Thursday, June 18, 2009

Positive May housing report

A smart reader asked:

What I don't understand is with higher unemployment RE is not where it should be. I guess first time buyers have simulated the market with lower interest rates. It does not make any sense why average home prices are not declining.
I guess I don't fully understand it either.

First of all, let me admit, that I did not see this coming. If you had told me in the winter, that by May, CREA would report a positive YoY average sale price in Canada (and a record), I would have laughed hysterically. My forecasts for early 2009 were much too pessimistic as I underestimated the effect that super low mortgage rates would have on buyers.

Secondly, I am not going to revise my forecast for 2009 just yet, but I have to admit that it is looking too pessimistic. If you wish to dismiss this blog as overly bearish on housing, feel free. 

I usually hate it when people who are wrong, blame others for being wrong. At the risk of doing this, here goes: 

I did not think that a 50%ish drop in equity markets worldwide, a $115 drop in oil prices, a 30% drop in the Canadian dollar, a 30% drop in US home prices, a 2% increase in unemployment, a 10% drop in home prices in Canada in 2008, overprime, failing pension plans and a 7% drop in GDP in Q1 would rationally allow a "soaring" real estate market. Basically, the reasons that I outlined here prevailed over the factors that I mentioned above.

Either I am crazy (in being dead wrong in recent months) or that Canadians are crazy. (I think it is the latter). Now, I don't think the CREA numbers are that accurate (either in 2008 or currently) but they are what they are. 

I have many people telling me "it's a good time to buy". I suspect that this has to do with the super low mortgage rates that were around until a few weeks ago. As Canadians, I think that when we think of buying a house, the only thing that we think about it "What are my payments?". Have we not learned anything about leverage in the past two years? 

Few people are asking the following questions:

1) Why are mortgage rates super low? Ummm, maybe because we are in a severe recession or a depression.

2) What happens when my mortgage resets in 5 years if rates are higher? Your payments go up. This is what happened in the US with ARM resets.

3) What happens if I have to sell before the end of my mortgage (say in five years) because if me or my spouse loses a job? What happens to my mortgage in such a case if my house value drops by 20-30%? Ummm, it's called foreclosure. Look at US real estate sites with foreclosures. There are pages of them and the lists are increasing. 

4) What happens to my house value if there are foreclosures galore in my area and I want or need to sell?  Your house will sell for a lot less than you think.

5) What happens when all these baby boomers need to free up cash as for many their home is the principal source of retirement savings? Again, your house will sell for a lot less than you think.

6) What happens to house prices if we have a banking crisis in Canada? What happens to house prices if we return downpayments to 20 or 25%? Sound far fetched? We have an oligopolistic banking system in a country smaller than California. Anything is possible. In the US, downpayments of 25% are fairly common in 2009.  Either a banking crisis or 25% down will send house prices a lot, lot lower.

Obviously, any of these things could happen in even normal times. These are not normal times! If you can handle some of these situations and still make your payments, then go ahead. I suspect that most Canadians have not even considered these questions or if they have, they smugly dismiss this as a US subprime problem.

I don't think the spring silliness in Canadian housing is sustainable for very long and I think this does little to change the longer term picture for Canadian housing. Canadians are foolishly ignoring the lessons of past real estate market busts and the lessons of most Anglo-Saxon countries of the present. If I was trying to sell my house right now, I would be thankful for this potential last chance.

Mortgage rates are already creeping up and some of the pent-up demand (caused by the virtual collapse of housing in the fall of 2008/early 2009) has now been relieved. I am not going to venture a guess as to when this bear market rally in Canadian housing will end, but I know that it will roll over and when it rolls over the next time, it will be very, very ugly for a very, very long time. 


Raj said...

Hello Adil,

June numbers have jumped more than expected as last set of eager beavers (first time buyers) have already made their purchases. With increase in the fixed rate mortgages, I see a downward trend starting from July and it should descend until March 2010.

BBC said...

I agree Raj, things are slowing down here in is like someone is shouting, 'last call' and only the really drunk ones are ordering!!!