'Investor' expectations and the condo boom
OCTOBER 13, 2011
The mental gymnastics are ramping up:
I've had a few interesting conversations lately regarding Canadian house prices in general, and the Toronto condo market in specific. Consider some of the comments coming through my Twitter feed by very intelligent people:
"preservation" is the goal...Thats why we are seeing move to condos and low yield apt buildings
Bond yields low, europe, us not well, middle east restructuring...peeps need to put $ somewhere
Many investors do not care about the monthly return on condos they now want to safeguard their intnl $
There's no doubt that there is huge demand for condos in Toronto (and everywhere in Canada it seems). We know that the latest estimates by Urbanation is that as much as 60% of new condos in Toronto are being purchased by investors, and this rises as high as 80% in the downtown core. Yet we also know that these condos do not cash flow using a traditional financing model of a 20% down payment.
Despite this, the current level of demand has been projected well into the future, as current starts attest to:
And we've seen that the current pace of highrise development in Toronto is massively outpacing New York and Mexico City, cities with 3 times the population of Toronto and twice the population of the GTA:
Despite the rampant 'investor' demand, prices have actually massively outpaced rents in Toronto using either the CPI rent index or CMHC's rent index, which should cause us to question just how intelligent these new 'investors' really are:
Of course this has the effect of compressing the 'yield' generated by these condos to the average investor. It's to the point now that the yields generated by these condos on an "all cash basis" (i.e. if you paid for it in full) are comparable to long government bonds once strata fees and property taxes are accounted for. And they fall well below the cap rates generated by the new residential holdings of most REITs, and even below the short-term bonds issued by some excellent corporations with strong balance sheets and earnings power. Something here doesn't compute.
If it's safety of capital and exposure to the Canadian dollar, Canadian bonds ought to be the primary choice.
If it's for a long-term investment, well, these investors have their blinders on. Cap rates for condos in many large US cities easily enter the 7-8% range. Good luck finding that in Toronto or Vancouver. You're lucky to get half of that. Any real estate investor understands that higher cap rates mean not only stronger cash flow, but also greater potential for future capital gains. Lower cap rates inherently means greater risk to your investment, a fact Canadian 'investors' seem willing to ignore for the moment.
So what's really the motivation?
Last week, Colliers International released a report with the following headline:
Some key quotes:
An overwhelming majority (86 per cent) of Canadian respondents indicated they are planning to expand their portfolios over the next six months. This is distinctly higher than the global investor stance (71 per cent) and up from 61 per cent the previous year. Furthermore, two-thirds (68 per cent) of Canadian investors believe the market will continue its upswing trend over the next 12 months.
The level of optimism expressed by Canadian investors is also translated into increased tolerance towards risk. Nearly two-thirds (64 per cent) of the survey participants from Canada confirmed they are willing to be more risk aggressive, the strongest level of risk tolerance among all regions surveyed globally.
This is not a market driven by international money seeking a safe home. While that is certainly happening, these are foreign speculators, not investors seeking a safe haven. The market is driven overwhelmingly by domestic demand, financed by easy access to cheap credit, with that debt being serviced in local currency either through local earned income or the pitiful yields the holdings are generating. This is a market currently sustained by speculators hoping to catch on the momentum train. What foreign capital currently is entering this market will cease as soon as momentum slows and the prospects of future capital gains diminishes. Once that happens and the speculators are flushed out, we'll quickly find out how condos are being priced by the true investors.
Condo starts nationally set to drop?
On a national basis, condo starts have remained strong.
Yet interestingly, this is at the same time that newly completed and unoccupied condo units are hitting levels not seen since the late 80s.
For the time being, unoccupied units in Toronto are relatively low, but have been rising. Inventory in Vancouver is very high compared to the levels of the past decade, certainly suggesting that the hot foreign money entering that city is starting to wane:
The bottom line is that this demand is not being driven by a flight to safety or preservation of capital. What foreign capital is flowing into this market is primarily speculative in nature. This is a market driven by Canadians taking on debt to jump into a temporarily self-sustaining market that is now reliant on more participants rather than fundamentals to justify current prices. Good luck to those taking the plunge.
-Ben
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47 Comments
I won't comment further on this post but I leave you with this.
