Economy Headed For Tougher Times

[mrlupin]

Longtimer,

You understand how net worth is calculated right? If through monetary policy you inflate the value of an asset(housing), you are inflating the net worth of everyone who bought early. That doesn't help the people who do not yet own a house. As the people who own the inflated assets try to sell them, its a market economy... supply and demand. There are allot more boomers than buyers...

If one is babyboomer age, I can understand how one can get the impression of wealth. A house bought in the 80ies must be good for quite the profit if sold now. What most people are: house rich but cash poor.

[Guest longtimer]

Longtimer,

You understand how net worth is calculated right? If through monetary policy you inflate the value of an asset(housing), you are inflating the net worth of everyone who bought early. That doesn't help the people who do not yet own a house. As the people who own the inflated assets try to sell them, its a market economy... supply and demand. There are allot more boomers than buyers...

If one is babyboomer age, I can understand how one can get the impression of wealth. A house bought in the 80ies must be good for quite the profit if sold now. What most people are: house rich but cash poor.

I do understand what net worth is but do you understand the true cost of that "baby boomer house" ?

In actual fact if you take a house purchased in 1980 as an example and then factor in the 25 years of paying a mortgage, you will find the net gain, to be very little when you factor in just the cost of the mortgage over that period plus any down payment. A $100,000.00 mortage using the interest rates from 1980 to 2005 would incur well in excess of 100,000.00 in interest (1980 rates were well over 25% interest) http://www.ratehub.ca/prime-mortgage-rate-history . My example does not of course use the max rate for the entire load period. So say you used an average of 8.5% over that 25year period the true cost of that house would have been in excess of $240,000.00 for a 100,000.00 mortgage. The true net gain would be the difference between house payments and renting but then you would have to include property tax, home upkeep etc. \\\

That being said, overall one is still, even now better off working hard to purchase rather than rent. The true gain comes not from selling the house when you retire but being able to retire with a paid off mortgage.

[inchman]

Ultimately, the only people who make money from rising house prices are the government (in land transfer taxes), banks (in larger mortgages) and real estate agents who now get their percentage on a larger price. The house owner is usually selling and buying in the same market so the best you can do is be lucky enough to get a desperate seller and an eager buyer.

There are certainly risks in the economy today, Mr. L, but methinks you might be a bit pessimistic. The Quebec decline in employment may well be tied to the resurgence in the PQ in that province. The rest of the country is doing surprisingly well. Not sure why, but keep it coming!

[Fido]

Ultimately, the only people who make money from rising house prices are the government (in land transfer taxes), banks (in larger mortgages) and real estate agents who now get their percentage on a larger price. The house owner is usually selling and buying in the same market so the best you can do is be lucky enough to get a desperate seller and an eager buyer.

and thus why the General had a bill for $72,000

[mrlupin]

I am likely guilty of pessimism re the economy. Some part of me just doesn't get the Vancouver, Calgary, Toronto and Montreal house prices. The bubble did blow up in the US and as far as I can tell, we aren't that much different here.

To add to the negativity, Bombardier just froze all of it's employee salaries last Friday...

Re: Longtimer, How is "true cost" relevant here? What do you want to compare it to? Interest paid on a mortgage can always be calculated after the fact or prior in the case where you get a fixed rate equal to term. That won't help if you want to compare with a mortgage today, all you have is present price and present available mortgage rates.

What I do get from your post is that mortgage interest rates have pretty much just one direction to go at this point. I doubt they will go back to the historical average anytime soon but it's pretty much a given that within a few years rates will be higher.

[Trader]

Longtimer, you are correct that the benefit of ownership comes when one retires and has the value the of the home provided it is paid off AND provided they sell it and are able to downsize considerably. Otherwise that 'equity/wealth' is essentially useless.

I many cases SAVING the equivalent of what you put into a house (less the cost to rent, since you have to live somewhere) will leave a person better off.

