Why low interest rates will be worse for the housing market in the long term

While we have been hearing " interest rates have no where to go up" quite a bit lately, the fact of the matter is that interest rates have not moved much in the last couple of years and Mark Carney's rate hold for May 31st is of no exception.  With Canadian household debt loads so high, many believe the Government will not crank up interest rates because housing will fall.  Believe it or not, but high interest rates would be good for the economy in the long run.  But first let's take a look on the good, the bad and the ugly on low interest rates.

From the Canadian Finance Blog: "Low Interest Rates: The Good, The Bad and The Ugly"

The Good

In general, low interest rates are good for anyone who wants to borrow money. Here are a few examples:

1. Individuals: 

2. Businesses: 

3. Governments: 

In general, lower interest rates are seen as stimulative for the economy, as consumers tend to buy more, businesses invest more, and governments can afford social programs.

The Bad

Low interest rates are usually not so good for lenders and savers like the following:

1. Older or Retired People: 

2. Risk Averse Savers: 

3. Insurance Companies & Pension Funds: 

Very low interest rates can lead consumers, businesses, and governments to take on more debt. They can also make it very difficult for retirees and other risk averse investors to achieve the returns they need.

The Ugly

Interest rates that are held too low for too long can lead to unintended consequences like asset bubbles, inflation, and other economic dislocations:

1. Real Estate Bubbles: 

2. Commodity Bubbles: 

3. Equity Bubbles: 

4. Debt Bubbles: 

Bubbles don’t become ugly until they pop. There are 2 main problems with any type of bubble: First, they always pop eventually. Secondly, we never know when they are going to do it.

Many believe Canada could experience Japan like interest rates for a decade or more. They believe that low interest rates will save the housing bubble from popping.  While they may be right in the short term,  in the long term, low interest rates are worse for an economy and this is why.

From Seeking Alpha " Artificial low interest rates hurt economies in the medium and long term"

Main­tain­ing arti­fi­cially low inter­est rates or exces­sive money sup­ply does per­ma­nent dam­age to economies in the medium- and long-term because it delays cre­ative destruc­tion, the process of replac­ing low-return invest­ments with higher-return invest­ments.
As long as the inter­est rates are kept arti­fi­cially low, profit from lower-return busi­nesses is pos­si­ble even if it is not sus­tain­able. Hence, the short-term ben­e­fits of arti­fi­cially lower rates are that they keep more busi­nesses oper­a­tional and slow the decline of exist­ing jobs and con­sumer spend­ing – which is what helps keep politi­cians in office and reg­u­la­tors employed.

Lowering of interest rates has definitely helped our Conservative Government over the past couple of years.

How­ever, since there is a finite amount of finan­cial cap­i­tal, the oppor­tu­nity cost of sub­si­diz­ing invest­ment in low-return oppor­tu­ni­ties is lost oppor­tu­nity to invest in high-return oppor­tu­ni­ties. I believe that the longer this pat­tern per­sists, the more dam­ag­ing and the larger the per­ma­nent loss of cap­i­tal, the longer the delay in cre­ative destruc­tion and the lower the long-term growth poten­tial of an economy.

In the same way that arti­fi­cially low inter­est rates lower the long-term growth poten­tial of economies, spec­u­la­tive invest­ing low­ers the long-term growth poten­tial of cap­i­tal mar­kets because it dri­ves allo­ca­tion of cap­i­tal to lower-returning invest­ments. In fact, taken to its log­i­cal con­clu­sion, arti­fi­cially low rates and spec­u­la­tive invest­ing can even­tu­ally, if left in place for too long, ruin economies and mar­kets entirely. In addi­tion, spec­u­la­tors, like low-return investors, can be put out of busi­ness quite quickly when rates rise or money gets tighter.

Low interest rates are not a sign of a strong economy.  And for a healthy real estate market, a strong economy is a must.  Low interest rates would be a sign of low inflation, which would lead to slow wage, GDP growth.   Low inflation would probably also mean high unemployment and the possibility of more frequent recessions. 

To think that Canada will have low interest rates for a decade or more and a housing bubble that does not pop is being very optimistic, if not unrealistic.  History in the last 25 years shows us that 2 of the biggest economies, Japan and the US, still had housing bubbles that popped WITH low interest rates.  Even with the lowering of these already low interest rates, this has not saved the Japanese asset bubble 20 years later and the US housing bubble a few years later from recovering. 

So in the short term, low interest rates will keep house prices where there are, maybe even squeeze some higher prices out, but over the medium and long term, when the housing bubble pops and it will, not even low interest rates will save the housing market.  And if and when that happens, look for authorities to prop the overall economy up.

Bank of Canada holds rates steady

Globe and Mail reported that Mark Carney holds rates steady, for now

Bank of Canada Governor Mark Carney held his benchmark interest rate steady at 1 per cent Tuesday, pointing to ongoing global threats and the dampening effect of the strong Canadian dollar on exports, but signalled that he’s also watching closely for an opportunity to begin tightening monetary policy.

For me, these means two things.  One, I expect more mortgage tightening.  Two, Canada might be looking at low interest rates for a few years.  You might expect this would keep house prices high, but it doesn't.   In the medium and long term, this is very detrimental to the economy and housing. Some say Canada may experience Japan like interest rates for a decade or so.  If that is the case, then expect Japan like housing price losses. I will be writing a post about this in a couple of days.

Did you buy a condo conversion? Buyer Beware

Globe and Mail has an excellent article " Faulty towers: The hidden dangers of low condo fees"

“This is a coming crisis that nobody is talking about,” said Chris Jaglowitz, a lawyer who specializes in condo law for Gardiner Miller Arnold LLP and a member of the Condominium Managers of Ontario. “You have all of these older buildings, and someone needs to pay for long-neglected repairs. And many people won’t be able to cover their share.”

That’s because condo buildings are owned collectively by the residents, and all repair bills are shared equally. Condo boards are able to levy special assessments in addition to condo fees to pay for projects. But the boards are made up of residents, who are sometimes motivated to keep fees low. And they serve short terms, which means long-term planning is often difficult.

