Back to Fundamentals

I've been silently watching the "blog drama" that has been going on for the last few days. I really have nothing to say on it, except that everyone should be polite and when not in agreement, respectfully disagreeable.

Also, there were some false 'spam flags' on this blog causing it to be locked out. That's why there were no new postings in the last few days. And google blogger takes its own sweet time to manually review the blog(over a week in this case). Perhaps a lot of people clicked on the 'report objectionable' button at the top of this blog! There are may be quite a few people who want this blog to be shut down.

Closer to the real topic, inventory is gradually inching upwards while the statistical measures (median, 'special case median' etc) have moved slightly downwards. But bulls are still clinging to their original stories of "we’ve reached a permanently high plateau of prices." Or perhaps, according to them the current prices are entirely in line with fundamentals. That is fundamentals of the 'high energy prices', 'recession in Ontario', 'real estate always goes up' variety.

I came across this very valuable study from OECD that compares Canadian real estate prices to the real fundamentals-yes, the stories without the price of oil or weather in them-the price to rent ratio and price to income ratios.

Here's the link to the actual data

(http://www.oecd.org/dataoecd/6/5/2483894.xls)

It only goes back to 2006, but it should tell us a lot about the state of the market inasmuch as we do know how things were like in early part of 2007.

It doesn’t focus exclusively on Alberta, but on Canada as a whole.

Price to rent wise, Canada as a whole is only slightly better than the biggest bubble places of all-Spain. We are far worse than the UK or even the much maligned US.

Of course, as mentioned numerous times, the real estate game is that of patience. That is if you are not a get rich quick speculator spoilt by the markets of last few years. Reversion to mean is a common place occurrence in all markets, and it will happen one way or the other- either prices will drop or prices will stagnate for a long time to erode all the gains of last several years.

Bitter Renters etc

I was traveling all over North America during the last couple of weeks. Too much stuff going on and too many observations. I will try to post some of these in the coming weeks. But for now, the new ‘blog on the block’ caught my attention. The vehement bitterness along with their gratuitous mentioning of our headquarters. We took offense to the rather dilapidated structure they showed as our headquarters and decided to do something about it.

For now, we have done one thing- we are saying good bye to our current apartment and moving on to a much bigger place.


The ‘bitter renter’ part in me was getting such a sweet deal that we had to take it. We just got a brand new house (2000 square feet) in South Edmonton for a princely $1500 per month. Very similar houses are on sale in the price range of $400 to $450k.

Of course, we'll be paying someone else's mortgage, but I guess it won't be more than half of the mortgage based on the current valuations. Based on our realistic valuation metrics, we'll buy this property if it were selling for between 100 and 150 times monthly rent.

A simple buy versus rent analysis for this property shows that renting will beat 'owning' for 30 years. Feel free to plug your data here in one of the better rent/buy calculators.

Obviously, most renters these days have reasons to ask for a little bitterness- the rental deals are just too sweet.

Final thoughts for 2007

2007 is coming to an end and before starting the New Year, let’s do a quick assessment of the Alberta Real Estate situation. Let’s start from ground realities. It’s still a lot cheaper to rent than to buy. Our ‘flipper’ friends make it abundantly easy to rent a brand new house/condo at less than half the total cost of ownership.

Take this example:

Rent for $1700 per month (will probably rent for $1500 to good tenants)

“Brand New 1466 sq ft in South Terwillegar, 3 Bedrooms, 2.5 Bathrooms, 6 Applicance, Great Living Room and Dinning Room, with a Double Car Parking pad, located in the much desired, charming neighbourhood of Riverbend, close to all Shopping amenities, Parks and many Walking trails, easy access the 23rd Ave, Whitemud and Anthony Henday, no smoking and no pets, $1700/m plus util, move in any time, call Andy at 780xxx to view.”

Own for $399k.

Brand new 1466 sq ft in South Terwillegar, 3 Bedroom, 2.5 Bathrooms, 6 Applicance, Great Living Room and Dinning Room, Master Bedroom has 4 piece ensuite and walk-in closet with window, Rear Deck & Double Car Parking pad, located in the much desired, charming neighborhood of Riverbend, close to all Shopping amenities, Parks and many Walking trails, easy access the 23rd Ave, Whitemud and Anthony Henday, Immediate Possession, call Andy at xxx to view.

Based on the ‘ancient rules of thumb for real estate investing’, a multiplier of 100 to 150 of the monthly rent gives a reasonable value of the property. Even at the inflated $1700 rent and the upper end of multiplier, the value should be around $250k. There’s nothing ‘crazy’ about this valuation, less than 2 years ago, the same property would sell for around $225k or so.

It’s possible that the rents balloon quite a bit (actually QUITE a bit) to make this property a worthwhile buy.

At a higher level, Edmonton and Calgary have massive inventory for this time of the year. Edmonton will finish this year with around 7500 listings in MLS alone and over 3000 in Comfree. Of course, based on anecdotal evidence and the number of de-listings in the recent months, it’s very likely that we’ll see another ‘tsunami of listings’ in early 2008.

