Wednesday, February 28, 2007

Creating Panic....To Buy

Here's a typical realtorspeak
It doesn't really matter that if you were to follow the gist of what the realtor is saying, you just can't buy in this market. Here's the message:

...The moral of the story....the price of your offer is not the only consideration. Sometimes it is better to spend a little more up front, than to find out you'll be spending a lot more once it's too late...

I'm just astonished that realtors can actually say things like these to their clients and the clients are 'opposite of smart' enough to believe in them.
Well, how about suggesting a little bit of rationality. And patience? Or does one really have to buy a condo coverted from a 40 year old building complex by over extending themselves and taking on a 40 year mortgage? Yes, buy now....Alberta will be out of land and building materials soon.
But let's not forget, there will be a time (don't really know when), when the same dynamics will work in the opposite direction. And the broken condos with huge deficits will not attract a single bid in months.

Alas, patience is the hardest virtue to practice.

Meanwhile....the party continues

For how long will this party continue here?
The party officially ended in the US a while ago and shows no sign of any revitalization.
This is a hard question. Will we follow the typical cycle that has been seen in the past- around a year's lag relative to the US?
Or is Canada really different? Or is it really different this time?
Can we really be immune to a slow down in the US? A slow down in China? A global recession?
For how long will oil prices remain high if there is indeed a global slow down?
The confidence of the masses is indeed very inspiring, but hopefully it is unlike that of the Chinese middle class who have been 'mortgaging' their homes to pawn shops to play the stock market.
But I personally know of several people in Edmonton and rural Alberta who have borrowed against the gains in their primary residence to invest in more real estate around the province.
Let's wait and watch to see how this will unfold.

Tuesday, February 27, 2007

The Bear Case-Part 4- It's Different Here

I remember an ad from Fidelity (or some other mutual fund provider) during fall 2000 that had a punchline something like: 'Ladies and gentlemen, yes It's different this time...'
The real estate equivalent for this has to be 'It's different here'. Of course Alberta is different. Just as BC, Ontario and NewFoundland are. Each place has its own set of advantages and disadvantages.
But 'it's different here' can become a really scary proposition after a few years into the bull market. Nobody has denied any arguments that were made in the 'bull case for Alberta Real Estate'. The problem occurs when the fundamentals no longer play a role in the valuations. Yes there are jobs in Alberta, but a majority of those are low end and trade jobs that will barely allow a low end dilapidated condo affordability.
Vancouver has seen even worse mania than we are seeing in Alberta because 'it is different down there'. They have mountains, beaches, world class skiing, restaurants, diversity, robust resource driven economy and much more. And everyone in the world wants to live there.
What does Albert have. At this point Alberta has jobs. And long winters. And crumbling infrastructure. And a massively polluting oil sands industry.
In some of the comments previously made, some one said that $100 oil is a possibility. But $100 oil is as much of a possibility as $30 is. Not everyone will agree with it, but I've never been a huge fan of price forecasting. The bottom line is- there are major oil sands projects currently underway and I've not heard of any new investments planned or any reductions in the proposed investments. So unless something major happens, oil sands projects will continue/increase production for the foreseeable future. But I think all that 'good news' has already been priced by the market in the prices.
Interestingly, Oil was close to its highest point in the last couple of decades during Fall 2005. But real estate prices in Alberta were about 40 % lower. So we can't really say that if oil goes to $100, Alberta real estate will go up by another 50%. It can, but in the past, this has not been the clear cut relationship.
So yes, Alberta is different that it has some solid economic things going for it, but after a while the solid economic numbers do not matter. Just as Yahoo could have been a great stock at $20 in 2000, it simply did not make any sense to own it at $300. Similarly, a starter condo might make sense at $150,000 in Edmonton but not at $300,000.

One of my favorite books on investments is Extraordinary Popular Delusions and the Madness of Crowds
Based on numerous examples in this book, the lessons that I have learnt are that people will believe whatever they want to believe. And if there are a sufficient number of people who believe in something- no matter howsoever absurd it is-many others will easily join them.And this is one of the fundamental ways in which markets (a social phenomenon) are different from physical sciences where fundamentals always remain true. As physicist Richard Feynman used to say "Nature cannot be fooled". But markets can be 'fooled' in that the 'fundamentals' and the market realities can be divorced for a very long time.

If a sufficient number of people are willing to believe that it is different here in Alberta and real estate always goes up, it could go on for a very long time.