I do not know how many apartments were converted to condos in 2007-2008, but I do know that Saskatoon lost over 5% of their rental pool because of the conversions.  Many of these apartments were built in the 70's and 80's and slapped with some lipstick when the conversions took place and then sold for more than a single family house in a decent area would fetch a couple of years earlier.  Some of these condos were not touched for 20 years.  I wouldn't look at one of these even if an engineer's report, a financial report, said things were OK.  As with a home inspection, nothing is guaranteed and an unexpected surprise can happen at anytime with these units. There is the chance it turns out to be a lemon and not only do your maintenance fees go up, you are stuck with the unit, because nobody wants a lemon.   This is also called "being priced in forever".

Saskatoon House Prices: A Permanently High Plateau?

People say that because Saskatoon house prices did not fall much when the recession hit in 2008, that they will not fall anytime soon.  They say that these house prices are the "new normal".

This is the same idea of thought that plagued many investors throughout history when looking at economic bubbles.

Just before the stock market crash signaling the beginning of the Great Depression, Irving Fisher, a noted economist at the time, was quoted as saying “Stock prices have reached what looks like a permanently high plateau.”

High prices are not justified by high prices.

From Irvine Housing Blog

This sentiment is based on the idea that inflated prices can stay inflated indefinitely. However, when valuations cannot be pushed up any higher, prices cannot rise at a fast rate. In residential real estate markets, the rate of price increase would only match inflation because wages and inflation are closely correlated. If the rate of price increase does not exceed ordinary investments, people lose their enthusiasm for residential real estate as an investment, and they begin to look for alternatives:  people choose to rent rather than own. Also, when the quality of units available for rent at a given monthly payment far exceeds the quality of those available for sale at the same monthly payment level, people choose not to bid on the property and they rent instead. One sign of a housing bubble is a wide disparity between the quality of rentals and the quality of for-sale houses at a given price point. People choosing to rent curtails the rapid rise in prices and thereby lowers the demand for real estate. This puts downward pressure on prices, which eliminates the primary motivation speculators had for purchasing the asset.  Greed created the condition of rapidly rising prices which in turn spawns the fear of being priced out. When greed ceases to motivate buyers, prices fall.


Once prices begin to fall, the fear of being priced “out” forever changes to a fear of being priced “in” forever. A buyer who overpaid and over-borrowed will be in a circumstance where they owe more on their mortgage than the property is worth on the open market. They cannot sell because they cannot pay off the mortgage. They become trapped in their homes until prices increase enough to allow a breakeven sale. This puts the conditions in place to reverse the cycle and causes prices to drop precipitously.

I believe the Saskatoon housing market is tapped out for higher values. Interest rates are at all time lows and commodities are booming, but house values have barely moved in the last couple of years.  Why? 2 main reasons. 

1.  Because household incomes have not moved much in the last few years.   
2.  New buyers have stretched themselves to the hilt in Saskatoon in regards to mortgage debt to income as far back as 2008.  People can not borrow much more with the amount of income and savings they have.

There has been very little room for people to take on more mortgage credit when buying a home with slow moving wage increases.  And if you do not know by now, it is mortgage credit growth that allows for higher price movements in house prices.  

To understand how inflation, wages and credit move in concert.
From the GREAT HOUSING BUBBLE

Over the long term house values are tied to incomes because most people buy houses with mortgages for which they must qualify based on their income. Inflation keeps pace with wage growth because people will bid up the prices of goods and services with their available income. Therefore, over the long term house prices, wages and inflation all move in concert. There are short-term fluctuations in this relationship due to variations in financing terms, migration patterns, employment, local limits on construction and irrational exuberance, but any such deviations from the mean will be corrected over time by market forces.

 Saskatoon house prices: A permanently high plateau?  History and common sense tells us no.

Steve Keen says Australia's housing bubble is bursting

Australia, was just a few of the holdouts of the global housing bust and many thought that it escaped the carnage.  Not anymore. Australia may have caught the global housing bust flu. Here is a video with Steve Keen saying that Australia's housing market is bursting.

Some excerpts:

I always said 10-15 years of my horizon after about a fall of about 40 per cent. 

I think you’re not likely to see falls of above 2.5 per cent per quarter, but you’re likely to see falls bouncing around between that 1.5-2.5 per cent level. And, the real force behind this, and this is, finally I’m getting some traction on even the property lobby listening to this point, what causes house prices to rise is rising debt, and what causes them to fall is falling debt. So actually to keep house prices rising you need accelerating levels of debt. We are now seeing decorating mortgage debt. So, we’re still getting a slow rise out of the level of mortgage debt but it’s rising much more slowly and that actually means just like a car that’s still going forward, but going forward at a slower speed, it’s actually decelerating. And, that deceleration is translating very quickly into falling house prices. And, the deceleration has only just begun and it’s got a long way to go and I think that’s what’s going to continue driving house prices down. 

Lelde Smits: If prices fall what impact will this have on rental prices?

Steve Keen: When these things happen people go back to their Mums and Dads. When you have a collapse like this you get an increase in population density, not because people want to have larger houses, but because the kids say, ‘I can’t finance a mortgage anymore, Mum and Dad can we move in with you”. Or, visa versa with the Mum and Dad investors these days, moving in with the kids. That’s certainly happened in America, there’s been an increase in population density there. That therefore means that even though there’s a plunge in the level of properties being built and investors selling properties to get out of them, you actually often have an increase in rental availability and rental prices fall.   

More on the Australian housing bubble:
5 myths that won't stop a housing crash
Steven Keen's blog ( a definite stop)
RBA warns many first home owners who used grants may now be vulnerable
Arrears on mortgage repayments spike to record highs 
Home loans drop to ten year low
Home prices down in most major centers

An Economy Driven By Real Estate Like Never Before

David Madani from Captial Economics was on bnn.ca today.  It is about 6 minutes long.
Renovation Boom Is a Symptom of a Housing Bubble

The Canadian housing market has resisted the price declines seen in developed countries around the world. But one economist tells BNN the substantial increase in the amount of money spent on home renovations is another sign that the the country’s housing market is in the midst of a bubble.

