a new program in BC they can buy with 0% down over there. Got it.

 

Your response seems like a jumbled interpretation of what I posted.

 

1) I did not say it doesn't matter, of course debt/income matters but it doesn't completely measure the ability to service that debt. Obviously, all regulated lenders in Canada must qualify borrowers on TDS and GDS ratios. Mortgage debt service ratios are not out of line compared to what it has been in the past.

 

2) The Canadian mortgage market is substantially different from what that of the US for a whole host of reasons that requires a far longer explanation than I care to delve into currently. I don't know why you brought up debt/income.

 

3) You need to provide a minimum number pay slips, notice of assessments, tax returns and sometimes a phone call to your employer to qualify on income at a regulated lender. There are regulatory safeguards to prevent shenanigans from happening but obviously there are still people who will try to get around the rules. Doesn't make it right but it's a reality.  The idea that this is systemic or widespread is completely unfounded and not backed by data.

 

4) I didn't say that averages don't matter - I said that average figures can be misleading. Take a look at Countrywide's annuals back in 2006. Their average credit scores, LTVs and such didn't look bad. It was the marginal borrower that really did them in.

Also, I didn't say that Canada was ok because on average they look better but I would say that mortgages in Canada are a lot more homogenous than the kind of stuff coming out of the US from 2003-2007. There are no exotic products like option ARMs, negative amortizing and teaser rates here. Plus, what's truly sub-prime is a speck of the mortgage market here compared to damn near 1/3 of originations in the US circa 2006.

 

Lastly, I'll leave this:

 

http://condo.ca/wp-content/uploads/2013/12/arrears-mortgage-Canada-United-States-comparison-Condo.ca_.jpg

 

I know that history isn't a predictor of the future, but there's a reason for this.

[rb]

Ask the people who bought in Toronto in 1989 how long it took them to get back to where they started. I'll give you a hint: The year starts with a 2.

And during that period rates went down. A LOT!

 

In other news banks are not very interested in taking credit risk in mortgages:

 

https://www.bloomberg.com/news/articles/2017-02-28/canada-banks-push-back-against-risk-sharing-mortgage-deductible

[cwericb]

NOTE: This thread started exactly FIVE years ago warning of the imminent collapse of the Canadian housing market.

 

Consider those people on this thread who made a decision back then to rent instead of buy because they were sure the “housing bubble” was about to burst. Had they bought five years ago, or four or even three years ago, their - non-taxable - capital gain would have been substantial. But instead they have helped make their landlords wealthy.

 

Contrary to what some may say, buying a house is NOT like buying stocks or most other investments. Different rules apply. If the value of your house drops by 30% you still have your home and a roof over your head. You also have time to sit and wait out housing market corrections. If it takes 10 years, so what, you have just paid off that much more of your mortgage. And at what 3%?

 

Too many people confuse Canadian housing pricing with what happened in the US. That is comparing apples to oranges. Canadian mortgages are not non-recourse mortgages like the US. You can’t just give the bank your keys and walk away. Most Canadian mortgages have either a high ration down payment or are insured by the Canadian government through CMHC. There are also stringent requirements to obtain mortgages in Canada unlike the lunacy we saw south of the border.

 

Are prices are too high in Canada? Well if you believe in the law of supply and demand they obviously are not. Will they correct? Perhaps - in some areas.

 

Also, too many people confuse Vancouver and Toronto as being Canada. There is a lot more to this Country than a couple of cities.

[wisdom]

Too many people confuse Canadian housing pricing with what happened in the US. That is comparing apples to oranges. Canadian mortgages are not non-recourse mortgages like the US. You can’t just give the bank your keys and walk away.

 

There are also stringent requirements to obtain mortgages in Canada unlike the lunacy we saw south of the border.

 

 

These statements are not accurate. I would recommend reading up on this.

 

As you said - Canada has different rules in provinces just as the US does. They are not the same everywhere.

 

EDIT: It does help rationalize why we cannot repeat what the Americans did. So this is understandable. Did Fairfax and Burry take those CDS positions in the US in 2003 and it took till 2008 to play out?

[mcliu]

NOTE: This thread started exactly FIVE years ago warning of the imminent collapse of the Canadian housing market.

 

Consider those people on this thread who made a decision back then to rent instead of buy because they were sure the “housing bubble” was about to burst. Had they bought five years ago, or four or even three years ago, their - non-taxable - capital gain would have been substantial. But instead they have helped make their landlords wealthy.

 

If that's the case, why invest in stocks at all?

 

Why not just put all your money into Canadian housing and watch it double every 5 years?  ;D

[Peregrine]

Too many people confuse Canadian housing pricing with what happened in the US. That is comparing apples to oranges. Canadian mortgages are not non-recourse mortgages like the US. You can’t just give the bank your keys and walk away.

 

There are also stringent requirements to obtain mortgages in Canada unlike the lunacy we saw south of the border.

 

 

These statements are not accurate. I would recommend reading up on this.

 

As you said - Canada has different rules in provinces just as the US does. They are not the same everywhere.

 

EDIT: It does help rationalize why we cannot repeat what the Americans did. So this understandable. Did Fairfax and Burry take those CDS positions in the US in 2003 and it took till 2008 to play out?

 

It is true that there are recourse states in the US - in fact, only 12 are 'non-recourse'. But in practice, many borrowers who were underwater during the foreclosure era still picked up and left in recourse states. Lenders often don't pursue deficiency judgments in a default event due to legal costs, length of delay and uncertain recovery. Defaulting in Canada is a completely different story.

[Yours Truly]

Thank goodness our family selected York Region (Richmond Hill) to settle on which is experiencing one of the fastest growth in the nation................ many thanks to our new Mainland Chinese/Iranian neighbours

[wisdom]

Frank - Canada also has non-recourse mortgages.