As an example. A friend has just about paid off his home, is in his early 40's with 2 kids. The house is worth $700,000. His wife wants to 'upgrade'. They are better off, financially, to sell the house and INVEST the proceeds in a diversified portfolio then to buy again. Take $700,000 invested at an average return of 6% and you earn $42,000/year. For that money you can rent a similar or nicer home and likely have money left over. When you consider maintenance, insurance, interest cost (if mortgaged) then it makes even more sense to rent. As well you then have the vast majority of your net worth well diversified while owning a home, which comprises the vast majority if not all of a families net worth leaves them exposed to the vagaries of the housing market.

The idea that owning is 'paying yourself' or providing a nest agg is a falacy UNLESS the cost is reasonable. Taking the risk of ownership out of the equation - the risk being having your money invested in a single asset - in todays market it makes more financial sense to rent in most regions.

The housing market is stretched which is exactly why the Feds pulled back on extending mortgage lengths to 35/40 years (which was nothing more than a ploy by the housing industry to sucker people into even higher prices) and why they have changed rules regarding home equity loans etc. Canadians have been buying more than they can afford and then, worse, as the 'value' of their home increased pulled equity OUT to fund a new kitchen, a trip abroad etc etc. Instead of paying down the mortgage as quickly as possible more Cdn's have been spending money which truely doesn't exist. To the point where today almost 2/3's of Cdn's retire with a mortgage!

Add to this high personal debt levels and a stagnant job market and you have a problem. Wage growth is low and teh only way to get rid of all that debt is to have wages outgrow it or to pay it off. Cdn's will have to pay it off and that 'deleverging' will take a while. We won't see a massive housing implosion like the US (probably) but there will be a correction of some sort. Anyone who thinks that we are different from the American (or Irish or Italians or Spanish) is deluding themself.

[Moon The Loon]

My folks built their final "house" (they're currently in a mid-rise condo) in 1964. The lot cost $4,000, the construction another $20K. At the time, Dad worked for TC and made about $8K/year; Mum did not work. Dad retired, they sold it 25 years later for $160K and bought the condo for $100K. It was their nest egg. They were fortunate that condo's were still looked at as almost second class dwellings to a real "house". In the ensuing 25 years, condo values almost equal present day "house" prices in the bigger cities. The advantage they experienced is quite reduced. To benefit the way they did, I would have to sell in my current market and move to a much smaller market somewhere else in the country.

Real estate is a turkey shoot - I lost quite a bit of money on the first two "houses" I owned. So as investments, they matched some of my other investments ( ).

Some years, you're the dog; some years you're the fire hydrant. Some folks fight their way to a dream job, some actually make it to that dream job, most of the rest settle for what they can get and never have anything dropped in their lap.

Which is why I feel particularly lucky with the way things have turned out for yours truly! Believe it, or not...

Very interesting thread, I might add...

[Boney]

Carbon tax in BC.

Quebec, well it's the same old story.

And you wonder why their economy struggles.

Hmmmmm

[mrlupin]

Add to this high personal debt levels and a stagnant job market and you have a problem. Wage growth is low and teh only way to get rid of all that debt is to have wages outgrow it or to pay it off. Cdn's will have to pay it off and that 'deleverging' will take a while. We won't see a massive housing implosion like the US (probably) but there will be a correction of some sort. Anyone who thinks that we are different from the American (or Irish or Italians or Spanish) is deluding themself.

Another possibility to get rid of debt is inflation. Governments use that all the time to render irrelevant past debts. It's not an option at an individual level but government usually have some options through monetary policy to create inflation. Problem at the moment is the low interest rates aren't stimulating growth or the economy as well as hoped. One would hope that inflation and salaries would rise in pair but they don't always, that is another thing to watch for.

