The bubble model

The bubble model for home buyers in Alberta goes something like this:

A reckless financial illiterate buying simply for capital appreciation using the loan which allows for the minimum monthly payment.

For example this is from Garth Turners blog about how to tell you are in a housing bubble:

When the number of people taking 35-year amortizations explodes higher. Overall, these loans have doubled as a percentage of all mortgages in two years but that does not tell the true story, since today 5/35 buyers constitute an absolute majority of new originations. Of course, 35-year borrowers pay off virtually no principle for years and years which makes this akin to renting money. No equity means no ability to withstand a market correction.

From this mortgage market report 53% of new purchases are for amortizations 25 years or less. 29% are for 35 years or greater.

Another snippet from Garth's same post.

Some observers, bless their good hearts and large stones, had the courage to warn recent buyers with mortgages in the 2-3% range they could be in deep financial trouble before too long. But you know that. The reasons why have been beaten to death on this blog already.

To be fair in this case he didn't say that 2-3% variable rate mortgages are the norm. But going back to the mortgage report 5-year fixed mortgages are the most popular.

-73% of mortgages held by 18-34 year olds have terms greater than 4 years.
-71% of mortgages held by 18-34 year olds have fixed rates, 9% combination

Of new mortgages within the last 12 months shorter terms do appear more popular, but not the majority. 56% have terms greater than 4 years.

Of course there are a significant number of mortgages over 30 years at a variable rate and these will most likely cause some amount of turbulence during the next leg down. The model that typical Canadian buyers have been recklessly overbidding $300,000 for a shacks in downtown Toronto or Vancouver using a 35 year VRM makes for good entertainment but does not reflect reality.

