Thursday, February 3, 2011

From the No Sh&t Sherlock files: rate hikes "could" spark house price collapse

The G&M has an interesting piece today (Kabloona posted link in comments from previous post).
Any move by the Bank of Canada could “easily” cause house prices to collapse, Capital Economics warns in a bleak report that suggests the Canadian housing market is likely to suffer the same sort of crash that has plagued countries such as the United States.
As the bank raises interest rates, mortgages will become more expensive for Canadians. Add inflation to the mix, and Capital Economics predicts prices could fall 25 per cent over the next few years. 
Said economist David Madani: “If the Bank of Canada does resume its monetary tightening this year, this could easily prove to be a tipping point for a house price collapse.”
Capital Economics also warns that a crash in prices could cost Canada Mortgage and Housing Corp., which insures high loan-to-value mortgages, to lose as much as $10-billion.
To be fair and balanced, Capital Economics is in the business of selling market research, mainly stock market research. Are they trying to beat the real estate isn't the investment you think it is drum? Shoebetcha. Are they right? Time will tell. But their research aligns with plenty of other independent research calling into question the dubious claims being made by "economists" who's incomes are tied to the ongoing performance of real estate markets and real estate debt products.

There's a commonly held fallacy in many people's minds these days: "if interest rates climb it means the economy is doing well and inflation is upon us; if inflation is upon us then our home's values are increasing despite rising interest rates, it's a can't lose scenario". If only it were so simple. And if only these true believers could point out one time in history where this held to be true for longer than a year.

I invite you to read Reid's post from a while back where he shows you exactly what happens to mortgage payments in a rising interest rate environment.



Canada is at a cross roads never before seen by her citizens: all time high real estate market values, all time high debt levels plus all time low interest rates. How anyone can point to history and say we've been down this path before and came out of it OK is far beyond "stretching the truth."

41 comments:

HouseHuntVictoria said...

National Post does a better job of tying the bigger picture together for readers on the same press release.

Shamus said...

There's no doubt that interest rates affect house prices. The more a buyer's monthly payments increase, the lower the price they can afford to pay. Simple.

But collapse?

The graph you posted shows "Safety" "Danger" and "Implosion" zones and looks very scary. Except for the fact that interest rates can rise another 2% (to 5.8%) and still be in the Safety zone. At .25% (or even .5%) rate hikes, this will take a while to accomplish.

Unless you are sugggesting that the next rate hike announced by the Bank of Canada will be in the order of 2-3%, which would certainly devastate the housing industry. But we all know it's highly unlikely that to get a mortgage in 2012 you will be paying 7% interest.

If you are concerned about rising rates, forget about a variable rate mortgage and consider a fixed-rate with the option to increase your payments. This way, if interest rates do climb, your payments stay the same but you have the option to preserve your equity by putting a little mnore in each month (I would hope that in 3 or 4 years you will be earning more than you are now).

Rhino said...

Shamus,

I don't think anyone would argue with what your saying. But the problem is your talking about the next 1,2, 5 years, while these monster loans have a 35 year amortization.

And for your pre-payment suggestion. Come on, do you think these kids taking out 400 and 500 thousand dollars loans will have enough left over every month to make any significant dent into that. Hopefully their wages will go up, but they will not all be CEO's!

Just Jack said...

I'll bet a lot of bank president's are meeting to find out how they are going to proceed after April 18.

The collective bank sphincter is about to tighten, like it did in the USA, and like it did here in the 80's. Interest rates may still be low, but if you can't get financing - you can't purchase. The financing pendulum is about to swing back, where bankers will want property surveys, appraisals and stellar credit ratings. The "big" banks will once again pick and choose and leave the dregs to the suitcase lenders.

We are at an all time high level of home ownership. I'll bet that most of the prospective first time buyers that are left, are not going to meet the lenders tightened regulations. Which is going to drop sale volumes off the chart in Victoria.

Like the stock market, when prices start falling - people don't buy.