Oct. 8 2011 Jim Flaherty
"It will take clear evidence of a bubble in the housing market in Canada, which we have not seen."
If Mr. Flaherty is the Finance Minister of Canada and has access to more information then anyone, that means your analysis is inaccurate. Please explain to the readers why your analysis proves there is a housing bubble that Mr. Flaherty has no concern about.
Since when a politician tells the truth?
Mr. Flaherty also assured us back in 2008 that Canada would avoid a recession. 'Nuff said.
Maybe it's a conspiracy. Is Flaherty a GS alumni?
Ah....I see Josh beat me to that comment...
Whether YOU think it's ridiculous or not, Goldman Sachs is everywhere - the IMF, BIS, U.S. Treasury -- and the list goes on.
Some people just see things before others do.
There are many factors at play in politics and government that defeat simple inferences like "the more information, the better".
First, there are political pressures from special interests. A prime example is the Iraq war, in which CIA analysts reported that their sober analyses were rejected by political staffers in the agency (cough cough, Feith et al) because they didn't fit a strategic interest being pushed by special interests.
Second, more information is not always better. Finding the good stuff is a search problem.
Third, data must be interpreted, and the cognitive limitations of the person performing the interpretation are relevant. Flaherty is a lawyer, so he is probably useless at dealing with data. The people around him in his department are likely government hacks who have long since fallen out of touch with the private sector, or even the average wage earner.
And who are you for Mr.F to tell you the truth? (sarcasm)
Please consider:
"Jean-Claude Junker (head of ECB) openly admitted "When it becomes serious, you have to lie." That admission came shortly after he denied there was meeting that he was actually attending."
Why is F different ?
This is the same Flaherty that did not see the 2008 financial crisis until it was well in the rearview mirror, right?
I think Ben has laid out his argument, data included. I would prefer to see the counter argument laid out in a similar fashion before disagreeing.
In fact I think Flaherty saw the possibility of a market bust in 2008 and sees the possibility of a housing bubble right now. It's simply strategic that he won't admit to either in advance. Your average voter just wants to hear that everything is going fine. Your same average voter won't remember his missed predictions once the next election comes along, just so long as it's 6 months after the missed prediction.
In short, everything you hear Flaherty say in the media is said with his politician hat on.
Greenspan and Bernanke did not see a housing in the US at the peak either.
Here is a huge list of koolaid drinkers who did not see the US housing bubble.
http://saskatoonhousingbubble.blogspot.com/2011/04/us-had-many-kool-aid-...
Here is a list of 12 who saw the financial crisis coming before and a few are saying that Canada's housing market is in trouble.
http://saskatoonhousingbubble.blogspot.com/2011/04/who-saw-financial-cri...
Yup. There is probably no better way to burst a housing bubble than to have the Minister of Finance admit one exists. For that matter, any politicians talking up a housing bubble will likely find themselves on the wrong side of their leader pretty quick. The topic is verboten. Nobody can admit it. (but I will bet some are selling before its too late).
Can someone please explain how condos are good for "preserving" an initial investment or "safeguarding" capital? These are purchases that usually involve considerable leverage, taxes, fees, sales commissions, etc. and uncertainty about future maintenance costs, with none of the underlying security (land value, etc.) provided by a traditional RE investment. I simply cannot understand buying a condo as an investment and renting it out at a loss every month as a way to "safeguard capital". If the goal is to not lose money, why not just buy a GIC and be done with it? Someone please educate me.
People are buying real estate for the long-term. It's an old axiom that stock market investors of yore used to espouse with pride. Buy and hold.
It's not even a matter of preserving capital. Real estate has increasingly become a vehicle for forced-savings that leave you "something" after finally being paid-off; and heck, you can live in it!
Real estate must be one of the dumbest and most unambitious investments one can make.
Safe and conservative - how Canadian.
This may sting a bit...
Canada to feel bite of Chinese trade slowdown
http://www.theglobeandmail.com/report-on-business/international-news/asi...
Appraiser - Agreed, with RE being one of the dumbest investments to make at this point in time. Why would somebody want to "force-save" and buy RE that will lose money if you wait a couple years? With these inflated prices and 70% home ownership, where is the demand going to come from? Buying RE at this point will actually force you to lose money. The evidence if overwhelming.