Since consumption is such a large part of the economy, cash strapped Canadian will at some point reduce expenditures like the folks Longtimer mentionned. Instead of spending going to the economy, it might end up exclusively contributing to the banking sector bottom line. That doesn't help the small business operators... (restaurants, shops, etc)

Éric

[inchman]

Trader, I disagree.

I had considered selling my current house a couple of years ago and renting and was not able to find any home close in rental payments to what I'm paying in total now unless I moved into a house worth about half what my house is worth. Needless to say... didn't happen.

The housing market and the stock market often follow the same path. So, investing in a home vs investing in the stock market have about the same risk. The biggest advantage of investing in a home is that if it loses some value, if you have planned well you still have a physical place to live when you retire for just the cost of taxes.

In addition, both the stock market and housing prices go up, historically, at about 6%. But you have to pay about net 25% tax on one but not the other. Yeah, you have to pay real estate fees to sell your home (maybe), but you have to pay brokerage fees to invest. And if you are borrowing to invest, you are paying a lot more for your money than you would if you had a mortgage.

The cost of municipal taxes and condo fees on a rental has to be paid by someone, and it's buried in the rent. So, there's no savings to a renter there. Depending on who you rent from, you are at their whim when they decide to sell your "home" out from under you.

Average returns in both the stock market and the housing market are about 6%. If you take $100,000 and get a $300,000 mortgage to buy a $400,000 condo or borrow $300,000 to invest in the stock market, after 10 years, in theory you should have about the same capital growth, but you will have paid more in interest on the investment loan and have to pay 25% of your growth in taxes on the investment. Sure, you can point out that if you bought Google at $85 or Microsoft at $3, you could make a lot more money, but those are outliers. You could also have bought RIM a couple of years ago.

The American situation was created because of bank greed, snap-back mortgage rates, mortgage salesmen working on commission and people getting $500,000 mortgages on properties that they only paid $400,000 for. It was a ponzi scheme that, fortunately, our government refused to let happen here, but that the US government encouraged as it furthered "the American Dream".

Ironically, the people who lost the most in the US after the housing crash were those who bought an additional property with cash near the top of the curve, then had to sell it after the crash. These were often retired, or close-to-retired people. They couldn't just walk away like the millions who borrowed way above their means.

I'm not saying that we're not over-extended in Canada, but it's not even close to what happened in the US.

[mrlupin]

Here is a house price to rent chart...

Followed by the US numbers prior to collapse...

And more recent data with deviation from historical average. One can think that this is the new normal but in statistics, unless so major change has occured, there is always a reversion to the average...

Re: Inchman, is it possible that the situation you faced was during a period where the house price to rent ratio was lower? Or maybe you live in an area where the prices are different? (averages always include outliers)

[mrlupin]

On a related subject.

Here is a series of videos on math. The teacher is actually quite interesting. The title appears pretentious to me but the content is essential must see for many. Try to get past the "the most important video you will ever see" title. The content is excellent. It re-frames knowledge we all learned in school by apply it to growth rates.

The teacher starts with a grand statement:

"The greatest shortcoming of the human race is our inability to understand the exponential function."

The statement again, is grand but listen to the content, it is solid, simple math.

https://www.youtube.com/watch?v=F-QA2rkpBSY

[Guest longtimer]

Good article in the FP on the economy / jobs. Much too long to post here and lots of charts

http://business.financialpost.com/2014/03/07/how-canadas-weak-economy-is-struggling-to-create-many-new-jobs/

[deicer]

I believe that what we are seeing is akin to the old 'ant farm' adage.

Throughout the 80's and 90's, economic growth was through expansion. Build more locations, you need more construction, more stock, more employees. Worked great as long as you were growing.

Now, like the childhood ant farms, the source of food no longer sustains the growth. We simply cannot keep going at this pace.

And like the ant farm, and as we see with the announcements recently by The Source and Staples, the die-off is beginning.

It is currently at the retail level, but will rapidly spread to manufacturing.

Then the trouble will grow exponentially.

Again, jmho....

