Author Topic: Garth Turner - Real Estate in Canada  (Read 488735 times)

KJP

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Re: Garth Turner - Real Estate in Canada
« Reply #1810 on: December 16, 2018, 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.

https://www.nbc.ca/content/dam/bnc/en/rates-and-analysis/economic-analysis/hot-charts-181214.pdf

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.

https://www.ratehub.ca/5-year-fixed-mortgage-rate-history

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.


SharperDingaan

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Re: Garth Turner - Real Estate in Canada
« Reply #1811 on: December 16, 2018, 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.
Change.

Not a bad thing.

SD
« Last Edit: December 16, 2018, 09:00:47 AM by SharperDingaan »

Spekulatius

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Re: Garth Turner - Real Estate in Canada
« Reply #1812 on: December 16, 2018, 09:12:11 AM »
My rule 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.
« Last Edit: December 16, 2018, 05:37:06 PM by Spekulatius »
To be a realist, one has to believe in miracles.

SharperDingaan

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Re: Garth Turner - Real Estate in Canada
« Reply #1813 on: December 16, 2018, 05:11:17 PM »
Always keep in mind that banking in Canada is an 'oligopoly', that operates at the pleasure of her majesty.
Her majesty has also been in the thieving busines since at least the 1500's, and is very 'old school' in the practice of 'good governance'  :D
https://en.wikipedia.org/wiki/Privateer

As european banks are essentially too big for their sovereigns to control; one bets on them screwing up, & ultimately receiving some kind of bail-out. In Canada they get 'broken-up, and the pieces merged into others'  ... arguably a similar discussion to the one that Deutsche Bank and Commerzbank are currently having  ;) https://www.pymnts.com/news/b2b-payments/2018/deutsche-commerzbank-german-bank-merger/

SD
« Last Edit: December 16, 2018, 05:15:57 PM by SharperDingaan »

Cigarbutt

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Re: Garth Turner - Real Estate in Canada
« Reply #1814 on: December 17, 2018, 06:16:59 AM »
Always keep in mind that banking in Canada is an 'oligopoly', that operates at the pleasure of her majesty.
Her majesty has also been in the thieving busines since at least the 1500's, and is very 'old school' in the practice of 'good governance:D
https://en.wikipedia.org/wiki/Privateer

As european banks are essentially too big for their sovereigns to control; one bets on them screwing up, & ultimately receiving some kind of bail-out. In Canada they get 'broken-up, and the pieces merged into others'  ... arguably a similar discussion to the one that Deutsche Bank and Commerzbank are currently having  ;) https://www.pymnts.com/news/b2b-payments/2018/deutsche-commerzbank-german-bank-merger/

SD
For expected extent, direction and quality of “good governance”, you may be interested in reading a 2011 report from the Bank of Canada:
https://www.bankofcanada.ca/wp-content/uploads/2011/06/sp150611.pdf#chart1

Message of yesteryear: we need to apply “vigilance” and “moderation”.

Somehow what happened (just continue the graph lines and data points up to Q3 2018) does not fit, at least to me, to the definition of vigilance and moderation.

The author of the note is now leading a venerated institution in London, may have to issue guidance through a different kind of transition and he’s likely to do whatever it takes. We have learned (in a Pavlovian way) to expect nothing less.

About 7 to 8 years ago, it was suggested that there was a risk: “our institutions should not be lulled into a false sense of security by current low rates. Similarly, households will need to be prudent in their borrowing… ”

Definitions:
Lull:  A temporary interval of quiet or lack of activity.
LOL: Laughing out loud, to denote great amusement.

With use, LOL has been overused to the point where nobody laughs out loud when they say it. In fact, the acronym may be a prelude that leads to a less than cheery consensus. More accurately, the acronym "LOL" could sometimes be redefined as "lack of laughter."

With profiteering, the problem was unreasonable profits from unreasonable delegation of government powers and now it seems that the problem is excessive presence of authorities giving the illusion of control. At least, a constant remains: opportunity to profit in times of stress.

LOL

wisowis

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Re: Garth Turner - Real Estate in Canada
« Reply #1815 on: December 17, 2018, 07:11:53 AM »

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.


Apologies, but I am having trouble understanding this point. If you are putting a significant share of your mortgage payments into the equity of the home, doesn't it reduce the risk to the system? At e.g. 100% LTV, and with all payments going to interest, any drop in the value of the assets could cause insolvency. But at 80% LTV, and 50% of payments going into to the principal, the scenario of going underwater requires a >20% drop in asset values. I understand (psychologically) why trading loonies for quarters would cause hardship for homeowners/homesellers, but certainly reducing leverage in the housing market (which capital repayment does) reduces systemic risk, right?

