Saskatoon wages could drop in a housing bust

Trying to tell Saskatoonians that their house can fall in value is tough enough, try telling them that wages can  fall when most think that this is the place of endless growth is worse.

Right now, housing activity has grown to be over 20%  of Canada's GDP. The most its ever been in two decades. That economic growth is not including the wealth effect that arises when house values rise which leads to more consumer spending.  Once there is a slowdown in the housing cycle and there will be, the only question is how big is the bust? And how will that affect household finances?   In the early 80', western Canadian cities experienced real income losses with the bust of housing and energy.

"However, real incomes in Alberta fell 2.5% in 1981, rose by 1% in 1982 and then fell by a catastrophic 11% in 1983 "

and Toronto in 1990 "But, as was the case in Alberta, real incomes in Toronto plunged by 9% in 1990 and kept falling until 1994. Once again the catalyst for the drop in houses prices appears to have been the economy. "

While the GTA was really the only area in Canada that had a true housing bubble in 1990, we can see the effects of what the recession had on real wages throughout Canada in 1991 in this graph. Wages in certain industries stagnated, while other industries saw wages fall with unemployment rising. Now just think if all the major centers in Canada have a housing bubble bursting  in 2011 and 2012 and what that would do to real wages.

Family incomes look like a yoyo after a housing bust in Alberta in the 80's and Toronto in the 90's.

 

If we go back to 2006-2008 and just think of where the influx of capital came from to launch Saskatoon house prices 56% in 2007 and over 30% the next year. 

Yes, there was some cash coming from Alberta and some cash that was already here but it was all mostly credit.  Remember that housing, especially new buyers, is highly leveraged with credit.  With the help of lax lending standards, credit is what was streamed into the housing market which found its way into the economy and pushed up wages for industries like construction. This was partly due to competition for workers. Construction wages have increased almost 40% since 2005. ( Construction will see the first decline in wages with a housing slowdown)  And the wealth effect from rising assets has made Saskatoon among the nations leaders in retail spending growth over the last 5 years.  But the foundation of wage growth in retail services is also mostly because of credit.



For every step of income growth, it is about 3 steps of credit growth.  Once we hit peak credit, which is pretty darn close, credit growth will contract and with that contraction so will wages.  Since this chart was made, Canadian household debt to income has hit 150%, surpassing US households as they trend lower at 146%.  The US housing bubble burst just under 150% in 2007 before it cruised over 165% with incomes dropping and debt still climbing. 

At the moment the average Saskatoon house price is about 310k and the average Saskatoon household income is about 85k putting the ratio of average house price to income at over 3.6.  Studies have pointed out that industrialized countries with cities that have levels of 3 or less usually do not have housing bubbles.  When most cities in a nation like Canada have levels over 3, it is only a matter of when the bubble bursts.  With a correction in housing prices, and the unsustainable role that credit has played in the housing bubble and economy, we should not be surprised to see a fall in average household incomes as this has happened in previous Canadian housing busts and could definitely happen again.   Once credit growth stops, the unemployment rate will rise leading to falling incomes.  And Saskatoon is no different; a housing bust would lead to falling household incomes.

The Canadian Housing Bubble has caused a Pension Crisis

Last week Jim Flaherty met with provincial leaders to do something about the upcoming pension crisis.  I find it funny they see a pension crisis unfolding but they say there is no housing bubble.  If it was not for people investing and speculating in housing over the last decade due to extremely low interest rates and lax lending standards which has been Government created, Canadians would more money left over each month to save and invest for their retirement.   Instead we have the government trying to solve a retirement problem that has been created indirectly by them blowing up the housing bubble.  It is of no wonder why real estate is about 50% of Canadians net wealth, while in the 90's real estate wealth was just over 35%, while total debt has tripled in ten years.


What do Canadians Pensions look like?

Pension Plans
Registered Pension Plans total just over 6 million people including defined benefit ,defined contribution and other plans.  About 50% of all pension plans are in public sector jobs.  This equates to about 38% of the working population compared to 45% in the early 90's.

RRSP
As for Canadians that save on their own using RRSP's.  Data from 2005
Overall, 6 out of every 10 families in Canada held savings in registered retirement savings plans (RRSPs) in 2005, and these plans had a median value of $25,000, according to a new study.

For people close to retirement The median for the group aged 45 to 54 was $40,000, and for those aged 55 to 64, it was $55,000.

Nearly 90% of families with after-tax incomes of $85,000 or more held RRSPs. This was more than double the proportion of only 35% among families with incomes of less than $36,500.

So RRSP's are not going to help out Canadians.

CPP and OAS
For 2010, the maximum amount is $934.17 for CPP.
While OAS is $524.23.

This works if you like peanuts.

So how much doe we need to retire?

Case 1: Bare-bones ( People who live off CPP and OAS and some savings)
Case 2: Pensions away! ( People with pensions)
Case 3: Pensionless in the city ( People without pensions will need to have over a million saved up)
Case 4: Living large ( A small per centage of Canadians will live like this)

Case 2 and 4 will be about 40% of the population.  Pensionless in the city with 1 million or more saved is going to very rare.  So over half the population will only have CPP, OAS and some meagre savings to fund their retirement.  But these people will need about $300,000 in addition to CPP and OAS to fund a bare bones retirement!  With many of Canadians with their net worth in housing, they will need to sell or tap into that equity for income.  With our economy being 2/3 consumer spending you can see why Governments are scrambling to fix this crisis coming down the road.  And don't forget the baby boomers who are 1/3 of our demographics and have just passed their peak spending years.

If they really want to fix this upcoming crisis, one of the things could do is put regulations in place to make housing affordable for everybody.  Increase the downpayment to 10%, shorten the amortization to 25 years,  do not allow any cash back mortgages to be CMHC insured and capping the amount of equity withdrawn from a house are all good starts.  Prices will revert back to historically averages and then those extra savings can be put into retirement. 

