Real Estate Freefall?

[photon]

Originally Posted by OracleOfCalgary

Look, things are good in Alberta, and if it weren't for the speculative bubble, I would have expected a long and gradual increase in prices over the long term. The RE bubble, however, has ruined all that and I think may damage the larger economy as a whole. $70 oil and $180 billion projects have become a rationalization for the high prices rather than the actual reason.

30 day trailing average price is down another $2K since yesterday. Median is down $1K.

Speculation is buying stuff on rumour or speculating that something will happen (ie that a lumber mill is going to be built in Town A, or a car factory in Town B, or that this country is going to become the next hot vacation spot).. Having the economy be strong, many jobs being created, etc isn't a result of speculation, it's real economics that are supporting the current market.

You call it a bubble but you don't provide anything to support it. During the high tech bubble it was obvious things weren't real; companies trading for huge amounts with no forseeable possibility of them ever making a real profit, etc. What stats do you see here that show you it's a bubble? Why is this the beginning of a crash rather than a normal market taking a breath?

You say high oil and all those projects are a rationalization... is 86,000 new jobs a rationalization too? Or the population of Red Deer moving to Alberta, all of whom need to buy or rent a place to live, that's speculation? Supply and demand.

But if those aren't the reasons, please share what's the real cause of this run up? You can't just say "speculation" because that doesn't mean anything. Please give some support for your position.

[Sylvanfan]

Originally Posted by Red

But real estate didn't go bizerk only in Alberta, and I mean bizerk, not your regular growth like we've seen in the past.

I think construction labour shortage had a lot to do with it too. The builders kept asking more and more money to slow down the demand which they couldn't keep up and the pre-owned homes followed. Now it seems that most of the construction backlog is catching up, how long before we see tons of new homes looking for buyers? And then the price reductions etc.....

Just speculations on my part.

I think the reason it exploded like it did is because at that time a number of new buying products were introduced to buyers coupled with the strong economic growth in the area at the time. Things like unlimited CMHC mortgages, 0% down mortgages, 40 year mortgages etc.. In 2002 was when they first started allowing CMHC insured mortgages on properties over 200 grand type of thing. So all of a sudden young people who used to need 50 grand in their pocket to buy a 200k house didnt'. That coupled with really low interest rates suddenly allowed people who had a combined income of 70-80k a year to get a 300 k house. Also demographically the front end of the echo generation got to an age where they were starting to be first time home buyers too.

[photon]

Originally Posted by Red

But real estate didn't go bizerk only in Alberta, and I mean bizerk, not your regular growth like we've seen in the past.

I think construction labour shortage had a lot to do with it too. The builders kept asking more and more money to slow down the demand which they couldn't keep up and the pre-owned homes followed. Now it seems that most of the construction backlog is catching up, how long before we see tons of new homes looking for buyers? And then the price reductions etc.....

Just speculations on my part.

Very true, I think a large part of the homes coming on the market are people who finally are getting into their new place and are selling the old one.

And I think part of the contribution to the insane runup (as you say, far beyond normal) was that prices here were so undervalued, affordability here was crazy high, and part of the runup was just catching up to other markets.

Look at the housing starts though, it's at near record levels but it seems to about match the number of people moving into Calgary, at least it doesn't far outstrip it.

[OracleOfCalgary]

Originally Posted by photon

You call it a bubble but you don't provide anything to support it. During the high tech bubble it was obvious things weren't real; companies trading for huge amounts with no forseeable possibility of them ever making a real profit, etc. What stats do you see here that show you it's a bubble? Why is this the beginning of a crash rather than a normal market taking a breath?

Sure, lets value a condo like we value any other investment. My girlfriend has been told she can rent her place for $1700. Units in her building sell for over $400,000.

Income (Rent) $1700
Expenses (Condo Fees) $200
Net Income: $1500
Annual Income: $18,000
Required Rate of Return: 10%
Valuation: $180,000

Looking at this another way:
Annual Income: 1500 x 12 = $18,000
Annual interest on $425,000 @ 6% = $25,500
... No chance of ever making a profit!