Home renovation over the long term is just under 2% of GDP.  Currently it is at 2.7%, down from the peak of 2.8%. 
Construction employment as a % of jobs for the national average is over 7%.  Compare this with Saskatoon, where in 2009, construction employment was 8.1% of all jobs and now I estimate it could be near 10%.  With the long term average between 5-6%, this is not sustainable.

The late 70's and 80's experienced about the same level of housing investment as the late 2000's.  In the early 80's and 90's, the aftermath of a economy that was driven too much by real estate was dealt with housing busts.  Will the early 2010's be the same?

If Canadian banking and mortgage lending were more conservative than their US counterparts, then why...

• Why did they get caught with their pants down investing in bad mortgages in the US?

CIBC lost 3.2 Billion 
CIBC also had a private bailout in 2008 with Cerberus
Royal Bank lost 1.2 Billion
http://wiki.ask.com/List_of_writedowns_due_to_subprime_crisis ( this was up to 2008)

I believe the total loss was over 15 Billion for Canadian banks.

• Why was there a swapping of assets with CMHC and additional monies paid by US authorities to Canadian Banks?

From CMHC 

Canada Mortgage and Housing Corporation (CMHC) will purchase up to $25 billion in insured mortgage pools as part of the Government of Canada’s plan, announced today, to maintain the availability of longer-term credit in Canada.

This ended up being more than 75 billion.

From the Globe and Mail, while not a bailout,  the US Government provided an additonal $111 billion to the big 5 Canadian banks through TAF ( Term Auction Facility) You can find other links here.

While I would not say it is a bailout, some do believe that the total " private bailout" for the Canadian banks was $186 billion. 

• Why was subprime lending allowed to be in Canada in the mid 2000's?

According to the Financial Post, published April 11, 2010:
“Prior to 2007, there were at least a dozen subprime lenders in Canada and it was the fastest-growing sector of the entire mortgage market, says Benjamin Tal, senior economist at CIBC World Markets, who pegged it at about 5% of the total market.

Subprime was not a problem in the US until house values starting dropping.  So far in Canada, prices have not dropped except for a blip in 2008.  Once there is a significant downturn in house prices, how will those Canadian subprime loans fare?

• Why did CMHC relax mortgages from 5% down over 25 years with a price ceiling on what would be insured, to getting rid of the price ceiling, introducing 0 down 40 year, interest only mortgages at the peak? 

• Why are Canadian banks and the Government still allowing  0 down and cash back loans to people who can not afford to save for a downpayment?

Canadian Banks have proved just by investing in subprime mortgages that they were not conservative and are prone just like other Banks around the world to making huge mistakes.  But I am not saying that the Canadian banks are weak, on the contrary, I believe they are among the strongest on the planet, mostly because the risk of the housing market is put onto the taxpayers.  But what I am trying to show with this post is that, Canadian banks and regulations have put the housing market and Canadians in a very precarious position through lax lending and risky decisions.  Right now it is easier to a Canadian mortgage than it is a US mortgage even though the average house price in Canada is over 340k, while the average house price in the US is about 170k.  Even though incomes are not that different between the countries, debt loads for Canadians are worse.

What will save the Canadian housing market from not falling to the depths of the US housing market is basically coming late to the party.  If the US housing market did not crash until two years later than it did, there is no telling how much more subprime would have entered this country.  Being late to the subprime party will save some of our Canadian bacon, but having high house prices and huge debt loads won't.

Consumers are getting squeezed and "forced savings" will not save the young buyers

From the Globe and Mail  " Rising Food, Fuel Prices Squeeze Consumers

Consumers are shifting their spending as higher gasoline and food prices strain family budgets, leaving less money for discretionary items such as trips and clothes.
Households will face even tougher spending choices in the months ahead as an expected hike in interest rates takes yet another bite out of their finances.

With Canadians already grappling with record household debt, higher energy and food prices are expected to curb spending in some areas, as well as reduce overall economic growth since consumer spending accounts for 60 per cent of the economy. 

And many consumers can also look forward to higher than average monthly housing costs, even with ultra low interest rates.

But everything is fine as " Home equity considered forced savings for young people"

“Buying a home can really be considered somewhat of a forced saving plan with a portion of each mortgage payment you make going towards principal and that builds equity in the property and increases your net worth,” says Campbell. “Over time with the equity building, when it comes time to eventually sell the property, you’ve actually got money in your pocket from the purchase. When you rent, all the money you pay goes to the landlord and you end up deriving zero benefit from this.”

If home equity is the only savings young people can do, we are in trouble as the average debt a University grad has is over $30,000.  A correction in the housing market would wipe up many young persons " forced savings". To say that renting from a landlord is zero benefit is bunk as we need a place to live. But I do agree that a home can be considered somewhat a forced savings plan.  With that comment I leave it with Irvine:

From Irvine Housing Blog " The US needs a home equity lock box owners can not raid"

The advantage of owning a home was the amortizing mortgage was a forced savings account, and inflation provided some additional return. Once we gave unfettered access to home equity, these features of home ownership no longer applied. As many Ponzis have proven, even after more than 20 years of ownership, a loan owner can lose their home to foreclosure.

 That's were the lockbox comes in. If a house is supposed to represent financial security, it should be a place of money storage, not an endless ATM machine spitting out spending money.

Don't think Canadians have borrowed beyond their means? Canada is now near 150% of debt to income.  More than those reckless Americans.



RBC Affordability May 2011: A Misleading Indicator?

RBC's Affordability report is out for May 2011 here

Here is their report for Saskatchewan

The Saskatchewan market cooled a little in the early months of this year, following solid performance in the second half of last year. Home resales eased by 2% and new listings rose by close to 7% in the first quarter of 2011, thereby loosening market conditions somewhat. Home prices reacted to the market cooling with bungalows and two-storey homes reversing part of their gains in the previous quarter. Within the province, both the Regina and Saskatoon markets saw greater availability of supply amid a sharp slowing in
home resales growth in the first quarter. Signs of softening property values led to further reduction in the cost of owning a home in the province. The RBC Measures for bungalows and two-storey homes fell by 0.7 percentage points in the first quarter, representing the third consecutive quarterly declines. Condominium apartments bucked the trend and saw their affordability deteriorate modestly amid higher prices.

