Option ARMS & Economic Recovery
If you were paying attention to the news over the last couple of years, you may have noticed a bit of a global financial hiccup that brought down house prices, stock markets and some banks while driving up unemployment. Subprime mortgages where blamed, because apparently loaning people money they can’t pay back to buy houses that are priced on enthusiasm rather than fundamentals is not a good long term business strategy.
Fortunately as of late some soothsayers are seeing green shoots that indicate the recession is nearing an end. This would mean that even if prices and economic activity don’t shoot back up to boom levels they would at least stop falling.
Unfortunately other soothsayers are seeing yet another problem on the horizon before this whole situation calms down: The bulk of Option ARMS are going to reset in 2011. These are the ‘pick a payment‘ mortgages that are perfect for sophisticated buyers with growing incomes, but can quickly get out of hand if the buyer chooses the negative amortization route. In the US about 40% of these loans made in 2006 – 2007 are already delinquent.
New Barclays Capital research from Sandeep Bordia and colleagues shows that the recasts in the next year or so are expected to be a minor event. But by mid-2011, these borrowers are forecast to see payments that are 50% to 80% higher than what they are grappling with now. (Many of these option ARMS are concentrated in former hot-spot real estate markets, such as California and Florida.)
Modification don’t seem to be working with these particularly noxious loans. In the face rising payments, borrowers don’t have an incentive to keep up with their current payments for homes that are already so horrendously under water, i.e. the loan amount is far above the current value of the property. Bordia says that many of the option ARM loans that do get modified turn delinquent soon after anyway. They’ve crunched some numbers and forecast that 95% of the loans that are slated for modification will eventually default. If you think that sounds bad, get this: They say that 80% of the option ARM loans out there that are ok and up-to-date as of right now will eventually default, too.
So are the coming resets in Option ARMS going to be another sub-prime crisis, or is this just a ‘sky is falling’ redux of the Y2K hype? Either way I hope somebody is watering those green shoots.
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July 31st, 2009 at 2:22 am
Todd is a great example of “not thinking” – or at least “not researching, and THEN thinking”. As such he is simply rather typical for a Vancouverite. Bless, the simple creatures.
July 31st, 2009 at 1:29 am
Todd:
I don’t think real estate is that high in bc on a global scale.
Vancouver has among the highest price/income and price/rent ratios in the entire world.
So what planet are you from?
I usually ignore this kind of post, but I couldn’t resist the comeback.
July 30th, 2009 at 11:32 pm
Housing Market Teeters Between Recovery, Relapse
http://www.washingtonpost.com/.....03270.html
July 30th, 2009 at 11:00 pm
http://vancouvercondo.info/200.....ment-49996
Careful Todd, this is a bear blog, the cup is always half full, most of the posters live in those basement suites you mention. Either that or they hate vancouver and are looking to move to Flin Flon. Our posts will eventually shrink to the size of their minds .
July 30th, 2009 at 10:25 pm
Everyone here is so negative that they are never going to own property and will always rent and sub standard rental housing.
A lot people are fixing there interest rates at very low rates for 5 years or more. If inflation increases during this period even if mortgage rates go up they should be protected.
Is it cheaper to rent? Look at the listing, if you want a nice place in Kits your looking 1,400 for a basement suite, check out Craigslist.
I don’t think real estate is that high in bc on a global scale.
July 30th, 2009 at 9:15 pm
Housing Recovery: Sell Now Or Your Capital Will Be Trapped
http://www.oftwominds.com/blog.....07-09.html
QUOTE:
As interest rates rise, then the Capital Trap shuts on all equity locked in real estate. I covered this subject last year: The Housing Capital Trap Snaps Shut (May 28, 2008)
The mechanism can best be illustrated with an example. Let’s say a homeowner who bought long ago has a $100,000 mortgage on a home which was once worth $450,00 at the bubble peak. Now the property has sunk to a value of $250,000. The owner still has $150,000 in equity: quite a substantial sum.
But if interest rates double, then the house would have to fall roughly in half to be affordable to buyers. Equity would shrink to a mere $25,000. Or alternatively, if the owner insisted the “true value” was still $250,000 based on other metrics, then the capital is trapped as the house cannot be sold in the marketplace.
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ALSO:
QUOTE:
The key concept here is that a house is only worth what someone can afford to pay for it. Thus we must be wary of divining “the bottom” based on metrics which don’t take rising interest rates into account.
Why can’t the Fed just print the $2 trillion the government wants to borrow? Wouldn’t that solve the problem? In theory, perhaps, but in practice, when the Fed did exactly that, announcing it was printing $300 billion to buy Treasuries, the bond market reacted violently by pushing rates up dramatically.
