Tuesday, December 15, 2009

Do you see what I see?

It seems articles on the Canadian housing bubble are starting to pop up everywhere in the mainsteam media.

Yesterday there was this one by David Rosenberg, chief strategist for Gluskin Sheff & Associates Inc, observed that "if being 15% to 35% overvalued isn't a bubble, then it's the next closest thing."

Meanwhile Bank of America Merrill Lynch, in its 2010 investment outlook, warned that Canada was "likely inflating a housing bubble" and that the "Bank of Canada may be underestimating the inflationary impact of a red-hot resale market."

So what do you know... it has become fashionable to acknowledge the presence of the 1,000 pound gorilla in the room.

Now what?

Yesterday's post covered off how both Carney and Flaherty aren't about to do anything about it.

And their inaction comes just as we learn that Canadian household debt has hit 145% of disposable income. Not only is this an all-time record, it's more debt than families in the United States had in 2006 when their real estate market collapsed.

Even more disturbing is the fact that, relative to incomes, Canadian housing prices are higher than they were in America when their R/E market collapsed.

The reality is... our situation is not all that much different than what America was facing. And, as has been posted numerous times on this blog, the factor that looms as the lynchpin for disaster is that our emergency, record-low mortgage rates are producing the exact same effect as teaser rates did on US mortgages.

Which brings us to this interesting little story in the Wall Street Journal.

Brian Fitzgerald, a WSJ writer, finds himself in the same position that one in four American's with a mortgage is in: he is underwater.

And the way he looks at purchasing a home now is dramatically different than it was when he made the decision to buy in 2006.

Do Canadians today see things the way he saw them in 2006?

Fitzgerald's New Jersey house is currently worth about $30,000 less than the current balance on his mortgage.

Fitzgerald stresses that he was not a home flipper or boom-era borrower who opted for an exotic loan with no documentation. In buying his house, he was making "a life decision."

Fitzgerald, you see, is remarkably similar to so many Canadian families who have purchased a home over the past three years. And his comments on how he came to be in this significant underwater position should send chills down the spines of those Canadian families.

  • "We started thinking about buying in 2004... we probably could have held out a few years in our sizable apartment in Metuchen, N.J., a bedroom community about 35 miles outside of New York City. But we knew interest rates were hovering at historic lows. It was impossible, working at The Wall Street Journal, to not read those headlines every day. At the same time, people all around me were buying homes and refinancing their mortgages to capture these relatively inexpensive home loans. It was like a race, and everyone else was crossing the finish line while I was still putting on my sneakers.

    When we started looking, one of the first things that struck me was how expensive even run-of-the-mill two-bedroom homes were–$450,000, $625,000 and more. A house going for less than $350,000 was rare, and what we found in that range would give pause to even the hardiest of fixer uppers. It was distressing. These weren't impossibly large homes either, at least not to this lifelong apartment dweller. Buying in tony Metuchen was out of the question.

    We weren't oblivious to the fact that people were stretching to buy homes. We were adamant about getting a fixed-rate loan. Rates really had nowhere to go but up, so why would we want an adjustable rate?

    We were concerned about the down payment... we [ended up] plunking down only 7% or so on the down payment. [As a result] we were faced with a steep insurance fee. I was naively insulted by this PMI – the idea that we were risky borrowers out of the box. So we opted for a "piggyback" loan, a second loan that would cover the rest of the down payment and allow us to avoid the PMI. We would pay about the same per month, and when our home's value rose, we would refinance and combine the two loans into one. A lot of the people I turned to for advice were recent homebuying colleagues facing similar questions, or longtime owners who were doe-eyed by low interest rates. I don't recall anyone saying 'Dude, wait a few years.'

    We negotiated a bit on the price and closed the deal in May 2006 for about $328,000 at a 6.12% rate. At the time, I didn't know that the second loan was a de facto home-equity line of credit. I knew it would be a higher rate–a little more than 2.5 percentage points higher. But the loan amount paled in comparison to the main mortgage, so I wasn't overly concerned.

