Thursday, August 7, 2008

The Long Term View

I’ve been enjoying the beautiful weather for last few weeks and haven’t been too tempted to sit in front of computer and do a fresh post. I realize a lot of readers would like to see postings more frequently, but I’m somewhat burnt out from a lot of over work during the last couple of years. So more frequent postings would be to my liking as well, but I’m spending more time recuperating and spending rest of the time on doing my work. I’d like to keep this blog going as much as you all want.

Coming to the real estate market in Alberta, so far not much different than what was predicted here on this blog has happened. Sales are slow, prices are gradually falling. There was no spring or summer rush. A lot of people are still paying more than one mortgage. The strong rental market is covering a good part of most ‘investor’s’ second/third/ multiple mortgage payment. Marketing gimmicks(h/t to one of the readers) are in full force but are yielding minimal results. The shoe boxes in Edmonton area are officially advertised for less than $300k. Last year these were at around $350k.

I won't spend time discussing the stats-they have been covered in detail on the realtor blogs. Instead, let's spend some time on the bigger, more fundamental questions. The ones that not too many 'investors' like to ask these days.

As we have mentioned earlier as well, the strong Alberta economy is really a function of construction growth and spending, more than the energy sector per se. And a number of stories in the recent past suggest that we are past the prime spending on construction, at least in this cycle.

On the commodity side, it looks like a bust is in the makings, the price of crude oil and other commodities having fallen by more than 20 per cent in the last few weeks. Should we go to levels below $60 (yeah, it’s a preposterous idea. But until it happened, real estate prices had never fallen in the entire US since the Great Depression) , it will raise some more serious questions, along with the perennial environmental issues, for the big oil contemplating oil sands investment.

But even if price of oil were to remain high for the foreseeable future, the big question is- What would happen once the construction boom runs its course? What would happen once all the oil sands projects are in production? Process industry typically doesn’t generate huge continuous employment like manufacturing industry does. What will fuel the employment growth five years from now? Ten years from now? I am fully aware of the perils of making forecasts, especially for what may happen ten years down the road, but asking some fundamental questions will be a good exercise. Especially those who are about to take a 35 year mortgage.

We have almost close to zero diversification and whatever diversification was done during the period between last bust to about three years ago has come to a naught. A lot of non energy companies have moved away from Alberta (and Canada) due to higher dollar and tight labour market. Those who bought or are still buying overpriced cardboard boxes on minimal down payment and 35 or 40 year amortizations need to consider this seriously.

A look at Windsor Ontario or Detroit will be instructive. Ten years ago it would have been hard to believe that Windsor Ontario would face the downturn it faces now. But this is what happens when an economy is singularly dependent on an industry.

As I’ve harped on so many occasions in the past, based on fundamental valuation metrics (availability of land, prices of raw materials), the current prices in Alberta are totally out of whack. As and when the labour market softens, there will be further downward pressure on the building cost pushing the costs down.

Those looking to buy at this point will do themselves a favor if they were to wait for at least one more year.

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