Up to our necks in debt
There are increasing indications that our reputation of being a financially conservative in Canada is more myth than reality. As a group, we’re taking on more debt than ever before and finding ourselves with less of a personal safety net should the economy take a dive. Since 2001 the number of people over 60 that still have a mortgage has been steadily increasing, and the mortgages that we all hold are of more and more exotic varieties. From todays Vancouver Province: Why we’re up to our necks in debt.
A rash of recent reports paint a scary picture of Canadians as spending like drunken sailors, leading to the prickly question of whether we should be forced to save money.
A Statistics Canada study showed Canadians are finding themselves with two mortgages and deeper in debt than at any time in their lives. They are increasingly house poor, and with housing values sliding, they often owe more on their properties than they’re worth.
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The StatsCan study came out at the same time that the Office of the Superintendent of Bankruptcy Canada reported that personal bankruptcies reached their highest level in more than four years during April, up 19.3 per cent over the previous month and 18.3 per cent over the previous April.
And things will only get worse if recent numbers showing a gross domestic product decline during the last quarter continue, signalling an economic downturn, and if unemployment rates should start to rise.
As it is, mortgage payments make up 37 per cent of average household spending in 2007, up from 32 per cent a year earlier.
And those mortgages are getting more ‘interesting’. The common refrain that the Canadian housing market is not as vulnerable to downturn as the US market because we don’t have ‘sub-prime’ mortgages is only part-true. What we do have is an mortgage insurance market that was liberalized in 2006 and has dramatically changed the landscape in the last few years with the introduction of zero-down, 40 year terms and adjustable ‘teaser’ rate mortgages:
With interest rates dropping, consumers might consider a front-loaded variable- rate mortgage. This option gives you a larger-than-normal discount from the prime interest rate for an initial period, say six months, before you decide whether to lock into a fixed rate.
Longer amortization periods, now up to 40 years, also are new. Holt estimates longer-term mortgages now account for three quarters of monthly insured purchase applications in Canada, with 40-year products accounting for half of that.
So will following the US lead into the area of ‘exotic’ mortgages lead to a similar result? Only time will tell, but it is interesting to see that this topic seems to be getting more attention within the government. That first article had this bit of info that was new to me:
Finance Minister Jim Flaherty recently suggested it might be wise to outlaw 40-year mortgages.
With up to a third of new mortgage applications opting for the longest term, removing that option could have a dramatic impact on our housing market at a time when it appears to be already slowing due to affordability concerns.
June 18th, 2008 at 3:29 pm
Jesse: Point taken, inflation of prices doesn't necessarily equate inflation of wages.
June 18th, 2008 at 3:03 pm
"Of course another possiblity is that investors are betting that rents will rise…
There are indeed signs that inflation is picking up.
For inflation to be translated to rent inflation, wages need to rise as well or people just densify to make it affordable. As an example from a specific profession, Vancouver area Realtors on average are earning 25% less commissions this year than last. Public sector workers have wage increases negotiated at 2-3% per year. Hardly inflationary. I'll believe stagflation when I see paycheques rise otherwise I'll just reduce my spending in other areas to compensate for goods inflation. I'm sure most Canadians are doing the same or maybe just going into debt.
June 18th, 2008 at 1:37 pm
Sorry everyone for the duplicate post, my browser froze. Also, I meant price/earnings is at all time high.
June 18th, 2008 at 1:31 pm
Dave: Yes, I think in the event of a prolonged downturn or stagnation, there is also the possibility that it would make sense for some to buy rather than to rent, depending on one's financial and the economic circumstances. But my point was that it would depend on a lot on the individual's situations, and it must be the case that there would be a balance between those for which it makes sense to buy and those for which it does not make sense to buy, otherwise if one camp were to greatly outnumber the other, the market would not be in prolonged stagnation and would start tip either way.
One point which hasn't been raised explicitly is that the criterion for deciding whether to buy or rent depends somewhat on whether one is buying to live in or buying to invest. For those who are buying to live in, sometimes there are other factors besides pure fundamentals and one often talks about an ownership premium. For those who are investing, the incentive in the past few years has been price appreciation since price/earnings (price/annual earnings from renting after expenses) is at an all time low right now.
If we have a prolonged stagnation, this incentive would disappear, suggesting that a prolonged stagnation is not stable and would tip towards an accelerated downturn if one believes there are a significant amount of investors playing the market for price appreciation (which I think few would deny).
Of course another possiblity is that investors are betting that rents will rise. However, historically if you look at the Saunder and statcan data, rents/salaries have more or less moved in tandem and followed inflation (with the important remark that couples now have to both work to maintain this salary against inflation).
There are indeed signs that inflation is picking up. However, our price points in Canada are higher than in the US, suggesting that the US has more room to handle inflation in terms of cost of living versus after tax salary (my guess as to why the BoC didn't cut rates last week). The evitable spikes in the interest rates that accompany inflation together with higher cost of living in Canada seem to also suggest a sharper downturn to bring the market to fundamentals first.
