The market looks "very ripe for a meaningful correction"

Last Saturday we profiled this tidbit from 'Alphabet Arnie'

AA told us that:

Terra Nova is like a microcosm for Richmond... and it isn't great.

Well it seems that our other favourite Richmond real estate, James Wong, has also been analyzing the Terra Nova barometer.

On January 21st, Wong blogged about 'the market standoff' in Richmond.

Like in other parts of Greater Vancouver, the real estate market in Richmond can be described as “a stand off” between home sellers and buyers. A typical area to track home prices is Terra Nova, a newer housing sub-division located to the north west corner of Richmond. Terra Nova is a better known by the local residents as one of the most prestigious and expansive neighborhood in Richmond.

And how have Terra Nova home prices done the past few years?

The chart below tracked the home prices for single detached homes with built-up area between 2,600 to 2,900 sq ft. These homes are generally consisted of 5 bedrooms and 3 to 4 full baths, and the lot sizes are from 5,000 to 6,000 sq ft.

Impressive gains to be sure.

At this point Wong gazes into his crystal ball.  What does he see?

The housing market in Richmond the past 8 years had been supported by wealth from new immigrants, not income.

A lot of this is wealth from newly arrived immigrants, although it is difficult to quantify it. Many of these purchases by home buyers the past few years don’t need a mortgage because they have the cash and can buy a house outright. But, with a sharp drop off in buyers, and amble supply of homes for sale, sellers are under pressure to cut their prices.

The possibility of a prostrated decline is real as declining home prices, tightened lending and high prices deter buyers to enter the market.

The supply of rich new residents to Canada is now diminishing, due to the changes happening in the immigration policy for new immigrants. There is a slowing down in people coming to Vancouver, especially foreign residents with a lot of money.

With lack of buying activities, the market looks very ripe for a meaningful correction.

Very ripe for a meaningful correction, eh?

Clearly Wong, an Asian realtor, is not placing much hope in the belief the market will see a Chinese New Year resurgence.

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Canadian Business Magazine asks: How low will house prices go?

Canadian Business Magazine joins the media attention on our housing bubble with an article that asks: How Low Will House Prices Go?

Before every housing correction, there’s a Looney Tunes moment. In the animated universe, there’s a gravitational peculiarity that briefly suspends an overzealous pursuer in mid-air, just long enough to flash a HELP! sign, before plummeting off the cliff he failed to navigate. When it comes to overheated real estate, there is a pause that follows the outset of a correction, during which the market fails to realize there is nothing below but air.

Ahh yes, the Wile E. Coyote moment.  Two weeks ago it was Macleans insisting that we were there, now it's Canadian Business Magazine.

The pattern is familiar: it starts with slowing sales activity. Listings begin to generate fewer offers. Would-be homeowners start to see the sense in holding off. In Toronto, where less than a year ago a rundown semi-detached could sell for $100,000 or more over asking price, the era of the bidding war is fading. “Buyers are sensing that prices are going to come down, so why buy now?” says Thomas Neal, a Royal LePage agent in Toronto, where housing transactions in December slid by 25% from the prior year. In Vancouver, the number of homes sold last year trailed the 10-year average by 25%. It is in those two markets where the twin epicentres of the Canadian housing shakeup reside. But the ground is beginning to shift under the national market as a whole. Those kinds of numbers support the view that “a potentially severe housing correction is underway,” says David Madani, an economist at Capital Economics, who for months has been predicting a 25% decline in Canadian home prices.

Which brings us to where we are now... the denial stage where sellers refuse to acknowledge the shifting market.

The real estate industry insists sellers will hold firm forcing buyers to capitulate and continue to pay higher and higher prices.  Canadian Business has a different take:

As usual, one-half of the market refuses to look down. “We’ve got a number of sellers who say, ‘If we’re not going to sell for a particular value, we’re not going to sell at all,’” says Victoria real estate agent Tony Joe. “A lot of people are still pricing their properties based on yesterday’s market.” So, even though demand is weakening, prices have yet to fall for most of the country.