China Effect

Chinese stocks dropped by more than 9 per cent yesterday raising concerns about the growth in China. If growth in China is being questioned, the growth in consumption of commodities must also be questioned. If Oil is the big story for Alberta Real Estate, growth in China and India is the big story for Oil (along with usual middle eastern unrest).
Already, they are talking about impact on Canadian commodity based stocks.
What does this have to do with Real Estate in Alberta. A lot or nothing, depending on your perspective. Alberta is priced for perfection, so to speak. And unlike a company whose stock is priced for perfection, Alberta has very little role to play in how the story will unfold. If demand in China were to soften and (if hell doesn't freeze over) oil falls to $30, what will happen to Alberta real estate?
Since $30 oil is now dismissed in Alberta as unlikely as a flat earth, this could be the Achilles' heel for Alberta Real Estate bulls. I'm not saying it is going to happen, but lower oil price as a risk factor is not on any one's radars.

Monday, February 26, 2007

The Bear Case-Part 3- The Disappearing Alberta Advantage

As I mentioned in one of my earlier posts, one of the reasons cited by Alberta RE Bulls for the rapid escalation in RE prices is the so called Alberta advantage- a combination of low taxes with less cost of living and high wages that makes Alberta such a desirable place to live in.
Well, here's a news for them- Alberta disadvantage is evaporating into thin air. Probably at the same rate at which the Real Estate bubble is inflating.
Let's ask a fundamental question: Why should a young family move to Alberta when a starter home of 1100 sq ft costs close to $400k and the average family income is no more than $70k?
Or, why should a young family based in Alberta continue to live here despite such high costs of housing?
Gary North, an astute, albeit bearish economic commentator, offers some perspective on this topic for the US market. He suggests such young families to move to Midwest where there are plenty of opportunities and lots of cheap housing. And shun coasts where starter homes have become very expensive.
If young families were to do something similar and shun Alberta, we'll see a drop in prices. We have heard of some stories where in people from Calgary have started moving to Saskatoon (and creating a mini-bubble over there!) in search of affordable housing.
Especially if you are not making a living working directly on the oil patch, is there really an advantage in living here in Alberta? If you work in a non-Oil and Gas industry, what is really the advantage of living in Alberta when it is hard to afford a detached single family home.
I remember the initiatives started by Alberta government and the cities of Edmonton and Calgary to diversify their economic base to avoid an 80s like disaster due to reliance on a single industry. It looks like all their efforts have gone in vain as the boom in a single industry has created factors to drive out pretty much every other industry.
Until a couple of years ago, Alberta used to pitch the 'Alberta advantage' story to companies from other industries-technology, manufacturing and finance etc- to setup offices in the province. With that advantage almost gone, how will the Alberta economy every diversify?
Contrast this with what Texas did in 1980s. From the ashes of the last oil bust emerged an impressive high-tech industry in Dallas, Houston and Austin. But we are still a one trick pony after experiencing the same bust.
And nothing really has changed, we are still the same oil and gas province as we were in the 1980s, this time only more arrogant and even more reliant on Oil Sands.

Sunday, February 25, 2007

The Bear Case-Part 2, some real data crunched

I had planned on continuing with some more abstract thoughts, but I came across the following interesting listings on craigslist:

For Sale
For Rent

We don't come across such gems for doing buy versus rent comparisons or to make a bull or bear case for real estate. This two bedroom condo is selling for $220,000. The same condo can be rented for $1100, all inclusive.

Old fashioned real estate value seekers would say that a good value for real estate is a property selling for 100 to 130 times monthly rent. In this case, the monthly rent, after excluding the condo fees is $758. Which means this property should be selling for no more than $100,000.

Or, the rent should really go in the $2000 range (plus condo fees). I'm not too sure how many people would be willing to (or able to) pay this much amount for this condo, at least in Edmonton. I think we still have not become Manhattan yet. May be if this mania continues for another15 years, but we are not there yet.

So by one metric, this property is severely overvalued. My guess is that this property was selling for around $120,000 less than two years ago- A time when sanity was still prevalent in Edmonton market place.

Let's take another metric-the Price to Earnings ratio for the property. Let's say you would buy this property as an 'investment' (as Realtors are so fond of saying).
What will be the earnings from this property? Assuming zero vacancy (not unreasonable to assume in the current Edmonton market, at least in the short term), the annual gross rent would be 13200 (1100*12) . The expenses are:

Condo Fees: $342*12= 4104
Property Tax: .01*220,000= 2200

We'll exclude any maintenance etc for this property for simplicity.
So the net income for the property would be : $6896

So for an investment of $220,000, the return will be $6896, making the P/E for this property around 32. Just for comparison, you can easily get 4% return risk free, hassle free from PC financial. If you take your $220,000 and put in that account, you'll get about $8800 in return.