    What we didn't foresee was home values–ours included–dropping so steep, so fast. Zillow.com now estimates our home is worth $270,000.

    The price drop sometimes feels like an apparition. On paper, my home is considered less valuable than what I am paying for it. In reality, it is the same home (warts and all) that I liked when I signed the papers. I can afford the mortgage and insurance payment, even with my wife at home raising the kids. That is a luxury I can't put a price on. I wouldn't call us comfortable like a nice pair of jeans, I would call us comfortable like the same pair of jeans after Thanksgiving dinner.

    Financial consultants would scream at me for how much of my net pay the loan sucks up. I could hold the least expensive mortgage in America, and I'd still be in trouble if I was laid off... if I knew in 2006 that in 2009 I'd be able to get the same home for a 20% discount AND still get a low rate, I never would have pulled the trigger."

Speaking to two mortgage brokers over the weekend, Fitzgerald's situation parallels the situation many Canadian buyers are in. They have also finagled their way around their downpayment by juggling finances to - for all practical purposes - borrow the money for the downpayment... similar to what Fitzgerald did.

Thousands, if not hundreds of thousands, of Canadian families are currently echoing Fitzgerald's comments in their lead up to purchasing their homes over the last three years. The similarity in the comments is undisputable.

  • They probably could have held out a few years,
  • They knew interest rates were hovering at historic lows,
  • People all around them buying homes and refinancing their mortgages to capture these relatively inexpensive home loans,
  • It seemed like a race, and everyone else was crossing the finish line while they were still putting on their sneakers,
  • When they started looking, it seemed even run-of-the-mill two-bedroom homes were expensive, homes in their price range would give pause to even the hardiest of fixer uppers. It was distressing.
  • They weren't oblivious to the fact that people were stretching to buy homes and they felt they had to do the same,
  • They were concerned about being able to even make the down payment.

All those things are being said by similarly pressured home buyers in Canada today.

And mark my words... the only thing that will change three years down the road when Canadians compare themselvest to Fitzgerald's situation will be the amount their homes drop in value and how high interest rates on mortgages have shot up.

In three years many Canadians will be saying, "if I knew in 2009 that in 2012 I'd be able to get the same home for a 40% discount, I never would have pulled the trigger."

And if the market only collapses 40%, we will consider ourselves lucky.


Email: village_whisperer@live.ca
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  1. As a person who is ready to buy (significant down payment and steady income), but not willing to pay these inflated prices, the wait for sanity to return is a test in patience. I hope this doesn't take three years for this mess to unfold...but I'm not going to buy any sooner if it doesn't. As one of the previous commenters said, where does a person put their money as we wait?

  2. Excellent Blog!

    Something Wicked This Way Comes

  3. Excellent article again!

    My wife and I are waiting too. We're anxious to buy, but not to go into negative equity from the start (good jobs and downpayment). Interest rates can only go up, stimulus will wind down in 2010 and massive deficits will ensue bringing higher taxes in many forms, unemployment is expected to increase, exports are down with the high Canadian dollar, there's significant slack in the economy, higher housing inventory in our area, and other factors are SHOUTING at me the prices are coming down, have been coming down, and will continue to fall in our area.

    Thanks again for another great article.

  4. Thanks for the comments.

    Paul, I will make some comments about you question later this week.

  5. I too would love to hear those recommendations to Paul. :-)

    I'm sitting on a 20% downpayment which moves to 40% pretty quickly if house prices fall. I confess to idly looking and throwing the occasional low ball offer, but so far no one has been desperate enough to bite - although one flipper just pull his house back off the market to do more renos. That's it buddy, sink another $40,000 or $50,000 into it and see if it sells then.

    Hint to that guy: If people aren't buying your house in Victoria - where most houses get multiple offers in just a few days - you are asking too much.