When 6 out of 10 Canadians live cheque to cheque and with housing being the biggest expense, it should seem obvious that the Government should look there first as a way to free up money so Canadians can start to save for retirement. This will be painful for many recent buyers and with 20% of Canadian GDP found in housing activity, there would no doubt be a recession.  But someone will need to be sacrificed to pay for the mistakes of the past decade. Canadians will not emerge from the housing and credit bubble unscathed, either now with mortgage rules being tightened, or down the road when the debt bubble does finally burst.  Many people won't be able to be helped, they are too far gone into debt. 

Make no mistake, the pension crisis is not an easy fix and will take many years to repair, maybe a generation. But if the right steps are taken, starting with deflating of the housing bubble, Canadians can be put on the right path for retirement.

Subprime is alive and well in Saskatoon part 2

Here is the first part from an earlier post about the City of Saskatoon, CMHC and the Saskatchewan Housing Corporation basically giving out subprime loans for different housing projects across the city.

Here is a new development that is encouraging more of the same stuff found in today's Star Phoenix called "New opportunities for home ownership"

Featuring 94 townhomes, all with single, attached garages, Hartford Greens aims at helping families with limited incomes move into their very own home.

Developers, Innovative Residential, say the ambitious $25 million condominium project will expand the opportunities of home ownership to families whose household incomes might otherwise have limited them to the rental property market.

More subprime here with the Mortgage Flexibility Support Program sponsored through the same government entities.

If these mortgages were not insured by CMHC the banks would not even give these loans a sniff.
Did we not learn anything from the US?

Immigration will not save housing

Stats can came out with a report showing an increase in Saskatchewan's population in the third quarter at 0.4%.  Total growth for Saskatchewan this year is 1.5%.  Canada's total population growth this year is forecasted to be 0.8%, which is about average for industrialized countries, but low compared to for emerging countries. 

Compared to the US,
Canada's natural growth rate is 0.3% while its overall growth rate is 0.9%, due to Canada's open immigration policies. In the U.S., the natural growth rate is 0.6% and overall growth is 0.9%.

To see how Saskatchewan population growth compares to some States in the US take a look here.  As we can see there are many States that have averaged more than 1.5% per year and still had their housing bubbles burst.  Arizona has had more than 2% growth per year.  So population growth does not save a housing market from bubble heights.

The Saskatchewan birth rate in 2009 was 14,525 while the death rate was 9,060.  I would expect to see similar numbers for 2010.  With inter provincial migration near zero that would mean for 1.5% growth, Saskatchewan would have gained just over 10,000 immigrants as Statistics Canada attributed more than 60 per cent of Saskatchewan's growth to the influx of immigrants.

We know that for 2010 73% or about 7500 immigrants will go to Saskatoon and Regina with about 4000 going to Saskatoon and 3500 going to Regina.  Now in regards to housing, we know that wealthy immigrants are migrating to the bigger centers in the nation, Toronto and Vancouver while Saskatoon is attracting less wealthy immigrants.  Our University is also attracting more international students from previous years which is pushing up the immigrant growth number. 

Most of the jobs they are filling are the Walmart, Tim Hortons type retail services jobs, while some are going into health care and construction jobs.  This will lead to shortage of housing if population growth continues.  But not in resale housing, but rental housing.  Most immigrants are not moving to Saskatoon with wealth but are moving here to attain wealth.  Recent developments such as condo conversions and builders building fewer rental properties will hurt this City in the not too distant future. Home ownership rates are too high and with possible mortgage rules tightening, there will be less demand for resale housing but more demand for rental housing.  When prices start to drop, people will be less likely to enter into the market.  In many places in the US, it is actually cheaper to own than rent but people continue to rent because prices are still trending downward and people do not want to lose that money.  The psychology of the bubble in reverse. While it is true that most immigrants see home ownership as a stable financial aspect of their lives, immigrants who want to move here might get priced out and look for more affordable alternatives in this Country or other ones.

A US style collapse in Canada?

Today yahoo finance had an article not whether or not there is a housing bubble in Canada but an article that asked "could a US style collapse happen here"

This is not the first article to ask about a Canadian housing bubble bursting and it won't be the last.  But this article was a bit different than usual.  This article went straight for the heart and there was no interviewing a real estate guy to show a rosy outlook. 
Here a some main points.

So a lot of people nearing retirement age are hoping the housing market will stay buoyant until they cash out, allowing them to downsize, pay off their debts and still have plenty of money left over.
A lot of American homeowners used to think that way. But from their peak in 2005, U.S. house prices have fallen almost 30 per cent, and they are still trending lower.

But could a U.S.-style collapse really happen here?
Obviously Bank of Canada Governor Mark Carney thinks so, and last week urged politicians and Canada's banking oligarchs to tighten mortgage lending requirements to slow Canada's plunge into debt.

So does this mean the Canadian real estate market is a bubble that is about to burst?
Only history will answer that question, but if you believe long-term trends matter when it comes to investing, odds are that housing prices will return to the mean. If you use past housing corrections as a guide, a correction could shave 30 per cent off their current values.

This would be about right, since history around the world shows that the average housing bust shaves 35% off and lasts about 6 years.

30 per cent off the value of a Canadian house price would put the average house price at 231k.  35 per cent off would put the average price at 215k.  While I do not believe we will see a US style collapse, Canada's collapse will be worse than previous housing busts in Canada.

 Saskatoon has values added to 2010.

Has Canada overbuilt?

This is a topic that is a bit puzzling.  If Canada has been overbuilding for 10 years, there should be a huge inventory of homes in every market across Canada.  Household formation has averaged 175k annually over the last 10 years while home building has averaged over 200k.  One would think that there should be significant inventory but there isn't.  Why?

In the 80's there was a bit of over building and with the housing bust in 1990, the 90's experienced more household formations than housing completions.  From 2001-2006, part of the overbuilding was to catch up to this gap.  This is from CMHC- Demographics and Housing Construction in 2006.

In the next graph from TD we see that the gap between actual housing starts and new households between 2006 and 2008 spreads even more than the 5 years prior.  An estimation of just over 150k units were overbuilt in those 3 years.

With interest rates being lowered and CMHC relaxing the lending standards for home ownership it is of no surprise that home ownership rates have increased.