American and Canadian House Prices

Metro Area	Median
Saginaw-Saginaw Township North	$61,400
Youngstown-Warren-Boardman	$70,700
Lansing-E.Lansing	$86,600
Toledo	$88,300
South Bend-Mishawaka	$88,500
Decatur	$88,500
Canton-Massillon	$89,300
El Paso	$94,500
Grand Rapids	$97,100
Cape Coral-Fort Myers	$98,000
Ft. Wayne	$102,500
Ocala	$102,700
Erie	$102,800
Akron	$107,200
Rockford	$108,700
Palm Bay-Melbourne-Titusville	$109,500
Topeka	$111,100
Dayton	$111,600
Springfield	$113,800
Binghamton	$114,200
Springfield	$114,400
Davenport-Moline-Rock Island	$115,600
Cleveland-Elyria-Mentor	$115,800
Waterloo/Cedar Falls	$118,200
Buffalo-Niagara Falls	$119,700
Indianapolis	$120,200
Wichita	$120,400
Florence	$121,300
Rochester	$121,500
Cumberland	$122,100
Amarillo	$122,500
Appleton	$123,500
Chattanooga	$124,100
Pittsburgh	$124,600
Syracuse	$125,200
Peoria	$125,200
Gary-Hammond	$126,600
Deltona-Daytona Beach-Ormond Beach	$126,700
Spartanburg	$127,200
Mobile	$128,300
Memphis	$129,300
Atlanta-Sandy Springs-Marietta	$129,400
Greensboro-High Point	$131,700
Cincinnati-Middletown	$131,700
Charleston-North Charleston	$132,000
Tulsa	$132,100
Little Rock-N. Little Rock	$132,500
Elmira	$132,800
Beaumont-Port Arthur	$133,600
Kankakee-Bradley	$133,600
Lincoln	$133,600
Montgomery	$134,200
Green Bay	$135,300
Louisville	$135,600
Saint Louis	$136,400
Sioux Falls	$137,200
Tampa-St.Petersburg-Clearwater	$137,400
Omaha	$137,600
Corpus Christi	$137,800
Gulfport-Biloxi	$138,000
Las Vegas-Paradise	$138,500
Champaign-Urbana	$140,600
Jackson	$141,200
Knoxville	$142,000
Fargo	$142,100
Columbus	$142,600
Phoenix-Mesa-Scottsdale	$142,700
Columbia	$144,000
Oklahoma City	$144,100
Lexington-Fayette	$145,000
Jacksonville	$145,700
Cedar Rapids	$145,700
Tallahassee	$145,900
Greenville	$145,900
Kansas City	$146,200
Columbia	$148,800
Dallas-Fort Worth-Arlington	$150,500
Pensacola-Ferry Pass-Brent	$151,700
Hagerstown-Martinsburg	$151,900
Shreveport-Bossier City	$152,300
Glens Falls	$152,400
San Antonio	$152,800
Birmingham-Hoover	$153,300
Boise City-Nampa	$154,700
Reading	$156,400
Des Moines	$156,600
Bismarck	$157,200
Bloomington-Normal	$157,200
Orlando	$157,900
Yakima	$158,400
Houston-Baytown-Sugar Land	$160,600
NY: Newark-Union	$164,300
Baton Rouge	$166,900
Riverside-San Bernardino-Ontario	$168,100
Gainesville	$171,800
Kennewick-Richland-Pasco	$172,200
Tucson	$174,000
Spokane	$177,600
Salem	$180,400
Albuquerque	$183,500
Durham	$184,300
Minneapolis-St. Paul-Bloomington	$184,800
Sarasota-Bradenton-Venice	$185,200
Farmington	$186,500
Sacramento--Arden-Arcade--Roseville	$186,600
Austin-Round Rock	$189,100
Reno-Sparks	$192,200
Charleston	$195,100
Colordo Springs	$195,100
Albany-Schenectady-Troy	$195,400
Springfield	$195,400
Milwaukee-Waukesha-West Allis	$199,500
Charlotte-Gastonia-Concord	$199,600
Dover	$200,000
Pittsfield	$200,500
Portland-South Portland-Biddeford	$202,800
Eugene-Springfield	$206,600
Kingston	$206,600
Raleigh-Cary	$207,900
Chicago-Naperville-Joliet	$210,100
Virginia Beach-Norfolk-Newport News	$215,000
Miami-Fort Lauderdale-Miami Beach	$217,000
Norwich-New London	$217,100
Madison	$217,900
Salt Lake City	$218,900
Atlantic City	$223,000
Worcester	$224,100
Philadelphia-Camden-Wilmington	$227,500
Denver-Aurora	$229,100
Providence-New Bedford-Fall River	$229,700
Allentown-Bethlehem-Easton	$230,500
Hartford-West Hartford-East Hartford	$237,500
Manchester-Nashua	$237,600
NY: Nassau-Suffolk	$241,300
Portland-Vancouver-Beaverton	$244,500
Baltimore-Towson	$261,100
Trenton-Ewing	$291,200
Barnstable Town	$319,700
Seattle-Tacoma-Bellevue	$321,500
Washington-Arlington-Alexandria	$324,700
Edmonton Area	$328,043
New Orleans-Metairie-Kenner	$343,800
Los Angeles-Long Beach-Santa Ana	$345,600
Boston-Cambridge-Quincy	$348,000
Boulder	$358,300
San Diego-Carlsbad-San Marcos	$378,100
New York-Northern New Jersey-Long Island	$384,900
New York-Wayne-White Plains	$385,400
Calgary City	$388,721
Nashville-Davidson--Murfreesboro	$389,100
Bridgeport-Stamford-Norwalk	$398,200
New Haven-Milford	$449,700
Anaheim-Santa Ana	$498,800
San Francisco-Oakland-Fremont	$538,100
San Jose-Sunnyvale-Santa Clara	$566,000
Fort McMurray (avg)	$600,970
Greater Vancouver (benchmark)	$710,892
Kalamazoo-Portage	N/A
NY: Edison	N/A
Richmond	N/A
Danville	N/A
Detroit-Warren-Livonia	N/A
Honolulu	N/A

Canadian dollar @ 0.9481 November 12, 2009
Sources
http://www.rebgv.org/
http://money.cnn.com/2009/11/10/real_estate/latest_home_prices/index.htm
http://www.ereb.com/REALTORSAssociationOfEdmonton.html
http://www.creb.com/
http://www.woodbuffalo.net/AboutCostHouse.html

Edmonton New Construction

The past two years residential construction in Edmonton has been in decline as the result of some overbuilding during the boom and from weaker demand since then. The glut of housing under construction has been mostly absorbed and going forward will contribute less to overall supply. Single family starts slowed rapidly after the market peak in the spring of 2007 and since then the amount under construction has fallen substantially. Single family houses under construction have decreased from the peak of 6528 in August 2007 to 1764 in April 2009. This has bounced back recently to 2216 in September 2009 as starts have picked up again.