[photon]

So one example of a property that doesn't work to rent out means the whole market is going to crash?

I never buy a property that doesn't generate positive cash-flow out of the box. Some investors even take into account their projected capital appreciation for a property (ie take a monthly loss but the capital appreciation makes up for it when they eventually sell), however I don't like to do that.

What about all the people that buy that property to live in? They don't have to worry about making a profit, they just have to worry does it meet their needs and can they afford it.

In your example you are also at 100% financing (you're counting $425,000 @ 6%). Residential doesn't valuate like commercial since the price is dictated by supply and demand, not the raw valuation.

[photon]

Here's an example from my portfolio:

Income (rent): $3200
Expenses (mortgage, maint, tax, reserve): $2000
Net: $1200

So before any capital appreciation, I'm up $1200 per month. That's enough that I could have even borrowed my down payment and be paying $470 / month on that down payment per month and that'd be an infinite ROI since I put no money down. And there's enough room there that if rents go down 30% it still works.

EDIT: And that's without taking into account tax benifits, mortgage paydown by the tenants, and capital appreciation of the building.

That's a real example.

[V]

I just bought a 2 bedroom single detached house in West Dover. 290,000.

I put down 25% cash, so the mortgage is $217,500

Mortgage Payment: 1327.60
Prop Tax: 91.33
Insurance: 42
Income: 1700

Total Profit: 239.40/month

That's ample cash to pay for repairs over the year, with probably a little bit left over.

There are lots of places that are not a good investment. But there are plenty of places out there that are.

[photon]

Heh, we're thinking of selling our duplex in Dover because it's difficult to rent (people just don't like the area that it's in). But that's east dover towards the tracks. West across 36th street is much nicer (is that still Dover?).

[I-Hate-Hulse]

Originally Posted by OracleOfCalgary

Sure, lets value a condo like we value any other investment. My girlfriend has been told she can rent her place for $1700. Units in her building sell for over $400,000.

Income (Rent) $1700
Expenses (Condo Fees) $200
Net Income: $1500
Annual Income: $18,000
Required Rate of Return: 10%
Valuation: $180,000

Looking at this another way:
Annual Income: 1500 x 12 = $18,000
Annual interest on $425,000 @ 6% = $25,500
... No chance of ever making a profit!

How are you coming up with a valuation of $180k? With no time period defined I assume you're not present valuing anything?

Also don't forget taxation: Your "loss" of $7,500" is approximately halved when you take into account the deduction that's created.

[Slava]

Originally Posted by fotze

Plus you/them are paying off the mortgage.

Why did you have to post that, I now feel guilty for not doing the same thing.

Realistically it doesn't matter that the mortgage is being paid down. The interest paid on this is tax deductible, while on many other debts it is not. The more prudent thing to do is crush the non-deductible debts first before you worry about paying down debt that is deductible (all things being equal, such as interest rates).

IIRC Oracle of Calgary has posted other threads about the demise of Calgary and its economy, so how much can you read into their thoughts? Likely about as much as you can into anything that I post deriding the Conservatives!

[V]

Originally Posted by photon

Heh, we're thinking of selling our duplex in Dover because it's difficult to rent (people just don't like the area that it's in). But that's east dover towards the tracks. West across 36th street is much nicer (is that still Dover?).

Yeah, it's actually called West Dover once you get west of 36 St. It is a fair bit nicer than Dover.

I've got a couple in West Dover, basically between 30 and 34 Ave, and 36 and 28 St. I've had no trouble getting them rented out, although 1700 isn't an incredibly large amount for a full house.

[MoneyGuy]

Originally Posted by Sylvanfan

So you being a financial planner....would like to see like 75% of the population go broke and basically be left with no money? I mean if the real estate market crashes big time chances are there are other things like stock market crashes, money market crashes, and commodity market crashes that drive it. In short if the real estate market does crash so hard.....chances are everyone is going to be screwed one way or another.