Our time is coming and don't crap your pants when it does.
Appraiser, your arguments make sense for actual houses or whole buildings, but not for condos -- "buy and hold" doesn't really apply when (1) there is no underlying land value, and (2) failure to maintain the property (through payment of fees dictated by the board) prevents you from selling the unit.
There are plenty of condos in the "inner suburbs" of Toronto that you can buy for around $100k but the fees are $800-$900 per month because of poor construction quality and years of neglect. I don't see how today's new condo builds will necessarily be any different. Buying and holding these newer units is probably a recipe for disaster.
I see Appraiser's point that people think it's a "safe and conservative" investment (and agree that it's dumb) but that still begs the question of why people get into bidding wars over the stuff, and why it only seems readers of blogs like this think that this market is closer to Tulipomania than "safe and conservative". Not only is the "yield" negative unless you paid for this whole investment in cash (and then barely positive) but also the prices seem certain to come down, and not only in the short run. If this is the work of Canadian "investors" (meaning people who borrow, since Canadians rarely pay cash) then we are in doodoo since Canadians are about to retire and downsize en masse. If it's the prodigal Chinese investor - we're still in doodoo since they did pay cash but only a windfall due to a bubble happening in their economy that they'll have no problem jettisoning when the time comes. I think our insightful Economic Analyst made a good case that this is not offshore-driven investing. So what next?
PS Ben thx for a great blog.
I find that most people are behind the curve when it come to investing in any asset.
I can understand the unsophisticated investor POV in real estate as they need to invest in something that is real and tangible that they can see and hold.
Most people get their investing ideas from main street media that relies heavily on R/E advertising. So the will never print anything that bites the hand that feeds.
I have seen lots of people buy real estate on the so called investment advice from realtors. The realtors and the investor never does the proper math on investments. And of course there is no reason for the Realtor to do the math as they just want the sale. There is a pretty big industry geared (group think) to perpetuate the R/E industry and they have got the message out to the masses.
Unlike stocks and bonds that are liquid and can have ups and downs in the matter of hours, the R/E market is very illiquid and watching it crash is very very slow.
As far as Flaherty is concerned, really what is he going to say? His sole mission is to perpetuate the debt/housing bubble while sending strongly worded letters to Europe, so when things implode he can blame someone else.
He even went as far to muzzle Carney and make him toe the Conservative line.
I feel Ben is at the front of the curve along with the Zero Hedge blog.
So what is Ben's motivation to write this blog? He states that he is a renter, it would be hard press to write this blog to instill fear and a market downturn so he could soak up all those properties on the cheap.
Thanks Ben for the continued research and keeping me ahead of the curve.
What had Flaherty done, specifically and publicly, to muzzle Carney?
Wow. Ben continues to be praised for his analyses on RE in Canada from G&M. And rightfully so. This is the most convincing blog on RE overvaluation in Canada.
http://www.theglobeandmail.com/globe-investor/personal-finance/preet-ban...
An American asks: Is Canada’s real estate market in a bubble?
The general consensus that Canada’s housing market can’t continue to increase in price forever is not new. Canadians have been asking that for the better part of a decade. Ben Rabidoux has some great insights on his site TheEconomicAnalyst.com and for an analysis of the divergence of housing price increases versus rent increases in various Canadian cities, click here for some great charts and commentary.
I've copied and pasted all the information about Manitoba in a word document from this site. Just an idea is to do "provincial profiles" in Canada and talk about if they are in a bubble, moderate bubble, or correctly priced. Remove the "Real Estate" or "Social Trend" tab from the tab and make it as "Provincial Profile"... but that might take more time to maintain so I can see why you wouldn't want to do it... Also, I haven't heard anything about your book for awhile because I would be a buyer.
How come appraiser never posts links that support his arguments? Because the only people that would suggest buying RE in Canada now would come from real estate board or realtor without any statistical information about current market information
Hadn't seen that one. Thanks.
Perfect midtown Toronto example:
2 bedroom, 1.5 bathroom, 800 square feet, 5 years old
Asking $400,000, condo fees $450/month, taxes $200/month
Could be rented for ~ $1,800/month.