[mrlupin]

Longtimer,

When I click your link, I get to the FP rss feed. Was is the title of the article you are refering to?

I see the following which have some relevance to the economy:

How Canada’s weak economy is ‘struggling to create many new jobs Canada’s overheated housing market could boost apartment construction, brokerage says Bombardier Inc to freeze salaries of 38,000 staff as CSeries delays hit profits

Canada’s economy sheds 7,000 jobs in second decline in 3 months

Air Canada weighs fare increases and new fees as loonie weakens

[Guest longtimer]

This should get you there. I fixed the link in my original post also. cheers

http://business.financialpost.com/2014/03/07/how-canadas-weak-economy-is-struggling-to-create-many-new-jobs/

[inchman]

Here is a house price to rent chart...

Followed by the US numbers prior to collapse...

And more recent data with deviation from historical average. One can think that this is the new normal but in statistics, unless so major change has occured, there is always a reversion to the average...

Re: Inchman, is it possible that the situation you faced was during a period where the house price to rent ratio was lower? Or maybe you live in an area where the prices are different? (averages always include outliers)

If you think about it, the first and second charts makes perfect sense.

As interest rates go down, so does the cost of maintaining a rental property, AND, the market for renters goes down, because more of them are buying houses, so rents go down.

At the same time, the price of houses goes up because of demand.

So, of course, the home price to rent ratio goes up when interest rates go down. It has almost an exponential effect which you see in the chart.

We are agreed that there is a bubble. The question is how tight the balloon is and how much noise it will make when it breaks.

[mrlupin]

Afternoon Inchman,

I don't even think it will burst... I think is will be a slow and painfull correction. First more houses will end up on the market... It will be a buyers market. The sellers believing "it's different here" will be reluctant to lower their asking prices. More houses will go on the market. The time to sell the houses will be longer and longer. Some seller will resort to having their houses proffessionally staged for sale... it will work for some but at some point there will be a downward pressure on prices. Probably not a big drop, but large enough for the 5% down crowd to take a trip into the negative equity territory. How long will the downward trend be? Some large institutions are quoting a 60% correction... I think that is too high a number. between 20-25% over three to four years would seem probable.

Then the domino effect kicks in. The contruction industry will slow, carpenters and such will have to look harder for work. Some will end up unemployed and have to find alternative employment. We have had so many boom years that our residential construction industry just expanded year after year. Now the markets will test whether or not we need that many people putting up drywall,plumbing etc...

It takes time and a decent job to deleverage... I hope both are there in the next few years.

For the price to rent chart,

I think you are reading more into the chart than is intended... Unless i missed it, there is no indication in there that rents went down. House prices are the only ones that moved. In Quebec, that is veryfiable data as the rent control board tracks all of that.

[inchman]

Clearly, the issue of whether one should invest in their home or in the stock market is complex, mostly due to the tax issues. The first thing that came to mind when you said you could borrow money at prime is that, yes, it's possible, but normally only if you buy investments offered by the source of your funding or you use the equity in your house to back your loan.

I have personally always done better in real estate than in the stock market. Many others have a different experience.

With as much money as I have tied up in real estate, I am certainly paying attention to the market, but the same forces that drive the real estate market drive the stock market so, unless one gets into the short game, trading one methodology for the other probably won't result in much difference through the dip.

But that's the key.... being able to ride the lows. The people who lose in a dip in any investment are those who have to sell. The people who make the most money are those who can buy. And that's one of the reasons why the rich get richer, Rich. (sorry, not really aimed at you, but couldn't resist).

[Zan Vetter]

Inchman from a few pages back I'm having a hard time understanding how you buying a $43,000 condo with a $60,000 salary is comparable to today's $250,000 prices. Wouldn't a person need to be earning over $300,000 to match your experience? Even today, $60,000 is a decent income for somebody in their mid-20's. 30 yrs ago it would have been quite fantastic, no?

