Monday, May 25, 2009

Housing recovery?

March & April saw big pickups in sales activity in most major markets. Prices still fell YoY although they were up in April versus March. 4 of 6 NHL markets are still down YoY, as Ottawa has returned to positive in April. Montreal is still barely up.

The media and the real estate industry are portraying this as a recovery and the worst is over. I will be honest, the strength of the April report did surprise me.

What is going on?

IMHO, this is due to the following:

1) Low interest rate buyers. As I mentioned recently, a lot of people are drooling over low interest rates. They crunch the math and they come to the conclusion that their mortgage is affordable. Unfortunately, they are not looking at the real cost of interest, which is probably 10%+ once you factor in house price deflation.

2) We had a huge crash in sales from October to February (5 months). Some of the people who held off in the fall crash need to buy or sell, and as such, there was an element of pent-up demand. This pent-up demand may persist for a few more months.

3) The huge effect of the recent layoffs has only started to be felt in the housing market. It takes many months before unemployed workers fall behind in their mortgage payments. I expect this effect to show up in the fall.

4) Seasonality: Most Canadians buy or sell their homes in spring or fall. The summer is short in Canada, and most people take vacation in the summer. The summer market is slow. For people to move prior to the summer, they need to buy in April or May latest. Therefore, March was the beginning of the panic buying.

Where do we go from here?

Also, let me revisit some predictions from prior months:

From March 16th:

March is also a decent report (the rate of decline stabilizes in the high
single digits) and the bottom callers will start. Remember the same phenomenon
happened in the US housing market back in 2007.
By April, we are back to negative double digits again.

Boy, was I wrong. April YoY was only -3%. I am the first to admit when I am wrong, unlike CREA.

Where do we go from here?

The Canadian housing market is in its last hurrah. People who are buying here with heavy leverage due to low interest rates are making a big mistake, in my opinion. They are falling in the trap of looking at cheap monthly payments versus the amount of debt that they are absorbing. The numbers and the anecdotal proof that I see are telling me that Canadians are completely in denial. Canadians think that the US housing bust is unique to the US and that it can’t happen here. Canadians don’t even think about mortgage rate resets in 5 years (when their 5 year mortgage comes due). Canadians don’t even think that it makes no sense anyone to receive a mortgage with 5% down.

In my opinion, we are in a deflationary depression. All the printing of money by the governments is only adding more debt when there is already too much debt. While consumers and businesses are de-leveraging, governments worldwide are re-leveraging and completely offsetting the de-leveraging. I suspect that markets are wising up to this and about to force the hand of the bond market. Long term interest rates have started to increase sharply and no amount of buying of bonds by the Federal Reserve will change this. The world is swimming in debt and asset prices have dropped by trillions. The world has never been asked to finance $4 trillion of government debt in one year. And then maybe the same amount in 2010. Who is going to buy all this stuff?

I look for a few things to happen in the Canadian housing market this year:

1) Mortgage rates are going to increase very soon as the bond market is getting killed. This could increase 5 year mortgage rates.
2) The stock market is going to go a lot lower. This will kill the current “green shoots” myth.
3) Unemployment is going to 9% soon. A 3% rise in unemployment in roughly 12 months is going to make some people think twice before adding hundreds of thousands of dollars of debt. This will ultimately impact foreclosures.
4) It has been conventional wisdom that Canada’s oligopolistic banking system is fantastic. I am short conventional wisdom. I expect the Canadian banking system to also encounter problems, which will ultimately impact access to financing. When this happens, that will send home prices falling. I also expect 25 year amortizations, a 25% down to come back at some point. That will also send home prices falling.

This home price drop will take years. It will unwind a little slower than the US but it will be quite severe when it is all over. TD came out recently with a 24% peak to trough fall in housing. They have been criticized for that being too pessimistic. I suspect that when it is all said and done, that will be optimistic.

It is likely that this pickup in housing sales can go on for a few more months, but big picture, it is just sucking up some more demand from the future and making the next drop more painful. I may have been wrong about April, but I don't think that I will be wrong on the big picture in housing.

Disclosure: Short Canadian banks, US financials, Nasdaq, long S&P puts


Anonymous said...

An interesting post. I would love to buy a house, but am extremely concerned about the prospect of renewing a large mortgate in 5 years. Seems like financing will only get more expensive, and housing prices can only go down.

I was beginning to think I was the only one who saw this trap, 'cause if you mention it in conversation to anyone, they look at you as though you just announced the world is flat.

BBC said...

Adil, I feel you are 'bang on' with your Big Picture prediction, it only makes sense. I have a question, what happens if Banks get into trouble? I know that customers have a limited amount of insurance on their savings but what happens if you have a mortgage/debt with a bank and it 'folds'?

Jen said...

Well Adil,

You were spot on with the mortgage rate call- RBC has raised residential mortgage rates effective tomorrow. Seeing as what's happened with the bond market, it's none too surprising. The question is will it continue, and what will the consequences of a higher cost of financing have on the economy right now?

Adil said...

don't know fer sure (don't quote me) but I would guess that the acquiring bank would pay something to acquire the mortgage of the folding bank (an asset).

don't think we see much impact from a 20 basis pt move in mortgages and thus far the rise in yields has been limited to government bonds (corporates have been fine thus far). I see this move up though as a precursor of more trouble in bond land as we move through 2009. if we move up 100 basis pts that would have an effect on mortgages (perhaps later in 2009, but not sure). Bigger problem will be the 25 year, 25% down issue that I think will inevitably return. Plus higher credit scores required for mortgages, again probably later in 2009 or 2010.