Net income from property if paid in cash = $1,150/month
Annual Yield = 3.45%
This is around what Canadian government short-term bonds are yielding, which are the safest investments after GICs.
So, would you put $400k in a condo whose price could drop more than 20% in the next few years or put that much in a bond ETF whose price might fluctuate 2%?
Agree...and that return assumes you handle all rental tasks, have $0 upkeep - including between renters - and 0 gaps in renting it out.
The following article, entitled "A List of Goldman Sachs People in the Obama Government: Names Attached to the Giant Squid's Tentacles" , shows how Goldman is influencing the "Obama government".
http://my.firedoglake.com/fflambeau/2010/04/27/a-list-of-goldman-sachs-p...
This list is by no means exhaustive. Corzine, who ran Goldman Sachs with Hank Paulson, became Governor of New Jersey. Our own Mark Carney, Governor of the Bank of Canada, is an ex-Goldman guy. Internationally I could give you many more names. Do you want them?
This is a discussion about the condo market in Canada in general, and Toronto in specific. Unless you can draw a clear link between Goldman Sachs people in the Obama administration and the condo market, all future comments related to that topic will be deleted.
Ben, I was making reference to your comment above: "Maybe it's a conspiracy. Is Flaherty a GS alumni?"
I also referred to Mark Carney, Governor of the Bank of Canada. He sets interest rates, which have been kept too low, the hugest factor in this housing mess.. In fact, Carney mirrored what the United States did. Bernanke came down to ZIRP very quickly after the crash in 2008, and so did Carney, even though our housing boom picked back up very soon afterwards. Australia didn't drop their rates, they were a commodity country like Canada, and yet we followed the United States to the letter.
I thought that the consensus on this blog was that this WASN'T foreign money driving prices higher. No, there was no speculation by foreign speculators, we were told.
Now all of a sudden the conspirators are correct. Foreign speculators are in the market. Who would have thunk it?
Let's get some real numbers on who is buying these condos, because the information is out there. Realtors know. They're not going to hand over the information, but someone has it. You can bet that Flaherty has it, or am I wrong on that? I must be wrong, no government officials would know what's going on because otherwise they would stop it, wouldn't they? They can't know!
You've got the message wrong. Is it happening? Yes. Is it the primary driver of the market, no. Even if it was the primary driver, can it continue? No. That has always been the message.
Here's some reading:
http://www.theeconomicanalyst.com/content/more-data-prominence-chinese-b...
http://www.theeconomicanalyst.com/content/upcoming-tv-appearance-inside-...
http://www.theeconomicanalyst.com/content/chinese-investors-vancouver-ha...
It's all there. My story has not changed.
So you base domestic home purchases on surveys? Where is the hard data that shows domestic purchases? Let me tell you why you're thesis wrong again.
Your second link is based on population growth which you assume must increase as an indicator that immigrants are settling in or buying homes. As I stated in previous posts, what matters is the rotating population of immigrants within the overall population. Example; the overall population could be growing at 1% however at the same time within that growth rate, base population (Canadian born) is declining while immigrant status (foreign workers/students) is growing. The immigration growth rate is a clear indicator that more immigrants are 'flowing' or 'rotating' through the overall population. This excess traffic is creating rent demand that keeps wealthy investors/speculators buying properties.
Your third link is based on sales figures (transaction sales) which doesn't represent home prices being raised from bidding wars. It would not take more then 2-3% bidding participation amongst the wealthy class (HAM) to bid up home prices. What would the number of non-resident transaction sales have to do with home prices? Example of price distortion.
10 homes sold for 450k and 2 homes sold for 2 million each is an average price of 708k. Does the 708k represent a price of the majority transactions? No.
Read about how many bids realtors where dealing with over the past few years--the numbers were overwhelming. How about all those multi-million dollar condos being sold in Toronto? I find it hard to believe that domestic buyers would be bidding so recklessly in their own area. It doesn't make sense. All in all, what matters in the end, is who is winning the bids and how much they are paying.
So you can rule out population and transaction data as an indicator. Show us some better data or clarify what other numbers you see to parse foreign from domestic purchases.
Bottom line: There is no solid data on the matter. The best we can do is look at what data we do have and try to decide if it jives with the story.
If it is wealthy foreigners paying cash for properties in Van and TO, and if this is what is actually driving the market, how do we reconcile that with the swelling debt figures in these areas?