Nor do they build. I'm guessing that one of the biggest industries in Victoria over the last decade has been real estate, with a quarter of all jobs created being directly related to real estate.

Our future is a shallow and dysfunctional marketplace where court ordered, estates and divorce sales dominate the market. New construction could drop down to a few homes a year. Marketing times to sell a home will go up and past 90 days. Most homes will only get one offer. Cash will be king. The Cubs will win the World Series (twice in a row)


Time to buy stock in U-Haul trailers.

omc said...

Shamus,

We must remember that your house is only worth what someone is willing, and able to pay for it. A 1% raise in the interest rates increases the mortgage payment by 10%. It doesn't take a stretch to see that this will cause a drop of house prices by 10%.

I know a lot of young families that are right at the edge, and won't need much to push them over. If they are in negative equity, and many are already, their options are limited.

Just Jack said...

Two years ago, I had a discussion with an economics student who owed ten thousand in credit card debt. His plan to get out of debt - was to buy a home.

Move forward to today and you can see how absolutely ridiculous that statement was. But if real estate prices had continued their double digit increases - then that student would have been able to roll all of his debt into the mortgage reducing his total monthly payments and becoming a home owner with equity wealth rather than a broke student.

And that was the first decade of the new millennium where one could finance themselves to lower payments and wealth by taking on bigger and bigger debts. When 250 years of economics didn't apply as there was no need to choose between scarce resources. You could have the home, the car, and the gold watch. And if you had them already, you could supersize them to the Mcmansion, the Porche, and the Rolex.

A decade, when what we produced meant nothing in relation to the value of the land and building that it was made in. A decade of false wealth, greed and fear.

The 1980's was the decade of greed. But compared to then, this last decade surpassed it. A decade that proved Milli Vanilli was just ahead of the curve.

HouseHuntVictoria said...

Shamus,

Equity is market value dependent. You can't "preserve your equity" by paying a little more each month, you can only prevent your lender from charging you a rate premium by keeping your mortgage "above water" in a falling valuation scenario.

The point of this post is not to suggest that a collapse is inevitable and will be foisted upon us in the next year, the point of this post is to solidfy what you've already stated to be true: market values tend to go up with falling interest rates and tend to go down with rising rates.

It matters little for current market values what kind of mortgage products and rates were available yesterday. Current market values are determined by current rates and lending terms which effect current sales. This spring, we'll see the effects of the reduced amortization restrictions. When rates do rise, we'll see the effects on the market in the near term.

Market values are set by sales. If people are forced to sell because their new rate makes their payments too high (or because falling valuations puts them into a panic, which I'd argue will have significantly more impact on sales intention than a 2% rise in interest rates) then those sales will set "current market value."

Alexandrahere said...

Perhaps in cities like Ottawa & Edmonton with income averages above Victoria (I think), a mortgage increase to 5.5%, would be create a huge setback to the homeowner and they would have to adjust their discretionary spending habits severely. However that kind of interest increase in Vancouver and Victoria would have devastating effects on homeowners with mortgages.

Also: So far this week in my areas of interest, I have only 4 SFH sales. Three of the four went for under assessment and the other one sold for two thousand over.

Mindset said...

Although I don't disagree with people throwing percentages around where % tightening = % price change, because it 'feels' logical enough, let’s keep some perspective on bubbles here.

Bubbles are not mathematical, they are emotional. Nortel stock never should have been worth $120 a share, and never should have corrected to $5 a share as quickly as it did. Just look at the graph:

http://magazine.globeinvestor.com/servlet/ArticleNews/story/GIGOLD/20021203/ingrmman2/magazine/home

Welcome to emotional investing and our ever accelerating free market boom and bust cycles.

When housing becomes a bad place to put money, there is a lot more to a correction than just a percentage interest rate change or reduced amortization period. The .com collapse or the US housing industry are recent examples of what happens when all the buyers flee from a market.