 Saskatoon

*Note- this affordability measure does not include property taxes and utilities.
Saskatoon is still a ways above the long term average of affordability even with low interest rates.  Put interest rates back up to normal levels and affordability matches the unsustainable highs of 2008.

Ben over at the economist analyst has a great post titled "why housing affordability is a misleading indicator"

1)  Affordability is still stretched by historic measures. 
2)  Interest rates will rise much faster than incomes over the next decade.
3)  The RBC Affordability Measure assumes a 25% down payment
4)  The measure is in pre-tax income
5)  The measure uses the 'standard' home
6)  The often-cited city-specific data excludes property taxes and utilities
7)  The measure ignores other consumer debt

Conclusion:
Affordability measures can be one indicator of potential housing market issues.  However, they should not be placed in front of other measures of fundamental value such as rent and income growth.  While the RBC measure in particular is interesting, it is not without its major flaws, a fact overlooked by some who would seek to portray the housing market as less risky than it truly is.

I totally agree with Ben, as the monthly affordability study which has its limitations is only one indicator we should be looking at to gauge the housing market.  That is why when we look at inflation, wages and rents, we can calculate that the Saskatoon housing market is around 30% overvalued.

      

Housing Bubble a National Problem

While I have not been able to get my hands on the report by Canadian Economics " Housing Bubble a National Problem", Canadian Business has quoted some of it in an article titled " The Calgary in the coal mine"

Home prices in Canada continue to defy gravity, rising another 8.9% in the 12 months to March 2011, on top of what most economists already consider overvalued levels. The appreciation was still greater in the major cities, except for one: Calgary. Average resale prices there fell 4% in the first four months of 2011 compared with the same period in 2010, according to the Calgary Real Estate Board. Does this reflect the unique dynamics of one market, or will the city become, like Washington, D.C., in 2006, the first domino to fall in a coast-to-coast crash? Calgary may be the first and others may follow,” muses David Madani, Toronto-based economist for Capital Economics, among the most bearish economic consultancies on the subject of Canadian real estate. While acknowledging that “the volatility in Calgary is a little more pronounced” than other cities, Madani reiterates his firm’s view that all of Canada is probably in for a U.S.-style housing contraction, and soon.
“This housing bubble is pretty much a national issue. It’s not just a Vancouver issue or one or two markets,” Madani says, summarizing a report that Capital Economics issued April 29. Income growth is insufficient to close the gap with residential price growth over the past decade, which is why the firm is predicting a nationwide price correction somewhere in the neighbourhood of 25%.

One astonishing sign of the times is that, with the Canadian and U.S. dollars at par (at press time the loonie was at US$1.04), Canadian homes now cost around double what their counterparts do south of the border. The Canadian Real Estate Association reported an average national home price of $371,286 in March, while the National Association of Realtors’ median for homes in the U.S. stood at US$159,600.

Incomes are a bit higher here, but so are taxes.  Mortgage regulation ( from what I have read) is now tighter in the US than here. And house prices are double in Canada compared to the US.  Yeah, no housing bubble in Canada :)

Subprime competition heats up among Canadian lenders

Think Canada has conservative lending? Think again.
From mortgage brokers.ca

Subprime lending is back, with institutional players positioning themselves ahead of the expected spike in B business.
“As at March 31, 2011, we had commitments to make future advances on mortgage loans of $9.2 million,” reads the Q1 financial report Equity Financial Trust, released in May. “We are targeting $100 million in outstanding mortgage loans within the first 12 months of operations and as at the date of this news release, we have funded outstanding loan balances of approximately $7 million.”

New mortgage rule changes ushered in by the federal government starting in April 2010, and most recently this April, will likely bolster revenue for subprime lenders. They are already being blamed for a 14-per cent dip in housing sales last month compared to the year-ago period. Growing numbers of first-time buyers, in particular, have had their homeownership dream frustrated by tougher qualifying terms and reduced amortization terms. The market’s three largest institutional lenders are hoping to win over those prospective buyers and the higher spreads attached to their business.

Were these guys in a f'ing coma over the last few years? These type of mortgages along with 0 down and cash back mortgages should be outlawed.

More on subprime lending in Canada and Saskatoon.
Subprime in Canada, the cracks are appearing
Subprime is alive and well in Saskatoon part 3

CMHC Housing Now: Saskatoon 2011 1st Quarter

CMHC is out with their 1st quarter report on housing for Saskatoon here
New Home Market

New home production up through March
Homebuilders across the Saskatoon Census Metropolitan Area (CMA) initiated construction of 648 homes to the end of March, up 78 per cent from the 365 units that began construction during the corresponding period in 2010.

New home supply up 29 per cent in March

 Accordingly, with an inventory of 165 completed and unabsorbed homes and 1,023 units under construction, total supply of multi-family units was up 44 per cent year-over-year in March. Meanwhile, with 836 units under construction and an additional 174 units completed and unabsorbed, the supply of single-detached units advanced 14 per cent year-over-year, reaching 1,010 units at the end of March.

Single-detached absorptions up 21 per cent

The 480 housing units absorbed to the end of March 2011 are on par with the prior year’s elevated pace, and represent the second highest first quarter tally of absorptions in 22 years. Of these, 363 single-detached homes were absorbed, up 21 per cent from 2010. Meanwhile, the 117 multi-unit absorptions recorded in the first quarter marked a 36 per cent reduction from the corresponding period in 2010.

Resale Market

First quarter sales increase over 2010 levels

Residential transactions from January through March totalled 823 units, up six per cent from the first quarter of 2010,

Meanwhile, new listings in Saskatoon increased relative to the first quarter of 2010 as 1,770 homes were listed for sale on the MLS® in the first three months of the current year, an 11 per cent increase over January through March of 2010.

Economy

Average employment slow to improve

On the heels of a 0.8 per cent reduction in 2010, the Saskatoon CMA saw continued weakness in job creation during the first quarter of 2011. Rapid gains in Saskatoon’s population base have eased the labour shortages that persisted through 2009 and 2010 when the unemployment rate
averaged 4.9 per cent. Accordingly, Saskatoon’s unemployment rate moved upward to 6.0 per cent during the first three months of the year, 1.3 percentage points higher than the corresponding period in 2010 yet considerably lower than the national average of 8.1 per cent. This was met with a reduction in the labour force participation rate which, at 69.3 per cent in the first quarter, was 2.6 percentage points lower than the previous year. Current labour market conditions have also inhibited wage growth in Saskatoon, as average weekly earnings in the first quarter declined 5.5 per cent year over-year.

