Saturday, February 26, 2011

Fighting a losing battle? Skip a payment.

Perma-bulls in the real estate world often use snippets of anecdotes to counter the data-driven arguments of the real estate bears who say current price levels are not supported by fundamentals.

One of the key points the bulls often fixate on is usually expressed in the form of a question with a barely passable answer attached:
"If Canadians are so stretched financially and can barely afford their homes, why aren't mortgage arrears showing up higher than they are? After all mortgage arrears are still lower than they were in the early 1990s and our Canadian financial institutions are prudent."
It's this kind of rhetoric that makes the real-estate-always-goes-up crowd breathe heavy on their finger nails before polishing them against their designer shirts in gleeful gloat mode because at this point, in their own minds, they've won the argument.  
"It doesn't matter what your data tells you, my data tells me this time it's different. And that's a fact."
Unfortunately, and you knew this was coming, that "data" provided as the bull's argument knock out punch, ignores the financial reality: it's only through mortgage product innovation that mortgage arrears aren't at record highs, despite the fact they're already double what they were just a few short years ago:



From 2006-2008, it was the 40 year amortization that allowed more over-extended Canadians to avoid falling behind. The government eliminated new origination's of 40 year mortgages in October 2008, but the banks found a way to allow the effects of them to continue: can't afford the increase in payments? Skip one. Every year. For as long as your term allows.

In 2010, the mortgage market was tightened ever so slightly by requiring CMHC-insured mortgages to be qualified at the discounted five year rate. You qualify for slightly less money, but you still have the flexibility of the 35 year amortization at the discounted variable rate to over-extend yourself into real estate financial Armageddon. The "prudent" banks are only too happy to oblige you because your mortgage is insured by the CMHC and they're turning around and selling these loans into the mortgage backed securities market faster than they're writing them anyway. In other words, the banks have zero risk in this game.  

In 2011, just 20 short days away from today, the CMHC will stop insuring 35 year amortized loans. The banks have already found their solution to this little issue, it's been working for them for a few years now: let Canadians skip a payment and roll the interest back into the principle. It's a little accounting trick that nets the debt holder more money as long as the mortgage doesn't default--Sh&t it's as close to a win-win-win as the Canadian mortgage game can generate: debtors don't have to pay their debts on time, banks don't have to default on the loans and the pension funds that eat up the MBSs being sold by the CMHC don't see any risk to their investments as long as the tax payers keep backstopping this prudent smoke and mirrors financial practice.

This skip-a-payment thing is offered by almost everyone in the mortgage game. If a household exercises this option once a year, as most mortgage contracts allow them to do, for a full five year term, it has the same effect on lowering payments as a five year extended amortization. So yeah, the 40 year amortization still exists. After March 18, 2011, the 35 year amortization will still exist. Just not in name. Case in point:

Current mortgage payment: $1500
Skip-a-payment proceeds: $1500
New "effective" mortgage payment: $1375

30 year amortization of $310,000 mortgage at 4.2%: $1500
35 year amortization of $310,000 mortgage at 4.2%: $1400

The more I become aware of what the banks do, precisely because there are few economic consequences to them thanks to Mr and Mrs Canadian taxpayer, the more I believe there is only one solution to this problem: privatize the CMHC. Prudent Canadian financial institutions my a$$.

42 comments:

vreaa said...

Good post, we hadn't heard about this before.
Thanks.

Aren't the bears getting the upper hand on the island?

happy renter said...

So my friends who think that I'm being too skeptical about the RE market asked me the other day if I can foresee any time in the future when buying might be a good idea. It's unrealistic, they said, to just expect people who "want to get on with their lives" to not get into the housing market and settle down. I didn't quite know what to say, obviously, because it depends on what happens out there. But can any of you see it being a reasonable time to buy a year or so from now? Or will it take longer than that? I'd be curious to hear what kind of time line you all think that those who want to get into the market should be looking at.

jesse said...

Another good post. Still the 5/35 to 5/30 will have an effect. Climbing arrears when employment is recovering is particularly worrisome.

jesse said...

Just to be clear, do so-called "skip a payment" schemes extend to loans insured under CMHC?

Reilly said...

@ happy renter

Since you asked, I’ve had my ear to the ground lately and I think it will take another 3 years for valuations to somewhat fall back in line with rents. The price meltdown has definitely begun, but it should take the shape of a backward S-curve, with the capitulation year likely 2013 or 2014. I imagine this blog has covered the reasoning at great lengths, so sorry for regurgitating..