 

But that does not explain it all.  Each year Canada experiences a number of housing units lost averaging 4k each year.  But this does not really make much of a dent in the gap.  I think this number might be under estimated by CMHC as there are many small towns that have vacant housing.  In Saskatchewan, at least.

The increase of secondary homes is another way that housing units have been gobbled up.
Around 1.1 million households owned such homes in 2005, approximately 200,000 more than in 1999"

Now this chart does not take into account the last 5 years in which there was a tremendous amount of money, credit and speculation that was poured into secondary homes.  So a significant chunk of the overbuilding gap can be found in secondary home market.  Older homes that were full time residences are now part time residences. 

Other suggestions from CMHC,
Social changes, such as rising divorce rates and shrinking family sizes, are one reason for the long-term drop in household size. The aging of the population is another factor. With advancing age comes the departure of children from the parents’ home and eventually the death of spouses."

"household growth exceeded population growth in all these centres, an indication that the size of the average household continued to fall as it has for decades.

TD wrote a report labelled Overpriced and Overbuilt: Canadian Housing Market Returns to Fundamentals in the spring of 2009.

Looking back on the boom in Canadian homebuilding from 2002 to 2008, it is now clear that unsustainable price increases drove unsustainable levels of building.
The steep erosion of affordability and the persistence of increases in house prices signal that speculation fuelled this inflation. In a self-fuelling spiral, expectations of higher prices were in turn driving prices even higher. This overpricing compelled a level of residential construction that exceeded its fundamental- justified level by approximately 12% during the “housing boom” that ran from 2002 to 2008. The excess was most exaggerated in the past three years.

How does Saskatchewan fare?
"Income growth was quite strong in Saskatchewan during 2007 and 2008. Nonetheless, affordability declined substantially over the past two years, as average resale prices strongly detached from levels justified by long-run fundamentals. Despite leading the country in 2008 with an estimated GDP growth rate of 3.4%, two consecutive years of 30% increases in the average resale price of a Saskatchewan house were nonetheless far in excess of the province’s performance."

The rapid influx of migrants during the past two years did justify some uptick in building. However, housing starts had already well exceeded household formation from 1997 until the end of 2006. Indeed, annual construction of 3,000 units was being sustained during 2000 to 2001 when the number of households in the province was actually shrinking. The overshoot of fundamentals implies that Saskatchewan homebuilders may have sped ahead of what the market could ultimately bear.

This was only a year and a half ago.  Thanks to low interest rates, and a false confidence this will continue forever again, homebuyers and homebuilders feel the good times were back.  And they are.  But for how long? Not long this blogger thinks.


So what does this mean?
Whatever you want to call it, stealth inventory, hidden inventory, shadow inventory, it is out there lurking.  And if we look at CMHC housing monthly, we can see there are many homes under construction at the moment. (3rd most in 10 years). All we have to look at is inventory in the fall of 2008 and we can see inventory can pile up rather quickly when there is a negative shock to demand. This inventory could come out due to house values dropping and speculators panicking, home ownership rates reverting back to the mean, boomers rushing to the exits, amortizations becoming shorter, interest rates increasing, China crashing, a combination of things etc. 

Previous Canadian housing busts had stricter lending

While I have read that at the peak of the lending madness, subprime was 7% of Canada's mortgage market and 25% of the American market, I have yet to see the stats.  But I do hear the false argument that because Canada has a conservative banking system compared to the US, Canada never gave out subprime mortgages to NINJA borrowers, our banks did not need a bailout so our market will not fall. etc, etc.  OK, so let's say I was born yesterday and I believe because of those reasons Canada's housing market will not crash.  How does that explain previous crashes in Canada's housing market?

Some Western Canadian cities in the early 80's took about 25 years to recover in real terms when the early 80's housing bubble popped.  Take a look at where Saskatoon is now.  Yeah, no bubble here!

While Eastern Canada did not experience a housing bubble in the early 80's like Western Canada, Toronto and area had a housing bubble in the late 80's that burst in 1990.  It took well over a decade and a half to recover in real terms.

A time period of CMHC down payment requirements and max amortizations.

1954-1990- Somewhere along this time, 10% became minimum down payment.
1990- 5% was introduced as a trial run, then officially accepted in 1999.
2001 – Genworth (GE Capital) enters the Canadian mortgage insurance market
2001 – CIBC offered below-prime mortgages.
Pre-2003 – CMHC: 5% down with price limit depending on area, 25 yr amortizations, no price limit if 10% or more down
Sep 2003 – CMHC: 5% down, 25 yr amortizations, removed all price ceiling limitations. Now any mortgage would be insured regardless of the cost.
Mar 2004 – CMHC: Flex-Down product allows 5% down to be borrowed and 1.5% closing costs to be borrowed (essentially zero down, but 95% insured)
Mar 2006 – AIG enters the Canadian mortgage insurance market
Mar 2006 – CMHC: 0% down, 30 yr amortizations (Genworth announces 35 yr amortizations)
Jun 2006 – CMHC: 0% down, 35 yr amortizations, interest only payments allowed for 10 years
Nov 2006 – CMHC: 0% down, 40 yr amortizations, interest only payments allowed for 10 years
Oct 2008 – CMHC: 5% down, 35 yr amortizations, investors need 5% down.
April 2010- CMHC did some minor tightening of their guidelines, investors need 20% down.
March 2011- CMHC only allows 30 yr amortizations, restrictions on pulling equity out
You can still get no money down payments from the banks.  Actually, they will give you up to 7% back.

As we can see, lending requirements dropped dramatically since previous real estate busts in Canada.  So, it shouldn't really come as a surprise that home ownership rates have been on the rise. They've climbed from just over 60% in 1971 to about 68% today and appear headed towards 70%.  Compare this to the United States where home ownership peaked at 69% in 2005 and is now below 67% and going further down.

From Edmonton housing bust

You can see why the real estate association does not want a move back to 25 years.  A smaller pool of buyers. Which would decrease prices and sales.  Home ownership rates would also revert back to the historic average.  But this very necessary. 

In the 80's, with stricter lending requirements compared to now, Canadian housing bubbles burst.  This time around, even though we did not experience the same level of American subprime lending, we did experiment with loose lending standards that fueled a housing bubble of epic proportions that will burst.  It is not different here.