Swelling debt would be amongst the lower and middle class, not the rich Ben! Why do you think the income gap is growing in Canada? You can add all the lower and middle class wealth and it still wouldn't equate to a fraction of the wealth held by high net worth Canadians. What immigrant status are Canadian millionaires? http://i53.tinypic.com/bfm8vd.png
Wealth consolidation and destruction amongst the middle class is what we're witnessing.
If you want solid data, look at immigration, roughly 90.000 new Canadians settle in the GTA every year (http://www.cic.gc.ca/english/resources/statistics/facts2010/permanent/11...). And as far as I know, they don't bring their own tents, they rent or buy condos until they can afford a house. That's is called demand. And yes, there is a RE bubble and it can burst in 20 years from now when prices in TO reach $1.000.000/unit.
Cute. Of course you neglect the role of supply in the discussion. Let me frame it for you: Over the past 10 years, Toronto has built 1 new residence for every 2.5 people they've added to the population (yes, that includes immigration). So let me ask you this: If supply has kept pace with demographic demand, should that demand have any meaningful effect on prices?
You may want to check out these two posts dealing with the 'population growth drives house prices' fallacy so you can provide an educated response:
http://www.theeconomicanalyst.com/content/revisiting-population-growth-d...
http://www.theeconomicanalyst.com/content/superficial-appeal-population-...
Ben, some buyers buy up five, six, seven condos at a time - one buyer. In some cases these units are never rented, but held for price appreciation. Now we have the same demand, but less supply. This all forces the price of properties up and up.
"Toronto has built 1 new residence for every 2.5 people they've added to the population"
Is that based on 2006 Census? I wouldn't trust those numbers with so many immigrants and low-income families living together today. The best indicator we have that reflects supply and demand is vacancy rates.
@backwardsevolution: Or in the REITs case, several entire apartment buildings (yes that's residential Ben) throughout the GTA. In a press release by CAPREIT, they stated the company had acquired 1,203 suites year-to-date--and that's just one company. http://phx.corporate-ir.net/phoenix.zhtml?c=124438&p=irol-newsArticle&ID...
On a side note, one thing that continues to perplex me is how nobody can obtain Canadian foreclosure data. I've been following some Canadian foreclosure websites and it seems like new listings are appearing every week. If I was a RE investor knowing that a recession is coming, low-income housing is where I'd be.
I find it hard to believe that an investor would hold 5,6 or 7 condo units off the market. It would cost the "investor" in the range of $500 - $1000 per unit per month to carry the condo fees and realty taxes alone, not to mention the cost of financing!
Not only risky - just plain stupid.
I charted the CMHC Toronto vacancy/rental rates for the conversation.
http://i54.tinypic.com/znwn4p.png
Appraiser,
Anything is a good investment for the right price. The argument against real estate isn't that it's a bad investment period, just that it's a bad investment right now (and only in over priced markets).
Buy and hold investing only works when you buy something for below value or at fair value. Stocks, real estate, anything. The difference with stocks is they come with little to zero carrying cost. Real Estate comes with land tax, maintenance, etc, etc. Stock market investors also espose "Buy low. Sell high". That's all we're advising here as well.
As for living in your "investment", you still have to pay interest rates (or forgo earnings if you buy a house cash instead of investing that money). If the costs of "renting" money to buy a house outweigh the costs of renting a house ... why wouldn't you just rent the house and invest the money?
Furthermore, if you can afford to buy a house ... go for it. However, many people can't "afford" to buy a house and "buy it" using massive amounts of debt. This works fine if prices keep going up ... if they don't and too many people are over extended ... well just look south of the border to see what happens.
Ben, you made the globe and mail (and vreaa again). The funny thing he links to you, complements your work, then lays out the red carpet for you to trample his subsequent analysis.
"then lays out the red carpet for you to trample his subsequent analysis."
Not sure what you mean by that. VREAA runs a fantastic blog. I happen to agree with virtually everything he (she?) writes.