A few surprises.  New home sales and resales have been stronger than I have expected which has not led supply to overwhelming levels.  I still believe supply could reach 2008 levels, but for now it appears less likely in the short term. If demand drops, then things get interesting as builders believe it is almost 2008.

While I have watched the unemployment situation grow from 4.6% just over 12 months ago to 6.1% this past April, I was surprised to see average weekly earnings drop.  Is this a sign of losing higher paying jobs? One last thing to note, is our economy becoming more real estate driven?  Housing starts, real estate related and construction jobs are increasing while the total amount of employment is decreasing.  Is this a blip, or a market top?

China is slowing, could it crash?

Where China goes, so do commodities.  And in Saskatchewan, "we have what they want".  But what happens when China slows down or...gasp has a hard landing?  Don't think it can happen?  Even though the value of commodities is going up, the amount of commodities going to China is dropping.  Is this a blip or something to warn us of what is yet to come?

From Capital Economics

Indeed, there are already warning signs in the recent data. For example, China’s demand for imported commodities has weakened sharply. The value of China’s imports is still growing rapidly, but this is a reflection of higher global prices. Focusing instead on the volume data, China’s imports of many key commodities are actually falling outright. Chart 1 shows the April data, released on Tuesday, but the year-to-date numbers tell a similar story.

From UBS Global Economics Research

You can see what we mean in the above chart. Total floorspace under construction (whether measured for overall building  construction or just for “commodity” buildings) peaked outright in January and has fallen sharply in the past two months. So have auto sales, which are now nearly 20% off November highs. Property sales peaked in November in volume terms and are declining sequentially since the beginning of the year. And after rising steadily for the last three quarters domestic steel consumption is now flat.

As Mike Shedlock points out

Dramatic Slowdown in China Coming

China is going to slow, much more than anyone thinks. The commodity producers and commodity producing countries like Australia and Canada will take a hit.

From credit bubbles, to property bubbles, to malinvestment and runaway inflation, China will slow down, but the questions are when and by how much.  Saskatchewan will definitely be impacted.  I do not believe it is 2008 all over again, but the situation in China is worth watching.

More on China and commodities here
China's Ghost Cities
Chinese Housing Bubble Pops?
Think resources will save the housing market from crashing?
TD Bank: Hard Landing in China would deal significant blow to Canada
Saskatchewan Government Resource Revenue

Economists and other thinktanks who have said there is trouble with the Canadian Housing Market

Don't believe me that there is a real estate bubble in Canada? The first 4 guys forecast the US housing market bubble and crash and here is what they are saying about the Canadian housing market.

Peter Schiff says Canadian housing is over valued
http://saskatoonhousingbubble.blogspot.com/2011/03/peter-schiff-north-american-interest.html

Robert Shiller mentioning Canada has a real estate bubble
http://saskatoonhousingbubble.blogspot.com/2011/02/robert-shiller-predicting-housing-bust.html

Paul Krugman says Canada has a real estate bubble
http://saskatoonhousingbubble.blogspot.com/2011/03/paul-krugman-oy-canada-looking.html

Dean Baker predicted the US housing bubble in 2002 says Canada houses could fall 25-35%
http://www.cbc.ca/news/canada/story/2010/11/17/housing-bubble-warning.html

BMO suggests that Canadian housing is overvalued by 14%
http://saskatoonhousingbubble.blogspot.com/2011/03/bmo-saskatchewan-housing-is-39-pricier.html

The Economist says Canadian housing is 22% overvalued
http://saskatoonhousingbubble.blogspot.com/2011/03/housing-market-seven-deadly-sins.html

Capital Economics suggest a 25-35% drop in Canadian home values within a couple of years
http://saskatoonhousingbubble.blogspot.com/2011/02/25-drop-in-canadian-housing-prices.html

Home Owners Can Never Truly Own Their Home

Here is a great post worth reading from Mike Shedlock.  He is talking about US houses, but everything he says is also relevant for Canada.

Imagine the perpetual loan, a loan that no matter what you do, you can never pay off. To help conceptualize the idea, think of it as a perpetual interest-only loan in which you are forbidden to completely pay off principal.

As preposterous as that deal may sound, it is highly likely you are in one.

If you own a house, you are in exactly that deal, except it conveniently not called interest. Instead it's called a property tax.

Twenty years ago you could get nice appreciation, but that is no longer true. Moreover, I suspect that once home prices bottom, prices will stagnate for a decade.

Thus, there is no compelling financial reason to own a house. Indeed, from a financial perspective, there are good reasons to not own a house.

However, there are more important things than money. If having a house makes you or a loved one happy, then as long as you can afford a house, and as long as it does not make you a debt slave, it is reasonable to buy one.

The biggest key right now is making sure your job is stable. If it's not, then buying a house might bankrupt you if you lose your job. Unfortunately, many people vastly overestimate the stability of their job.

Houston vs Saskatoon, it's not even close

 

List Price	$198,689
Entered	05/06/11
Beds	4
Full Baths	2
Partial Baths	1
Property Type	SFR
Sq. Ft.	2,802
$/Sq. Ft.	$71
Lot Size	5,613 Sq. Ft.
Year Built	2011
Source	Houston Realtors Information Service, Inc.

Building Type : House

Bedrooms : 2

Bathrooms (Total) : 1

Bathrooms (Partial) : 0

Floor Space : 695 sqft

Built in : 1929

Land Size : 40.00x140

Price: $199,900   $/Sq. Ft.    $288

Median household income in Houston : $54000   Median household income in Saskatoon $63,000. Unemployment rate in Houston is 8.2%.  Unemployment rate in Saskatoon is 6.1%.  One of these markets is experiencing a housing bubble.  Guess which one.