First of all, a serious correction won't bankrupt 75% of the population. Even if the RE market fell by 40%, which is extremely unlikely but that's close to what the stock market tumbled in 2000-02, your fear would not materialize.

Fact is, RE isn't as volatile as are stocks. I don't know their standard deviation, but I'd guess it's about half to two-thirds of that of stocks. If the 40% market decline I mentioned is about as big as it gets, then a RE freefall might be 20-28% of so.

Even if he market fell by 30% of more, why is that a bad thing? It wouldn't be.

Right now we have a whole generation of young people who are going to really stuggle to own a house. I'm older than most of the people here. This is my children's generation. Unless they're innovative and buy a house with parents or a friend, no way my kids and others of their generation can own a house. At least not without taking on huge, (maybe) lifelong, crippling debt. A RE freefall, which I define as a long, difficult decline of at least two to three years from start to finish, would enable many young people to get into the market. I want my kids to be able to own a house without relying heavily on the Bank of Dad, and right now it's verfy difficult.

What else would this accomplish? This would bring some sanity to rents. Right now owners are able to charge almost anything they want and renters don't have a lot of choice. A big correction would create enable many of these renters to get into their own homes.

This is a selfish reason, but I have clients who believe that RE is easily their best investment, despite the fact that stocks have historically blown RE away over the long term. They've witnessed a serious stock correction and highly volatile markets, but they've never seen a big RE correction.

I kinow a young fellow who is 26 and owns five houses. It matters not to me if he ever buys stocks, but I wouldn't mind if these guys learn how the markets really work. I've told him that there is risk in RE, that he's not diversified and long term stocks do better. He doesn't see the risk. I remember a person on this very site once writing something like, "Risk, what risk? How is it risky to buy RE when it only goes up?"

Market corrections deliver short-term pain for long-term gain. It would bring sanity to the RE market, which has some pretty compelling benefits, I feel. I'd love to see a 25-30% correction. Yes, I am a homeowner.

In short, I think your fears are unfounded.

[Sylvanfan]

Well I'm not going to quote your whole post. IMO Those aren't my fears, I just find it funny when people say a crash would be good. In order for an all out crash to occur....something really bad has to happen that fata's pretty much anyone who was trying to build wealth...hence..crash. When in fact they maybe want a correction. No doubt even a 5-10% decrease in price over the next 12 months would help most people out and most home owners would still be in fantastic shape. But for 25-30% to occur you're talking about a pretty substantial ecomic recession in which people will be having a tough time getting work and the like. I lived in Prince George from 1996 to 2001 and over about a two years period that happened. Unemployment was like 20% and things were really bad there. I don't think I'd ever wish that on anyone again having experienced it, and I was luckey. I had a job that wasn't that adversely affected, but it still sucked for the general population. In fact I did really well because I wasn't a home owner, could rent dirt cheap and had all the bargaining power in the world if I wanted to buy something. Certainly there are those who can really take advantage if a down time if they're still making a living. But those people are a select few.
But really look at Western Europe or Japan...how do people in those countries own land? Because generations help each other out and pass on wealth. IMO many North American families are now established into their 3rd and 4th generation and my wild guess is that they're a lot better off now than they were 75 to 100 years ago when many of them first came to North America. Chances are you will inherit a fair bit from your parents and that you will have even more to pass down to your own children someday. As much as North Americans like to cling to their make it for yourself ideal, a big chunk of your childrens future is going to hedge on how much you helped them out. No doubt my folks helped my out a lot, and if I ever have my own kids, I won't hestitae to try and help them out even more. And no I don't apologize for this to those who'll say I'm a spoiled kid who had everything given to me.

EDIT....and for the 26 year old guy who owns 5 houses...I say good for him. At his age he easily could have been blowing that money in the bar, or on a Hummer, or something ill advised. If he really deseved to make the money he should by buying all those houses, eventually he'll realize on way or another that he needs to balance his holdings in order to realize the maximum benefits.