Great, work, basically the market is doing great and RE is doing amazing. This blog is great for bulls, because you might actually help us before the tipping point comes. I always sell my stuff in bidding wars, so I never exit, because the market is so strong. I have yet to not have sold in less then 10 days. The market just don't have enough for this amazing demand. Good times are here to stay for sometime, right call, your timing is probably 2 years to early. Best of luck
I'm not so sure that the market is strong as I've been explaining on some recent posts that the housing market can only continue if the market is willing to fund mortgages. People need to understand that banks DO NOT fund mortgages. After they underwrite the mortgage it is pooled into a MBS (mortgage back security) and sold off to investors. Banks aren't stupid and will not use their money to finance overpriced real estate.
Today (Ben), we had an odd divergence in the REITs closing at -0.307% compared with TSX 1.43% which could be a signal that something is wrong in the REITs holdings. http://i52.tinypic.com/dwe4jc.png Normally this index tracks above the TSX.
At the same time we had Bloomberg just report that the Prime Mortgage Bond Index is fueling up some concerns amongst investors. This could be related to the REITs or something much bigger brewing.
"A surge of activity in derivatives indexes measuring risk in prime mortgage bonds threatens to shake investor confidence in the underlying securities just as some observers thought they were starting to attract buyers again after the crisis. "
http://online.wsj.com/article/SB1000142405297020400230457663154145526399...
These are the same signals we seen prior to the 2008 crash. I'll say it again, when the market stops funding, everything stops.
Right now money is free and our leaders have said it will be for sometime, enjoy the party and get rich with the rest of us.
It's been free in the States and Japan for even longer. Funny how 'free money' never seems to be associated with a sustainable increase in house prices. Hope you have a good exit plan...
"Right now money is free and our leaders have said it will be for sometime, enjoy the party and get rich with the rest of us."
landlord - THAT IS THE PROBLEM. There are so many problems with that statement.
1) Homeowners are feeling the "wealth effect" and they use lines of credit to dig them deeper. This boosts the economy. With a house price correction, all of a sudden things aren't looking so good.
http://www.theeconomicanalyst.com/sites/default/files/u3/lines_of_credit...
2) Everyone IS enjoying the party too much. Home ownership rates are 70%, larger than USA when their RE crashed. What demographics can they extract from now? Demographics are NOT in favour for homeowners when baby boomers start dumping their homes and downsize
3) People think that interest rates will stay low and that's why the affordability levels are acceptable now. In the short term, I don't see rates increasing but it will take 25 years to pay off a typical mortgage
So many more to add... global economy (EU, China slightly losing steam, US economy in shambles, loss of FIRE employment during housing bust, the list goes on. I think Ben is dead-on with his argument. But you're right it may take 2 years. It wouldn't surprise me the least. Timing this is tough and that's why Ben never gives a timeframe...
I watched "Kill the Irishman" the other day. Debt collectors did some pretty nasty things to the debtors. People gotta feel lucky that things aren't like that anymore.
Just to add on that, housing affordability can misleading as seen here - http://www.theeconomicanalyst.com/content/why-housing-affordability-misl...
Explain this
Why have I seen bidding wars for over six years now?
Long term real estate graph in Canada. Chart it.
I don't care about stocks and bonds. I own land that is my business. I secure buyers, build and deliver. This is not any speculation. Only if I have demand. I build after a large deposit
All the cranes and construction you see with amazement has been paid and sold. These are not builders taking a flyer. Money has moved. Deals closed
My buyers have great jobs and families they want a future with
Nothing is every perfect. But in over 30 years I have never seen this much demand without spec building. The spec building in Canada has always been on the CRE side. That I can see slowing down. But homes and condos. No way. We just can't find space in GTA or for that matter even secure labour. This is a good thing for Canada. Not good for CRE
Landlord - what do you mean "and get rich with the rest of us". The warnings are all over the place about the sharply rising household debt in Canada, did you read this post:
http://www.theeconomicanalyst.com/content/td-debt-canada-oecd-leading-in...
the cost of ownership is sky high and keep rising and it undermines all the other consumer oriented businesses. So if you happen to be "rich" along with the folks from the FIRE - it is at the expense of "the rest of us". I am sure that it will get back fired as in the economy one particular area can not flourish when the rest is in an ...
Why crow about bidding wars? They're meaningless. I can list a $500k house for $300k and get a bidding war, guaranteed. Doesn't mean it's worth bragging about.