Thursday, November 27, 2008

How much will you pay for your next house?

Garth has an interesting post on becoming a property vulture. One of the reasons we stayed away from buying a house was the arrogant attitude of builders, realtors and pretty much everyone else in the real estate food chain. Hopefully, the last 15 months will have given them some idea of what's about to come. But certainly, by the time we reach a bottom in terms of economic activity, housing, commodity prices and morale, almost everyone in this country will begin to treat their customers with respect.

Moving on to the main point of the post, the most important question that one must ask is-what is the fair value of house? How much will you pay for the house?
As I've mentioned in a couple of posts last year, the following metrics will be of help:
  • Cost per square feet. I think $100/sq feet is a very reasonable number. Accordingly, for the links that bearclaw posted for 1700 sq ft properties, they will be fairly priced in the $175k range. Some might find the price outlandish, but for me it's merely the representation of a cookie cutter shoe box on a tiny lot in the middle of prairie with harsh winters, half trick economy and no recreation other than a big mall.
  • Price to Rent Ratio. The old school fair value of a property was 100 times monthly rent. Assuming the current rental rate of this property at $1700 , it values the property at around $170k. But given the current level of elevated rents, the actual rent in the not so great times might be only $1300. So based on this metric, the fair value will be $130k.
  • Cashflow positive etc. A lot of 'investors' buy properties based on this metric. I'm not a huge fan of this method.
  • Historical values. Some say 2002 prices will never return to Edmonton. Perhaps. But to get a true sense of 'normal times', we must go back to the years when Edmonton used to be associated more with 'block heaters' and 'rednecks' than prosperity and oil sands. 2002 is a good year for making that comparison. Economy had started getting out of the gutter of late 1990s bust and things were beginning to sell. Builders were selling fairly priced homes that were affordable and had good quality. A friend of mine bought a similar home (to the ones shown above) in 2001 for around $165k in south Edmonton. You could buy similar homes in the $160-$190k price range until 2004. And then the caravan trips began.
  • Buy versus rent metric. Don't use the calculators provided by the realtor organizations. The best ones I've seen is from NYT and using the calculator.
You can guess that the time for me to buy is quite a bit away. I won't rush into buying inasmuch as even if prices don't fall beyond a certain point, they are likely to languish there for a while.
For most people a house purchase will be the biggest purchase they make in their lives. Most people unfortunately, spend too little time on this. They won't haggle, negotiate or simply walk away from the purchase. And the consequences of such nonchalance are seen in years and decades ahead.

Your thoughts?

Thursday, November 20, 2008

$50 Oil is here....

and is very likely to overshoot on the downside. Is $40 or even $30 possible. Why not? If 3 months ago anyone questioned that oil could go below $60, he or she was termed fool, like several posters here. Too bad people have such short memories. Even the champions of doom and gloom such as Garth Turner buys into 'higher long term energy costs' while we are in an ocean of deflation. But just yesterday, the DOT reported that the number of miles driven has fallen by around 5 per cent in the US in September. People are now saying, "anytime you drive your vehicle and it's not for work, you are wasting money." Ouch. With the prospect of a multi year bust and double digit unemployment, where is the demand for oil going to come from? The Chindia bull is dead for the moment, but who knows.
In the mean time, our province faces more fundamental problems- What will Alberta do once the oil sands engine is cold? Not much. All the diversification attempts have come to a naught with a merciless exodus given to all non oil and gas companies. Intutit, Dell, TD Call Center and many more have left the province(or even Canada).
Now that the bubble inflated by artificial supply of credit and fake demand for worldwide commodities has burst, are we going to revert to our core competency of selling cheap manufactured goods to the US, attracting US tourists based on a 70 cent loonie and handing out film tax credits? It should not be outside the realm of possiblitiy. It was after all only 4 short years ago that Dell when opening its Edmonton location even refused to pay for training its new recruits. Such was the state of desperation for new jobs in Edmonton. Any big corporation will now be extremely reluctant to take advantage of massive unemployment and cheap loonie anywhere in Alberta after our success in driving out most non-energy companies out of here. And for that, the primary reason was wage inflation driven by high cost of living created primarily by the high cost of housing. Perhaps Alberta government should do something about reining in the speculation in Real estate based on subsidized mortgage products.