The reluctance of sellers to compromise is understandable, given recent history. For more than a decade, real estate in Canada appreciated almost without interruption. Even the financial crisis and ensuing Great Recession registered as little more than a blip. Meanwhile, most economists take the current trends as indicative of a “soft landing” for the sector, with just a slight moderation in prices afoot. But asking a bank economist or real estate market insider about the likelihood of a soft landing is like “asking your barber if you need a haircut,” says George Athanassakos, a finance professor at the Richard Ivey School of Business, who expects a “severe correction,” and soon. The current resilience in home values could simply be the brief mid-air pause before physics brings about the plunge fated for inflated housing markets and cartoon coyotes alike.

People tend to have short memories about real estate, Neal says. Since 2000, the average home price in Canada has shot up by 125%, which has reinforced the perception that residential real estate is infallible.

So what will trigger a slide?

Just as excessive faith in home appreciation can overheat a market, so too can a change in sentiment accelerate and intensify the downside. With the rate of home ownership now close to 70%, and with household debt at a record high, much of the financial health of Canadian households is inextricably linked to home values, making it the kind of dominant concern that not only affects household finances, but consumer psychology and confidence.

Even most bank economists believe Canadian housing is overpriced somewhere in the range of 10% to 20%, perhaps more so for the hottest condo markets. That’s manageable as long as interest rates and unemployment remain low, says Doug Porter, deputy chief economist at BMO Capital Markets. Absent an external economic shock that would ultimately put Canadians out of work, there is no reason to expect markets to correct hard and fast, he argues. “What would force people to feel that they have to sell at much deeper prices, given that the interest rate environment is likely to remain quite benign at least through next year?” Without a trigger, there should be no national housing crash, Porter says.

Ahh yes, the lack of a national trigger. That's been Tsur Somerville's argument.

But there are some mortgage professionals who argue that the catalyst for a national reaction has already arrived by way of the federal government, which deliberately cooled the market by tightening mortgage regulations. Those changes would have disqualified almost 10% of all 2010 homebuyers, according to a report by Will Dunning, chief economist for the Canadian Association of Accredited Mortgage Professionals. “That’s taking a lot of demand out of the market,” Dunning says. “You’re putting the housing market at risk, and the broader economy.” Now Dunning says the market is “weak enough it could result in prices falling in many places across the country.”

And under these conditions, which group of seller's might panic and bail on the market?

In 2011, Toronto had record condo sales of more than 28,000 units. “The kind of construction we’ve seen is absolutely off the charts,” Porter says. “It is the kind of market that is so heavily supported by investor demand, we could have a temporary spell of a pretty serious correction.” Investors are potentially more likely to sell when prices decline, which could ultimately flood the condo market with resale listings. With 240,000 more planned condo units yet to be built in the Toronto area, many are worried about a burgeoning supply-demand imbalance. Already, investors are backing away from the Toronto condo market, which reported a drop in third-quarter unit sales of 30%. Developers reacted to both slowing sales and a record high level of unsold inventory by launching just five new projects in the third quarter in the 416 area, which typically sees 15 to 20 new projects per quarter. 

Investment demand also looms over Vancouver, where the condo market spent most of the year in full retreat. Since May, the benchmark condo price in Vancouver has already fallen by 13%. If the expectation of appreciation disappears, another layer of demand could shrink from the market. Ohad Lederer, an analyst at Veritas Investment Research, calculates that investors buying condos to supply the rental market are accepting annual returns of less than 4%. “That only makes sense if buyers believe that prices will go up.” But if prices in those two markets fall significantly, as Lederer believes they will, condo investors could face some tough decisions. “That’s where the intestinal fortitude of those investors will be tested,” he says.

The market has 'softened', to use the R/E industry phrase, but it has not crashed hard - yet. So we still have a saw-off in analysis which each side firmly sticking to their positions about where we are going:

The stability of housing in Canada relies on a Goldilocks economy—not too strong and not too weak. Economic expansion could lead to rate hikes, which would expose the unsustainable finances of many indebted households. On the other hand, a destabilizing economic event could trigger the housing crash Canada avoided in 2009. The historic crash in the United States is not likely to be repeated here. The U.S. bubble was more a product of risky lending. “A lot of people were allowed to take on debt with little or no prospect of paying it back,” Porter says. In Canada, debt is better distributed among middle and upper-income borrowers, he says. “There still is a relatively solid credit-vetting process in Canada.” Still, many Canadian homeowners are stretched thin. According to a Euro Pacific Capital report, high-risk mortgages make up more than $500 billion of Canada’s $1.1 trillion housing market.

