Economy Headed For Tougher Times

[Mizar]

For some strange reason there was a lot of doubt about my earlier statement of the large number of foreign buyers in the Canadian market.

In keeping with the large number of recent links in posts on this thread, I thought I would confirm for any doubters the significant factor of foreign buying in certain markets. Which is great if you are a seller.

There does not appear to be any government data on this issue so it really is dependent on firms in the know to do studies.

For those willing to read from a copy and pasted article:

Foreign buyers fuelling sales in luxury real estate market: report

by The Canadian Press on Tuesday, September 10, 2013 6:23pm -

TORONTO – Sales of luxury homes will likely gain momentum in the fall, fuelled by demand from international investors, according a new report from real estate sales and marketing company Sotheby’s International Realty Canada.

The report released Tuesday suggests the largest proportion of foreign buyers will be from China, Russia, the Middle East, India and the U.S.

Elli Davis, a sales representative with Royal LePage in Toronto, says many foreigners buy condos for their children to live in while they attend school in Canada.

“I’m seeing a lot of foreign names on showings of all of my listings,” said Davis.

“More foreign names than not.”

The Sotheby’s report says the high-end condo market in the Greater Toronto Area has rebounded after a slower start to the year, a trend that is expected to continue into the fall.

“There were a lot of numbers that were starting to look worrisome in Toronto,” said Sotheby’s president and chief executive Ross McCredie.

However, while some economists are cautioning about an oversupply of condos about to hit the Toronto market, McCredie notes that there are far fewer high-end units available.

“It’s not like the $600,000 shoebox condos where you’d have investors buying them and looking to renting them out,” he said.

“If it’s a well-built building in a good location, people want to live there, so it’s more about lifestyle than pure investment.”

McCredie also notes that those in the market for a luxury home are less likely to be deterred by short-term fluctuations.

“They’re not first-time homebuyers,” he said.

“They’ve seen cycles before. Most of our clients remember what it was like in the early 80s and the early 90s, when you had major corrections, so they’re not going into these markets blindly.”

Sales of luxury homes are also expected to gain traction in Calgary and Vancouver and remain balanced in Montreal, according to Sotheby’s.

Sotheby’s said sales of high-end homes worth at least $1 million were up in major Canadian urban markets in the first half of the year compared with the second half of 2012.

Sales were up 65 per cent in Vancouver, 67 per cent in Calgary, 61 per cent in Toronto and 29 per cent in Montreal.

[W5]

And there is this:

Will China shake the world again?

http://www.bbc.co.uk/news/business-26225205

Unless you are an aficionado of the great moments of Chinese Communist history, you probably won't have heard of Wuhan (it is the site of Chairman Mao's legendary swim across the Yangtze).

But perhaps more than any other Chinese city, it tells the story of how China's remarkable three decades of modernisation and enrichment, its economic miracle, is apparently drawing to a close, and why there is a serious risk of a calamitous crash.

In Wuhan I interviewed a mayor, Tang Liangzhi, whose funds and power would make London's mayor, Boris Johnson, feel sick with envy. He is spending £200bn over five years on a redevelopment plan whose aim is to make Wuhan - which already has a population of 10 million - into a world mega city and a serious challenger to Shanghai as China's second city.

The rate of infrastructure spending in Wuhan alone is comparable to the UK's entire expenditure on renewing and improving the fabric of the country. In this single city, hundreds of apartment blocks, ring roads, bridges, railways, a complete subway system and a second international airport are all being constructed.

The middle of town is being demolished to create a high tech commercial centre. It will include a £3bn skyscraper that will be more than 600m high (roughly double the height of London's Shard) and either the second or third tallest in the world (I met executives of the state owned developers, Greenland, who were coy about precisely how tall it would finally be).

And, of course, the point of my visit to Wuhan was to tell a broader story. Over the past few years, China has built a new skyscraper every five days, more than 30 airports, metros in 25 cities, the three longest bridges in the world, more than 6,000 miles of high speed railway lines, 26,000 miles of motorway, and both commercial and residential property developments on a mind-boggling scale.

Third wave

Now there are two ways of looking at a remaking of the landscape that would have daunted Egypt's pharaohs and the Romans. It is, of course, a necessary modernisation of a rapidly urbanising country. But it is also symptomatic of an unbalanced economy whose recent sources of growth are not sustainable.

“Start Quote

When a big economy is investing at that pace to generate wealth and jobs, it is a racing certainty that much of it will never generate an economic return”

Perhaps the big point of the film I have made, to be screened on Tuesday (How China Fooled the World, BBC2, 9pm) is that the economic slowdown evident in China, coupled with recent manifestations of tension in its financial markets, can be seen as the third wave of the global financial crisis which began in 2007-08 (the first wave was the Wall Street and City debacle of 2007-08; the second was the eurozone crisis).