No new mortgage changes...yet

From the Financial Post

There has already been “some softening” in the Canadian real estate market so there is no need for further tightening of mortgage rules, said Jim Flaherty, the finance minister.
In the depths of the crisis Canada’s banks remained strong partly because of steps taken by the government aimed at boosting liquidity such as buying more than $70-billion of home loans from lenders. Ottawa also increased the limit on the volume of mortgages banks could sell into the Canada mortgage bond program.
Critics say that one unintended result was that banks were encouraged to make more home loans, which helped push up prices in the market.

He is right that there has been "some softening" in the real estate market as most major centers experienced lower sales year over year in April.   Consumer credit has slowed big time, which is good for household balance sheets, but not so good in the short term for the overall economy.  I believe that consumer credit growth may even slow some more as less equity can be borrowed from one's house and some mortgage loan insurance is no longer available for HELOC's since April 18th. While not running in double digits, at 7% year over year, residential mortgage growth is still outpacing incomes and GDP growth and this is not sustainable. If this continues or even grows some more in the next half year, I would expect another round of tightening of mortgage rules.

US and Canada: Residential Investment as % of GDP

Two charts to look at today

As I have compared the US and Canadian housing markets before, these two charts just add to my reasoning that Canada is not different from the US.

The Education Bubble: How Will It Impact The Canadian Housing Bubble?

In 1980, a full year of arts and science cost $655.00
In 1990, a full year of arts and science cost $1344.00
In 2010, a full year of arts and science cost $4900.00
That is an increase of almost 650%.  To put that into perspective, housing inflation since 1980 has increased by 350%, while inflation has increased just over 150%.

This chart shows tuition fees across Canada versus inflation between 1990 and 2005.

 Higher Education's Bubble Ready To Burst (from the US)

It's a story of an industry that may sound familiar.

The buyers think what they're buying will appreciate in value, making them rich in the future. The product grows more and more elaborate, and more and more expensive, but the expense is offset by cheap credit provided by sellers eager to encourage buyers to buy.Buyers see that everyone else is taking on mounds of debt, and so are more comfortable when they do so themselves; besides, for a generation, the value of what they're buying has gone up steadily. What could go wrong? Everything continues smoothly until, at some point, it doesn't.Yes, this sounds like the housing bubble, but I'm afraid it's also sounding a lot like a still-inflating higher education bubble.

Consumers would balk, except for two things.
First -- as with the housing bubble -- cheap and readily available credit has let people borrow to finance education. They're willing to do so because of (1) consumer ignorance, as students (and, often, their parents) don't fully grasp just how harsh the impact of student loan payments will be after graduation; and (2) a belief that, whatever the cost, a college education is a necessary ticket to future prosperity.

What does this have to do with the housing bubble?

From Education is a Right

According to Statistics Canada’s Youth in Transition Survey, 70 per cent of high school graduates who do not go on to post-secondary education cite financial reasons as the main factor...Monies owed to the federal government alone for student loans will surpass $15 billion this fall.

The average University graduate is leaving school with a debt load past $30,000.  But it is not uncommon for a couple of recent grads to have a debt load of over $75,000.  And they are getting peanuts out of University? And that is if they get a job in the field they went to school for!

What does this have to do with the housing bubble?
With house prices and debt loads so high, many recent grads will have to delay the purchase of a home and/or the starting of a family will be delayed by a few years.  And the only reason why first time buyers are willing to pile on the debt to buy a home is that they believe that real estate is a firm and safe investment. We have to remember that first time buyers are the foundation of the housing market.  If consumer sentiment about real estate changes, then the first time buyer is not there any more. Take away first time buyers and the market collapses.

I firmly believe that the housing market/bubble will pop.  Many economic housing indicators show we are in a housing bubble.  The questions I have, are a) How far will it drop? b) How long will it take to hit bottom?  History tells us that the average housing bust shaves 34% off of prices and lasts 6 years.  
Does Saskatoon and/or Canada have an average housing bubble?

We know that as boomers get older, they will negatively affect real estate.  But to think that the generation of future buyers who are currently working at DQ and will most probably be saddled with massive debts out of University will save the housing bubble from popping is a stretch.  Why would they stretch their pay cheque to be a depreciating asset?  They will want to enjoy life and will not want to be house poor like many of Saskatoon's recent first time buyers.  The recent article in the University paper " City housing cost's too high." makes me believe the new generation of buyers will be smarter than the last one.

Saskatoon's housing market is at least 30% overvalued, maybe more

A real estate bubble or property bubble (or housing bubble for residential markets) is a type of economic bubble that occurs periodically in local or global real estate markets. It is characterized by rapid increases in valuations of real property such as housing until they reach unsustainable levels relative to incomes and other economic elements, followed by a reduction in price levels."

Within mainstream economics, some argue that real estate bubbles cannot be identified as they occur and cannot or should not be prevented, with government and central bank policy rather cleaning up after the bubble bursts.
Others, such as American economist Robert Shiller and British magazine The Economist, argue that housing market indicators such as house price to income, and house price to rent can be used to identify real estate bubbles.

I am not mainstream but I have read a bit of Robert Shiller, Dean Baker, Peter Schiff, Paul Krugman who all say that bubbles can be identified and who identified the US housing bubble and also say that Canada is in a huge housing bubble just waiting to be popped.

This post will take a look at some housing market indicators that measure housing in Saskatoon. Using just one economic measure is not proper as each measure has it's own faults, but using a variety of measures allows us to hit it from different angles and gauge the market properly.  Let's see how big the housing bubble in Saskatoon really is.

Saskatoon Average House Price

Growth in House Prices and Personal Disposable Incomes in Saskatoon Since 1987
Over the long term it has been established that house prices move in concert with inflation, wages, rents, GDP growth.  If house prices move out of alignment with these long term fundamentals, it usually means that irrational exuberance ( aka global real estate fever in the 2000's) has hit the market place. 

If the long term fundamentals are not the main reason for growing the housing market, an increase in debt has to make up for the difference.  While I do not have any debt stats for Saskatoon and the ones for Saskatchewan are limited until February,  I do have national numbers from 2000 to 2010.