The average home price, at more than $350,000 (which is double the median existing home price in the United States), now sits at about five times the average household income. Housing investment is close to peak levels at more than 7% of GDP—about the measure reached in both the late 1970s and late 1980s, Athanassakos says. “Right after that, the market collapsed in both cycles.”

Canadian demographics no longer support inflated prices, Athanassakos argues. The proportion of Canadians of the age when homes are typically purchased is at a turning point and is set to decline, which historically has been a powerful indicator of housing trends. “The long cycle is most of the time affected by demographics,” he says. And a very long cycle it could be. He foresees a 20-year span of declining home prices. There need not be an explicit economic trigger for an acute housing correction. The imbalances are already there. Changing sentiment could be the spark, Lederer says. “When it turns, it turns very fast.”

And Canadian Business Magazine gives Athanassakos' prediction prominence making it clear where they think we are going:

(hat tip VMD)

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Canadian Business Magazine proclaims "Canada's Housing Crash Begins - The Vancouver market has cracked.”

Canadian Business Magazine is out with an article proclaiming "Canada's Housing Crash Begins" Some excerpts:

In just one year, Vancouver house prices have dropped by 12%, and unit sales are plummeting in both Vancouver and Toronto.

In August, the number of sales in Greater Vancouver fell 21.4% from the previous month, after dropping 11.2% in July and 17.2% in June. The Real Estate Board of Greater Vancouver chalked it up to a “summer lull,” but the numbers suggest a trend that can’t be dismissed as simply seasonal. Last month, unit sales were the lowest for any August in the past dozen years, and nearly 40% below the 10-year August norm. Even more worrying, the average home price in Vancouver is now down more than 12% from a year ago—a worrying sign for the country’s priciest city.

The poor global economy is souring foreign investors’ appetite for expensive property overseas. The federal government, meanwhile, is trying to tame the market by tightening mortgage lending standards and warning the public at every opportunity that Vancouver is a risky city for buying real estate. Interest rates are still low, but the Bank of Canada keeps promising to raise them, which would quickly lower affordability. All of which leads David Madani, an economist with Capital Economics, to conclude: “The Vancouver market has cracked.”

Vancouver won’t be the only one. The next market to crack will be Toronto, starting with the city’s overheated condo segment.

For months, policy-makers have expressed concerns about the country’s two biggest real estate markets. Now it’s clear that trouble is ahead. The weakness in both cities marks the start of a reversal in the long boom for Canadian real estate.

What’s surprising about the weakness on the West Coast is the absence of any change in economic fundamentals, such as a spike in unemployment, to explain it. The Vancouver market was cooling even before the latest round of mortgage tightening by Ottawa, which took effect in July.

A change in buyer psychology may also be occurring, says Madani. “I don’t think there are enough people now who believe we can continue these outsized price gains we’ve seen over the past decade,” he says. “As those expectations change, potential buyers step back.” With Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney constantly warning about Vancouver real estate, it’s not surprising their pleas for restraint are being heeded.

If this change in mindset truly takes hold, the entire Vancouver market will be affected, not just the multimillion-dollar homes.

The city’s real estate has always been mind-boggling to outsiders, but reached a particularly confounding peak this year in terms of affordability. The median house price in Vancouver is 10.6 times greater than the median income, according to urban policy consulting firm Demographia. That makes it the second-most-unaffordable major city on the planet after Hong Kong. The only way to account for the market becoming so detached from fundamentals, in Madani’s view, is a pervasive belief among buyers that prices will keep rising.