Why do I say that?

Well in the autumn of 2008, after the collapse of Lehman, there was a sudden and dramatic shrinkage of world trade. And that was catastrophic for China, whose growth was largely generated by exporting to the rich West all that stuff we craved. When our economies went bust, we stopped buying - and almost overnight, factories turned off the power, all over China.

I visited China at the time and witnessed mobs of poor migrant workers packing all their possessions, including infants, on their backs and heading back to their villages. It was alarming for the government, and threatened to smash the implicit contract between the ruling Communist Party and Chinese people - namely, that they give up their democratic rights in order to become richer.

So with encouragement from the US government (we interviewed the then US Treasury Secretary, Hank Paulson), the Chinese government unleashed a stimulus programme of mammoth scale: £400bn of direct government spending, and an instruction to the state-owned banks to "open their wallets" and lend as if there were no tomorrow.

Which, in one sense, worked. While the economies of much of the rich West and Japan stagnated, boom times returned to China - growth accelerated back to the remarkable 10% annual rate that the country had enjoyed for 30 years.

But the sources of growth changed in an important way, and would always have a limited life.

Toxic investment

There are two ways of seeing this.

First, even before the great stimulus, China was investing at a faster rate than almost any big country in history.

Before the crash, investment was the equivalent of about 40% of GDP, around three times the rate in most developed countries and significantly greater even than what Japan invested during its development phase - which preceded its bust of the early 1990s.

After the crash, thanks to the stimulus and the unleashing of all that construction, investment surged to an unprecedented 50% of GDP, where it has more or less stayed.

Here is the thing: when a big economy is investing at that pace to generate wealth and jobs, it is a racing certainty that much of it will never generate an economic return, that the investment is way beyond what rational decision-making would have produced.

That is why in China, there are vast residential developments and even a whole city where the lights are never on and why there are gleaming motorways barely tickled by traffic.

But what makes much of the spending and investment toxic is the way it was financed: there has been an explosion of lending. China's debts as a share of GDP have been rising at a very rapid rate of around 15% of GDP, or national output, annually and have increased since 2008 from around 125% of GDP to 200%.

The analyst Charlene Chu, late of Fitch, gave a resonant synoptic description of this credit binge:

"Most people are aware we've had a credit boom in China but they don't know the scale. At the beginning of all of this in 2008, the Chinese banking sector was roughly $10 trillion in size. Right now it's in the order of $24 to $25 trillion.

"That incremental increase of $14 to $15 trillion is the equivalent of the entire size of the US commercial banking sector, which took more than a century to build. So that means China will have replicated the entire US system in the span of half a decade."

Anyone living in the rich West does not need a lecture on the perils of a financial system that creates too much credit too quickly. And in China's case, as was dangerously true in ours, a good deal of the debt is hidden, in specially created, opaque and largely financial institutions which we've come to call "shadow" banks.

There are no exceptions to the lessons of financial history: lending at that rate leads to debtors unable to meet their obligations, and to large losses for creditors; the question is not whether this will happen but when, and on what scale.

Which is why we've seen a couple of episodes of stress and tension in China's banking markets over the past nine months, as a possible augury of worse to come.

Slowing growth

More broadly, for the economy as a whole, when growth is generated over a longish period by debt-fuelled investment or spending, there can be one of two outcomes.

If the boom is deflated early enough and in a controlled way, and measures are taken to reconstruct the economy so that growth can be generated in a sustainable way, the consequence would be an economic slowdown, but disaster would be averted.

But if lending continues at breakneck pace, then a crash becomes inevitable.

So what will happen to China's economic miracle?

Well, the Chinese government has announced economic reforms, which - in theory - would over a period of years rebalance the economy away from debt-fuelled investment towards consumption by Chinese people.

Charles Liu, a prominent Chinese investor, with close links to the government in Beijing, explained to me how far China's growth rate is likely to fall from the current 7-8%:

"I think China could do very well if the quality of the growth is transformed to higher value add." He said. "You're really looking at 4% is fine."

But as yet the reforms are at a very early stage of implementation, and the lending boom goes on. What is more, the current building splurge so enriches many thousands of communist officials, from a system of institutionalised kickbacks, that there are concerns about the ability of the central government to force the changes through.

Also, the social and political consequences of Charles Liu's 4% growth could be profound: it is unclear whether that is a fast enough rate to satisfy the people's hunger for jobs and higher living standards, whether it is fast enough to prevent widespread protest and unrest.