[SeeGeeWhy]

As many have pointed out already, those "average home price" figures are dubious at best. The CREB is constantly changing their 'average home' definition, making the usefulness of the data as a short term forecasting tool ineffective.

I thought Oracles were supposed to espouse on the future, and not be concerned with short term trends?

Originally Posted by MoneyGuy

Fact is, RE isn't as volatile as are stocks. I don't know their standard deviation, but I'd guess it's about half to two-thirds of that of stocks. If the 40% market decline I mentioned is about as big as it gets, then a RE freefall might be 20-28% of so.

Even if he market fell by 30% of more, why is that a bad thing? It wouldn't be.

Right now we have a whole generation of young people who are going to really stuggle to own a house. I'm older than most of the people here. This is my children's generation. Unless they're innovative and buy a house with parents or a friend, no way my kids and others of their generation can own a house. At least not without taking on huge, (maybe) lifelong, crippling debt. A RE freefall, which I define as a long, difficult decline of at least two to three years from start to finish, would enable many young people to get into the market. I want my kids to be able to own a house without relying heavily on the Bank of Dad, and right now it's verfy difficult.

What else would this accomplish? This would bring some sanity to rents. Right now owners are able to charge almost anything they want and renters don't have a lot of choice. A big correction would create enable many of these renters to get into their own homes.

This is a selfish reason, but I have clients who believe that RE is easily their best investment, despite the fact that stocks have historically blown RE away over the long term. They've witnessed a serious stock correction and highly volatile markets, but they've never seen a big RE correction.

I kinow a young fellow who is 26 and owns five houses. It matters not to me if he ever buys stocks, but I wouldn't mind if these guys learn how the markets really work. I've told him that there is risk in RE, that he's not diversified and long term stocks do better. He doesn't see the risk. I remember a person on this very site once writing something like, "Risk, what risk? How is it risky to buy RE when it only goes up?"

This was an interesting post for sure. My responses are to the parts in bold.

1. I'd say that you should qualify your desire to see a large RE correction by first asking yourself the question "What are the fundamentals of the correction?". If the market drops out because oil goes to $30, or the government puts a big carbon tax on CO2 emissions, or something catastrophic along those lines, your kids and their friends will still not be able to get a house because they will be out of work. As crazy as mortgage practices have seem to have become, I am pretty sure that the bank requires that you are gainfully employed before they write up your loan, especially if it is their practice to sell it to another institution (which it very likely is). I am with Photon in the sense that, while precarious, the economics of real estate in Alberta are still favourable for investors. But I see what you are saying - you want the market to correct to the point that it is also favourable for the average homebuyer to get in. This is also a good thing for the investor because it makes things even more predictable.

2. Of course this is true - rent will always be a reflection of what it costs to purchase in an area. A landlord, unless subsidized to do otherwise, will always put their rent cost in the area of 75 - 90% of the monthly payment required to finance purchasing the property using the lending vehicles that are presently available. Owning property is a business like any other, why would they not charge what they can? Again, your point is reflecting your desire to see your kid out of your door and onto their feet.

3. This is where things get blurry. What stocks are you comparing to what real estate markets? Real estate as a sound investment is much less risky than real estate as speculation. The same is true with stocks - are you buying blue chips like Coca-Cola, or are you acting on a tip that you got from a commerical or a friend of a friend and are now deciding to buy a penny stock or a "5 star" mutual fund. The difference between the two (investment vs speculation) is like comparing buying a government bond to taking your bankroll down to the Casino. The bottom line is that it is much easier for an investor to become well versed in the fundamentals of real estate than it is to know how the market is going to value a publically traded company.