• Total household debt has exploded by 135% between 2000 to 2010.
• Mortgage debt has exploded by 131% between 2000 to 2010.
• Consumer debt has exploded by 146% between 2000 to 2010.
• This is at a time when the average weekly wage increased by 30%.

As of November 2011, total Canadian household debt is just shy of $1.6 trillion.

With that let's get to some measurements of valuation for Saskatoon house prices.

House price to income
For this, we will use two measures, median and average.  Historically, both ratios have always been under 3.  Even though there is no reason for housing to be pushing the ratio of 3 in Saskatoon, we will use that number for simplicity.

• Median house price to median household income.

This one is easy as, we will just use Demographia's study of a Saskatoon median house price of $277,000 and the median household income of $63,000.  The ratio is 4.3.  In an affordable housing market the median house price should not be higher than $189,000.  This measurement shows that houses are 32% overvalued.

• Average house price to average household income.

According to the City of Saskatoon, the average household income is $69,000.  The average house price was $315,000 in April 2011.  This works out to a ratio of 4.56.  For housing in Saskatoon to be affordable the average house price should not be higher than $207,000.  This measurement shows that houses are 34% overvalued.

The problem with this measurement is that it does not take into account interest rates.

House Price to Earnings
For this measurement, the house price is divided by the annual rent minus property taxes, insurance and maintenance.
Historically, anything over 17 is usually considered overvalued, anything over 25 is definitely a bubble.
I will do a few of measurements here as these are all real examples in Saskatoon.

• The first one is a apartment building that was just recently converted to condos.  The rent on the apartment was $800 and now I see that the condo is listed for $129,000.  If property taxes, condo fees and other fees are $300 a month, that means $129,000/$6000 gives us a ratio of 21.5. This condo should be no more than $102,000 and is overvalued by 21%.

• The second one is a townhouse that rents for $1300 a month and is listed for $260,000.  If property taxes, condo fees and other fees are $450 a month, that means $260,000/$10200 gives us a ratio of 25.5. This townhouse should be no more than $173,400 and is overvalued by 33%.

• The third one is a house that rents for $1600 a month and is listed for $340,000.  If property taxes, and other fees are $500 a month that means $340,000/$13200 gives us a ratio of 25.8  This house should be no more than $224,400 and is overvalued by 34%.

The problem with this measurement is that it does not directly take into account wages. Also,  I believe that rents are in a bubble as wages have not kept pace with rents.  Funny thing is that rents have not kept pace with house prices.  That is how big the housing bubble really is in Saskatoon.

Monthly affordability
RBC does an monthly affordability report 4 times a year.  This measure is using 25% down with a 5 year rate over 25 years with a median household income.

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).

the modified measure used here includes the cost of servicing a mortgage, but excludes property taxes and utilities due to data constraint in the smaller CMAs

This graph shows that the monthly costs for a bungalow and two story cost about 31% and 33% of income respectively.  But it does not account for property taxes and utilities.  If it did, the monthly cost would be pushing 40% for the two.

The problem with this measurement is that interest rates are at all time lows. As well, over the years downpayments have shrunk.  A 25% down was probably not uncommon for someone entering the market in the 80's or 90's.  Nowadays, the majority of first time buyers and even some move up buyers can not put 25% down.  Using normal interest rates ( 3 points higher) and 5 % down, this graph would show bungalow affordability at 50% of income.  Anything over 32% is deemed unaffordable.

Saskatoon house price to inflation
If you have followed this blog long enough, you know that I quote Shiller almost every week.  He has proven that over the long term, the return on real estate was just about zero after inflation. In 1981 the average house price in Saskatoon was $64,756, in the four months of 2011, the average house price is $300,000.  House prices have appreciated by 369% while the Canadian inflation rate since 1981 has totaled 149%. Even though Saskatoon house prices experienced a peak in 1981, if house prices followed inflation since 1981, the average house price would be $160,000.  This measurement shows that houses in Saskatoon are overvalued by 47%.

Conclusion 
While there are more indicators to look at, such as savings rates, debt to income, tax rates, population growth, long term supply and demand etc, the measurements I did here, show over the long term, what the average house price should be in 2010.  Each of these measurements show a calculation that the average house price in Saskatoon should be between $160,000 and $207,000 for 2011. I have yet to see just one calculation that justifies anything close to $300,000. With the average house price hovering near $300,000, these measurements show that there is definitely a pretty big housing bubble in Saskatoon.

457 sales for 1144 realtors in the Okanagan for April 2011 = Housing Bust

From OMREB
Kelowna, BC
Inventory 4,888 units compared to 5,309 in April 2010 and up slightly from last month (4,739) – with new
Sales 297
Overall unit sales during April dropped 32.35% compared to 2010 (to 297 from 439)
Vernon, BC 
Inventory  2,489
Sales  86
Overall sales for April 2011 declined 54% compared to the 188 units sold during the previous April
Sicamous, BC
Inventory 1522
Sales 44
Overall sales dropped 27% from April 2010.

From VREEA
North Okanagan: number units sold for this and past Aprils:
2011: 86
2010: 189
2009: 127
2008: 179
2007: 266
2006: 265
Looks like business is down 70% from the boom years 

All I can say is ouch. This is what a real estate bust looks like. I am expecting the contagion to spread as many other places across the nation are very weak as well.

4800 less people employed in Saskatoon from last year; Unemployment rate 6.1%

Stats can is out with their monthly labor survey report.  The three month moving average shows that for Saskatoon ( page 44)  the population grew by 5300 people, the labor force shrunk by 3700, and employment shrunk by 4800 compared to stats from April 2010.  The unemployment rate is at to 6.1%, up from 5.3% a year ago and definitely higher than the 3.5% in March of 2008.  Nationally, the rate is at 7.6%.  Since the summer of 2009, the National unemployment rate has been creeping downward but Saskatoon's unemployment rate has been creeping upward.
Here is a interactive map of all major cities in Canada showing unemployment rates over the last 20 years.