The chart below shows the amount under construction from all types of residential housing. While single family homes have bottomed, apartment condos (shown in orange) continue to decline. I added inventory which has been completed but not absorbed in gray. This does not make up a terribly significant portion, but it is interesting to note that SFH spec homes have been cleared while condos have accumulated.
In general the number of completions should be roughly in line with the number of starts only delayed. We have seen completions exceed starts for quite some time resulting in a decrease in the amount under construction. Right now the 12 month moving average for starts for all residential is 403 while still 795 for completions.
I expect completions to decline going forward contributing less to overall supply.

Buy vs Rent

The following comparison will illustrate how the low interest rates are reducing payments enough to compete with the rental market. Under more reasonable financing terms mortgage costs are not terribly out of line with the rental market. With more creative financing it is easy to see why sales are currently strong.

First consider this 1716 sqft house in South Edmonton for $374,900

Looking on craigslist for rentals in Edmonton I found the following.

The 1680 sqft house is the closest match. The advertised price is $1500 but after a few months the price increases to $1700.

1680 Square Foot Beautiful house in Edmonton's most popular newly developed community called Ellerslie crossing. The house location is seconds walk from ETS bus stop and kids school buses. Close to all amenities. Its next to South Edmonton Common, Anthony Henday, Calgary Trail and Whitemud. The lake is visible from the bonus room....Starting rent of $1500.00 will increase by $50 on December ($1550), January ($1600), February ($1650) and will get fixed at $1700.00 from March, 2010 onwards.

Comparing full asking price and rent results in a ratio of 220. That is fairly high even though it is from one of the more reasonable priced houses on the MLS (there was only one rental to choose from in the neighboorhood).

Looking at the price vs. rent things are a little closer.

Assuming full asking price, 10% down, 2% CMHC premium, 4% 5-year fixed rate and 25 year am.
$1814/month. $674 of which is principal.

There is a premium here, especially when taxes and maintenance are included. However, after 5 years the balance will be $300,255.

A buyer under these terms will end up paying a moderate premium and pay down some of the principal over 5 years. Meh. Not terribly exciting.

However if a buyer chooses a more risky mortgage a more interesting comparison appears.

Full asking price, 10% down, 2.4% CMHC premium, 2.25% variable and 35-year amortization.
$1192/month. $543 is principal (the first month, at least)

So for $1192/month + taxes + maintenance a buyer can move out of an apartment into a house and become a homeowner. The problem of course is not considering the interest costs for the entire duration of the loan and the effect of this stimulus on the asset price itself. Is this a bubble? Are current buyers the greater fools by recklessly overpaying for houses due to blind faith in future appreciation? Not entirely. Buyers may be incorrectly assessing the risk of future financing costs and not accounting for the asset inflation caused by low rates. This is a more subtle mispricing as opposed to a bubble and due to this I expect a less dramatic unwinding.

The type of financing above is an artificial boost to the housing market. What about the rental market? Low interest rates and creative loans reduce demand for rentals as the monthly payments attract people towards becoming homeowners. While rents have been falling partially due to the weak economy, I think another reason is from these financing terms. If/when these financing terms become less attractive the rental market may gain strength.

But its Halloween so we have to consider we may be in a deflationary depression where everything is toast.

Policy advice for Mr. Carney

Dear Mr. Carney,

Today you made the following statements regarding the Canadian housing market:

"We expect prudence from lenders," he said. "We expect, and we have confidence in, prudence from Canadians. We remind people that borrowing is for the period you are going to borrow, not just for the moment you take out the loan."

That is a concise statement and echoes what many people have been saying for some time. However this appears to be a case of CYA so in 2011 you can say "hey, look! I told people to be prudent", while still allowing the heightened demand for housing contribute to precious green shoots.

You don't need to remind borrowers of anything. All that needs to be done is for CMHC to require qualifying income to be set for more normal interest rates. If CMHC ensured that borrowers could handle more normal rates that would limit the downside if/when rates increase. For example it would be more reasonable if CMHC required a qualifying rate of 6% to insure these mortgages.

Obviously people are qualifying and depending on super low interest rates. This has been going on for awhile. Consider the quote from the July 2nd article First time buyer like low rates:

What really helped? The 2.75-percent interest rate they were offered. It ultimately allowed them to move from a $1,800-a-month apartment into their own home.