Add human emotion and the fact that Canadas increasing house prices have been a rising tide floating all economic boats (it masked the entire recession), and things get really interesting when the prices start ratcheting down.

We have been on the edge of a serious price correction for years, it just wasn't obvious until now because ol daddy Harper decided to kite the visas to make our distressed family feel rich, and we just hit our credit limit.

Mindset said...
This comment has been removed by the author.
Mindset said...

Looks like the Nortel bubble graph from my previous post was truncated... heres a tinyurl to the link.

http://tinyurl.com/6dwreko

Just Jack said...

For houses in the core since the beginning of the year, I have 25 out of 91 (27%) selling below the assessment.

For condos, I have 37 out of 84 or 44% selling under their assessed value. The extreme sales were at 70 percent of the assessed value and 170% of the assessed value. Almost 31 percent of the condos sold within 95 to 105 percent of their assessed value.

I'd expect quite a wide variation in condo assessments, because there is no such thing as a sale of vacant strata lot. So while two condominiums can be physically exactly alike, their position in the building would give them different market values.

Just Jack said...

The Home Equity Lines of Credit, added one more dimension to kiting visa and cheques.

I survived by kiting cheques and visa and master-card payments in the 90's. Eventually, you run out of wiggle room and the game is over. Back then my credit limit was, by today's standards, low. So I only dug myself into about $15,000 of debt.

Today, most credit cards have limits way over $15,000 and people have a half dozen or more in their wallets. So, I bet you're now having people amassing 50K, 100K or more of debt.

Debt that gets that high is not re-payable unless its amortized over a long period. The strange thing is that if you hadn't bought a house - you wouldn't be this deep in debt.

Debt - its a wicked mistress

DavidL said...

I got myself into "bad debt" situation 20 years ago ... it was an invaluable learning experience.

After a failed business venture, I found my self about $4000 in debt and about to default on $8000 of student loans. I worked out payment plans with my creditors and eventually repaid it all. My credit rating was about as low as is gets (R8) - and so I had to live for 7 years with no credit.

I learned to budget carefully, save for a contingencies, invest carefully, and live within my means. These personal finance "lessons" taught me to regard debt completely differently and to avoid debt when possible.

Ironically, after 7 years of no credit - banks were offering me "gold" and "platinum" cards ... stumbling over themselves to indebt me now that I has a clean credit rating.

DavidL said...

Quoting from my posting on January 18th:

When interest rates are very low (as they have been for the past 3+ years), even modest increases in interest rates can have a profound change in the corresponding monthly payment. Assuming a 30-year amortization, a modest increase of 1.5% (5-year fixed rate adjusted from 4% to 5.5%) will increase monthly payments as follows:

$315K = $1500 @ 4% -> $1776 @ 5½%
$420K = $2000 @ 4% -> $2368 @ 5½%
$525K = $2500 @ 4% -> $2960 @ 5½%
$630K = $3000 @ 4% -> $3552 @ 5½%
$735K = $3500 @ 4% -> $4144 @ 5½%

A 1.5% increase translates into an 18% increase in monthly payments. Keep in mind that the modest 1.5% increase is in line with most of the current predictions by major banks and lending institutions for early 2012.

So what happens in a few years from now if rates climb to 7% (still well below the long-term norms)? This results in a 38% increase in the monthly payment.

How many people can afford an 18% (or worse yet, a 38%) increase?

DavidL said...

Does anyone else notice a big surge in their PCS listings (and price changes) since February 1st?

Note to self: Must drink less coffee and therefore post less to HHV blog. ;-)

Watching and waiting said...

DavidL.

Definitely. Esp on Feb 2, 2011 for my search parameters - lots of new listings and price changes.

I have to laugh at 2026 Chaucer St with their $1000 price drop.Sure it's a start but wouldn't logic dictate that people would have offered $1000 below asking?Besides appeasing the sellers, what's in it for the realtor apart from having a listing and continuing to shell out $26/week for the mls listing? Seems pointless to me. Mind you, then you have that other home on Blackberry who upped their price from $549k to $566k. Makes no sense unless we are in a buyers market.

