Thurs Post #2: Canadian home prices to tumble 25% according to one economist. Buyers and sellers in a standoff.

As buyers and sellers in Vancouver remain locked in a standoff, Canadian Press tells us about an economic report by Capital Economics which counters suggestions by some Canadian Banks that the housing market is headed for a soft landing.

If the Canadian real estate market continues to cool, house prices could see substantial declines next year and could fall by as much as 25 per cent over the long term, according to an economics report released Wednesday.

Though some economists have suggested that a tepid slowdown so far in the market suggests it is headed for a "soft landing," Capital Economics economist David Madani said he continues to believe that a more drastic drop is on its way.

"We think a housing correction over the longer-term is inevitable and still stand by our earlier view of house prices declining by 25 per cent," he said in the report.

The flurry of opposing opinions has been triggered by the fact both national home sales and the average home price were down year-over-year last month.

The national average home price in June was $369,339, down 0.8 per cent from the same month last year.

This triggered some pro-real estate groups to claim that you shouldn't pay attention to the average price (as we noted yesterday).  These groups suggested you follow their 'formula' which cast the 13.3% decline in the average Vancouver price as a 1.7% increase.

Home sales have dropped four per cent in the past two months and Madani said the trend is likely to continue given Ottawa's recent move to further tighten mortgage rules, by capping the maximum amortization term at 25 years.

Capital Economics economist David Madani went so far as to assert that considering that there is usually a lag between a drop in home sales activity and prices, significant declines in home prices could come in five to nine months.

The Capital Economics report acknowledges that house prices haven't started to fall en masse, but dismisses theories that Canada's housing market is enjoying a soft landing.

"There is always a stand-off period at the end of a housing bubble, when prospective buyers refuse to meet the prices of sellers, who refuse to drop to the asking price," said Madani.

The report warns that any stagnation in prices can be misinterpreted as a successful soft landing.

Certainly there is no doubt that the local real estate market has entered that stand-off.

And with record low interest rates already in place, no sign the federal government is going to reverse direction on mortgage rules to flush the market with more easy money, and an world economy that is showing no immediate signs of significant improvement... the next move is clearly in the hands of the sellers to reduce prices.

The only question is... how long will they wait.

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Our housing bubble "bound to burst"

One of the greatest complaints in the local blogosphere is that our mainstream media seems so beholden to the Real Estate industry because of the tremendous revenue stream they deliver via advertising.

That's why an article on Friday in the Vancouver daily newspaper, The Province, is such a pleasant surprise.

Saying what the blogosphere has known now for several years, The Province headlined "Housing Bubble Bound to Burst: When it does, the result isn't going to be pretty, economist says"

• With fresh signs from the Bank of Canada that interest rates will stay lower for longer, Canada's still-hot housing market has many of the hallmarks of the U.S. situation just a few years ago.
  
  House prices dipped during the recession, but bounced straight back and have kept climbing since. And homebuyers are taking on record debt to buy houses at historically high prices.
  
  When interest rates eventually rise, some forecasters warn the result isn't going to be pretty. "Our view is that we are in a housing bubble, that housing prices have risen very sharply over the last 10 years, and that there is a big disconnect between housing prices and fundamentals, including interest rates," said David Madani, an economist at Capital Economics in Toronto.
  
  "It really does look like a housing bubble that will have a very unhappy ending."

Now the economist making this prediction is David Madani of Capital Economics.  We have profiled Madani before and these statements are consistent with comments made earlier this year.

What is so surprising is to see one of Vancouver's two main daily newspapers headlining the news is such dramatic fashion.

The article notes what I believe will become a crucial point in the coming years when the collapse is well underway:

• "The government, fretting about high debt levels, is working to engineer [a]  soft landing with tighter rules for government-backed insured mortgages that took effect in March. The changes cap mortgage terms at 30 years rather than 35 and cut the amount homeowners could borrow against their homes to 85%  from 90%."

The Government is aware.  We have seen that in the comments of both Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty.

Benjamin Tal, senior economist at CIBC World Markets says what is becoming the accepted wisdom on our current housing bubble:

• "In order to crash you need two preconditions: a huge increase in rates as in 1991, which is unlikely, and a subprime type situation, namely very low-quality mortgages."