“But we don’t have a lot of [wiggle] room,” Morettie said. “We can go up to four percent, but then we’re done.”

Ouch.

craigslist rental sample

The price to rent ratio remains elevated in Calgary and Edmonton. I suspect this is due to an irrational negative attitude toward renting in Alberta and very low interest rates. However, I do think that some part of the price difference between Alberta and the US is a real difference between the cost to rent (and build). Its simply more expensive to rent in Calgary and Edmonton than Phoenix and because of this prices should be comparatively higher.

Consider this selection of craigslist rental ads for $1250.

Edmonton

$1250 / 2br - Apartment For Rent at RentersOnline.com

Two -2- Bedroom, apartment condo , approx 900 sq ft with a nice sized west facing balcony in a 3 yr old west end elevatored building is available immediately. The suite comes complete with fridge, stove, dishwasher, washer and dryer.

The suite also features underground parking.

The unit is on the top floor so there will be no noise from above.

Heat and Water are included in the rent.

The master suite has a walk in closet and full 4 pce bathroom. The second bedroom has a large closet with sliding mirror doors. The second bathroom is next to the second bedroom and is a full 4 pce bathroom and also houses the upright washer and dryer.

The suite also has a full storage room and linen/storage closet.

The kitchen, with ample counter and cupboard space, is open onto the living/dining room and comes with an island.

The suite is located in an area that is close to schools, YMCA, parks, shopping, dining,transit , just south of the Whitemud and just west of 170 st.

Lease duration is negotiable but preference is given to a 1 yr lease.

Calgary

$1250 / 2br - Stylish 2 Bedroom Upper Suite in Killarney (Killarney / Inner City)

Beautiful and bright 2 bedroom upper suite in the desirable inner-city community of Killarney. Minutes from Downtown, Marda Loop and Mount Royal College. Located on a quiet tree lined street conveniently nestled just several blocks from 26th Avenue and 17th Avenue transit corridors. Close to Westbrook and Westhills shopping centres; Killarney pool; parks, and University of Calgary with easy access to Crowchild Trail and Glenmore Trail.

Crisp, clean, open concept suite with laminate and tile flooring and a brand new renovated bathroom. Features a private balcony, high ceilings and in-suite laundry. Street parking (a two car insulated garage is also available).

No smoking or pets. Please call for more information and to schedule a showing of this beautiful suite!

Phoenix (Mesa)

$1250 / 3br - 2Ba-Single Story-2160 SqFt-3 Car Garage-Inc Gardener (Mesa)

This is a Spacious near new 2160 SqFt 3br 2ba single story home. 3 car garage with electric garage door opener. Beautiful earthtone carpet, and tile through out. Large master bedroom with sitting area and a hugh walk-in closet, garden tub, and separate shower. Raised vanities, ceiling fans, separate laundry room and Faux wood binds throughout. Upgraded kitchen cabinets, gas range and microwave. Grass landscape in rear with rock landscape in front all irrigated by electric timer. 1 mile South of 60 Freeway close to schools and shopping. More pics and floor plan on request.

• cats are OK - purrr
• dogs are OK - wooof

Right question. Wrong answer.

I'm back, and it only makes sense to start with a post about a mortgage calculator after a six month break. Remember the buy vs rent calculator? Well this is similar except the scary thing is I don't think it's broken.

Mike from the Albert Bubble blog commented on this mortgage calculator from President's Choice Financial.

How much can I afford?

I was shocked at the vast sums of money one could qualify for based on a 35 year amortization and a 2.25% VRM. Consider 3 cases:

Case 1

Individual
Income: $66,000
Down: $20,000
Debt payments: $0
Taxes: $2200
Heating: $75

Pre-qualified for a $391,970 mortgage! It was limited *not* by the income, but by requiring a 5% down payment.

Case 2

Couple
Income: $120,000
Down: $80,000
Debt payments: $100/month credit card
Taxes: $4000
Heating: $180

Pre-qualified for a $711,371 mortgage! The reason one can get qualified for so much money is it uses a rate of 3.64%.

Case 3

Professional Couple
Income: $170,000
Down: $80,000
Debt payments: $100/month credit card +
Debt payments: $300/month auto loan
Taxes: $4000
Heating: $180


Pre-qualified for a $ 1,058,721.73 mortgage!




Right question. Wrong answer.
3x income is probably a more reasonable measure and allows for more normal interest rates and some discretionary income.