I also have to laugh at Suzy Hahn`s price drop on her $745k properties on Westall creating hype about getting in before the new mortgage restrictions but oh wait there`s a caveat: `valid only in exchange for an unconditional full price offer acceptable to sellers by 2011/02/10 closing date of Feb 28/2011`. Sounds real buyer friendly. What happens after Feb 28, 2011 - do the prices revert back to the original $765k? sounds like a fortuitous opportunity too good to pass up. Smoke and mirrors folks ...

Watching and waiting said...

oops .. meant to say "makes no sense unless we are in a sellers market."

patriotz said...

Just wondering, what's your definition of a "seller's market"? And don't tell me "it's when houses are easy to sell" - houses are always easy to sell. It's the sellers who make houses hard to sell by asking too much.

DavidL said...

@ patriotz wrote: Just wondering, what's your definition of a "seller's market"?

To me, a "seller's market" means that houses are selling at (or above) asking price. More importantly, it means that houses are selling quickly.

Multiple prices reductions, selling below assessment, and languishing for months before selling is not a sellers market.

Dave said...

The definition of a seller's market is when there is less than 6 months of inventory (or MOI).

If you don't like the definition, then come up with another term for what you are trying to describe.

HouseHuntVictoria said...

Dave, I'm not sure that less than 6 months of inventory is "sellers" market, absolutely.

I've seen analysis that says 4-6 months is considered balanced market conditions, less than 4 = seller's market and greater than 6 = buyer's market. I noticed some of the industry associations started moving this yardstick up a month last year to 5-7 from 4-6.

Typically, prices rise when sales to new listings ratios exceed 60% and prices drop when sales to new listings ratios diminish below 35%, but only when this occurs over a period of time... as in a couple or three months in a row.

Using a snapshot of market activity in one month to judge a market as buyer's, seller's or balanced is problematic. Markets require time to gather momentum before price change activity takes hold.

I called January as the start of a buyer's market. Here's why:

Nov 10 = 7.8 MOI
Dec 10 = 9.1 MOI
Jan 11 = 9.7 MOI

Here's why I think prices haven't changed in that time:

Nov 10 = 66% sales to new listings
Dec 10 = 67% sales to new listings
Jan 11 = 28.5% sales to new listings

Just Jack said...

4 to 6 months or 5 to 7 months.

Its more of a rule-of-thumb. What you would also have to see is flat to declining prices and increasing days-on-market.

And I don't think all markets would necessarily be the same. For example, new construction versus the re-sale market. A good portion of new construction is listed before the home is completed and that may stretch out that metric to a year. Nor would Norther BC have the same metric as Victoria with its all year round weather.

Personally, I don't like the term buyer and sellers market. To me, its more clear to say that the market is bearish or a bull or even that that the market is "soft"

Marko said...

Last 6 months compared to the same 6 months in 2009-2010 as far as unit sales per month go....

August 2009 - 764
August 2010 - 425

Septemebr 2009 - 776
September 2010 - 395

October 2009 - 742
October 2010 - 467

November 2009 - 604
November 2010 - 479

December 2009 - 453
December 2010 - 349

January 2010 - 418
January 2011 - 339

Total Aug 09 to Jan 10 - 3757
Total Aug 10 to Jan 11 - 2454

February and March are going to be super important months, will we see a bounce in terms of sales?

HouseHuntVictoria said...

I added percentages:

August 2009 - 764
August 2010 - 425
Drop of 44%

September 2009 - 776
September 2010 - 395
Drop of 49%

October 2009 - 742
October 2010 - 467
Drop of 37%

November 2009 - 604
November 2010 - 479
Drop of 21%

December 2009 - 453
December 2010 - 349
Drop of 23%

January 2010 - 418
January 2011 - 339
Drop of 19%

Total Aug 09 to Jan 10 - 3757
Total Aug 10 to Jan 11 - 2454
Drop of 35%

I agree with Marko. This spring will, with the tone set in February and March, will play a large role in determining this year's market performance.