The faith in low interest rates is tied to the worsening economic climate and level of sovereign debt. For 20 years now we have enjoyed artificially low interest rates to support the economy.

Faith in this going forward is folly but not as much folly as what Tal the Province article closed with:

• "Canada's national banks are more conservative lenders than America's fractured regional banks were, and there is virtually no sub-prime market, where riskier borrowers end up paying higher rates. Mortgage interest is not tax-deductible, so the incentive to buy a home is less. And a large slice of the mortgage market is insured by the government."

We have covered the folly of this extensively.  CMHC has enabled the lending through our banks and there most certainly sub prime borrowers out there... and in numbers that we believe will be proven to be far greater than in America.

So while it is pleasing to see the media cover the fact that this bubble will burst, it is disappointing to see the primary cause of the collapse continue to be justified.

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Wed Post #2: Another R/E Bubble Warning

We last heard from Capital Economics (CE) back in June 2011.

 They are an economic think tank founded in 1999 to provide "independent macro economic research in the US, Canada, Europe, Asia, Latin America, the Middle East and the UK, on the property sector", had concluded that Canada's housing market was in a bubble that's set to burst.

They say housing prices could plunge by as much as 25%.

• “Housing valuations have lost all touch with fundamentals and household debt is at a record high. Canadian house prices are overvalued at close to the excessive levels seen in the frothy U.S. market at its 2006 peak.”

Two months later the group continues to pump the same message.  The Globe and Mail put out an interesting chart on Monday by the group which shows 'house price to income per capita'. As you can see we are nearing the same levels the Americans had just before their crash took hold (click to enlarge):

CE notes that our current boom has produced the largest increase ever seen in Canadian housing prices and has wrenched real estate out of its usual alignment to people’s income and concludes that all signs increasingly point to a housing bubble.

“The stories we hear about people buying homes to rent out as investment properties, and others buying homes fearing that if they wait they will be priced out of the market, only convince us even more,” CE's David Madani (pictured above) writes in a research note.

Madani restates the same concerns as those articulated in June.  Mass psychology – “animal spirits” – have driven housing prices to unsustainable levels and that it can only lead to a collapse of at least 25% over the next few years.

In the short term, Mr. Madani sees any further gains as modest. “Housing affordability is already stretched, with costs accounting for a very large share of household income, over 40 per cent according to some estimates.”

Olympic Village - Millennium Water

Speaking of bubbles and a declining market, have you seen the latest bit of promotional desperation over at the former Olympic Village (now Millennium Water)?

Our friends over at Vancouver Condo Info are reporting today on the latest from the sales team team at Rennie Marketing,

The website hails: "We’re kicking off a brand new promotion tomorrow—an amazing move-in package of essentials for every buyer—it’s everything you’ll need for life at The Village!"

And almost as if you are watching a Ron Popeil commerical, the list of goodies carries on missing only Popeil's trademark "but that's not all... you will also receive..."

The package includes:

• A hybrid bicycle – for your 5KM ride along the seawall to Stanley Park
• A portable BBQ – for Saturday’s BBQ with the in-law’s, on your balcony or at Hinge Park
• A one-year Aquabus ferry pass – for a last minute trip to Granville Island or Yaletown
• A single person kayak – get to know the neighbourhood sea life
• A year’s worth of one-zone Translink FareCards – the skytrain is only 5 minutes away
• A coffee per day for a year at Terra Breads Café – just downstairs
• A pair of running shoes – run the seawall in style
• A year’s worth of groceries from Urban Fare – an elevator ride away
• A year’s membership to Modo Car Co-op – for your day trip to Seattle
• A set of All-Clad cookware – for your Miele kitchen

I wonder if Rennie could get Weird Al to redo his Popeil song for him?  "Now how much would you pay?"

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Anyone got a pin? - Updated

For three years now there have been articles all over the Canadian blogosphere warning that the debt levels of Canadians has been getting too high, that real estate valuations are out of whack and that, much like the rest of the world, the real estate bubble in our country will burst.

Over the past year, many of those same warnings have started to appear in the mainstream media, lead by the consternation's of our central banker and federal Minister of Finance.

But while the mainstream media has been content to simply warn of the consequences of too much debt and over valued real estate, recently articles have started to suggest the bubble is getting ready to pop.

Yesterday CBC carried one such article.