Unemployment rate for Saskatoon, past, present, future

Recent home buyers are confident the economy in and around Saskatoon will be strong in the near future.  But the near future is only a couple of years not the 25-35 years the length of a mortgage.  Not only are interest rates going to be different in 5 years ( higher), the job market is really an unknown.  Now I am not saying that recent home buyers will lose their job, but if this City experienced a 10-12% unemployment rate the value of their house would plummet.  Don't think that can happen?  Saskatoon has had double digit unemployment rates as late as 1993. 

Here is a Unemployment rate graph dating back 20 years for all major Canadian cities.

In the last 20 years the unemployment rate for Saskatoon has gone from a high of 12.5% in April of 1991 to a low of 3.5% in Dec of 2006.   For the decade in the 90's the unemployment rate averaged just over 8% but as the decade came to a close the rate was lower than the decade average.  From 1997-2005 the rate averaged about 6.5%. Since 2005 the rate has averaged about 4.5%.  It is currently at 5.6% which is well below the Canadian average of 7.6%.

It is easy to see why the unemployment rate has dropped from the early 90's.  The outflow of people seeking better employment prospects in Alberta contributed to less people on unemployment which equaled a lower unemployment rate from the mid 90's to the mid 2000's. Consumer spending is about 65% of our economy and with interest rates be lowered over the last 2 decades and baby boomers in their peak spending years, consumer spending has been cranked up.   With the commodity boom creating confidence and jobs, the City of Saskatoon doubling spending in 5 years, the wealth effect of the housing bubble, this all adds up to the peak job creation per capita in this City.  How long will this all last?

While interest rates have no where to go but up, the problem will not be rising rates but total debt.  Since our debt to income has surpassed the Americans not only now but at the peak of their credit bubble, it is pretty easy to say that debt levels will choke off some our consumer spending economy.  Equity extraction from homes accounted for an 8% increase in average household disposable income.  Commodities are always in a boom/bust pattern and with possible trouble in China this cycle will keep repeating.  The City shows no sign of slowing down spending which is not too much of a problem now, but it results in a huge problem down the road.  (I'm working on a post about this but very slowly)  With housing activity creating 20% of our GDP, the highest in 20 years, and which can not last forever, its not hard to see it slow down, taking jobs with it as well.  And the boomers?  Their population is about a third of nation and they are entering into slowdown in spending.  This will be huge drag on growth.  While they will create more jobs in health care and other related industries, this will lead to higher taxes and our consumer spending economy will take a huge hit and jobs lost with be greater than jobs created.

Now what the long term future holds for the unemployment rate in Saskatoon remains to be seen.  But with reasons explained above and with all the world in turmoil from the fall out of the worldwide housing and credit bubbles, there should be reason to believe we could experience double digits in the unemployment rate some time in the next 25-35 years.   Sadly, most new home buyers think that is the unthinkable. 

Housing your best investment? A classic sign of bubble behavoir

If you had 63k in 1977 and put it into any of these vehicles, we see that over the long term, housing is clearly a loser at being your best investment.

Shiller mentions that people who believe that housing is your best investment is a classic sign of bubble behavior. 
Who is Shiller?  Only the Wayne Gretzky of real estate economics.

Canada may face housing bust: Shiller ( it has not come true...yet)

How a Bubble Stayed Under the Radar

Understanding recent trends in house prices

Saskatoon real estate: Buy now or be priced out forever( The bubble years)

Buy Now Or Be Priced Out Forever - Not!

"When prices rise faster than their wages, people can obtain less real estate with their income. The natural fear under these circumstances is to buy whatever is available before there is nothing desirable available in a particular price range. This fear of being priced out causes even more buying which drives prices higher. It becomes a self-fulfilling prophecy."

Here a just a few articles about Saskatoon and Regina in 2007, that don't say, but do imply " buy now or be priced out "


“Even though some people are getting a little frightened by what’s happening in the market, we’re still behind other centres as far as housing prices are concerned,’’ Duggleby said.
And with average prices $100,000 below the national average, there’s plenty of room for  price increases, he added. “If you’re waiting for prices to come down, don’t hold your breath.’’

The spring of 2007 has been a different story. The March average selling price of $200,938 represented a 28 per cent hike over the same month in 2006. This rather startling change, combined with the acknowledged shortage of housing inventory, sent many Saskatoon residents to their computers, combing websites in an attempt to get a handle on the estimated value of their own homes.
Going way out on a limb, here is how it looks from my perspective -- by the spring of 2008, the average selling price in Saskatoon will be $300,000

"I guess it might be said that anyone who's out there thinking, 'I'm going to wait to purchase a property because prices are going to come down,' we should encourage them to not think that way."  "We do see people, call them first-time home buyers, caught in the market where they know what's going on, they've heard that prices have been increasing. They're fearful that they will be left out in the dark if they don't get into the market soon," Bittner said

"It just makes sense for folks to get into that market more easily," Kotlar said. "I've heard umpteen stories of people saying, 'I'll get a bonus in June and by then I'll save a couple thousand dollars.' Well by then, the $4,000 they (saved) has been overshadowed by a $15,000 price increase."




But you know what? These guys that made these statements were right.  It became a self fulfilling prophecy.  There definitely was a buzz at the time and herd mentality took over. People heard about the virtues of real estate at work, in the newspaper, on TV, in magazines, on the Internet.  The global wide housing boom bubble had finally reached Saskatoon's doorstep. Who really cared if the long term growth fundamentals of the housing market were not being followed.  As was said in the Leaderpost about Regina's market in 2007 "“We’re just playing catch-up.’’  Even though we all know that argument does not hold any water. If it did, that would mean our housing prices would now need to go in reverse to catch up to the ones that have fallen.

I really believe if the real estate association was really in it for the best interest of its clients, there would be some statements such as" its possible what happened around the world in regards to the housing and credit bubbles could hit Saskatoon".  But you won't see that printed in the Star Phoenix.  As I have said before, there is no long term benefit to a local economy which has high house costs compared to previous history.  There is always the debt that society has accumulated that needs to be paid back in a housing boom or bubble, whatever you want to call it. 