Monday, November 17, 2008

Welcome to the New World

We are back after spending a week in the US. The US has changed quite a bit since our last visit almost a year ago. From waitresses in Manchester, New Hampshire who offered suggestions on getting special combo deals for breakfast as ‘every cent counts’, to the sales clerks in Wrentham, MA who hugged me to buy lots of things on the Veteran days sales, it seems like the deflation reflected only in the asset prices so far has finally found its way into consumer items as well. Hotels have become a lot cheaper as well. We stayed in decent Holiday Inn and Mariott rooms for less than $70. Of course, unlike most Canadian hotels, these were large, nicely furnished rooms with flat screen TVs and included breakfast. In booming West though, you only get a roof over your head for this much price, that is if you are lucky.

A retail sales associate in Nashua mall checked on me at least three times to make sure I found what I was looking for. Obviously, with low sales volumes, everybody is scared of losing their job. And what better way to ensure job security than actually doing what you are paid for! What a novel concept. I don’t really recall sales reps being this good in the last ten years. Of course, Albertans are still living in their fantasy land and the nonchalance of sales reps is still very conspicuous in almost every place where I shop. While taking the delivery of my Accord I casually asked the sales manager if their sales were declining and she remarked, “Yeah, there’s a little slow down, as some people see all this gloom in the US and get worried. But it’s their economy and not Canadian economy!”
Of course, she will be learning some painful lessons in economics and firmly grasp that ‘we are all dependent on the US economy’ the coming months as oil prices drop below $50 in the coming weeks and months.
A friend of mine who has family in India says things are getting gloomier there by the day. Perusal of the economic press there talks about major reduction in workforce, fall in real estate, stocks and pretty much every other asset class.
Remember the decoupling theory? Nobody wants to talk about it anymore. It is in graveyard along with the titans of Wall street. It was the ray of hope for the world after the US housing bust, even though the entire world’s growth was piggybacked on the insatiable US (and perhaps other first world) consumers. Remember India was going to save Alberta. And China too. Now that these countries are looking for their own saviors, who is going to save Alberta? Yes, the OPEC production cuts. But didn't we have the second largest reserves in the world? Can't we do something about it? I guess almost every oil company is going to do something about it and the answer won't be to the liking of anyone whose fortunes are tied to high oil prices.

When I look back at things, I could never have imagined they would get this bad. I thought the biggest swindlers and crooks on Wall Street still had everything in control. But I guess with TARP firmly showing up on their balance sheets, they couldn’t care less for the fate of the main street or the rest of the world.

In the coming months and years(hope not), those who possess cash will be in a lot better shape than those who don't. The inflationary period characterized by too much money chasing too few goods (houses, stocks, oil, cars, labour, art work, RVs, boats, carry trade currencies) is definitely over. In the new world, cold cash will rein supreme and those who possess it will have the upper hand over those who have no cash but possess too much of stuff (stocks, cars, houses, debt, art work, RVs, boats etc). The latter group unfortunately represents bulk of world’s population today (exceptions in some parts of Europe, Asia etc).
Too bad nobody in Canada will wake anyone up on what’s about to be unleashed on everyone pretty soon-government hiring cuts, tax hikes (GST going back to 7%, when?), budget deficits, falling loonie, house prices cut in half, high unemployment….
After all, it's only today that the economists in the US have managed to agree that the US is in a recession. So much for the foresight and wisdom of the dismal scientists.
The list is long and painful. Only those who were characterized as the doom and gloomers (including yours truly) who have had nothing but cash in their account for the last several years have been proven right. Not that I’m happy about it.

Saturday, November 8, 2008

How did we get here? And where do we go from here?

Things have changed so much since this blog was started in February 2007. There was euphoria in the markets at that time. The housing bubble in the US had burst, but the sheer magnitude of the devastation it would unleash, as well as its ramifications on the rest of the world had not been anticipated by most observers. Only those in the 'borderline insanity' category had the prognosis of the disease whose symptoms are now becoming visible.

The disease was easy credit abetted by the viruses of greed, speculation, leverage, stupidity, lax regulation, hubris and ignorance. In almost every asset class in almost every part of the world, there was an asset bubble. From the trailer homes in Fort McMurray to the art market in Eastern Europe, from the high end apartments in Bombay to the stocks in China. Easy credit of last twenty years gave high hopes and ‘can’t go wrong with xyz’ mentality to almost everyone. There was 'death of risk.' Even know, despite all that has transpired, morons are dime a dozen, who want to borrow and invest in Canadian stocks.

