by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
You heard it here first. Canadian real estate is in the danger zone. Well, maybe not all of Canada’s housing stock will fall but the Western provinces look overvalued. If you subscribe to my site, you heard about this over the weekend.
It all started back in 2003. A barrel of oil was trading around $30. Then, we liberated Iraq from Saddam Hussein. Oil spiked up then retreated to the mid 30s for the rest of 2003. Dubya landed on an aircraft carrier, proclaimed “Mission Accomplished”, and the war was over.
Kind of. Then, the “police action” started. That’s when the rapid ascent started in oil prices. By the middle of 2005, we crossed the $60 threshold. Then Dubya pushed the food for fuel policy that caused our farmers to reallocate their crops to refiners rather than grocers. In the past 18 months, the price of oil doubled. We called this commodities-push inflation at Bartley Hall. The discretionary dollars got crunched by triple digit tanks and five digit mortgage payments and America became a subprime nation….
…and Western Canada got rich….so they all bought real estate.
In commodities-rich Canada, they prided themselves on “sober” lending guidelines. No sub-prime mortgages and a heavily regulated mortgage industry insured that the irrational exuberance we displayed in The States wouldn’t mirror up north. Then, the Canadian Mortgage and Housing Corporation (CMHC) ripped a page from the Wall Street playbook, extended the amortizations, lowered the down payment requirements, and it was the wild, wild west, all over again. Same scene; different location.
American real estate crashed, the Fed lowered rates, and the US dollar tanked. In late 2007, the loonie reached parity with the dollar. In Calgary, the median price was $200,000 (Can), in 2000. It grew to $250,000 (Can) in 2005. It grew to $417,000 (Can) in 2007 (suspiciously with the rise in oil prices). If you bought an Calgary investment property, in 2000, you doubled your money. This chart shows that household incomes spiked along with housing prices so there might not be a need to worry…unless…
The Calgary real estate market is overbuilt…AND…
The Calgary household incomes come from the oil industry. ..AND…
marginal job growth is tied to commodities and construction.
Does Calgary sound like Phoenix ? How about Vancouver as San Francisco or Victoria as San Diego? Consider this report by TD Bank Financial Group:
The rate of increase in prices has also exceeded the growth in household income, with the result that national housing affordability has deteriorated significantly. The share of personal income needed to finance mortgage interest and principal payments on a 5-year fixed mortgage with 15% down for an average priced home in 2004 was roughly 28%. Since then, the ratio has climbed to 38%. From a lender’s point of view, a ratio greater than 32% for an individual household is viewed as undesirable.
While the share of personal income going to mortgage interest and principal payments has increased in virtually all regions, there are certain places that affordability has become extremely stretched. Specifically, the western centres of Vancouver, Victoria, Calgary, Saskatoon have experienced a shocking deterioration in affordability – particularly for detached bungalows.
As the accompanying charts show, the weakening in affordability is not consistent with a continuation of the price and sales growth that was experienced in 2007. This raises the issue of why real estate conditions didn’t cool sooner. In our opinion, some of the new financing arrangements may have delayed the impact. For example, shifting to a 40-year mortgage lowers the ratio by about 5 percentage points, and we know that a majority of first-time home buyers are opting for the long amortization mortgages. However, with rapid price growth, we have recently seen the 40-year affordability ratio breach the 32% mark. So, the weakening in affordability is a strong signal that it is only a matter of time before sales moderate and market conditions become more balanced. The only question is when.
They sound like Bill Gross of PIMCO in late 2005. It’s deja vu all over again. Mix in my thoughts that the commodities bubble is about to burst and the scene is set for Edmonton to look like Cape Coral, FL.
Canadian Wealth Builder, Benjamin Bach, straightened me out when I declared that the swaggering Canadians, tossing around their loonies for Arizona properties would be licking their wounds next year. He noted that the impending doom might pass over tech-hub Kitcher Waterloo:
When I spoke with Benjamin Tal last month, a head Real Estate analyst in Canada, he singled out Kitchener Waterloo as the bright spot for Real Estate investors in Ontario. I agree, and my clients do too – voting with their wallets.