This post is not to rag on realtors, some are great, some are OK, some are bad.  Just like every other profession.  My problem is that the leaders of the real estate association and the people who really know what is going on with this housing bubble have never really stepped up to the plate, past, or present.  Statements like the ones in the paper a few years ago did a lot of damage that most do not realize is coming.  Maybe the people making these statements did not know any better at that time.  Hopefully, in the future, this will change and the right people will make the right statements for the best of the clients.

Saskatoon housing prices inflation adjusted 1980-2010

If Saskatoon housing followed inflation step for step since 1980, the average house price would be about 162k for 2010.  We all know that the average house price for 2010 is about 300k.  (Sorry for the rude additions to the chart.)

The launch to the top is much like what the US housing market did.  And now the US is in free fall. Are Canada and Saskatoon just a few years behind the States or is it different here?

Robert Shiller in 2007 "From 1890 through 1990, the return on residential real estate was just about zero after inflation.In fact, I'm inclined to think there's a good chance that the return on real estate will be negative, substantially negative, over the next 10 years because all booms reverse in the end. "

A couple more articles from Shiller that are must reads, he is the Wayne Gretzky of real estate economics.

Canada may face housing bust: Shiller ( it has not come true...yet)

How a Bubble Stayed Under the Radar

Understanding recent trends in house prices

Mean Reversion"Too often, homeowners make the damaging error of assuming recent price performance will continue into the future without first considering the long-term rates of price appreciation and the potential for mean reversion. The laws of finance say that markets that go through periods of rapid price appreciation or depreciation will, in time, revert to a price point that puts them in line with where their long-term average rates of appreciation indicate they should be. This is known as mean reversion. "

"Prices in the housing market follow this law of mean reversion too - after periods of rapid price appreciation (or depreciation), they revert to where their long-term average rates of appreciation indicate they should be. Home price mean reversion can be rapid or gradual. Home prices might fall (or rise) quickly to a point that puts them back in line with the long-term average, or they might stay constant until the long-term average catches up with them."

At first, it is hard to imagine a drop from 300k to 160k for an average Saskatoon house price.  But then again, it was only 4 years ago the average house price was 160k.  Clearly prices are not supported by the long term fundamentals, but are mostly supported by credit and are ripe to fall.  Will prices go all the way back to the mean reversion?  I don't think so and I don't hope so, but I do expect prices to fall towards the mean reversion in a significant way.  When the bubble bursts, how far it drops and how long it lasts are questions which still remain unanswered.

Saskatoon real estate bubble: A refresher on some stats

Saskatoon
The median house hold income has increased from 49k in 1998 to about 83k in 2010
The average house price has increased from 100k in 1998 to about 300k in 2010.
Saskatoon was not undervalued and the economy was not the reason house prices launched skyward
Saskatoon New Home Price Index increased 67% from 2006 and 2008.
City of Saskatoon spending has doubled in 5 years. Debt has increased 8 fold.


Canada
Total Canadian debt held by families in 1999 was 515 Billion.
Total Canadian debt held by families in 2010 is over 1.5 Trillion.
Average house price in 1999 was 156k.
Average house price in 2010 is about 330k.
48% of Canadian net wealth is in real estate in 2010.  In 1999, it was 38.3%.
20% of Canadians own 69% of net wealth
6 out of 10 Canadians live pay cheque to pay cheque
Our debt to income is worse than the US.  Don't be surprised to see it hit 160% in the next few years.


In the Western World it has been stated that Nations that have the majority of their housing markets with a average house price to average income at 3 or lower and new entry level housing is at 2.5 or lower will avoid housing bubbles.  Saskatoon is well over those levels, as well as many of the cities in Canada. The only question is when Canada joins to rest of the world in the global housing bust.

What does an average housing bust look like? What about Canada?

"We find that asset market collapses are deep and prolonged. On a peak-to-trough basis, real housing price declines average 35 percent stretched out over six years,"


What if the bubble heads are right and there is bubble in Canadian real estate? What would the bust look like?

Economists Carmen M. Reinhart and Kenneth S. Rogoff wrote a research paper that chronicled housing and equity booms and busts over the years from around the world.  If you take a look at the list, you will see some established markets that had their bubble burst in the late 80's and early 90's and then there were the emerging markets that had their bubble burst in the late 90's.  Also in the list are some of the countries who had their bubbles bust in the last couple of years during the global wide housing bubble.  It kind of goes with my theory that housing markets are mostly synchronized around the world especially if they belong to a certain class, ie developed or emerging markets.

THE AFTERMATH OF FINANCIAL CRISES

The US and Japan have been the No.1 and No.2 economies in the world over the past 30 years and Japan experienced a real estate bust so big that they have not recovered from in over 20 years ago.  The US is entering into its 5th year of the bust and prices have farther to fall than the 30% they have so far.  According to Case Shiller: Here Are The 15 Housing Markets That Will Fall The Most By 2012.  The US will definitely experience a more than average housing bust lasting longer than 6 years and a price decline of well over 35%.  And if we look at some the European Countries caught in the housing bubble, they will also experience a bust that lasts longer and is deeper than the average.

Looking at the different cities in the Canadian housing market, it has been 20 years from some ( like Toronto) and others it has been 30 years (western Canadian cities) since they experienced a real estate bust.   Maybe Canada did not have as loose lending regulations, not as much subprime and the same bubble behavior as the Americans.  But if you are reading this site you should know by now that the Canadian housing market has not followed the long term growth fundamentals of a sustainable housing market and will eventually bust.
We never had to follow the Americans down the same avenue to achieve housing bubble status.  We just took a longer and a more conservative avenue to housing and credit bubble status.

It is possible that the US experiences a housing bust that last 15 years and real average prices declines of 50%.  A Canadian housing bust lasting 6 years and real average price declines of 35% would be conservative. 

Canada could tighten mortgage rules: Flaherty and Canadians' debt mountain tops U.S. were the two big stories today, just before for the busiest shopping part of the year.  While our climb to the peak credit ( or close to it) took longer than the US, we finally passed them.  Canada is still going up while they are deleveraging. 