Calgary is no different with close to 7500 properties for sale in MLS alone with around 3000 in WeList.

Here are some points worth remembering:

• It’s still a lot more expensive to buy than to rent same/similar properties.
• Current Inventory is very high for this time of the year and will likely increase rapidly in the first few months of 2008.
• A lot of sellers are counting on a spring rebound that may not occur.
• At a global level, the credit crunch is taking its toll on the biggest banks and the lenders are becoming more hesitant to write ‘speculative’ mortgages.
• Even as BOC cuts interest rates, mortgage rates are inching upwards due to a change in the risk appetite of the Canadian banks.
• Prices are easily off by $50k for a good chunk of properties in Edmonton and Calgary. I was browsing Comfree this morning, and in Edmonton, there are tens of 2 bedroom condos available in the 175 to 250k range. Similar condos were selling in the $225-$300k range a few months ago. But just over 18 months ago, the same condos were selling in the $125k to $150k range.
• There are around 12000 to 15000 properties currently under construction in Edmonton(pdf) and a similar number in Calgary that will be finished this year and released in the market. A good chunk of these might have been sold, but given the current levels of affordability, it’s very likely that most of these were bought by ‘flippers’ and up-graders.
• Fewer people are moving to Alberta from other places due to high cost of living and the greatly diminished ‘Alberta Advantage.’
• Despite the nearly 10 to 15 per cent fall in property prices in the last few months, affordability is still very low(pdf). Very few people can own the median property while earning the median income. It was not like this just until 2 years ago.
• There are no fundamental reasons for expensive housing in Alberta. There’s plenty of raw material available nearby and almost limitless supply of land. The temporary labor shortage will be alleviated in the coming months and years. When that happens, housing prices will revert to their mean values.

If you are a first time buyer then probably a little bit of waiting will be helpful. It’s a lot cheaper to rent than to buy and of course given the above factors, it’s quite possible that the prices can easily tumble by 20 to 30 per cent in real terms over the next few years. If you are about to commit to a big mortgage (40 years?) and have waited thus far, it won’t hurt to wait for another year.

Finally, please keep the tone of comments civil. Personal attacks and redundant posts diminish the thoughtful contribution of other posters.

My best wishes to all the bulls, bears and bystanders for a healthy, productive and prosperous new year.

UPDATE:

Calgary numbers for December don't look pretty. Going by the old criteria for which we have comparable numbers are easily available, inventory is the highest for any month since late 2004. Sales too are the lowest for any month since November 2004. Thanks for quick compilation of stats Bob!

UPDATE2:

Edmonton numbers apparently look great! Everything is up, as per the numbers here. So this is perhaps the launching pad for a spring rebound. Weirder things have happened. But given the high level of inventory, noticeable reduction in sales volume and the reduction in the price per square foot numbers, I won't bet the house on it.

Some thoughts on Renting in Alberta

One of the most common arguments made by those feverishly bullish on Alberta real estate is that rents in Alberta will keep on rising. More like "To Infinity.....and beyond".
But those with more subdued opinion on Alberta's real estate know that it ain't going to happen. It hasn't happened anywhere else, even in the preposterously expensive locations such as NYC and London, UK.
Rents can't generally keep pace with the housing prices in a period of extreme price increases. In the last two years, while the average property has doubled in prices, the average rent has not. It's as simple as that. Our own rent, for example, has gone up by no more than 10 per cent in and this includes our experience in both Calgary and Edmonton in the last two years.
A typical non-neo-landlord (sorry for the phrase) accommodation has gone by no more than 30% or so. On the other hand, we see numerous rental listings as if Edmonton and Calgary have indeed become Manhattan.
This house in Edmonton for example. It is the second time this house has been listed after the expiration of the first listing. My belief is that in life you don't get what you want but what you deserve. Similarly, in the rental market, some of the neo-landlords are soon going to find out that what you get for your new house or condo is not what it takes to pay your mortgage/property tax/maintenance and other expenses (yes Virgina, there are other expenses too!). It is simply what typical renters in your location can afford to pay.
Unlike the dream of 'owning your house', having a roof over your head is a fundamental necessity. We all keep on hearing about the strong growth and new jobs and similar blah about Alberta. It's all true. But we don't have no very many jobs other than McJobs.
So what if someone offers $15 for a McJob? If the rent of a typical one bedroom apartment does go up to $1400 (as this flipper sure hopes), who will be able to afford it? We don't have an army of executives making $80k (even with that $1400-around 35% after tax income- for 1 bedroom is very steep and those moving here will have to very seriously consider the implications of their move).
So people do simple calculation-can they pay their rent, clothe themselves and put food on table-and still live in Calgary or Edmonton. If they can, they stay here, but if they can't, most will leave the province.
We have not seen too may egregious examples of these so far, because the rents have not gone up that steeply.
Plus, there is the strong competition from incumbents. Take these two town houses for example. This is a typical townhouse from a company that probably paid around $50k for it several years ago. It now rents for around $1000-1100. 2 years ago, in a very high vacancy market, similar units rented for around $700-800. This is based on our first hand experiences. This company knows its business and is simply milking the business based on strong market conditions.
Take this other townhouse.
Most probably acquired recently by a flipper for around $250-300k. Who is going to pay more than a $1100 premium for living in a newer building, especially when we live in a world when money paid in rent is considered 'wasted'.
Those acquiring properties purely for becoming 'landlords' will soon discover that even though rental market may not be very elastic till rents reach a certain value, it does become fairly elastic if rents do go beyond a certain point. People will show their 'elasticity' and move to cheaper locations. Or the wages will have to rise steeply, to keep up with the prices.
So if you are counting on minting money by acquiring a $300k condo and hoping it to rent it out for $1800 per month (and hoping for 5% perpetual increases in rent or 50% increase in prices), the end result may not be very pleasant.
The US is already waking up to this, and the sooner we do the lesser the damage. Is anyone listening here?

