Author Topic: Garth Turner - Real Estate in Canada  (Read 446082 times)


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Re: Garth Turner - Real Estate in Canada
« Reply #1810 on: Today at 08:24:06 AM »
Reason for this post: I’ve held a basket of Canadian banks in the late 90’s, did quite well (eg a quite rapid double with CIBC) but eventually put that result in the failure file (file #2 of 4: good result and bad process) because it was basically luck. I want to invest in Canadian Banks again but need to understand better what will happen to Canadian real estate.

Viking has elegantly suggested the possibility that we may somehow muddle through and that’s a reasonable alternative.

This post was triggered by a phone call and a one-page note.

I understand that a significant fraction of Canadians are hurt by rising rates and profiles obviously vary. A member of the extended family circle recently called me to ask advice about a topic unrelated to money or investment. Going to general talk (during which she offered unsolicited financial advice), it became quite clear that she had become financially stretched in the context of a recent purchase of a new (and quite expensive) car and as a recent owner of a nice condo. At the conclusion of the conversation, I made a mental note to prepare an answer that would not appear condescending in order to politely deflect an eventual invitation to participate in an Occupy-Wall-Street type of event in the future.

The one-page note (see below) shows how 1-the % of mortgage debt servicing to disposable income has remained quite stable although there are small peaks that help to define the concept of margin of safety and how 2-the composition of the mortgage payment has changed over time (principal and interest strip). However what the author considers to be a source of “strength” and financial flexibility may correspond, at least to me, to a terrible misconception if the value of the underlying asset bought and financed is overvalued. In some scenarios, the price obtained upon selling may be a relevant input and a source of significant hardship as the value of liabilities is much stickier than the value of assets. At least, that’s one of the lessons learned from the American Experience in 2007-9.

Putting the anecdotal and the statistical together

An amazing phenomenon that has occurred (in North America at least) is that consumers have responded to improved energy efficiency in cars and relatively cheap gasoline prices (despite environmental and high gas prices headlines) by buying heavier and more expensive cars. Can somebody explain that conundrum other than saying that “rational” people respond to prices? The same way, people have responded to ultra-low interest rates by buying larger and more expensive (and progressively overvalued IMHO) homes and this new era even prompted some (?5% of households) to buy a home when it would have been financially safer to rent one.

What’s the point and why it may be relevant now?

People refer to the “hawkish tone” displayed by the Bank of Canada and describe the recent rise in rates as a “shock”. A link is provided below for historical perspective. If what has happened to the recent mortgage rate trajectory is found to be traumatic, the historical perspective helps to define the extent of the household leverage situation and the precarity of the residual margin of safety for many. The expression that comes to mind for the residual margin of safety is “peau de chagrin” which cannot be translated directly but which means that, at times, all you may be left with is sorrow.

This post is getting way too long but I looked also at the exposure to fixed and variable rates and the nature of Canadian debt, especially the mortgage debt that has a significant fixed component, which is felt to offer protection in a muddling through scenario but which may also happen to be a curse in disguise.

Disclosure: no long position in Canadian banks, yet.

That historical decomposition of mortgage payments is interesting.  Nice example for those who believe the biggest factor in asset prices is the availability of credit.  In my experience, most people looking at big purchases (houses and cars) accept the salesman's logic of "What monthly payment can you afford?"  I don't think people understand the potential problems if they cannot hold the asset until maturity, just like they don't understand that there's an interest rate embedded in the lease they've been offered.


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Re: Garth Turner - Real Estate in Canada
« Reply #1811 on: Today at 08:58:32 AM »
You might want to keep in mind that had Alberta NOT shut in production early this month, we would be reading about widespread mass lay-offs in Alberta today - and mass non-recourse mortgage foreclosures at the Sched-A banks by the end of March; with a number of o/g firms following shortly thereafter. Hence, most would think that at least some of the money going into those railcar purchases, has a BoC guarantee ;)

You might also want to remind yourself that Canada has reverse mortgages.
The borrower can borrow up to 60% of the equity in their property by taking receipt of a monthly 'reverse mortgage' payment. The premise being that if today's $1M of home equity declines to 400K by the time you're in your late 70's, the forced sale will clear your debts & give you the money to down-size to something smaller (& at a time when you really need to). If you then continue with the reverse mortgage, there will be near zero equity left by the time you're dead, & your heirs will essentially inherit nothing. A rude awakening for many heirs.

Problem is 'what if the value of the property suddenly drops 30% to 700K?, from the prior $1M'?'
Mom/dad get down-sized early, adult stay-at-home kids start getting evicted, & all those 700K houses suddenly start being listed for sale. What used to be a 'rarity' (& therefore higher priced) now becomes 'common' - reducing prices further.  However, most would expect that at least some of a Sched-A banks capital being used to keep these houses off the market, would have an OSFI/BoC 'understanding' ;)

There will not be a 'collapse'. Much more likely is a market driven 'controlled descent'.
But there will be quite a bit of forced 'reckoning', and of course - the social disruption that goes with it.
Versions of today's protests in Paris move to Vancouver, Calgary, and Toronto.

Not a bad thing.

« Last Edit: Today at 09:00:47 AM by SharperDingaan »


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Re: Garth Turner - Real Estate in Canada
« Reply #1812 on: Today at 09:12:11 AM »
My rules is to never invest in banks, if I don’t likely the macro environment in the future. banks are foremost macro bets, due to high leverage and to some extend market perception. They will do poorly, if credit spreads start to rise or the macro environment takes a hit. that’s why I don’t invest in British banks (prior to Brexit) or the like. A lot of times, it has been said that it’s priced in, but in my experience, it never is.
To be a realist, one has to believe in miracles.