People from Toronto, Montreal, Vancouver, Calgary, New York, California and recently even Kuwait are attracted to our low prices and great economy. Condos from 130Ks (they’re nice!), newer single detached homes in *nice* areas from the $230,000s – and we’re less than 1 hour away from Toronto, and Pearson International Airport. [ed: Waterloo Regional also flies to international destinations]
Just like in the US, there are some areas where, to me, prices feel high. But Canadians as a whole have not embraced the sub prime lending that the US has seen in recent years, and *most* Canadians aren’t buying huge homes they can’t afford, without equity. Clearly, there are always some who do, and independent of the economy, they’ll get burned, almost every single time.
So…Kitchener Waterloo is the Seattle of Canada; tech-based and impervious to decline. I can live with that. The point is this:
Western Canadian real estate is a VERY dangerous investment right now. If Edmonton or Calgary, or Vancouver, or Victoria is where you’re thinking of putting your loonies, consider investing in Phoenix, or Long Beach, or Las Vegas and buy those properties with some cheap-ass greenbacks. Three things will happen:
1- Western Canadian real estate will decline 10% or more.
2- The battered American markets will come back.
3- The greenback will regain its premium to the loonie.
Trading a condo in Vancouver for a craftsman in Oceanside might make a lot of sense…if you’re an investor.
Sheez…now I’m a bubble blogger.
Jeff Brown says:
Reading every word was worth it just to read the words — ‘Sheez…now I’m a bubble blogger.
My day is made. 🙂
June 9, 2008 — 7:57 pm
Tom Vanderwell says:
🙂
But look at it this way, Brian. If by being a bubble blogger, you can save one family from financial ruin, wouldn’t that be worth the “laughs?”
Keep on telling it like you see it.
Tom
June 9, 2008 — 8:29 pm
Bob Wilson says:
Except that the bubble bloggers would tell you that San Diego County still isn’t the best option for investors – not even in the top 10 list yet.
I would agree.
June 9, 2008 — 8:31 pm
Brian Brady says:
“I would agree.”
Killjoy.
Not a bad place if you’re buying in loonies- You get to own coastal real estate, battered by a market, with some 15% downside protection (currency devaluation).
I feelya, though.
June 9, 2008 — 8:46 pm
Bob Wilson says:
I know, but patience is a virtue, and here it means you’ll save even more (double up that 15%).
June 9, 2008 — 10:46 pm
Benjamin Bach says:
Better yet, trade the Vancouver condos for *three* Kitchener-Waterloo condos, and have cash left over for closing costs at the end 🙂
June 10, 2008 — 4:47 am
Benjamin Bach says:
“Trading a condo in Vancouver for a craftsman in Oceanside might make a lot of sense…if you’re an investor.”
Better yet, trade the Vancouver condos for *three* Kitchener-Waterloo condos, and have cash left over for closing costs at the end 🙂
June 10, 2008 — 4:47 am
Ken Smith says:
When the dollar was strong I had investors buying outside the US to protect against the potential devaluation of the dollar. These same investors are now selling their foreign properties to buy in the US again. These investors feel that the dollar is ready to rebound as are many US real estate markets.
June 10, 2008 — 4:15 pm
Robert Kerr says:
It seems like every realtor has played the “foreign investor” card this year.
First it was going to be Japan, then the Saudis, then every nation on the Euro. None have materialized.
… and now it’s Canada?
I was expecting a send-up, a tongue-in-check coup de grâce, some classic Brian Brady dénouement that left me laughing, but when I reached the end, it hit me: you’re serious?!
Aside from the occasional corporate mega deal, like the Chrysler building, I would be shocked to see any significant volume of cross-nation real estate purchases at the house level.
June 12, 2008 — 8:20 pm
Dave says:
I fully agree with the downside coming in western canada. I sold my home in late 2008 and I have watched foreclosures rise and prices slide. My question is how can money be made off this fall? Is there a way to purchase insurance or bonds that make money when home values drop or mortgages default?
February 13, 2009 — 1:08 pm