So why would someone buy this property? Simple- in anticipation of double digit price increases.

Can anyone see the bubble yet?

Saturday, February 24, 2007

The Bear Case-Part 1

Every bull market generally starts on the basis of solid economic reasons. The reasons could be the relative undervaluation of assets or an increase in the expected future returns. However, as the bull market matures, it gets divorced from the economic reasons that started the bull market. I have personally witnessed several of these bull markets and their degeneration into manias in my life in different parts of the world at different times during last 15 or so years. The most recent one was the housing bubble mania down in the US and the one prior to that was the NASDAQ bubble in 2000.
Once the bull market enters the bubble phase, the same bull market story is sold to the masses and is given as the primary reason for asset price escalation.
The Alberta Real Estate bubble is no different from any of the prior manias we have seen in the past. The same arguments appear here-it's different here, we have a solid story (oil sands, strong economy etc) and other factors as mentioned in my previous post.
Alberta real estate market was in a healthy bull run till around 2005 spring after which all hell broke loose. I personally know of two long time investors who sold at about that time. One was an apartment building complex in Edmonton that was sold for roughly twice the amount it was bought for seven years ago (1997).

Take a look at this listing. Two years ago you could buy a detached starter SFH for around $175,000 in a good part of Edmonton. Now, you'll be lucky to even get a studio for that much!

The question really is-what has changed in the last two years. Why have most of the SFHs more than doubled in price? I do know the simplistic answer-it's the demand and supply. But if only it were that simple. Back in the heady days of Nasdaq bubble, I distinctly recall the day Palm made its IPO appearance. That day the market capitalization of Palm was more than the market captialization of 3Com, the company that actually owned most of Palm! And we do know what happened to Palm a few months after that.
Last year Warren Buffet mentioned a similar disconnect when he mentioned that the sum of land value and the improvement value of homes was way less than the amount for which homes were selling for in the US. The reality is that in a mania the fundamentals matter no more. It's greed and fear. Fear of being priced out forever. Rampant greed of speculators who think that they have become the next investing genius because of their three earlier successful flips. Ultimately, we might want to philosophize this as the 'fallen nature' of humans that expects something by doing nothing.
And if this is the way in which the market has been moving, how can the fundamentals or anyone talking of fundamentals be respected.
I've a lot more to say on this and will continue in my next post.

Making the case for Price Increases

Let me start the first real post on this blog by making the bullish case for Alberta real estate. Here is the stuff that is all going on in favor of Alberta:

- Overheated economy with minimum wage of $15/hour commonly seen.
- Massive proposed capital spending planned for next several years. Figures routinely quoted range from $50 to $100 billion.
-Massive influx of immigrants making Alberta a really popular destination for new immigrants who would otherwise be going to the 'Big 3' destinations (Toronto, Vancouver and Montreal).
-Massive inter-provincial migration.
-Lower Taxes in Alberta- the oft quoted 'Alberta advantage'.
-Relatively lower housing prices as compared to BC (Alberta is not lower than any other place any more).
-Alberta is different (due to above factors) and hence the economic rules applicable in the rest of the world do not apply here.

Alberta has witnessed an almost seven to eight year bull market in real estate due to above reasons. And as per bulls this is likely to continue for at least several more years before the 'crazy-maniac' prize increases subside to a respectable high single digit growth rates.

Next, I will make a bear case for Alberta real estate.

Welcome to Alberta Bubble

Well, the last few days were bad for Real Estate Bubble bloggers in Western Canada. First VHB threw in the towel, then our beloved Rob at Calgary housing gave in. They say it must be close to the top (yes, the real top) when long time bears capitulate. I don't think either one of these guys really capitulated, but it makes you wonder.
And while somehow navigating through over 200 comments at Calgary blog, I realized that we just don't have adequate forums to discuss the happenings in Alberta real estate. Especially when you see the craziness- multiple bids, bidding wars, condo reconversions of absolutely dilapidated buildings, real estate agent condescension, owner condescension, 'Alberta is different' stories and a long list of items we will hopefully cover in coming weeks and months.
I can't guarantee you any particular frequency of the posts, but I will try to post as often as I can.
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