[inchman]

VZ,

The bottom line is interest rates. In 1985 I was paying 13%. Today, interest rates are 3%.

There's two sides to this. First, what the banks will allow you to borrow and second, what you are willing to pay on a monthly basis.

​

Let's look at what banks were/are willing to lend. (The below assumes no other debt, but you could have a monthly car payment of up to 8% of your gross and not affect your max mortgage).

In 1985, at 60k salary, 13% rates, the banks in 1985 would lend a max of $150,000 and the monthly breakdown would look like:

Monthly Net Pay (assumes a 35% tax rate) $3,250

Monthly Mortgage Payment$1,598

Estimated Monthly Homeownership Costs$252

Balance (disposable income) $1,400

The CPI has increased 99% http://www.bankofcanada.ca/rates/related/inflation-calculator/ since 1985, so, in theory, someone in the same job would now be making $120,000 per year (unless they were a pilot ).

Today, at 120k salary, 3% rates the banks will lend up to $686,000. The breakdown looks like:

Monthly Net Pay (assumes a 35% tax rate) $6,500

Monthly Mortgage Payment$3,196

Estimated Monthly Homeownership Costs$504

Balance (disposable income) $2,800

A person currently earning $60,000 could get a $340,000 mortgage.

Now, clearly, I didn't go to the max that I could have borrowed. Nor would I expect most people to do so today, but you can see a clear difference in the total amount of funds available to people nowadays. That, in itself, would run prices up. At a lower end of income, it allows thousands more people into the market. People with household incomes of only $60,000 can now borrow enough money to buy a house worth $340,000 with very little down.

So, if we go back to my lowly 43,000 condo, I stayed a full $100,000 under by borrowing power. If people today stay 100,000 under their borrowing power, they can spend $240,000.

The other way to look at it is the simple monthly mortgage payment.

My mortgage payment in 1985 on $39,000 at 13% over 25 years was $442.

Because the 2014-me is making twice as much now, if I double that $442 and get a 3% mortgage, I can borrow almost $200,000 for that $884 monthly payment. If I'm willing to spend another $230 a month, and put down $15k, I can buy that same condo that 1985-me had at todays prices.

But this stuff all starts at the bottom. There are thousands more people out there making $60,000 who can now access LOTS of money and can buy my previous home so 2014-me might even have a bit bigger down payment. So I might not even have to top up all of that $230. And they are giving thousands in the next layer the downpayment that they need to move up a home.... and so it goes.

The problem is that if interest rates go from 3% to 5%, my $884 mortgage payments jump by a couple hundred bucks a month. If people don't plan properly, it can mean them losing their house and if enough people go into foreclosure, it can affect the market. The good news is that Canadian rules prevent people from borrowing more than the value of the house.

So to answer your question simply, the ratio of income to home price has no bearing on how much house I can buy .... it's all based on the ratio of income to monthly payment. Low interest rates mean a bigger home can be bought for the same monthly payment. That introduces new buyers to the system, driving prices even higher.

[deicer]

On a related note...

http://www.bbc.com/news/business-26510495

Japan's deficit hits record as economic growth slows

Japan's current account deficit widened to a record 1.5tn yen ($15bn; £8.7bn) in January, the largest since records began in 1985.

In further bad news, the country's economic growth figures were also revised downwards.

Japan's economy grew by 0.7% in 2013, down from an initial estimate of 1%.

Investors reacted with disappointment to the news, with the benchmark Nikkei 225 index falling by 95 points, or more than 0.6%.

From October to December 2013 Japan's economy grew by just 0.2%, after earlier estimates showed an increase of 0.3%.

Tax increase

The sluggish growth and growing deficit come just before a planned sales tax increase, scheduled to take effect in April.

Many economists had expected growth to pick up towards the end of 2013, as consumers spent ahead of the tax rise.

But the latest revisions show consumer spending increased by 0.4% in the fourth quarter of 2013, revised downwards from 0.5%.