Update on anonymous comments: Although I'm not a huge fan of enforcing strict controls over speech, requests from those who contribute on this blog and incidents like these helped me change my mind. You'll now need to be registered to post comments on this blog. Thanks for your feedback and discussion.

Revisiting the Fundamentals...

As frenzied buyers try really hard not to get priced out forever from the Alberta real estate markets by assuming huge debts, we should ask some basic questions again.
I keep on repeating some of these posts with the basic questions because it is so easy to get confused and lose your judgement and perspective when you are surrounded by the
cacophony of flippers and 'proud' owners. If you refer to the comments here, you will hear the almost deafening noise of Canadians proclaiming 'It's different here'. The US is different. There is no mortgage fraud here. There is no speculation here. Our banks are smarter. Our builders are smarter. And only fools buy Nortel at $120.
This is a contrarian signal saying that the end must be near for Canadian Real Estate, but you never know. This much of positive sentiment often ends abruptly, but it can also go on for a while.
I also saw this the other day at this blog where the blogger was almost trying to convince himself to buy. It is not an unexpected reaction given what is going on in the market in Canada.
They are loudly proclaiming victory before the implications of the melt down in the US have
been fully felt, even within the US. This too is a contrarian sign when long time bears begin to have doubts about their own judgement. I remember that during the equities bubble of late 90s,
long time bears like George Soros capitulated in 1999 and 2000 and entered the tech stocks in a big way. And lost major amounts of money subsequently.
Investing requires discipline-belief in yourself and your investing/moral principles in face of extreme adversity. Contrarians are often ridiculed for their beliefs and investing contrarians are no exception.
Having said this much, here's my stance on the housing market in Alberta, again.
Real Estate in Alberta is overpriced as per pretty much any measure such as

• Relative historic norms.
  

• Earning capacity of Albertans
  

• P/E ratios using rental yields.
  

• Traditional metrics of real estate valuations (multiple of monthly rent of 100 to 120 times)

Even though there is short term shortage of quality accommodation in several cities in the province, there are hundreds and thousands of vacant condos awaiting further flipping. The flipping will have to stop at some point of time and someone will have to assume the role of 'landlord' and start chasing after tenants and collect rents.

Out of province buyers and new immigrants who are not familiar with 'good' and 'bad' locations of a city are buying the worst homes at worst locations due to the extreme fear of being priced out forever. They don't realize that once this mania ends, they'll be stuck with assets that will simply be illiquid.
They may have to give those away as no body would want to live in those parts of the city.

At the same time, many new 'landlords' and first time buyers are unaware of true costs of ownership. Their decision are being made on the basis of fear and greed and not rational thought. I have seen people who have barely lived in this country for a year go on and buy $250 homes with 5 % down payment. May be their immigrant work ethic will save them from trouble, but did they really have to buy?

So anyone who is about to capitulate, here are some questions you should honestly answer yourself:

Assuming you can discount(no pun intended) the above mentioned valuation reasons , do you really need to buy?
Are you buying because you think you will get rich?
Are you buying because you think you will be priced out forever?
Do you think real estate prices will always keep on increasing?
Do you think the rent for a 2 bedroom apartment in Edmonton and Calgary will hit $2000?
Do you think you might get better opportunities of work by moving to some other place?
Do you think you can create a small business by moving to a much cheaper place?
Do you think you can take a $20k pay cut and move to a cheaper place?'
Does renting really suck so much?
What will be the impact of 10-15% annual rent increases to your bottom line in the next few years?
Do you think assuming a debt of over $300k for 30 years will make you happy?
Do you have skills as a minor 'handyman' to fix problems with the 27 year old townhouse you are about to buy?
Do you have time to shovel all the snow that will be on your driveway and sidewalks?

I think if you answer these questions honestly, your urge to give in and buy will be reduced. Mine sure did :)