[MoneyGuy]

Sylvanfan, I can't say I disagree with anything in your post. As for the 26-yr-old, he's a friend of the family's and he said to my daughter that, "I think your father disapproves of what I do." Well, yes I do and no I don't. While I disagree with what he's doing, in part, there is lots that he's doing that I agree with. I don't think he should be loading up on real estate, granted, and I disagree with the highly aggressive speculative investments (I struggle with that term because I feel that aggressive speculative ventures are not investments in the traditional sense, and my CFP studies taught me that these things are not investments - the speculative stuff, not the RE). However, you're absolutely correct, and I've told him this, that while I disagree with his choices, he's way smarter than most 26-yr-olds. I'm proud that he's doing this, if not the best thing at least he's not pissing his money away as most people do at his age.

Very good points you make, SF. Cheers....

Originally Posted by SeeGeeWhy

As many have pointed out already, those "average home price" figures are dubious at best. The CREB is constantly changing their 'average home' definition, making the usefulness of the data as a short term forecasting tool ineffective.

I thought Oracles were supposed to espouse on the future, and not be concerned with short term trends?

This was an interesting post for sure. My responses are to the parts in bold.

1. I'd say that you should qualify your desire to see a large RE correction by first asking yourself the question "What are the fundamentals of the correction?". If the market drops out because oil goes to $30, or the government puts a big carbon tax on CO2 emissions, or something catastrophic along those lines, your kids and their friends will still not be able to get a house because they will be out of work. As crazy as mortgage practices have seem to have become, I am pretty sure that the bank requires that you are gainfully employed before they write up your loan, especially if it is their practice to sell it to another institution (which it very likely is). I am with Photon in the sense that, while precarious, the economics of real estate in Alberta are still favourable for investors. But I see what you are saying - you want the market to correct to the point that it is also favourable for the average homebuyer to get in. This is also a good thing for the investor because it makes things even more predictable.

2. Of course this is true - rent will always be a reflection of what it costs to purchase in an area. A landlord, unless subsidized to do otherwise, will always put their rent cost in the area of 75 - 90% of the monthly payment required to finance purchasing the property using the lending vehicles that are presently available. Owning property is a business like any other, why would they not charge what they can? Again, your point is reflecting your desire to see your kid out of your door and onto their feet.

3. This is where things get blurry. What stocks are you comparing to what real estate markets? Real estate as a sound investment is much less risky than real estate as speculation. The same is true with stocks - are you buying blue chips like Coca-Cola, or are you acting on a tip that you got from a commerical or a friend of a friend and are now deciding to buy a penny stock or a "5 star" mutual fund. The difference between the two (investment vs speculation) is like comparing buying a government bond to taking your bankroll down to the Casino. The bottom line is that it is much easier for an investor to become well versed in the fundamentals of real estate than it is to know how the market is going to value a publically traded company.

1. A RE correct can occur that would help out potential buyers without necessarily resulting from a crash in the energy sector.

2. Okay.

3. I don't deal with highly speculative ventures or stocks. I'm taking about mroe conservative equities, blue-chip stuff. I'm not highly aggressive myself and clients who wish to be are discouraged by me and I even refuse to do some stuff that is beyond my comfort zone.

Very interesting thread. I'm surprised at some of the posts in the sense that there are some folks on here who are pretty smart about these things. I came on here expected to see some inaccuracies that needed to be corrected, but really haven't found anything that demanded a correction. Good job.

[Radley77]

My reason for not investing in Alberta real estate is the lack of affordability and the lack of sustainability. Alberta now has the second lowest housing affordability in the country it takes 45% of before tax income to buy a house. After tax is 77% leaving, the average consumer with only 23% left to buy transportation, clothing food and communication. Talk about being housepoor!

Also, a rental unit will not generate positive cash flow. Half of first time buyers require a 40 year mortgage to buy a house. Conventional oil and gas reserves will be well depleted before that point.

Inventory has been at record levels this year and I imagine there will be only higher inventory at this time next year due because it takes approximately 3 years to finance, design and build a lot of these projects. I imagine a lot of people that intended to flip condo's will be unable to sell and have to walk away from their deposit. There are 18000-20000 condo units approved or already under construction.