Headlined "Canada's Housing Bubble deemed close to bursting", the Mothercorp detailed ruminations of economists from Capital Economics, an economic think tank founded in 1999 to provide "independent macro economic research in the US, Canada, Europe, Asia, Latin America, the Middle East and the UK, on the property sector."

Glancing their ivory tower eye towards Canada, they conclude that the Land of the Maple Leaf's housing market is in a bubble that's set to burst.  And they say housing prices could plunge by as much as 25%.

“Housing valuations have lost all touch with fundamentals and household debt is at a record high.”

And that's for the nation as a whole, imagine if the study were centered on Vancouver?  Particularly in light of the new 'facts' from the Real Estate industry which conclude that HAM is not a significant factor in our inflating land values?

Capital Economics says that Canadian house prices are overvalued at "close to the excessive levels seen in the frothy U.S. market at its 2006 peak."

None of it is news to the blogosphere.

The linchpin, in our opinion, is that significant drops will be driven by rising interest rates.  As we have said ad nausem, there may be a slow melt in the short term but the big crash will not occur until interest rates start to rise.

And Capital Economics's expects that the Bank of Canada will stay the course in the near term on interest rates as financial worries at home and abroad keep Mark Carney from taking action to raise rates.

So is a correction still a long ways down the road?

Interestingly Realtor Larry Yatkowsky has posted data (also hilighted over on VREAA) that shows R/E sales on the 'HAM-infused' westside of Vancouver are down by over 60% this past month.

As VREAA asks, "Is this the start of the seasonal summer slowdown, or the beginning of buyer drought? Who will be stepping up to take the über-jumbo-mortgages necessary to ‘buy’ these properties when prices start falling?"

Pin anyone?

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It's all about interest rates

Pretty much since the first day this blog started, the fundamental theme has been that the one element that will prick the massive housing bubble being blown in our little hamlet in the Village on the Edge of the Rainforest is interest rates.

Interest rates have been artificially suppressed by the powers that be since the dot com crash after 1999.

All around the world this factor has contributed to a real estate boom.

Here in Canada, cheaper access to mortgage funds combined with an easing of mortgage credit terms have created the liquidity that homebuyers have used to drive the price of real estate skyward.

When interest rates reset to the historic norm (8.25% over the past 20 years), the housing bubble will pop in spectacular fashion.

Today Capital Economics has come out with a bleak report suggesting that the Canadian housing market is likely to suffer the same sort of crash that has plagued countries such as the United States.

The catalyst?

Interest rates, of course.

In an article in today's Globe and Mail newspaper the headline screams, rate hikes could spark house price collapse

According to economist David Madani, “even small rises in official interest rates have been shown to have a big effect on homeowner confidence in other countries under similar circumstances as they can change perceptions towards the housing market very quickly. If the Bank of Canada does resume its monetary tightening this year, this could easily prove to be a tipping point for a house price collapse.”

This is no great surprise. The problem is NO ONE believes interest rates will ever return to those historic norms.

That's why we get ridiculous surveys like the one released by the Canadian Association of Mortgage Professionals last year showing that Canadians are confident they can shoulder higher mortgage payments without too much difficulty, with 84% saying a $300 monthly increase was no problem.

That's because no one evisions any sort of dramatic hike in rates.

Using the CMHC mortgage calculator for a $550,000 mortgage, the current monthly payment amortized over 35 years at 3.75% is $2,377.79.

Hike that rate to the historic 20 year norm of 8.25% and drop the amortization to 30 years (as per the new rule changes for mortgages) and the monthly payment on renewal jumps to $4,078.61.

How many households can handle a $1,700 jump in monthly payments?

Even if the rate only rises to 6%, the monthly payment jumps by almost $900... triple the $300 per month jump the survey says most Canadians can handle.

Capital Economics predicts that "as the central bank raises interest rates, mortgages will become more expensive for Canadians. Add inflation to the mix and prices could fall 25%-35% over the next few years."

The domino effect of a drop far smaller is what triggered the collapse in the United States. Combine this with the fact that our home prices are severely out of whack with elements such as incomes and the cost of renting and you have the recipe for a massive collapse here in Vancouver.

The elephant in the room is interest rates. And many Canadians are in denial that they will ever be allowed to rise above 5% again.

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