And what if the lending and investing bonanza can't be staunched? Then we would be looking at the kind of crash that would shake not just China, but the globe.

The biggest story of my career has been the rise and rise of China. Hungry, fast-growing China has shaped our lives, sometimes but not always to our benefit.

It boosted our living standards, by selling us all those material things we simply had to have, cheaper and cheaper. But its exporters killed many of our manufacturers. And the financial surpluses it generated translated into our dangerous deficits, the secular and risky rise of indebtedness in much of the West.

Also its appetite has led to huge increases in the price we all pay for food, for energy, for commodities. What's more, China's influence in Asia and Africa has profoundly shifted the global balance of power.

So would an economically weakened China be good for us in the West? Well, it wouldn't necessarily be all bad.

But a China suddenly incapable of providing the rising living standards its people now see as their destiny would be less confident, less stable, and - perhaps for the world - more dangerous.

Watch This World: How China Fooled the World - with Robert Peston on BBC Two at 21:00 on Tuesday, 18 February. Or catch it later on the BBC iPlayer.

[mo32a]

"$600,000 shoebox condo" - definitely first world problems.

[mrlupin]

A potential future bump on the road ahead for the economy. Expect more houses for sale on the market...

Sun life survey finds that 24% of boomers plan to finance retirement by taking equity from their homes or selling their homes as a primary source of retirement revenue.

Twenty-four per cent of respondents to Sun Life Financial’s annual “unretirement” survey said they agree with the statement, “My residential real estate will serve as my primary source of retirement income.”

http://www.theglobeandmail.com/globe-investor/personal-finance/retirement-rrsps/a-quarter-of-canadians-see-their-homes-as-a-primary-source-of-retirement-income/article16939799/

[mrlupin]

The possibility of a real estate correction is increasing.

Here are as seen by me, the factors that can contribute to the correction:

- excessive supply of houses for sale (condo glut in YYZ)

- Change in demographics (boomers retiring)

- Price to rent ratio at a level rarely seen

- House prices have doubled in the last 8 years

- Salaries are up by approx 15% over the same period

- Mortage are very suceptible to rate hike ( a 2% rate hike would put many in a situation where they cannot meet their obligations)

- Job market ???(I'll wait and see more data for that one)

- Consumer debt levels at higher levels than what was seen in US prior to bubble bursting...

Of all those potential problems, it's the combination of a few of them that is of most concern. The high consumer debt load and the demographics change pretty much garanties that the recovery would not be as quick as in the US. Before the consumer can start buying houses (after or during a recession), he needs to deleverage and that takes time. The boomers selling homes is likely to bring a situation where more houses are for sale then there are buyers. That would also send a negative pressure on house prices. It goes on on on.

[Mizar]

Thanks for the link, once again Mr. Lupin.

Isn't a correction desired but on a relatively slow and mild pace instead of a sharp, sudden downturn. In other words correction good, bubble burst, bad.

[mrlupin]

The Conservatives single handedly created the housing bubble through their policies. Will they also be the ones to bust it?

Some more news coming on the bubbly housing front. We can confirm tommorow but I believe Flaherty is trying to delicately **bleep** the bubble he created in real estate when he removed the upper mortgage limit, allowed subprime lending and raised mortgage max duration to 40 years. (he has since reversed most of his bad policies)

Stand by for annoucement from the CMHC tommorow. At this point you will not need much to burst this bubble...

http://www.cbc.ca/news/business/cmhc-may-alter-mortgage-insurance-terms-friday-1.2553758

[mrlupin]

The price to insure mortgage loans is going up...The already indebted consumer will have to pay more to insure loans. This will act as a further barrier to younger folks buying houses.

Supply and demand... If you increase borrowing costs, (ceteris paribus) demand drops as consumer can afford less of a house...

CMHC hikes mortgage insurance premiums

Housing agency increases amount homeowners must pay to insure their loans

http://www.cbc.ca/news/business/cmhc-hikes-mortgage-insurance-premiums-1.2555076

[Guest longtimer]

The price to insure mortgage loans is going up...The already indebted consumer will have to pay more to insure loans. This will act as a further barrier to younger folks buying houses.

Supply and demand... If you increase borrowing costs, (ceteris paribus) demand drops as consumer can afford less of a house...

CMHC hikes mortgage insurance premiums

Housing agency increases amount homeowners must pay to insure their loans

http://www.cbc.ca/news/business/cmhc-hikes-mortgage-insurance-premiums-1.2555076

The article says the additional cost will be $5.00 per month, hardly a deal breaker.....