The United States housing market peaked in 2006 while debt kept climbing and incomes started to drop until the debt to income peaked just before the crash of 2008.  One could say that the Canadian housing market peaked in 2010 and even though the housing market could start to fall, debt to income will continue to rise for the next year or so, even if debt spending is curtailed.( I doubt it)  Why?  If history is repeated, real wages will fall.

"However, real incomes in Alberta fell 2.5% in 1981, rose by 1% in 1982 and then fell by a catastrophic 11% in 1983 as unemployment soared in the wake of a collapse in oil prices"

and Toronto in 1990 "But, as was the case in Alberta, real incomes in Toronto plunged by 9% in 1990 and kept falling until 1994. Once again the catalyst for the drop in houses prices appears to have been the economy. "

The US experience and past history show us that real wages collapse when the housing bubble burst.  But the debt remains, while wages fall, creating a debt to income that keeps climbing.  Don't be surprised to see a debt to income of 160% or more within 2 years.

Canadians real estate wealth vs net wealth

If anybody follows Garth Turner's site, you will know that he mentions from time to time he says " the bulk of Canadians wealth is in real estate, this will not end well."  Something like that.  Well, being a numbers guy, I went searching to see what is what.  How much of wealth is tied to real estate and how does this compare to years past?

One of the first things I found was that in 2000 Canada's net worth rises to $3 trillion.  In 2010, net worth is just under 6 Trillion.  For comparisons sake the average house price in Canada was $163,992 in 2000.  In 2010, the average house price in Canada is about $330,000.

Real estate assets comprised 38.3% of the net worth of Canadian households in 1999.
Real estate assets comprised 42% of the net worth of Canadian households in 2005.  With home ownership rates rising from 67% in 2005 to over 70% in 2010 and the average Canadian house price going from 249k in 2005 to 330k in 2010 it is of no wonder that Real estate assets now comprise 48% of the net worth of Canadian households and are the highest in two decades.

Now we see that real estate wealth has increased more compared to other financial assets.  Total debt is about 1.5 trillion. Net wealth of 6 Trillion. So one might think that isn't too bad until you dig a little deeper and find that  The richest 20% of Canadian households control about 69% of the wealth in Canada. The next quintile down possesses a further 20% of our national net worth. Not much is left over for other people. The bottom 60% of households control only 11% of Canada’s wealth. In fact, the bottom fifth of the population possess no wealth and actually owe a few thousand dollars more than they own.

 

Real estate is now 48% of our net worth.  With consumer spending exploding the last 5 years, I'm sure other non financial assets, and vehicles are up from 8% to 10%.  Equity in business is probably still around 10% leaving about 32% of all financial assets in pensions, and non pensions. 

So why does it matter if the bulk of our wealth is in real estate? Wealth is wealth right? Two main problems.  First, the wealth created in real estate is because of debt.  We all know that now. And second,we are boomer heavy in demographics.  About one third of our population are boomers and they just passed their peak spending age in 2008.  Many are house rich and cash poor they will need to cashing out of real estate, downsizing, or take one of those reverse mortgages to fund their retirement.  This chart says it all about demographics.

In the mid 90's real estate wealth comprised of about 35% of total wealth for Canadians.  Back then, real estate was mostly thought of as a place to live in.  No double digit gains or bidding wars.  The average price in Canada went from 146k in 1990 to 156k in 1999.  In 2010,we find that the global housing bubble has burst with only a few countries like Canada left to join.  When it bursts expect real estate wealth to fall to the low 40's to mid 30% of total wealth again and home ownership rates to fall as well.  You will know when this happens.  Real estate will be thought of as a place to live and not as a speculative investment. 

Real estate always a good investment when prices go up?

When house prices rise, the majority of people believe it is a good investment.  What they fail to realise is that it is more expensive to rent from the bank than it is to rent from a landlord.  Plus, moving costs are more expensive when owning compared to renting. 

There is a townhouse that was bought in 2008 for 325k.  I went to the open house back then.  Now is listed for 336k on Saskatoon MLS. Was this a good investment?  Well, lets take a look.
5% down ($16250) at 5.5% over 25 years is a monthly payment of $1884, plus condo fees of $136, house insurance of $58, mortgage insurance of $35 and taxes are $250 = $2327 a month

Total mortgage loan is $317,240.  So after 30 months of paying 43k in interest and 15k in principal, the mortgage is paid down to 302k.  Let's say it sells for 98% of list price.  (330k) So if we use 6%,4%,2%2% for each 100k, realtor fees are $12,600 and other fees are close to 15k.  So this owner is left with 315k and a total outstanding mortgage of about 302k. So this owner turned $16,250 (DP) into $13,000 in 30 months.  Or a loss of $3,250.

And we have not taken into account the cost of "owning" ( fees, taxes, maintenance).  So this person paid $69,810 ( 30 months x $2327a month) to rent $317,240 from the bank for 30 months and then will pay ( if they sell for 98% of list) $15,000 more just to move.

The cost of renting that unit would have been $1450 a month over 30 months ($43,500)  So they could have saved $877 a month renting and if they put the down payment and the monthly savings into a savings account earning 3% they would have just about 45k after 30 months. 

Total cost of renting from the bank and moving $85k.
Total cost of renting from a landlord and moving 44k.

Net return after renting from the bank -$3,250.
Net return after renting from the landlord $44,800.

And this is with a place that increased in value.  What happens when prices edge down? 

Bond Vigilantes: Could they make their way across the Atlantic to Canada

A bond vigilante is a bond market investor who protests monetary or fiscal policies they consider inflationary by selling bonds, thus increasing yields.
In the bond market, prices move inversely to yields. When investors perceive that inflation risk is rising they demand higher yields to compensate for the added risk. As a result, bond prices fall and yields rise, which increases the net cost of borrowing.