Printing trillons of dollars is seen as inflationary by the bond market, and if inflation is being ramped up to 4%, why buy a bond that pays 2%? To keep buying bonds which are guaranteed to lose money is simply unwise. The net result is the Fed cannot just print $3 trillion (don’t forget all the bonds which have to be rolled over) and buy Treasuries–the bond market would instantly demand much higher rates to compensate for the additional risks of inflation.
Real estate industry cheerleaders counter by saying housing “always rises in inflationary eras.” By that they refer to the 70s, when real estate shot up alongside rising inflation. But what they forget is that housing was rising from extreme levels of affordability, and that the Baby Boom was entering its prime homebuying decade in the 70s.
Now we have 18.7 million vacant homes, a high level of unaffordability and rising interest rates.
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An excellent article with many good charts and graphs.
I see more and more experts are now cutting to the chase and explaining in clear s-i-m-p-l-e English why Gov’ts cannot print money endlessly and why interests rates are bound to rise and hence wreak havoc on Real Estate, etc.
July 30th, 2009 at 8:37 pm
Short 1500 Volunteers ?
Awww ……poor VANOC:
Maybe their is a very good reason.
I’ve been told by some informed parties that being a VANOC Volunteer takes a lot more time, commitment and personal cost than simply wearing a shit- eating grin for 2 weeks.
Some potential volunteers have also stated that VANOC wants you to fit VANOC’s schedule and a sport VANOC assigns you…thus turning off Volunteers.
Some of the more amusing Volunteer positions I have been informed of involve the glory of accompanying athletes to the washroom and making 100% sure they pee in the bottles for the drug tests.
I’ll be wearing shit – eating grin if 2010 falls flat on its face….and I think the early warning signs are that it will. VANOC’s latest plea simply adds to the list.
PS Anyone got an update on the Olympic Village?
COV has about 90 days to finish and turn it over to VANOC,….. Man time flies !
July 30th, 2009 at 8:13 pm
NO -LYMPICS:
However, a sign on one persons property says “CALL A LAWYER BEFORE YOU BUY AN RV PAD “.
That anyone should even feel the need to point this out demonstrates the current sorry state of the BC mindset. You need a lawyer for any RE transaction.
And moving on: Friends, Vancouverites, countrymen – lend us your employees:
Lend us your employees, Olympic organizers plead
Well businesses may be a bit reluctant as they have the bottom line to look after but I’m sure the provincial government can lend a little off-the-books assistance, eh Gordo?
“The Olympics can no more have a deficit than a man can have a baby”
- Jean Drapeau
July 30th, 2009 at 8:01 pm
Been out of town for a week ……so some catching up on this VCI blog:
Was up in the Shuswap area.
Real Estate up in that area is “interesting”.
One latest trend is to buy a strata pad to park your RV or approved mobile home. One can buy a serviced pad of approx 2500 sq. ft . for $70,000. However, a sign on one persons property says “CALL A LAWYER BEFORE YOU BUY AN RV PAD “.
Upon inquiry, I found out that one developer had left many RV pad owners hanging by not giving them title to their RV pads and had used the funds to purchase more land to do the same RV development nearby. They bought up another private campsite and began developing, but stopped and it has sat frozen for a year. These people are using their finished strata pads , but may not by next year…its all in the lawyers hands.
However, their are no real design guidelines, per se, and yet paid $70,000? Many will park a trailer or 5th wheel, build a roof over it and a porch. Then they add little sheds all over the place, which I suspect are guest cottages.(Why else air condition a 10 X 10 shed? ).
One owner I talked to says they will use it maybe 3 weeks of the year and pay strata fees of $150 per month. Observing some mobile homes in this strata, it appears easements don’t exist as some are parked literally on the property line. What if a fire breaks out? They are near the lake but have no view of it. I mentioned that in many areas of BC one can get an acre lot(clear title /no strata) near a lake for approx. $50,000(or less). However, on the beach is a number of 3 storey walk-up condos, asking approx $750,000. A number are for sale, as are many units (asking $850,000 )at another condo complex surrounding a nearby marina.
Also: Many of these condo units have their own sewage treatment plants…they are not hooked up to the local Gov’ts.(too rural) I can forsee major expenses when things go wrong or the treatment plant manufacturer goes broke etc.
IMHO, the RE market has passed these people, as this is the 2nd year that many of these units have been for sale. If you can’t sell a waterfront unit by the 1/2 way point of summer with perfect summer weather ie 30 + degree celsius, one is in trouble.
One developer is currently building another RV pad strata, but it has caused a lot of controversy. He now has an 8 ft. plywood fence in front of the project…not a good way to sell…I think he has misjudged the market. The other problem with rampant development is the Local Gov’t feels pressure from NIMBY’s and starts to go hog wild with new OCP’s , Bylaws , stricter building code, and more cash grabs.