Listings should keep climbing until the ‘S’ point as potential sellers continue..
* feeling the sting of rising taxes, fuel, food, utilities, dollar (hurts tourism, timber, et al)
* to be pressured by rising rates and term renewal
* losing net jobs (BC now highest unemployment after maritime provinces)
* relocating to more affordable job-producing jurisdictions (especially babyboomers in order to retire and spend winters in sunbelt)
* slowly realising it’s far cheaper to rent
* understanding how cash draining their speculative investment properties are each month
* a glut of starts in the past few years now beginning to hit the market

Reilly said...

May as well throw out a few demand-side diddies I’ve heard at the water cooler..
* move-up and first-time buyers now in demographic decline
* tightening credit
* debt levels finally slow the consumer
* declining international demand due to dollar, changing immigration policy, slowing developing markets, rising rates

I’m rambling.. couple final thoughts.. Repubs or Obama will finally bring on some penny-pinching next term. Governments are also close to debt limits. Global investors will force their hand. Plus public is clueing in that money printing is not the solution. Even if more printing continues and local property somehow avoids steep nominal declines, it is important to note that when adjusted for inflation, property will still be one of the worst investments for years to come.

..what will help keep prices slowly falling until capitulation (in addition to seller denial) will be potential buyers thinking things seem ‘cheap’ ..unless they have visited the gator state recently.. ramble on, zeppelin

Devore said...

@Jesse

Yes.

RBC notes "Additional requirements apply for CMHC-insured mortgages.".

BMO is a little more generous: "Take a Break and Family Care options apply to principal and interest payments on conventional and Genworth/CMHC-insured mortgages for owner-occupied single-family dwellings only, including condominiums and duplexes."

Marko said...

Wow, the home on Forbes went big time over asking.

Just Jack said...

Well, the Forbes home was listed pretty cheap for Fernwood. that brought most of the attention. Even at $515K, I think they could have squeezed a buyer up to $530K or possibly $540K. Because $515K is the low end for a suited home in Fernwood.

But it does show that there still are potential buyers out there willing to beat each other up over price than wait for another home to come up for sale.

omc said...

The #s may show there is lots on the market, but most I am seeing is the same overpriced stuff from last year. Boy, have I said that before or what. So, even if the #s show that it should be a balanced market; I would say it is a sellers market if the home is 1/2 decent and anywhere near reasonably priced. I don't think this will change until, at least, the end of March.

Deanna said...

Never mind privatizing the CMHC. Just get rid of it altogether.

jesse said...

Right but does "take a break" mean additional MI (for HELOC) or does CMHC accept this as part of the first loan, and was this added exactly when rules were tightened in '10 or was it always there or just better publicized? IOW did we use to have 45 year ams?

HouseHuntVictoria said...

Jesse, I can't find when this started exactly, but it seems like there's been a lot more emphasis on it lately in advertising etc.

I'm guessing that in certain circumstances we did use to have "45 year AMS."

More important than the existence of these types of "flexibilities" built into lending contracts is how many people are exercising them. I doubt very much if that number is tracked and publicly accessible.

It's no different than a cash back CMHC insured mortgage IMO. The point of this post is to say that it really doesn't matter what limitations are placed on the CMHC, as long as the government backs the lenders the lenders will give the consumers tons of options to overextend themselves because they have little skin in the game.

Privatization of the CMHC won't be enough to end the trend either. After all, Genworth gets the same gov't guarantees the CMHC does in it's product lines too.

The government needs to end taxpayer backing altogether.

At last count the CMHC had $8B in capital to cover over $400B in potential liabilities. What other financial institution is allowed to capitalize at 50:1?

omc said...

Lets have a bet, closest to the actual sales #s gets a free realtors licence! I don't think the snow will affect the #s much, as most contracts have a few weeks to have conditions lifted.

I will guess 490 sales

a simple man said...

ok, omc. I could use the licence.

I agree that this snow will hit the March numbers, not the Feb numbers to any appreciable extent.

503 sales for Feb.

Marko said...

The sales numbers would be worse if it was not for the 15 new condo sales in Cook Street.

Prices are going to be up from Janurary I think.

Leo S said...

I'm sticking to my estimate of 500 from the beginning of the month.

a simple man said...