Commodities: Boom and Bust, always have been, always will be

From the Globe and Mail

Oil plunged more than 8 per cent Thursday, heading for the third biggest daily drop in dollar terms on record, as concerns about economic growth and monetary tightening spurred a sell-off in commodities.
Selling pressure on oil and other commodities came on several fronts this week, with investors weighing factors from the death of Osama bin Laden to the impact of higher fuel and commodity costs on the economies of consumer nations to monetary policy in major economies.
“Crude oil is selling off sharply for two primary reasons: QE2 is coming to an end in June and without a QE3 behind it, it will take liquidity out of the market, hurting risky asset classes such as commodities,” said Chris Jarvis, senior analyst, Caprock Risk Management in New Hampshire.

I am not suggesting that we will see a commodity bust right now, but the market is very volatile.  And volatility is what would shake consumer confidence in this province.  People are believing the notion that we will see endless growth for commodities.  While it may be true to over the long term, demand for commodities will grow, but along the way we will experience severe shocks because of speculation and debt loads.  These shocks could last months or even years. Like I have said before, people who are buying homes, especially first timers are over optimistic when they should be cautious.

As Mike Shedlock says

"Thanks to loose economic policy globally, commodity speculation is running rampant already. No importers want to add fuel to that fire.
China is overheating, and the global macro picture, especially from a Chinese perspective is far worse than that. The world may not have noticed yet, but Europe is in trouble. The PIIGS are imploding under austerity measures and the most of the rest of Europe except perhaps Germany does not look very good."

Western Canada Housing Markets April 2011

BC
Victoria  continues it's downward slide in sales.

April 2011 (percent change from 2010 in brackets)
Net Unconditional Sales: 574 (-24%)
New Listings: 1,577 (-12%)
Active Listings: 4,561 (+8%)
Sales to new listings ratio: 36%
Sales to active listings ratio: 12.5% or 7.9 MOI

April 2010 totals
Net Unconditional Sales: 756
New Listings: 1,783
Active Listings: 4,229
Sales to new listings ratio: 42%
Sales to active listings ratio: 21% or 5.6 MOI


Vancouver continues to defy gravity as prices and sales are up year over year.

Daring to go where the market has not gone before, April saw the average price of a detached home in Vancouver surpass all previous records as it reached $1,204,587.

But while Greater Vancouver saw a price increase of 6%, sales were down 8% year over year.

Okanogan is toast.  I am not even bothering to wait for their April stats but expect some parts of the Okanogan to have about 2 years of inventory.

Alberta
Calgary is busting even with ultra low interest rates and oil over $100 bucks a barrel.  So much for low interest rates and resources saving an housing bubble. While prices are up year over year, single family homes sales were the worst in over half a decade. Even a place like Airdrie just outside of Calgary is busting with March 2011 levels worse than March 2010.  And just to think that in 2010 Calgary and area had the weakest sales market experienced in a decade.

Edmonton
Single family homes sales in April were the worst in 7 years.  While prices are about 70k off the peak from the spring of 2007, they have not really moved since the fall of 2007. 


Saskatchewan
Saskatoon 
Prices are up while sales are down. Sales for this April were the worst April since 2006.  It was not drastic, but it was not 2007 or 2008 either.

Regina
Prices are up 5% year over year while sales are down 6%.

Comments
In all major centers, except Vancouver, prices are up while sales are down year over year.  High house prices and the tightening of mortgage rules has cut more first time buyers out of the market.  This has skewed average prices up as there are less entry level buyers.  I believe buyer and debt exhaustion has hit the housing market as debt levels and the home ownership rate are at unsustainable levels. While "affordable housing programs" might squeeze a few more renters into owning, I believe we are at the peak homeownership rate right now and this rate has no where to go but down.

One would think, because every major center in Western Canada has experienced major population and housing growth over the last half decade that sales should be stronger in 2011 than in 2006.  But for most centers, this is not the case.  This should be raising alarm bells for the industry. The housing market is not "strong, stabilized, stable or healthy" For the time being, prices are stagnant at best and that is one of the reasons why listings are not near record levels.  But if the market continues on like this, prices will start dropping signaling the housing bust is in.

Saskatoon Real Estate Numbers April 2011

SRAR is out with their media release for April 2011.  It can be found here.
Prices are up by 6% year over year, but sales are down. 

The increase in the average selling price indicates strong sales activity in the mid to upper price range.

Actually, sales for this April were the worst April since 2006.  It was not drastic, but it was not 2007 or 2008 either.

An important factor of a strong housing market is the activity experienced in new home sales. Saskatoon’s new home market remains strong with steady city lot sales taking place. Interest rates are favorable to purchase that next home and job creation in the Saskatoon area remains steady. The forecast for the remainder of 2011 is for listing and sales numbers to continue to balance and for resale prices to move up slightly due to demand.

People are confident in the economy now and in the future, that is why people are willing to pile on the debt to get into the housing market.  What if that confidence is falsely misguided? 

While the population grew by 2%, Job creation is steady? Where? According to Stats Can, ( page 44) there were 4300 less employed people in March 2011 compared to March 2010 in Saskatoon.  In 2009, 8.1% of all jobs in Saskatoon were construction, since then, construction jobs have taken off and this number could be close to 10% now.  A diverse economy should have between 5-6% of all jobs in construction.  What happens when construction jobs revert back to the mean when the "boom" ends?  We will find out that the housing market is not so strong after all.

Go and Vote Today

Here is the NDP platform
Here is the Liberal platform 
Here is the Conservative platform

This is not a political website and I do not intend it to be.  But I am a little leary of the NDP's cap and trade.  A possible 10 cents a liter added to gasoline?.  Could cap and trade of today have some of disastrous effects like the 1980's National Energy Program of 1980's?

If you are wondering what NEP did to house prices in the 80's

As cited in a report by Phillips, Hager and North, the U.S. Office of the Federal Housing Oversight (OFHEO) reported overall declines in real estate prices of between 10% and 15% from 1980 through 1985, the years of the NEP. That same report presents information from the Canadian Real Estate Association (CREA) showing that during those years (1980–1985) most eastern Canadian markets fell 10%-15% and the Toronto market held relatively steady. In contrast, the CREA historical data shows a decline from 1980 through to 1985 of approximately 20% for Vancouver, Saskatoon and Winnipeg while the drop approached 40% in the oil dominated economies of Edmonton and Calgary.

 Make your voice heard.