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*****Also, be warned or advised of your actual voting rights if you are a Non resident. *****
You may own one or 10 properties, but you can only have ONE vote , but if you are a resident, one vote per eligible resident, ie you may rent it to 10 people or have a family of 10 people, then your property has 10 votes.
This is one of the biggets crocks of the Elections Act. Many recreational areas have very low % of resident owners, but it is not unheard of that this often vocal resident minority get certain intiatives placed on ballots or referendums (Fire halls and funding is a prime example) with poor if any notice and get their pet projects approved, knowing full well that the majority (aka non -residents) aren’t aware nor able to vote.
This is exactly happened in the Cariboo Regional District last year. The locals lost out on an improved Volunteer Fire Hall upgrades in the late 1990′s, due to, ironically, an ex -fireman petitioning against it……Local residents claimed they would have reduced fire insurance costs,….which I investigated and found was BS for a number of reasons. Last year, they held a referendum over 2 weeks, with 3 actual days to vote, in late August and gave less than a months notice, even though last year was also a civic election year and the referendum could have been on the Nov. civic ballot. Pretty obvious they rigged this vote when the majority (aka non residents who also aren’t eligible for the homeowners grant) were likely not around as Labour Day and summer’s end approaches ). This time, funding got approved, and a bare property is now levied an extra $50 per year, and a property with any structure is levied and extra $200. This is in addition to dramatic rise in property assessments(and hence property taxes). The current property taxation rates are at least twice that of say a Lower Mainland city, with F*ck all for services(no water, no sewer, gravel roads, nearest school of hospital is 30-45 minute drive). To be even more blunt, and having talked to a number of informed sources, one is far better off having ones building burn to the ground and start over than having a fire dept save it.
================
Also: Heard from a local that Fisheries fined a guy $25,000 for dumping sand on his beach.
Finally, many of these units appear to be bought on spec. However, even if they aren’t, most of them are seasonal, hence NON -primary residences. (aka they do tend to have colder winters than us on the coast). As such, many of them will inevitably end up in “estate” situations (ie the boomers and their parents are buying them ) and CRS with its claw/hand out. Thus, in my view, Recreational property is an even worse investment, given the outrageous prices paid for part time use of non – prmimary residence, and, given the RE market predictions, any recent purchases will sooner be in negative equity than say primary residences.
In a worst case scenario, my understanding is that upon the death of the owner, and if no joint tenancy is in place , the unit is deemed sold and a price is established by CRS. Someone may have bought at peak price, passed away, and the heirs owe CRS aprox. 30% of that peak price. If the property doesn’t sell, or drops, too bad, CRS wants its money. In other words, in a perfect storm one could get caught paying taxes on something appraised by CRS at say $750,000 but may get caught in a crashing market and sells for say $450,000.( I won’t even get into the NDP’s #$** 3 % probate fee ).
Just some advice if you ever get the itch to buy Recreational Property.
July 30th, 2009 at 7:38 pm
Any mortgage where the principal exceeds the fundamental value of the property (the net rental income discounted to present value using the prevailing interest rate over the amortization period) is economically unsound and prone to default. That’s whether you have a US-style option-ARM or a Canadian-style floating rate or short term mortgage.
Needless to say the principal has greatly exceeded fundamental value by any credible estimate for any property purchased in Vancouver over the last 4 years.
Because the lender is (or will soon be) paying more in financing costs than the economic return on the property (net rental value) the portfolio (property/mortgage) is bleeding the owner’s wealth with every payment. As will be the case for a vast number of Vancouver property “owners” for decades to come.
No investor in his right mind would borrow money at 3.5% to buy, say, a bank preferred yielding 2.5%, but that is the kind of thing that Vancouver house buyers are doing right now. Bank preferreds are yielding about 6% right now BTW – that’s the kind of yield spread sensible investors want.
July 30th, 2009 at 6:27 pm
bums up2: “…am expecting basically no price appreciation over the next decade”
Real appreciation is likely to be negative. Whether or not nominal prices decline is irrelevant if you can do better by investing elsewhere. Looking for avoiding nominal price declines is nothing but a way of saving face and justifying why your bad investment is actually, well, not so bad after all.
July 30th, 2009 at 6:24 pm
From Garth’s blog…
(Some crystal ball numbers)
QUOTE:
But, hey, free country. That’s their choice. If they think this is Japan, and rates will stay at 0% for a decade, no prob. Amoritize yourself silly. If they think house prices can rise by 5% a year for the next decade, putting the average Toronto home at $648,000, then believe that, too,
However, crunch this: If the typical Toronto home does hit $648,000 (and realtors claim an annual 5% appreciation rate is ‘normal’), and if mortgage rates return to their 20-year average of 8%, then to buy it with 10% down ($65,000 in cash, plus another for $18,100 in land transfer tax, plus closing costs) will mean mortgage payments of $4,500. Add in a grand a month for property tax and monthlies, and that ends up being a cash flow drain of $5,500. To afford that average house, according to CMHC guidelines would require an income of $17,000 a month – or $204,000 a year.