Of course, easy access to credit is necessary for people to act on their beliefs. Interest rates have been at record lows since the financial crisis in 2008, making it relatively easy to obtain large mortgages. Rates have, in fact, been falling steadily since the 1990s, helping push the home-ownership rate in Canada to a record high of 68.4%, according to Statistics Canada. Household debt has ballooned, whereas wages have not. “If home prices rise substantially above income growth, the only way you’re bridging that gap usually is through mortgage debt,” says Ben Rabidoux, an analyst with boutique research firm M Hanson Advisors.

While the average resale home price has jumped nearly 128% since 2000, rents have risen by just 16.7%, as measured by the Consumer Price Index. “In order to sustain prices at these elevated levels, you need a continuous supply of new buyers willing to take that mortgage debt, and [able to] get it cheaply,” he says. Those buyers may not be forthcoming. Interest rates will inevitably rise, as the Bank of Canada keeps pointing out, and the federal government has instituted numerous changes over the past few years that will make a home purchase more difficult for first-time buyers.

“It seems like Vancouver is past the tipping point,” says Sonya Gulati, a senior economist with Toronto-Dominion Bank. Gulati estimates the market is overvalued by 15% to 20%, and says prices could fall by an equivalent amount over the next two to three years. Rabidoux foresees an even greater decline, perhaps a 30% to 40% fall in average price. The weakness in sales and the rise in inventory is uncomfortably similar to the market drop in late 2008, he says. Back then, the Bank of Canada slashed interest rates and the federal government launched a program to repurchase mortgages from the banks, which sent the housing market rallying. This time, the authorities are taking away support for the housing market. In the past four years, the maximum amortization period for government-insured mortgages has fallen from 40 years to 25. Such tightening makes an immediate rebound unlikely.

What’s happening in Toronto and Vancouver today marks the start of a much broader slowdown in housing. Affordability is becoming an issue in other cities, especially Montreal, Kelowna and Abbotsford, B.C.

After past housing booms in Canada, the subsequent hangovers lasted many years. The average price in Vancouver fell by more than 20% in real terms between 1995 and 2001 after a steady run-up.

A price adjustment may sound scary, but some say it’s necessary to restore affordability to the housing market and stop Canadians from piling on debt. “We’ve had a very good run in housing over the last decade,” Madani says. “At some point, it just runs out of gas.”

Amazingly... so many will insist they never saw it coming.

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Royal Bank says our real estate market is "vulnerable to a marked correction"

Well I think you can definitely say the alarm bells are ringing everywhere you turn now.

Royal Bank is the latest with warnings.  And this is no tiny warning.

No only does RBC tell us the Village on the Edge of the Rainforest may experience a correction.  Canada's biggest bank is now afraid we are vulnerable to a "marked correction."

Says the Huffington Post:

If you haven’t heard yet that Canada’s housing market is facing potentially serious problems, you’ve probably been hiding under a rock, but a recent study and comments from Canada’s top banker are bringing the point home once again.

A report from RBC released Thursday says Vancouver’s housing market is 'vulnerable to a marked correction.' For a market analysis from a major bank, those are pretty strong words.

Strong indeed.

Even scarier than the rhetoric about a looming catastrophe are the hard core statistics from the report:

“Typical Vancouver-area homebuyers would need to allocate 92 per cent of their income to carry the costs of a two-storey home (based on market price) and almost 45 per cent for a condominium apartment.”

RBC says they expect house prices in Vancouver to fall between 7 and 12%.

When you consider the average price is already down 20% from last May, this forecast from RBC is devastating news for a city whose economy is reported to be over 30% dependant on real estate.

Perhaps even more disturbing is that the numbers quote by RBC are very conservative compared to what Bank of Canada Governor Mark Carney hinted Wednesday might be the actual scale of a Canadian housing correction.

As the Huffington Post article noted:

In comments to the House of Commons finance committee, Carney said Canada’s housing market is overvalued by 35%! While house prices historically in Canada have hovered around 3.5 times average income, they are now at 4.75 times average income.

In some markets that ratio is worse.

Vancouver housing is estimated to cost 9.2 times the average income.

The tension between Canada’s booming housing market and the weakness in the global economy is at the heart of Carney’s dilemma: Whether to raise interest rates to halt a growing real estate bubble, risking an economic slowdown, or to keep them low, and risk blowing up even larger bubbles in Canada’s economy.