Leo - you will get dual-province licences if you are the winner for picking at the start of the month.

think said...

450

Russ said...

I'm wondering if anybody has done any research or invested any money with the idea of speculating on a RE crash?

Obivously if you're a bear your not looking to buy Real Estate at the moment, but besides that, has anybody shorted a bank or a home builder or invested in something (I'm not sure what) that would do well in a RE crash?

This being RRSP season, I've been looking at my portfolio and reading lots about about ETFs etc lately. It got me wondering how a RE crash might play out in the markets.

I wonder if Canadian bank shares would suffer at all? Even if there is a wave of defaults they are protected by CMHC so is it possible they would carry on without a hiccup?

I'm not exactly sure how a REIT works, but would they get hammered and therefore are something you could short sell?

Has anybody come across discussions like this on other financial blogs?

I'm not looking at jumping into exotic investments I don't understand, and I'm not talking about betting my whole RRSP, I'm just curious what other thoughts/opinions are out there.

cheers

a simple man said...

hi - I just bought a utilities GIC for my RRSP this yr - I know utilities are going up, there is little doubt of that. Seemed safer than the general stock market.

jesse said...

HHV while I agree CMHC is undercapitalized we cannot compare to a normal insurer of dwellings for, say, fire or auto insurance. CMHC will always have a high recovery rate (>50% except in severe economic hardships) because they insure both structure and land. Using 50:1 ratios is not apples to apples.

I ran simple stress test calcs here on CMHC's liability to taxpayers a few months back. I think, though it is worse than that because they will be forced to cover a rolling snowball of loans if prices start falling. I will run the numbers again but it could be as high as 30-40BB bailout over the next few years.

happy renter said...

"The stronger-than-expected turnout in the fourth quarter increases the risk that the Bank of Canada moves sooner than our anticipated July rate hike," TD Bank economist Diana Petramala said in a note. "However, we are still comfortable with our view that the Bank of Canada will remain on hold until mid-2011 and only move gradually with interest rates."

CBC: Economy Expands Faster Than Expected

Marko said...

Monday, February 28, 2011 8:00am:

MTD February
2011 2010
Net Unconditional Sales: 451 621
New Listings: 1,197 1,460
Active Listings: 3,603 3,280

Please Note

Left Column: stats so far this month
Right Column: stats for the entire month from last year

Marko said...

Will March bring us better numbers?

Cheers, Marko

Leo S said...

Looks like you won, think. :) Quite surprising, I would have thought some more activity would be going on by now.
Sellers are also holding off compared to last year.

Deanna said...

Just got an emailed survey from some pollsters. In addition to them seeking my opinion on Christy Clark and the HST, they threw in some questions about my opinion of realtors! In addition, they wanted to know if I thought the transfer tax and the HST was making it too difficult for people to buy houses. They also asked what I thought BCREA could do to improve my opinion of them.

Heh. I had fun filling out that survey.

a simple man said...

450 with one day left...perhaps 465? Still low. March should be hit by this snow and the rule change...brrrrrr

Alexandrahere said...

Good morning all, here are my stats for the week of 21-27 Feb 2011:
SFH: Min two beds & 2 baths, priced between $375K & $775K in all areas of Victoria, Oak Bay, Esquimalt, Saanich East & Saanich West.

NEW: 39
SOLD: 25
P/C: 20
OM: 8

Eight out of the 25 went for below BC assessment and 11 houses sold were advertised as having suites.

Avg Selling Price: $556K
Med.Selling Price: $549K

Condos: Min 2 bedrooms, priced between $$260K & $675K in most areas of Victoria (not downtown)and Saanich East, all areas of Oak Bay & Esquimalt and Gorge, Tillicum & Interurban areas of Saanich West:

NEW: 24
SOLD: 6 apts & 5 townhouses
P.C: 11
OM: 3

Three of the townhouses went for under assessment.
Avg T/H selling price:$416K
Med T/H selling price:$369K

Avg apt selling price: $354K
Med apt selling price: $369K

Hey! We have some sun today.

Alexandrahere said...

Marko: Are the condos on Cook St under MLS? They don't show up on my PCS.

Leo S said...

1125 Caledonia. After 6 days on market at $399,999, they accept an offer for $350,000. That's 28% under the 2011 assessment of $487k

Just Jack said...

At one time, I had mentioned that your best deals are going to be estate sales in Victoria.