Marko said...

If sales in February and March don't break 500 and 650 respectively things could get very interesting.

Prices in Victoria appear to be resilient to lower sales volumes but below 500 and 650 would be pretty severe.

omc said...

From talking to one of the older realtors; I have been led to believe that March and April are the hinge months. Jan and Feb are usually sellers markets where prices may go up due to low inventory. This kind of matches what I have been seeing for the last few years that I have been watching closely. If there is any momentum as spring approaches prices will go up further, if not they go back down.

This year sales are down, with prices down in the usual sellers market months. We also have new mortgage rules, for the high ratio fools, coming into effect as spring starts. I expect a strong buyers market starting in March and not ending until affordable levels are reached at normal interest rates. When this is, who knows.

Russ said...

I was talking with a collegue at work yesterday, he is around 30 and building a McMansion in Highlands. He might have put down a bit on his lot from a previous sale, but is looking at a large mortgage for our income level.

His exact words after reading the article about rising interest rates hurting home prices was: "They (the government) will never raise interest rates, too many people will be screwed."

I was stunned but the other guy at the lunch table was nodding!

He mentioned later that the only way he can afford the house he is building is because it will have a $800/mo suite.

I can't believe he thinks the govt sets mortgage rates, that rates will stay this low for a long long time, and that he has taken on so much debt based on these erroneous assumptions.

Also that he is $800/mo away from possible default.

Its stories like this that convince me that we face a US style meltdown.

DavidL said...

@ Russ wrote: His exact words after reading the article about rising interest rates hurting home prices was: "They (the government) will never raise interest rates, too many people will be screwed."

It sounds like you colleague doesn't have a clue about how interest rates get set. As for the government not screwing people by raining interest rates - just look back 30 years to the early 19080's to see how powerless the BOC was when variable rate rates quickly climbed to 17%!

DavidL said...

"raining" = "raising".

Must be s slip about the current weather!

Animal Spirit said...

Two topics for comment:

1 - anyone else notice how many houses on MLS have brown lawns :) Must be some hold overs from the summer re-listing without thinking to change the pictures to the green lawns of winter

2 - Just updated my listing distribution stats for Victoria not counting westshore - will post it on google docs if I can figure out on to do it. What is interesting is that while the number of houses in my search today is exactly the same as mid-march, 2010, the distribution curve of listing prices is almost exactly offset 50k less than last year, but is still 50k higher than the same date in 2009.

The bottom of the barrel tear-down listings are at 350-400K now vs 400-450K a year ago, and 300-350K in 2009. This could mean that low end lot value for developers has gone from 325K two years ago to 425K last year to 375K now. For the 500-550K house range we are interested in to drop to what we are willing to pay, the bottom end houses will need to drop further.

The question is: are specu-developers dropping bid prices or falling out of the market for these houses? I'll follow the listings a bit to see what happens.

Taigaa said...

What percentage of houses for sale are sitting empty? 25%? Seems quite high judging by the pictures on
Mls and the houses we have gone to look at. Is this normal or is it high right now? You would think any house that is empty would be more likely to drip the price to get it sold quickly..

Marko said...

Monday, February 7, 2011 8:00am:

MTD February
2011 2010
Net Unconditional Sales: 78 621
New Listings: 334 1,460
Active Listings: 3,312 3,280

Please Note

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

omc said...

Thanks Marko,

There are 20 business days in Feb, with only 4 gone. If we were to do a linear prediction we would get only 390 sales. I don't know if a linear prediction works for February, but that would be a 38% decrease in sales.

a simple man said...

Saw three open houses on the weekend - a flip on Oliver and two houses on Musgrave.