Carney has hinted in recent interest rate decisions that the day is nearing when Canadians will no longer be able to count on historically low interest rates.

The RBC report makes it clear that interest rates will be a major factor in determining the dierction of house prices in the months to come, but highlights a wild card in the equation: Foreign real estate investors who have been snapping up residential properties and driving up house prices.

“Risks will be further heightened by Vancouver-area valuation’s dependence on a strong and steady flow of wealthy foreign buyers and recent immigrants — a phenomenon that is both poorly documented and potentially vulnerable to adverse external shocks."

And that's the kicker.

If the market starts plummeting, not only will the "strong and steady flow of wealthy foreign buyers" further evaporate... you could see those same foreign buyers start dumping properties to cut their losses.

At which point calling it a "marked correction" will be a generous understatement.

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Sat Post #1: Bloomberg - Canadian Housing Market heads for severe correction

On Thursday we ruminated on the impact the plethora of mainstream media articles about the Canadian Housing Bubble and pondered what effect it was going to have on the real estate market.

How long before all the negative press convinces buyers (local and internationally) that now is NOT the time to buy?

Yesterday we noted that  TD Bank may have upped the "do not buy" ante with a note to clients in which TD economists said that a "housing correction will take hold in 2013."

Well... the negative press parade continues. Joining TD Bank's claims that the Canadian market is going to correct is Bloomberg, who headlines, "Canada Housing Heads For Severe Correction". 

As headlines go, you can't get much more specific or dire than telling your readers that the Canadian housing market is headed for a 'severe' correction.

Bloomberg interviewed George Athanassakos, professor of finance at the Richard Ivey School of Business. In the article, Bloomberg charted Canada’s housing investment as a percentage of gross domestic product, and the declines in inflation-adjusted house prices that follow when this ratio tops 7%.

According to Athanassakos, “eventually, everything boils down to demand and supply. Whenever this ratio (housing investment as a percentage of gross domestic product) goes over 7%, it signifies overinvestment in housing and two or three years later, we have a severe correction.”

Athanassakos noted that Canada’s housing market is booming as historically-low interest rates fuel purchases, driving up home prices and adding to record household debt. Canada’s ratio of housing investment to GDP has averaged 5.8 percent over the last 50 years but has recently jumped to about 7%, based on Statistics Canada figures as of the third quarter of 2011.

Hence Athanassakos' conclusion that Canada is poised for a 'severe' correction and TD Bank is joined in it's prediction that Canada's housing market is about to face a significant correction.

Will it have an impact? All those Asians with extreme gobs of money won't hesitate to snap up pricey Vancouver real estate because they 'want' to live here and the prospect of seeing their investments "severely" drop isn't an issue... right?

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Fri Post #1: Do not ask for whom the bell tolls...

Yesterday we ruminated on the impact the plethora of mainstream media articles about the Canadian Housing Bubble was going to have on the real estate market.

How long before all the negative press convinces buyers (local and internationally) that now is NOT the time to buy?

Yesterday morning TD Bank may have just upped the "do not buy" ante.

In a note to clients, economists at TD said that a "housing correction will take hold in 2013." Prices are already down from their highs in May of 2011 and TD sees 2012 being a weak year... but the real 'correction' will start in 2013.

Ummm... okay.

So let me ask you a question.  If you are looking to buy, prices have been dropping lately, everyone and their dog is talking about housing bubble, listings are booming, sales are dropping... and TD Bank comes out and says the real 'correction' won't ramp up until 2013 - would you buy this year?

More importantly, if you are one of those 70% of Boomers who don't have adequate funds set aside for retirement and whose entire plan for your golden years is selling your bubble inflated real estate and downsizing in the next 5 years... do you hit the panic button yet?

Thirty-five years ago you bought that Richmond, Burnaby or even Vancouver house for $65,000.  It currently is valued at anywhere from $700,000 to $2,000,000... if local prices start to slide much more, do you undercut the market and still get out with a succulent profit (thereby creating even more downward pressure on prices) or do you stubbornly hold on because the house was valued at 15% more last May and it's "worth" at least that now?

2012 is shaping up to be a very interesting year.

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