Thursday, May 17, 2012

Are the swirling winds of change blowing towards a Nexus point?

HAM... or Hot Asian Money... has been a prominent feature of our real estate bubble.

As China pumped more stimulus money, per capita, than the Americans into their economy a huge bubble has been blowing.

One of the benefits has been China's real estate.

Buoyed by inflated real estate values, wealthy Chinese have extracted equity and utilized equity to leverage real estate purchases overseas. And Vancouver has been a primary beneficiary.

But what happens when the bubble begins to burst?

One of the first consequences is the access to easy money disappears... and with it the free flow of money to locales such as the Village on the Edge of the Rainforest.

HAM is basically AWOL in the Vancouver Spring Real Estate market and all indications are the situation in China is worsening.

Mish Shedlock noted on his blog yesterday that the Real Estate Crash in China is Underway.

Citing an excellent report (China Real Estate Unravels) by Patrick Chovanec, a professor at Tsinghua University's School of Economics and Management in Beijing, Mish notes that Chinese developers, burdened by 70% leverage ratios and loans threatening to come due, rushed to complete projects already in their pipeline, to put those units onto the market and raise cash.

That rush to complete inflated real estate investments, investments that were allegedly up 23.5% in the first quarter.

But other statistics from the report tell the real story.
  • Year-on-year sales in Q1, for all real estate, was down 14.6%.
  • Residential property sales were down 17.5%
  • Office sales were down -10.2%
  • Sales in January-February were a disaster, falling 20.9% overall, compared to the first two months of 2011, -24.7% for residential.
  • Total amount of floor space “for sale” was up 35.5%, compared to the same date last year
  • Floor space of residential units “for sale” grew 47.4%.
  • At the end of 2011, total floor space “under construction” was roughly 4.6 times the floor space sold
  • A year and a half worth of excess inventory is hidden somewhere in the pipeline
  • New starts in April fell 14.6% year-on-year and 27.0% month-on-month, for property as a whole
  • Housing starts fell -14.4% year-on-year and -23.4% month-on-month
  • Office starts fell -21.0% year-on-year in April, and -45.1% compared to March
  • Retail property starts fell -18.7% year-on-year, and -36.8% compared to March
  • Land sale revenues in April (RMB 27 billion) were down -54.7% compared to April last year
  • Foreign funding for property development was down -91.4% in March and -80.8% in April, compared to the same months last year.
Chovanec notes:
"Clearly a crash is underway and the Chinese soft-landing thesis is collapsing.

The “resilient” growth in real estate investment that seemed to promise a “soft landing” is not very resilient at all. It’s more like the last gasp of a market that’s running out of steam. Once the surge in completions plays out, the declining number of new starts will become the pipeline, and growth in property investment will flatten or go negative.

Property investment accounts for roughly a quarter of gross Fixed Asset Investment (FAI), and net FAI accounts for over half of China’s GDP growth. As I noted in January, in a back-of-the-envelope thought exercise, if property investment plateaus (growth falls to zero), it could shave as much as 2.6 percentage points off of real GDP growth. If it fell 10% (in real, not nominal terms) it could bring GDP growth down to 5.3%.

At the time I first saw this dynamic in the data, when the Q1 numbers came out, I figured it would take several months to begin playing out. But the April numbers suggest it is already happening.
Chovanec notes if real estate investment drops by 10%, GDP will come in at 5.3%. But what if real estate investment falls by 20% or 25%?

Moreover, why shouldn't it?

The real estate crash in China has arrived and is underway.  The GDP crash will follow shortly.

What comes after that?

After that comes the second consequence for the Village on the Edge of the Rainforest... the panic sale of overseas assets to meet financial demands at home.

All of which is shaping up to hit us just as the OFSI rule changes come into effect.

The swirling winds of change are blowing towards a convergence point that can only be described as the perfect storm combining the Boomer Trigger, the China Trigger and the Speculator Trigger with upcoming mortgage rule changes.

People email me and say my prediction of a collapse in real estate values here of 70-85% is completely unrealistic and they just can't see how it could possibly come to pass.

Not only do I think it is very easy to see... I sometimes think my estimate may be underestimating the full extent of what may play out.


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  1. Pull up! Pull up!

  2. In the words of Bob Dylan "Oh the times...they are a changin' "

  3. Just to add to your day. I like the blog. One item I find rather qualitative is your 70 to 85% correction. Just for fun I would ask you to show us a real estate market in a G20 country that has seen this type of correction.
    Key word - "market" = country

    I will leave that with your viewers. Cheers,

    1. Las Vegas, Nevada

  4. Sockeye
    I assume the link is for me. Read it and don't see how Vegas equates and it was 61%.

  5. Hard to imagine, but soon, people, in mass will run from real estate! I was looking for muliplex in Montreal in 1998 and the for sale sign was every where, its coming back.

  6. I also think that 85% is excessive but one could argue that since Vancouver has become on of the most unaffordable cities on earth that high valuation is more prone to high percentage losses when the debacle ensues. This kind of destruction would need to be have regulation coupled with interest rates becoming very high in addition to a deep recession. When there is no bid though, things can drop in a hurry.

  7. That is the missing factor - a significant increase in rates. And we can see from our friends south of the border that is not going to happen anytime soon. So,one thing people hate is to take a loss(it has been shown in studies) so they will hang on. So, I do believe in a correction but 70 to 85% will only occur when a Mad Max world begins.
    A slow bleed will be the case 5 to 10% each year for a few years.

  8. I think the baseline case would be a 30% decline. Such a decline would trash the local, if not the national, economy. If that results in CMHC failing (hardly a surprise) and dragging down the fed govt, the sovereign debt may behave like those of Greece/Spain. In such scenario, another 20-30% is quite possible.

  9. It's not crazy. My baseline for some time has been up to a 70% drop based on return from 10x average income for a home to something historically supported like 3x. I felt the same as you thought that it seems like such a big number, but ultimately Vancouver is so over-inflated it's gonna drop. Fundamentals always prevail over the long term.

    An important thing to remember is it won't happen over night. I saw this happen in the US and it is year after year after year. Each year if the market dropped an amount, say 5% to 10%, it seemed like the normal price - and a reasonable deal at the time. After all with the latest drop, that's what buyers were willing to pay. However, looking back after a few years the drops add up materially. In my experience at some points in time, the prices even seemed to plateau, and then proceed to continue to edge down at a later point.

    If I read it right, Garth Turner reported this week YOY price drop of 10% documented in Van. That's already a start to year 1. Multiply that by 5-10 years of malaise and you got yourself the 70%. I actually think the first couple years in Van could be 15% or more.

    As an aside, I believe the market has largely been driven by locals buying from locals. Once people start holding off because of fear of market decline, it's set to decline. Once it declines, those high ratio borrowers are screwed and some small percent will begin to bail - cementing the beginnings of YOY drops and will go on for years IMHO. That will happen even without the distressed sales that will be coming, resulting from people on the edge who can't afford their renewal as near zero interest rates edge up even just a few points in the coming years.