June 18th, 2008 at 1:25 pm
Dave: Yes, I think in the event of a prolonged downturn or stagnation, there is also the possibility that it would make sense for some to buy rather than to rent, depending on one's financial and the economic circumstances. But my point was that it would depend on a lot on the individual's situations, and it must be the case that there would be a balance between those for which it makes sense to buy and those for which it does not make sense to buy, otherwise if one camp were to greatly outnumber the other, the market would not be in prolonged stagnation and would start tip either way.
One point which hasn't been raised explicitly is that the criterion for deciding whether to buy or rent depends somewhat on whether one is buying to live in or buying to invest. For those who are buying to live in, sometimes there are other factors besides pure fundamentals and one often talks about an ownership premium. For those who are investing, the incentive in the past few years has been price appreciation since price/earnings (price/annual earnings from renting after expenses) is at an all time low right now.
If we have a prolonged stagnation, this incentive would disappear, suggesting that a prolonged stagnation is not stable and would tip towards an accelerated downturn if one believes there is a significant amount of investors playing the market for price appreciation (which I think few would deny).
Of course another possiblity is that investors are betting that rents will rise. However, historically if you look at the Saunder and statcan data, rents/salaries have more or less moved in tandem and followed inflation (with the important remark that couples now have to both work to maintain this salary against inflation).
There are indeed signs that inflation is picking up. However, our price points in Canada are higher than in the US, suggesting that the US has more room to handle inflation in terms of cost of living versus after tax salary. The evitable spikes in the interest rates that accompany inflation together with higher cost of living in Canada seem to also suggest a sharper downturn rather than a prolonged one.
June 18th, 2008 at 10:39 am
Jesse
Well if someone were to attempt to use that explanation then they really also owe an explanation of why purchasers were wrong about fundamental value then and they're right now. An explanation of how this realization could come about in such an incremental fashion would help too.
June 18th, 2008 at 9:59 am
"explain how prices can triple without any real fundamental change in the market?"
That's easy: prices were significantly undervalued before. Nobody realised it until just a few years ago. Besides, prices are forward looking and the future is looking pretty good. Future's so bright, I gotta wear rose-coloured shades.
June 18th, 2008 at 9:48 am
"it is also possible prices will continue to rise. What if they go up another 5 to 10% and then drop an equivalent amount?"
Good luck with that. It's possible but unlikely to say the least. Don't say you didn't get the memo
. Anyways if prices went up X% and fell back to today's values a renter who is paying less in rent than the interest/taxes/maintenance for owning the same property is still further ahead.
"I have yet to hear anybody say they are holding out to buy in Burnaby, North Van, Coquitlam or Richmond. The reason for that is because those places are still affordable."
Once again you miss the big picture. Lump everyone's incomes into a giant pot and lump the appraised prices of residential properties into another pot. The income pot cannot carry the property pot.
It doesn't matter if someone can afford a 30 year old walkup condo in Surrey. They have made a lifestyle choice and can rent a great place downtown for way cheaper than it is to buy it. Sounds like a good deal to me. They're likely going to "miss out" buying at the peak as well.
June 18th, 2008 at 9:42 am
Dave
"Only 40 years? That covers quite a few economic cycles within the same market (i.e. apples and apples).
Unless you subscribe to long wave theory (e.g. Kondratiev), then I think it is a solid time period to use."
Wow, you really don't pay attention do you? I've said a half dozen times already to you that I believe the bump in the '90s was a feature of our current mega bubble. Certainly the market has been abnormal since the late '80s. I know your type always wants to believe Vancouver is "different", although nobody has really explained why it's different and you certainly seem happy to use other cities as proxies when you think it fits your argument. The fact is bubbles have been happening for hundreds of years and the result is always the same. Prices drop to approximately the level they were at before the bubble.
I know you'll probably argue that it's not a bubble. If that's your line then explain how prices can triple without any real fundamental change in the market?
June 18th, 2008 at 9:30 am
Dave, don't feel bad for me on missing out. I'm saving roughly $6,000 a month renting versus buying the same place.
I have saved the difference and have done far better investing that sum than if I'd bought the place outright.
My position is that we don't have a strong enough economy to support $5,000 dollar rental pricing now, nor will we in ten years. $9,500 a month? I'll give it a reasonable chance in twenty five years. (This is for 1,200-1,400 sq. ft. prime Yaletown).
Nor do I think we'll see suites selling for $2,000 a square foot for standard floor plate, 1,200 sq. ft. suites within fifteen years.
With those assumptions, I'll be just fine renting in perpetuity, thank you.
June 18th, 2008 at 8:53 am
What if they go up another 5 to 10% and then drop an equivalent amount?
Possible, but not very likely.
Ok lets say they did, If I'm looking at it as an investment it still an extremely poor one. Transaction costs are what, around 6%? So after that rise and drop I'd be down about 6% IF I bought with 100% cash down. Thats ignoring the opportunity cost of that cash.
Lets say it takes two years for your imagined rise and fall. In that time the difference between what I save on rent vs. purchasing costs is currently around $2k per month. That adds up to almost $50K that can go into better investments than a stagnating (more likely dropping) real estate market.
If I was a gambler (you'd have to be to buy in Vancouver right now) I could take out a loan and make leveraged investments in any sector.
Let me ask you a direct question if you believe Vancouver Real Estate is not a bad deal right now: are YOU buying at these price levels?