Well a duplex zoned property on Caledonia with an old timer home in need of repairs. (I know, I know its just a syringe throw from the downtown core) sold for $350K. Originally listed for $399K. This was an estate sale.

Last week, on Forbes in Fernwood, multiple bids drove the prices of a home, also needing repairs, up to $515K. The agent successfully created an auction where at least two people duked it out with the winner being outbid.

I know most would chalk it down to location, location, location. But that's a big cash difference for under a 10 minute walk and less than 10 city blocks, between properties.

My opinion is that something else is going on in the market. The remaining buyers are being huddled together, competing among themselves in an ever smaller segment of the market. And Fernwood appears to be ground zero. The buyers collective actions are driving the prices in Fernwood outside of reason in relation to the prices in neighboring areas.

If real estate is in a bubble, then Fernwood is the pimple on the bubble.

Just Jack said...

Interesting sale on St.Patrick in Oak Bay. Here is a sale of side by side duplex on 0.4 of acre, just two blocks from the Beach in South Oak Bay (wow!) for $845K. I've seen asking prices for homes in this area at this price for homes on 6,500 square foot lots. I mean didn't someone just pay the same amount last week for a vacant building lot in Broadmead!

It took 8 months to sell this property in prime South Oak Bay! And a drop or two from the original list price of $1,050,000.

The one thing you don't want to be holding when the market turns is property where the land contributes the majority of value. I'm also seeing some Westshore land developers sell undeveloped subdivisions rather than put in the streets and build the homes. That's not a good sign for land prices and construction in general.

Just Jack said...

Once again, I would say that you don't want to be buying land as the market is peaking.

Such as the property on 15 acres that fronts onto Elk Lake. Almost 4 years ago, the home was put up for sale at $3,550,000. But finally sold this month for $1,930,000.

So what were the vendors waiting for? Prices to go up?

So for $845K you can have a house on 0.4 acres in south Oak Bay or for about twice the price you can have a house on 15 acres with frontage and a dock onto Elk Lake.

Obviously, these two properties appeal to vastly different people and as some would rightly say they are not comparable to each other. But, I'm thinking - price ceiling here. If you can write a check for 2 or 3 million you can pretty well have anything in Greater Victoria.

And if you have a shade under 5 million you can own the Aerie Resort on 85 acres overlooking the Saanich Inlet.

"red-rum, red-rum, red-rum"

omc said...

Lots of new listings and price corrections today.

Marko said...

Hmm, bidding way on 1602 Haultain St. Looks like people want a house in Fernwood with a suite.

SJ said...

I remember going to an open house for that duplex on St. Patrick St. in Oak Bay a few years back - probably around 2003 or 2004. I think it was selling in the 400K range - maybe Marko can tell us what the previous sale was. There was also another duplex across from Casey's market, on Central, which was listed around $399,000 (again, maybe in 2002 or 2003. Does seem like those prices are light years away from today's - yet only a few years ago. It's amazing how easy it has been for buyers to adjust to these high numbers!

Just Jack said...

Fernwood is an odd community and suites are much needed mortgage helpers.

I would have thought the property on Falkland would sell higher than a corner lot onto the Haultain collector road. Or at least put a $580,000 offer on the property on Victoria Avenue in south Oak Bay. But while both of these properties are vastly superior in location to Haultain - they don't have suites. The difference in land prices alone between Haultain and quiet streets in South Oak Bay has to be $150K to $200K.

But you need that suite income to qualify. And you don't have the extra $25,000 cash to finish a suite in the Oak Bay homes, then you are going to have to pay premium prices for none premium locations.

I wonder who was the last person to put a tape measure around the home. It don't look that big from the pictures? The lot size at 4,400 square feet is small and even worse its a corner lot with no private yards and fronts along Haultain. I'd keep my fingers crossed on this one, it could go sideways on financing.

HouseHuntVictoria said...

The latest round of "flurry of activity" sales screams 5% down 35 year amortizations to me. They all have one thing in common: buy now, get as much cash flow as possible now, pay later.

Just Jack said...

HouseHuntVictoria said...
The latest round of "flurry of activity" sales screams 5% down 35 year amortizations to me. They all have one thing in common: buy now, get as much cash flow as possible now, pay later

And just when I thought everyone that could be had already been sucked into the madness.

I say bring on the spring market.

Just Jack said...

That was me, S2 above.

Just Jack's better half.

S2

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