[mrlupin]

It's about a 1000$ on a 250000$ mortgage. I don't know where you get one of those these days unless you want to live in northern Ontario. It still adds up...

[Fido]

It's about a 1000$ on a 250000$ mortgage. I don't know where you get one of those these days unless you want to live in northern Ontario. It still adds up...

a $1,000 over 25 years.

Bet the buyers spend more than that on granite counter tops.

[Guest longtimer]

a $1,000 over 25 years.

Bet the buyers spend more than that on granite counter tops.

Or double doubles....

[mrlupin]

More negative news on the job front.

7000 job losses in Canada. 25500 job losses in Quebec and 10500 in BC.

http://www.cbc.ca/news/business/7-000-jobs-lost-in-february-unemployment-stays-at-7-1.2563573

Employment in pictures...

http://www.cbc.ca/news2/interactives/unemployment-stats/index.html

I am still at a loss to figure out how people are buying houses at the current price with the current economic conditions. I'm at a decent salary and there is no way I could afford a house in the present market... How people do it is beyond me..

[Guest longtimer]

I guess the real story is that the rate of unemployment held steady at 7% 95,000 jobs added in February but Regionally, Quebec and British Columbia both had employment declines — 25,500 and 10,400 respectively — while Alberta and Nova Scotia saw gains of 19,000 and 2,900.

Six out of 10 provinces posted gains.

[conehead]

I am still at a loss to figure out how people are buying houses at the current price with the current economic conditions. I'm at a decent salary and there is no way I could afford a house in the present market... How people do it is beyond me..

I too, am perplexed by this.

[Fido]

A most telling number is that there are now more people employed in Alberta than in British Columbia.

[Guest longtimer]

The folks I know that have recently purchased a house only did so after examining their budget and removing all "unnecessary expenditures"

eg.

- instead of buying books, they joined their local library

- started packing a lunch

- elimination of fancy coffee drinks

- reduced eating out to once a month

- purchased a starter home rather than than what appears to have become the norm (all the extras...... )

etc etc etc.

In other words they made a life changing decision to purchase and afford a home.

[mrlupin]

Longtimer,

I would like to see that rosy picture but from what I see, the basics aren't present in this economy. For the job numbers, you see 6/10 with job increases, I also saw that but the second month in a row of job loss is the trend I am looking at. Maybe it will reverse next month but I just do not see how that would happen as of yet. Maybe more jobs are coming on the manufacturing front since the $ is down but otherwise I see few rosy linings.

What has changed in the last 12 years to make house prices triple? The basics aren't there to justify the increase. The only thing that permits this ludicrous appreciation is the low interest rate. That isn't fixed in stone... you don't have to go back 30 years in time to see 8-9% annual mortgage rates. How many mortgages would survive that? Just look at what would happen to a 500K condo with a 6% interest rate...

Add job losses to that, dropping Can $ (the sunny vacations, fruits, vegetables, gas, tires,clothing etc prices are going up since out money buys 10% less)

I would like to see the rosy picture you see but those folks you mentionned would probably end up insolvent with a 3% increase in the mortgage rate. (unless they had a huge downpayment and those are hard to accumulate when banks pay 1% interest)

Éric

[inchman]

The price of homes is tied to a combination of interest rates and median salary.

In 1985 I bought a condo for 43000 in Mississauga with $4000 down and interest rates at 13%. I was making about $60,000 at the time. If you look at the "affordability" amount on any bank site, at $5,000 a month in earnings and moderate condo fees and taxes, I was eligible for a $147,000 13% mortgage at the time. If we apply some inflation to the earnings, at $7,000 a month in earnings now, double the taxes and condo fees and apply 3% mortgage rate, the "affordability" is now $432,000.

Basically, the average person buying their first condo can now "afford" to buy a condo worth almost $200,000 more than in 1985. Interestingly, the price of that condo today... $250,000.

Extending the example to even pricier homes for people with down payments.

The house we bought in 1989 was $325k. Interest rates were 11.75%.

With $100,000 down I was paying $2500 per month in mortgage payments.

At 3%, $100,000 down and payments of $3000 per month (after all, it is 25 years later), the house could be priced at $700,000. Guess what it sold for last year?

The price of homes is almost entirely dependent on interest rates and median salary.

The greater danger is not employment... it is interest rates. If interest rates go up 2%, that $700,000 house drops about $100,000 in value.

It doesn't really matter as long as you don't have to sell, but if you've got that big mortgage, your monthly payment just went up $600 per month. If you can't afford that, you, and a bunch of other people, will have to sell, which will drop prices even further. That's what happened in the States, along with a bunch of other stuff. Fortunately, you can't start a home "under water" in Canada like they were doing down there before the big dump.