So, yeah, makes sense to me. Average family income up 300% in the next ten years. Why not? Let’s party.
=========
Conclusion:
— Realtors never lie
— Gov’t always looks out for our best interests and
— Our living standards will continue to rise in sync.
PS I have a bridge to sell you…how about the one thats down to 5 lanes and has a view of the ocean and mountains !!!!
July 30th, 2009 at 5:50 pm
RE: Option ARMS & Economic Recovery
Its very simple isn’t it?
Stupidity and greed knows no economic,ethnic , cultural etc, bounds.
The first wave of stoopidity was the subprime, with stories of people on welfare being given mortgages, or hairdressers buying 5 condos etc. etc. based on the myth real estate can never go down. This was simply a social engineering experiment with roots back into the Clinton Democrats which created a level playing field all right, one of quicksand for the middle class.
This Option Arm seems to imply parties of more secure and higher incomes got sucked in as well with another circus act of cheap money financing.
IMHO, even if the Option Arm never existed, the seeds were already sown, with far too much real estate already in default, dragging A-L-L prices down across the board. Now we have even more people shitting bricks with homes that have lost value yet fear new and likley higher mortgage rates coming soon. I’ll bet many of them have neighbours already foreclosed on, if not already handed in the keys to the banks.
Another bailout package when the Option ARM ? Yeah right ! The last one worked…right ? Another disaster in the making, in fact this looming Option ARM reset may be the icing on the cake.
Fasten your $eatbelts !
July 30th, 2009 at 5:31 pm
From $450,000 to $35,500: A 93% price drop in Palm Springs
http://www.redfin.com/CA/Palm-.....kelowna.ca
July 30th, 2009 at 4:23 pm
By “no price appreciation” do you mean your expecting prices to drop year over year for more than a decade like they did in japan?
July 30th, 2009 at 3:41 pm
bums up2
Short term interest rates set by the gov’t only have a bearing on variable rate mortgages – gov’t rates are already at ZERO – I would suggest they only have one way to go.
Long term rates are set by the market – right now they are pricing in a long drawn out recession (even with the 10% bounce in the last few months). They are also affected by the credit quality of the issuer and the demand for money – I would suggest that if you look at both these factors rates will 1) stay low b/c the economy sucks – bad for asset prices and
2) Have you seen the deficits being run by all levels of gov’t domestic and foreign – bad for rates staying low.
We are at the lows of a 25 year credit cycle … if you buy (pls don’t) make sure you lock in for ten years and make sure you put down a hefty dp.
July 30th, 2009 at 3:38 pm
I agree, and am expecting basically no price appreciation over the next decade as well.
July 30th, 2009 at 3:06 pm
“Look to Japan’s experience of the past 20 years to know where interest rates are heading. This bear is about to capitulate.”
I’d suggest looking at graphs of Japanese home prices since 1989 and report back on how low interest rates helped prop up prices. Not well at all, in the end.
July 30th, 2009 at 2:59 pm
I think interest rates will stay low and have no fear of variable rate financing.
Look to Japan’s experience of the past 20 years to know where interest rates are heading. This bear is about to capitulate.
(Time will tell if that makes me the greatest fool or not!)
July 30th, 2009 at 12:03 pm
Attention should be paid to the difference with “reset” of interest rates which are artificially low and “recast” of payment where the payment has to cover interest and principal.
The result will be the same though.
July 30th, 2009 at 9:45 am
An observer
o you think ftb’s can throw multiple offers? Try to understand the topic do not confuse yourself,There is no more legs to shoot down, current leg is the only option left for this world and there is no more downturn in decades to come in “the best place on earth”.
July 30th, 2009 at 9:19 am
“An observer Says:
July 30th, 2009 at 9:03 am
Could this not be applied to all the FTB that are currently snapping up RE in Vancouver simply due to all time low mortgage rates? What will happen when their mortgages “re-set”? There is little doubt that mortgage rates will be higher when it is time to renew. How high…who knows, but I don’t think it will be pretty for a lot of people.”
Exactly. Although it won’t be quite as bad as the US, some Option ARMs there go from 3% to 12% or other ridiculous resets.
July 30th, 2009 at 9:03 am
Could this not be applied to all the FTB that are currently snapping up RE in Vancouver simply due to all time low mortgage rates? What will happen when their mortgages “re-set”? There is little doubt that mortgage rates will be higher when it is time to renew. How high…who knows, but I don’t think it will be pretty for a lot of people.