Cigarbutt

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Re: Garth Turner - Real Estate in Canada
« Reply #1816 on: December 17, 2018, 08:46:31 AM »
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.
Apologies, but I am having trouble understanding this point. If you are putting a significant share of your mortgage payments into the equity of the home, doesn't it reduce the risk to the system? At e.g. 100% LTV, and with all payments going to interest, any drop in the value of the assets could cause insolvency. But at 80% LTV, and 50% of payments going into to the principal, the scenario of going underwater requires a >20% drop in asset values. I understand (psychologically) why trading loonies for quarters would cause hardship for homeowners/homesellers, but certainly reducing leverage in the housing market (which capital repayment does) reduces systemic risk, right?
Hi wisowis
Don't apologize. :)

It is a question of perspective, price/value and ability to hold to maturity.
The underlying assumption is that there has been a growing disconnect between intrinsic value and price.

-Perspective
Elevated down-payments and accelerated principal reimbursement are sound principles and a sign of conservatism.

-Price/value and ability to hold to maturity
The potential problem is paying a premium to intrinsic value and financing a part of that purchase with debt. Then part of the "principal" repayments includes the premium and if you have to sell (for any reason) before maturity when the premium is gone or even has reversed you may end up with an underwater loan and eventually no house left.

Think of dollar-cost averaging for investments. You assume that, over time, the price to value discrepancies will cancel each other. With housing in Canada, it seems to me that a lot of home buyers have increasingly used dollar-cost-averaging to buy and reimburse an over-valued home and some may not have the chance to take advantage of the full cycle.

Also, the higher principal component in the debt servicing implies that people were encouraged and rendered comfortable buying a more expensive home, not considering the over-valuation issue discussed above.

Have you spoken to real people about disappearing home equity going through this in the US 10 years ago?
In the US, leading up to the peak, there was a lot of home refinancing and some of the dynamics was different but the people I spoke too have a feeling the "equity money" that disappeared reappeared (through a creative process) in somebody else's pockets.

SharperDingaan

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Re: Garth Turner - Real Estate in Canada
« Reply #1817 on: December 17, 2018, 08:50:57 AM »
The report cited is 6 1/2 years old, and the world today is a very different place to what it was in mid 2011.
Past results are also not a reasonable predictor of future activity, especially when the future conditions are very different to what they were.

Vancouver real estate is a hot-spot for money laundering, and widely believed to be corrupt. Costs are set by the international buyer, and not the local trying to live there; and we have seen repeated market actions to diminish the influence of foreign buyers (foreign resident taxes, LOC rule changes, mortgage rule changes, etc.). The influence of foreign buyers it is also a common experience elsewhere (London).

Most banks will not lend if the mortgage payment exceeds 1/3 of take-home, corresponding to a house value of roughly 3x salary (1/.33). In low rate environments, house values are higher and banks lend more as the lower interest cost permits a higher borrow. Floating rate mortgages issued over the last 12 months+ have also been subject to a 200bp stress test at time of issue.

Comes renewal time your banker can either demand payment in full, only offer a fixed vs a floating rate loan, or demand a partial principal repayment; hence if you're a sh1t credit, you can become someone else's problem. It's a numbers game, the banker has deeper and better quality historic information than you have, and the bankers need fresh foreclosure examples to show others.

We would suggest that while the 'Canadian' banking system has been reasonably prudent, it's borrowers have not been; and the chickens will come home to roost as interest rates progessively climb back to historic levels. It is not the BoC's job to protect the dumb from their own actions, and they will let the market solution prevail.

People will get hurt, as they should do
But it's not going to result in a systemic crash of the Canadian banking system.

SD


John Hjorth

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Cigarbutt

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Re: Garth Turner - Real Estate in Canada
« Reply #1819 on: December 19, 2018, 07:43:08 AM »
YouTube - FORMAFIST [December 16th 2018] : Tim Bergin [Our fellow CoBF member TBW]: Shorting Real Estate. Specifically Canadian Real Estate.

Series playlist.
Thank you for this link and the post in the BRK-general news section concerning Home Capital.
Another confirmation that Mr. Buffett is in a league of its own.
The BRK news release is a classic piece.

BTW, I liked several aspects of TBW's interview and I know he has commented above in this thread concerning Mr. Buffett's involvement in HCG.

If one thinks of the real estate picture in Canada as potential dominoes to fall, one would think that a company like Home Capital is in first line and before government involvement is triggered.