Bottom line from an old-timer... you can't control your job and the other "$hit happens" stuff, but you can control your mortgage. Always make sure you can afford to stay in your house at 2% more than your current rate.

It scares me a bit, longtimer, that your friends have cut to the bone to get into the market. That tells me that they can't afford the inevitable rate rise.

[Guest longtimer]

inchman, they don't think they have cut to the bone, just back to where they can afford a house and still maintain some other savings (I guess I assumed folks would know that is part of the "standard budget" package). As far as the "bone", packing a lunch, only going out once a month etc are not what my generation considered as cutting back to the bone.

[Guest longtimer]

Éric: regarding the economy, it all comes down to what part of Canada you are looking at and that has always sadly been the case.

[mrlupin]

Some people think the interest rates are directly tied to what the bank of Canada sets as it's benchmark rate. That isn't the case. If 3-5 year bond rates start rising in the US, they will also rise in Canada. (would you buy a bond form the BOC that yields 1.4% if that same bond yields 3% in the US?) The overnight lending rate is controlled by the BOC but any longer terms are influenced by the exterior markets as well. It's a bit more complex than that but at this moment we have more upside risk than downside risk.

Like Inchman wrote, interest rates can easily sink the mortgage holders who budgeted too tightly.

[Guest longtimer]

Like Inchman wrote, interest rates can easily sink the mortgage holders who budgeted too tightly.

That has always been the case. Conversely an increase in interest rates can greatly benefit those who have been saving something for the next rainy day.

[mrlupin]

If the average Canadian is in debt for 166% of his salary, how much savings do you think he has?

As for where you are in Canada, average debt is just that "average" I am sure many Albertans are smack in the middle of this statistic.

Same for housing. If people in Alberta make more than Québec citizens, they will also boost house prices to a higher level. If houses correct due to interest rates, they will also correct in Alberta...

[Guest longtimer]

If the average Canadian is in debt for 166% of his salary, how much savings do you think he has?

As for where you are in Canada, average debt is just that "average" I am sure many Albertans are smack in the middle of this statistic.

Same for housing. If people in Alberta make more than Québec citizens, they will also boost house prices to a higher level. If houses correct due to interest rates, they will also correct in Alberta...

The number you quote is "debt to disposable income" and not 166% of salary.

http://www.statcan.gc.ca/daily-quotidien/121015/dq121015a-eng.htm

For 2011, household net worth was revised upward from $6.3 trillion to $6.6 trillion. The majority of this increase was due to improved valuation of unlisted shares. Unlisted shares are now recorded at market value rather than book value. This added approximately $108 billion to household net worth. On a per capita basis, household net worth was revised from $182,900 to $190,800.

The household credit market debt to disposable income ratio was revised upward from 150.6% to 161.7%. This revision is due to three factors. First, the methodological changes in the compilation of the national balance sheet resulted in an upward revision to household credit market debt from $1.59 trillion to $1.61 trillion. Second, there was a redefinition of household disposable income as part of the historical revision of the national gross domestic product (GDP) by income and by expenditure accounts published on October 1, 2012, that lowered this measure. Third, the removal of the non-profit institutions serving households from the household sector served to push the ratio higher since these institutions had a dampening effect on previous estimates.

Your debt-to-income ratio reflects your true financial situation

Do you know what a debt to personal disposable income ratio is? Do you know how to calculate yours? Do you know what your ratio is?

Personal disposal income is the amount of money you have left over after you've paid your income taxes and social security contributions. The debt-to-income ratio is a unit of measurement that compares your total disposable income to your debt total. In a nutshell, it tells you what percentage of your monthly gross income goes toward paying off debts. And it is used in the lending industry to give financial institutions an idea of your repayment ability.

A simple way to calculate it is to add up all your recurring debt (mortage/rent, home insurance, taxes, car payments, credit cards, student loan, etc.) and divide the total by the sum of your gross monthly revenue, including any monthly investment income you may have. Note that non-debt expenses such as food and utilities are not included. However, it is a good idea to also know the total amount of these expenses to stay on top of your budget.

Anything less than 30% is excellent, 30-36% is good. Anything above 40% may make it difficult for you to secure a car loan, student loan, mortgage and to make your payments. Unlike credit scores that only show your payment history, debt-to-income ratios take into consideration your current income.

Here is the latest report on "Household Debt"

http://www.statcan.gc.ca/daily-quotidien/120323/dq120323b-eng.htm

So yes the debt load of those still working is on the increase but so is their net worth.