The period of easy credit is over. And so is the period of feigning low risk by absurd mathematical models created by armies of glorified economists. When I try to put a perspective on the massive oil sands related investments that had been planned for Alberta, I see that they were fueled more by the easy credit and low risk environment than by any fundamental factors. Most readers are familiar with Warren Buffett’s comments (paraphrased) on oil sands that ‘you could be the best mining engineer in the world, but if you are not sure that the price of oil would be in the $120 range, oil sands may not be the best investment.’ Of course, the temporary high prices speciously bolstered by the doomsday scenarios (but fundamentally caused by speculation and leverage) gave enough reasons to almost all underwriters to finance the billions of dollars of projects easily. As the price of oil comes down further, oil sands will be get hit twice as hard inasmuch as they are very high risk investments (environmental, economic, currency) amortized over very long periods. In easy credit environment such investments could be financed easily but in tougher environment where cash is the most precious thing anyone wants to possess, such projects become akin to financing in year 2001. Not impossible (there are always some fools around), but very hard. I trust bulls in Alberta and Canada have at least that much intelligence to figure out the ramifications of significantly depleted oil sands investments on the province, the loonie and Canada as a whole.

Cash really will be the king, as I have tried to mention numerous times in the past. Deflation really is strengthening its hold and there’s nothing central banks can do about it. The sins of past have to be absolved for; and the time to do that has arrived. You just can’t weasel your way out of the bad karmas of credit orgy so easily.

Being early in the deflationary bust cycle is one common mistake most people will make. Yesterday, even I committed such a mistake. No, I didn’t buy a house, but I did buy a new car. I thought I was getting a great deal-Almost $5k off the sticker price of a Honda Accord. But giving up almost $25k in cold cash from savings account did not feel very good. But my rationalization was that my old civic is almost ten years old now and hasn’t been reliable. And I needed to reward myself (yeah, the same North American malaise that leads to the current mess)…Perhaps, I will look at my Accord whenever the temptation of buying a house comes to me in the next few years.

Now the mainstream media is catching up with the sea of negative news that was predicted here and at so many other blogs. Pretty soon, it will be self reinforcing cycle. An economy that is driven 70% by consumption will feel the pain when people stop buying cars and houses, reduce their vacations, minimize eating out, stop buying expensive clothes and desert the malls. Businesses will start laying off people and the anti-goldilocks economy will be at work. Businesses dependent on retail companies (IT, Human Resources staffing etc) will cut down their investments and hiring, making things even worse. And all this while the central banks have interest rates at zero.

Yet, all this is necessary for the revitalization of the economy. The inefficient and diseased corporate hierarchies of North America and much of the first world need cleansing. The FIRE based economies of First World need real savings, real production and real wages.

The coming bust will be a hard one. Unemployment will be high, bankruptcies will soar. A lot of generation X and Y kids will learn painful but much needed lessons. By the time this is all over, savings in bank accounts will not be derided upon.

I’m flying to Boston for a week long vacation to escape from everything for a while. Have a great weekend.

Monday, November 3, 2008

No Subprime in Canada yet Sales Plummet in Calgary

I've been very busy last week or so....this post from 'rjt' puts things into clear perspective:

If you read my posts over the past couple of months, I predicted that the end of 40 year mortgages and zero down mortgages would create a major gap in buyers. I figured that since 40% of mortgages originated in Calgary in 2007 were the 0-down, 40 year variety, when these went a way, sales would drop substantially.

Well, the numbers are out, and while there are other factors in play, it appears that sales volume did fall off a cliff in Oct 2008.

Sales Volume (old criteria of combined SFH and Condo, from BT’s site)

Oct 2001: 1821
Oct 2002: 1930
Oct 2003: 2021
Oct 2004: 2135
Oct 2005: 2584
Oct 2006: 2122
Oct 2007: 1944
Oct 2008: 1442

How about days inventory?
- This is calculated based on month end inventory from BTs site, divided by monthly sales, multiplied by 30

Oct 2001: 101
Oct 2002: 95
Oct 2003: 121
Oct 2004: 100
Oct 2005: 46
Oct 2006: 96
Oct 2007: 154
Oct 2008: 226

Look at Days Inventory over this year. Impressive October!

Oct-07: 154
Nov-07: 148
Dec-07: 148
Jan-08: 134
Feb-08: 131
Mar-08: 148
Apr-08: 162
May-08: 171
Jun-08: 159
Jul-08: 160
Aug-08: 167
Sep-08: 161
Oct-08: 226

A huge number in October 2008, way above anything we’ve seen in Calgary since at least Jan 1999, which is where my data set begins. The second closest month had days inventory of 171 (May 2008).

People, disregard the spin from the media about a “balanced market” and “normalization” and all those other bullsh-t sales pitches. If you are in the market for a house, make sure to low-ball big time, as you are likely the only potential buyer by a mile.
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