In Europe, the bond vigilantes are feasting in the PIIGS countries.  Each of these countries had a housing and credit bubble that burst and some ask if the boom was worth it.  Some say that bond vigilantes are deemed to be obsolete when countries like the US can print money.  But it was only 16 years ago that the bond vigilantes forced Clinton's administration to reign in spending.  10 year yields climbed from 5.2% to just over 8.0% in 1993-1994.  In 2010, could they be making a comeback in the US to reign in spending? There does seem to be some Shades of 1994 in bond market.

Could they come to Canada? While I don't think they will, it is a possibility.   The feds know what can happen when bubbles burst and spending is out of control.  So they are looking to balance the books and are warning households on their record debt. Heck even the banks know there is a huge problem with household balance sheets and something needs to be done. Inflation is not the problem, it is record debts across the board.  Bond vigilantes would force bond prices down and yields up.  This would push fixed rate mortgages up and demolish many household balance sheets.



Going back to the PIIGS and lets compare their debt to Canada's debt.
From amercia.canada.blogspot

Net government debt is total liabilities minus total assets. Assets can mean different things to each country, but usually includes the savings in public pension plans (CPP) and other financial assets. Net debt is a useful perspective when evaluating the solvency of a country, as countries who have accumulated a significant amount of them can liquidate them in the event of default. Net public sector debt can be referred to as the negative net worth of the country.

Gross government debt is the stock of outstanding government liabilities. The above chart shows what is owed, assuming that Canada does not liquidate its assets such as the Canadian Pension Plan.
Canada is marginally in second place to Ireland in terms of total debt-to-gdp. Canada has significantly higher household debt than all other countries.

If households and governments can not get their debt spending in order , the bond vigilantes may enter into Canada and force austerity upon everybody. You don't want to be neck deep in debt if they do.



Saskatoon inventory, rental market, housing starts and housing under construction update

CMHC came out with their fall rental market.  Nationally, the rental apartment vacancy rate decreased from 2.8% in Oct 09 to 2.6% in Oct 10.  Saskatoon bucked the trend going from 1.9% in Oct 09 to 2.6% in Oct 10.  The availability rate is now at 3.8% up from 3.4% in Oct 09.  Average rent for a two bedroom apartment went up 4% to $934 a month.

Now if I am reading this right, it looks as though percentage of condo apartments in rental vs ownership has gone up from 14.2% in Oct 09 to 19.5% in Oct 10 in the secondary rental market.  So it looks as though there are more landlords this year than last year. Speculation, investment?  I could be reading this wrong, though.

I also took a look on kijiji to see what is being offered for rentals.  There are currently 472 house rentals being offered , 600 apartments for rent and over 550 rooms for rental within 10km of Saskatoon.  Some of these are probably duplicates.  There are other sources such as the Star Phoenix, but I think the majority use kijiji.  It does look like the rental market has eased somewhat.

Note: This is for Saskatoon CMA
As for housing starts November 2010 saw a 29% drop from November 2009 with 256 units started.  Between January and November, starts were 2182 this year compared to 1305 last year in the same time period.
Housing starts were 256 in 2010 Nov
Housing starts were 361 in 2009 Nov
Housing starts were 82 in 2008 Nov
Housing starts were 160 in 2007 Nov.

Note: This is for Saskatoon CMA
As for housing under construction ( Saskatoon is usually on page 96 or near it on the monthly report)
There were 1527 completions and 1821 still under construction this year up to Oct.
There were 1589 completions and 1314 under construction in 2009 up to Oct.
There were 1864 completions and 2335 under construction in 2008 up to Oct.
There were 1182 completions and 2001 under construction in 2007 up to Oct.

For Saskatoon ( not Saskatoon CMA) housing inventory there are 1007 units on MLS, 227 on saskhouses , 341 on kijiji, 20 on property guys.  But many of these are duplicates.  I think total inventory for Saskatoon is close to 1300 for December. 
Saskatoon inventory for Dec 10 will probably end at 900. ( this is mls only)
Saskatoon inventory Dec 09 was about 700
Saskatoon inventory Dec 08 was about 1150
Saskatoon inventory Dec 07 was about 380

Demand in 2011 will need to be stronger than 2010 to offset a possible surge of listings to record highs in the spring.  Builders are still going quite strong and there are almost 500 more units under construction now compared to this time last year.  Much of 2010 sales were front loaded with the scare of interest rate increases and renters jumping into the market.  

I am forecasting the spring of 2011 to have the second highest levels of inventory of recent years.

City of Saskatoon spending boom

The capital and operating budgets came out today for the City of Saskatoon.  In the past years, the captial budget would come out in December and the operating budget would come out the spring. 
From the report

"The City of Saskatoon’s 2011 Preliminary Budget proposes combined capital and operating investments of approximately $678 million, with approximately $352 million going to capital projects, and $326 million going toward paying for the City of Saskatoon’s operations"

The 2010 capital budget was 326 million.  So the spending increase to 352 million in 2011 does not disappoint. Just think, in 2006 spending was 165 million.

 "Saskatoon’s economic fortunes began to change in late 2006. Since that time, Saskatoon has welcomed approximately 20,000 new residents to our city"

Hmmm. City spending started its lift off then and the housing bubble and the consumer credit bubble also started their lift off as well. Our economic fortunes have not really changed, mostly its our appetite for debt has increased. Total inflation has been a paltry 8% since 2006.  So we needed to spend almost 200 million per year to accomodate 20,000 new residents?

 "Since 2005, as shown in the chart below, the median price of a home has grown faster than the median income, resulting in an erosion of housing affordability."

*Historically, an index value of 3.0 has been considered to be "affordable" 

"Although housing is not a traditional responsibility of the City of Saskatoon, the City is aware of the impacts that the lack of affordable housing options has on the individuals, families, the economy, and the community. As a result, the City of Saskatoon has adopted an innovative Housing Business Plan (subprime)to help encourage the building of more affordable housing options in the city."

In the western world, it has been proven when most markets of a nation ( some markets can be above the index of 3, Vancouver, Victoria and be ok) have an index level at 3 or lower and new entry level housing is at 2.5, housing bubbles do not form.  The above chart says it all.  And new entry level housing?  When the smallest lots in Evergreen are 105k and the cost of buildng is about $200 sq/ft, there is no way Saskatoon can fall under the index of 2.5 when the average household income is about 80k.