Japan's trade gap also rose to a new record last month, increasing by 71% to 2.79tn yen in January, official figures showed.

That was largely down to weak export figures, which were impacted by global turmoil in emerging markets and a weakening yen.

Japanese Prime Minister Shinzo Abe says he plans to push ahead with the sales tax hike as a way to tackle Japan's debt.

However, to counteract the increase, which is scheduled to go from 5% to 8% - Mr Abe unveiled a stimulus package of 5.5tn yen in December.

[Trader]

inchman, the significant difference is that when your life savings is invested in a home, which is illiquid, you expose yourself to risk. The issue in Canada is that it appears a good majority of people have overbought at low interest rates. A jump of 1-2% will put a good number of people in a position of either negative equity (since the concept of buying the max they can with just 5% down is seen as 'normal') or in a position of being unable to pay all their bills. The last survey that just came out shows that 1/3-1/2 of Cdns retiring in the next few years will HAVE to downsize in order to fund their retirement.

The simple fact is that Cdns, generally, SUCK at investing and saving. They have also been sold on the idea that because the boomers bought homes and did well that they will do well also (despite the fact that if the market corrects significantly that many of these boomers will actually NOT do well and, considering that that over 1/3 still have mortgages, they may not walk away with as much as they thought).

We bought our first home ( a 2 bedroom, 90 year old house) because we could afford it on ONE income. The bank thought we were nuts and told us we could 'afford' twice the house (hell, who cares about CMHC costs--the bank offered us at the time a 5% 'cash back' option so essentially no money down was needed). The Real Estate agent said the same thing. This has been going on for the last 15-20 years--everyone pumping home ownership and, more importantly, increaingly leveraged/debt home ownership. Even the Gov't got involved when they increased terms to over 30 years, only to pull back when they realized how tenuous the situation has become. The gov't is also aware that interest rates will rise sooner or later and that too many Cdns are far to leveraged.

I agree a home can be a great investment but only if it is treated as such and only if it pasrt of an overall portfolio. To have all your eggs in one basket is dangerous especially when that asset is illiquid (and add to that the 4-5% commission you pay to sell it).

I'd add that the entire housing industry is corrupt!!! The Cdn Real Estate Board has come under scrutiny recently. They produce their own 'housing index' number but don't release how they obtain the figure. They have been proven to have double and triple counted home sales because on their MLS system the house has been listed in multiple markets so when it sells it counts for each market. ETC ETC ETC. If the finance industry behaved liek the real estate boards they'd all be in jail. The real estate market is completely unregulated.

[deicer]

Another 'Tell' from the American economy...

http://intellihub.com/20-facts-great-u-s-retail-apocalypse-will-blow-mind/

[Zan Vetter]

Inchman, no amount of interest rate math is going to convince me that two people each earning $60,000 have the same life choices ahead of them when one has the ability to purchase a home for less than 20% the cost of the other. $43,000 vs $240,000?! You're kidding, right. Money is money, just because the bank will give it to you doesn't mean you don't have to pay it back. Even with the interest rates of the early 1980's, because house prices were so low you could reasonably plan to save up for a meaningful percentage of the house. The virtuous task of "tightening your belt" to save for a home was a realistic dream. Today, forget it. And for the record, I don't know anyone in their twenties that earns $120,000, the "equivalent" of $60,000 in 1985. Oh sure, don't buy that latte and pack your lunch as some have suggested. Now you have an extra $100 at the end of the month. Only several tens of thousands more to go.

The real estate is the embodiment of the greater fool theory right now, because the value of a home is no longer connected to the median wage of workers. I think a crash or correction is inevitable, because borrowing a quarter of a million dollars for a starter home, more than 5x the median annual income, cannot be passed off as the New Normal indefinitely. How much is a home going to be when my kids need one in 20 years? $2 million? And they'll still be earning $60,000. Won't that math be magical.