Wow. Overpriced. Oliver spec'ed the house with materials that looked quality but were the cheapest possible substitute. Whoever buys that house better be ready to replace a lot in the first five years. One house on Musgrave was tiny and the other needed to be torn down - both in the $600,000's. Insanity still lives in Oak Bay.

At least the $870,000 flip on St Ann hasn't sold yet.

Alexandrahere said...

Hi all. Here are my stats for the past week of Jan 31 - 6 Feb.

SFH: Min 2 beds and 2 baths, priced between $375K and $775K in the core municipalities of Victoria, Oak Bay, Esquimalt, Saanich East & Saanich West.

NEW: 43
SOLD: 14
P/C: 25
OM: 12

Avg selling price:$592K,
Median selling price: $615K
Five out of the 14 sold went for under assessed value.

Condos: Min 2 beds priced between $260K & $675K. In most areas of Victoria and Saanich East, all areas of Oak Bay and Esquimalt and Gorge,Tillicum and Interurban areas of Saanich West.

NEW: 25
SOLD:12 apts & 2 townhouses
P/C: 6
OM: 9

Avg selling price apts: $373K
Median selling price apts: $370K

The 2 townhouses sold for $460K & $360K and the one sold for under assessment. Four of the 12 apartments sold under BC assessment.

omc said...

You can tell how the market is changing, and our expectations. Not too long ago us bears would have been dancing with such bad #s. Now we expect it.

On another note, I was talking to someone who was very worried now that the max amortization has been decreaseed, even though he has already bought. He is already amortized at 35 yrs, but was planning on amortizing again at 35 yrs when his mrtgage comes up for renewal in 5 yrs. That was his plan to try to minimize the effects of interest rates that will be a couple of % higher. Now he doesn't know how he will be able to afford payments 20% higher.

Deanna said...

Marko,

I keep forgetting to ask: What municipalities are your stats for? I'm assuming all of Greater Victoria, Saanich Peninsula, Sidney, Langford, Colwood, Sooke (and any points in between I may have missed), but I'm not sure how far up the Malahat that extends - Goldstream? Shawnigan Lake?

Thanks so much for your weekly updates!

a simple man said...

TD is the first bank to raise interest rates for 5-yr mortgage by 25 points.

nan said...

I would like to add a bit to the sellers market/ buyers market discussion. When I think about the concept of market conditions, I don't think about it in wholly numerical terms.

First, lets forget about the rich -they don't really matter that much. Lets get one thing clear - although many Victorian's are rich, 90% of the people buying houses here are working class.

Second, I believe that a buyers market can only exist when the buyer that should be living in a property can acquire that property and forsee themselves either saving up to buy or paying off the mortgage in a reasonable time frame. Ignoring interest, giving up 10 years of your life to afford a house is fair I think, at differing income levels, this may be half or double this number, up to 20 years.

This means that a house designed to accomodate a young family should be priced such that a young family making an average wage can pay for it within 10 years, on average.

In Victoria, assuming the 65k average family wage, and other life expenses (taxes, retirement, kids, etc) leaving a family with 1/3 of its gross to spend on housing, the average house should cost about $215k (1/3* 65K* 10). Victoria is nice, so lets throw in another $50,000 "Victoria Premium" bringing us to $265k. A 25% premium is consistent with the income multiple being closer to 4 or even 5 in nicer cities

When housing gets to this price or below, it will be a buyers market in Victoria for the working class.

Until then, it is a sellers market, as the buy/sell transaction simply transfers too much value to the seller.

Many may argue that $265k is too low for Victoria, but this is a much truer definition of affordability than the heavily doped market we have today.

DavidL said...

@nan wrote: Many may argue that $265k is too low for Victoria, but this is a much truer definition of affordability than the heavily doped market we have today.

In 2002, the average Victoria home was selling for about $265K.

Your calculation that the average family should be able to pay it off in 10 years does not include accrued interest. Even at a modest 6% interest, it would take 15 years to pay off the extire mortgage at $26.5K per year.