"Borrowing

The 2011 Capital Budget contains borrowing of $49.7 million for a number of projects including the Circle Drive South Project, the Police Headquarters, and a number of utility projects. While borrowing is budgeted for projects as a source of funding, the actual borrowing is based on cash flow requirements. The total outstanding debt is expected to be an estimated $174.8 million by the end of 2011, which is well within the approved debt limit of $400 million for the City."

Looks like the City upped their debt limit from 298 million.  While the 174 million in debt is not a concern yet, debt has increased 8 fold since 2003.  The concern is when housing and consumer spending slows, so does revenues.  Will the city curb spending then? Expect the traffic bridge, bus barns, etc spending to add to the debt total as the Federal Government embraces austerity.  In the next few years, the City will be borrowing more because the Feds will not be increasing spending.  In fact, they will be cutting spending as they know what happens when there is too much debt( Europe, PIIGS).

A couple of points

Property taxes have increased over 30% since 2004.

City spending has more than doubled since 2005.

Total debt has increased from 23 million in 2003 to over 170 million in 2011.

Water rates are increasing 7%.

Property taxes are increasing 4.65%.

20,000 new residents since 2006.

It was never the economy that pushed up house prices

As I have mentioned before: It was never the economy that pushed up house prices, it was house prices that pushed up the economy.  Usually in a well functioning housing market, inflation rises and puts pressure on wages and then wage growth puts pressure on housing which leads to higher house prices.  Nothing wrong with that.  But it would seem that Saskatoon had it all backwards.  Saskatoon had wild house price growth which led to wage growth and then a rising CPI (inflation).  Looking at the numbers from 1998 to 2010, average house price growth is over 200% ( 100k to 312k) median family income growth is about 51% ( 54k to 82k), inflation is up about 28%. 

Looking back at a CMHC forecast in the spring of 2006 and there was no mention of Saskatoon housing being "undervalued" and prices needing to rise 53% in the next year to be fair value.  CMHC expected house prices in Saskatchewan to rise about 9% even though there were 3800 less people working in 2006 from a year earlier in Saskatoon. So much for the idea that job growth raises house prices.  But the psychology seeds of the world wide housing bubble had just entered onto Saskatoon's doorstep with speculators from Alberta crossing the border only a few months after this report.

Bidding wars erupted and new found wealth was right under their noses: their homes.  The equilibrium of house prices from around the world had entered into Saskatoon.  Years later, everybody knows that the global housing boom was a bubble funded by easy credit.  But not in Saskatoon, it is different here.    Even though wages have not fed the boom, it should be of no surprise the bubble keeps on going.  Record low interest rates, record spending by consumers and governments are producing a false confidence for the market and economy. 
Most people believe this is the "new normal". 
Most people don't see whats coming.

True affordability

RBC came out with their housing affordability report last week and I wondered what the true affordability is for a first time buyer.  So here it goes.

First the measurement of affordability.

The measures are based on a 25% down payment, a 25-year mortgage loan at a five-year fixed rate and are estimated on a quarterly basis.

The five year rate used in the report is 5.5% and 25% down is 78k.  Now we all know that there are very few first time buyers using 78k as a down payment.  According to CMHC, the average down payment for a first time buyer is 7% or about 21k.  I would figure that is about right since we still have subprime and cashback mortgages in Canada that allow 0% down.  I wanted to know what the affordability would look like if an average home buyer only put down 7%.  Here is what it would look like.

As you can see, a smaller down payment makes a big difference in affordability.  In this graph, affordability is just shy of 50% at 49% using 7% as a down payment. Without a doubt, there are more first time buyers putting down payments closer to 21k (7%) than there are down payments of 78K (25%).   

This is what RBC said about housing expenses:

Typically, no more than 32% of a borrower’s gross annual income should go to ‘mortgage expenses’ — principal, interest, property taxes and heating costs (plus maintenance fees for condos).

Yeah, typically!

The Saskatoon Advantage

Saskatoon has the 9th most expensive real estate in Canada.  Not long ago we were one of the most affordable places in the world.

Just a quick reminder on some of the long term growth fundamentals of the Saskatoon's housing market and since 1998 we see that:
Total inflation has increased 28% according to the Bank of Canada
Median family income has increased 67% for Saskatoon.  Median household income has increased far less.
Average rents have increased 75% for Saskatoon
Average house price in Saskatoon has increased about 200%
According to TD in 2009, Saskatoon's affordability was only worse in Vancouver and Victoria.
In 2010, RBC pegs affordability in Saskatoon the highest in the country except for Vancouver, Victoria, Calgary and Toronto.
Average house price in Saskatoon has increased about 200% since 1998

It was not inflation, or wages, or rents that pushed up house prices. 

Canadian Debt
Since 1999:
Mortgage debt has increased over 150%
Lines of credit have increased over 720%
Credit card debt has increased over 358%
The only boom Saskatoon has had is a spending boom backed by credit.

Here are a couple of stories that should make you ask " is this progress?"
 Sask. sees over 20% increase in food bank usage

 In Saskatoon, individual client use of the food bank has increased 25.15 per cent from September 2009. The number of households assisted has increased by 27.66 per cent in the same time period.

Rents must track incomes, because no "creative" financing is available.  Renters can not borrow against their house.  Much of the wage growth is at the top which skews the average wage.  The wealthiest one per cent  accounted for 32 per cent of the growth in incomes during the booming years between 1997 and 2007.  Expect more people to be using the food bank in this so called "boom".

Charities see alarming trends as donors become older, fewer

The number of Canadians making charitable donations is falling sharply and the total amount donated has dropped by nearly $1-billion over the last two years. Meanwhile, the average age of donors has risen to 53, leaving many charities wondering where future funding will come from.

“You begin to worry at a certain point, is this the hollowing out of the middle class? Is this the lack of social connection?”

Nowhere To Go- Homeless in Saskatoon
A short video on Homeless in Saskatoon.

With real estate prices and debt at record levels, is there any wonder why food bank usage is at all time highs and charity donations are falling sharply?

Is this The Saskatoon Advantage?