January Numbers and other thoughts

We are experiencing the best of the times in this province. Looking around, there are signs of prosperity. Everybody is happily employed or has the best shot they ever had at getting some jobs. Some people have high paying jobs. Lending is still pretty lax and people are still getting their HELOCs based on elevated values of their ‘residential portfolios.’

Yet, the houses are not selling at the pace witnessed in 2005, 2006 or 2007. The sales to listings ratio is close to the lowest levels in many years in both Calgary and Edmonton.

Perhaps, we are slightly past the best of the times in this province.

While the media and the usual suspects are trying desperately to make a trend of an almost statistical aberration in the change in median prices (average isn't the favorite of creb itself), the reality is that if you are a home owner trying to sell your property, you have to wait for a long time to sell your property, if you are able to sell it.

There’s nothing unexpected here.

I won’t spend too much time dissecting the numbers here because it has already been done and also because it’s easy to paint the numbers as ‘half full’ or 'half empty', based on your market perspective. There's nothing conclusive yet that the bubble is deflating.

However, as honest 'students' of markets and not paid shills or 'professional' salespeople , we can look at trends and try to draw some conclusions from them.

The most important trend that hasn’t changed at all is that of continuously rising inventory and falling sales.

As per old criteria, Calgary had only 3500 or so properties for sale in January 2007 and there were over 2631 sales. A hot market.

This year, at month end, Calgary had over 8093 properties and only 1800 sales. That's almost 4.5 months of inventory and it's only January. This is without counting properties on WeList or other FSBO channels.

The price movements do not adequately reflect what the sellers are experiencing as expressed in the days of market statistic.

One of the most unusual things about the Alberta bubble has been the rapidity with which the prices rose and then the abruptness with which the prices began to fall. Even in the worst bubble markets in the US, prices did not double in less than two years. So Alberta is indeed very different from almost any other market, with the exception of perhaps Saskatoon (where Alberta equity locusts went to buy the cheap houses), that we saw price declines on the first sign of major inventory build up. The typical behavior has been inventory build up accompanied by slowing sales ultimately leading to price declines.

But the peak we reached in Alberta was so precipitous that the early declines occurred with severe rapidity, not unlike the fall of NASDAQ from its peak reached in spring of 2000. By early autumn 2000, NASDAQ had almost recovered to over 80 per cent of its peak.

The important questions are- How will things proceed from here?

Alberta market can play out in two different ways. First one, if there’s an 'oil sands shock.' And by that, I mean the sole economic engine powering Alberta’s growth-the oil sands-is adversely impacted by some event. I’m fully aware of the overall lack of correlation between oil prices and real estate, but Alberta which used to be 1 trick pony (Energy sector comprising oil and natural gas) has now become only a half trick pony (oil sands). May be some day natural gas prices will rise and we’ll have a full trick pony again, but we don’t know when that is going to happen. There isn’t much to speak of in terms of diversification of Alberta’s economy and even though energy sector contributes around 30 per cent to our provincial GDP, it is the sector from which every other sector drives its growth. Even the ‘technology companies’ based in Alberta are based on oil and gas sector! No wonder then, if energy sector goes down, Alberta goes bust. The 'shock event' could be of environmental, economic or political nature. If that happens, things will become pretty bad and we’ll probably have to look back at the Alberta of early 80s or the Detroit of today to see how an area that’s dependent on a half trick pony fares when that pony falls ill. Let’s hope and pray that nothing of this sort happens for it will be immensely painful for everyone around. We haven’t diversified a single bit and the unplanned growth only goes on to kill the feeble attempts made at diversification when the energy sector is roaring.

The second scenario, the more likely one, is that there’s no major ‘oil sands shock’ and things just begin to implode-like we have been witnessing since last summer. As mentioned earlier, we still have the best of the times in the province, yet people are not lining up to buy homes. Last year, when the prices were this high, there were multiple bids and the ‘investors’ just couldn’t get enough of Alberta’s real estate. Prices are roughly at the same level that we saw in early 2007 and yet there’s no frenzy to buy. The factors fundamental to Alberta’s real estate are at work. It’s still a lot cheaper to rent a place than to buy it. A house selling for over $400k is easily available on rent for around $1600 to $1800.

We have been looking at renting a bigger place for ourselves and the last few days we have been checking out places for rent. We have been to over a dozen places and every single house was bought either as an investment property or as a consequence of an upgrade. It’s anecdotal, but it clearly indicates a lot of speculative activity and multiple ownership. Speculation that was (and still is in some places) a global phenomenon. In places as far away as Southern tip of New Zealand, to the bustling cities of china, suburbs of Indian metros, resorts and villas in Spain, flats in the UK, condos in Miami, houses in Phoenix and closer home in Vancouver, Victoria and Saskatoon, it has been the same story. Funded by lax lending standards, abetted by the almost non-existent checks and balances in the financial systems, fueled by the ‘getting something for nothing’ mentality of the crowds and the greed of almost everyone involved in the real estate value chain, we saw a massive real estate bubble globally. Yet, every place has its story to cover up the sordid tale of speculative mania. So you don’t need oil sands or anything else to be a part of this frenzy.

What we saw in Alberta, more so than in any other place was a massive ‘hoarding’ of residential product. Hoarding that deprived families a chance of owning a home and improving their quality of life. Hoarding that will prevent stronger migration to this province. Hoarding that prevents a genuine diversification of the province’s economy and ultimately leads to a less than stellar future and extreme dependence on a single industry.

The number of properties under construction is still close to an all time high and they are still building more. The rental market is also getting pretty competitive but there’s no fear or desperation yet. People still have jobs so properties are still getting rented out, even at a monthly loss.

So, is it possible that a spring rebound can occur? Weirder things have happened. Nobody can figure the mysteries of Mr. Market. But based on the inventory levels, falling sales pattern, the extent of speculative activity and the ongoing credit cycle contraction, it doesn’t look likely.

Once again, this is not meant to be a prediction. Make your decisions based on your critical abilities and knowing fully well that you are making a 25/30/40 year commitment to live in frozen tundra (sorry couldn’t resist this after the weather of last 10 days). If you are professionals not dependent on the energy sector, there are better and warmer options out there!

I’m busier than usual and if anyone (bull or bear) would like to write a guest post, please feel free to drop a line to me at albertabubble@gmail.com.

Finally, a request to everyone to keep the tone civil and arguments logical. Remember, this is a forum to give bulls and bears 'equal opportunity' to make their case and present their side of the story without making any personal insults or ad hominem attacks. It will give the readers a good chance to make decisions without having to scroll through scores of meaningless diatribes and flame wars.

Is Alberta isolated from rest of the world?

As the markets tumble across Canada and the US and the sub-prime meltdown continues, and the US readies for a recession, we should pause for a moment and think whether any of these events are likely to have any meaningful impact on Alberta's real estate.
The 'specuvestors' will continue to believe that Alberta is different and in its own league and the entire world wants to live here and oil prices will always remain high. Their arguments may have had some merit if the market were playing on some fundamentals. As I've mentioned a number of times before, for a market that is no longer connected to fundamentals (300x monthly rent is the typical valuation these days in Alberta), any change in the underlying fundamentals simply won't matter. At least in the short run in which the real estate market has acquired a momentum of its own.
I think this market is driven a lot more by speculation, easy credit, equity locusts from BC, lure of easy money, fear of being priced out than by oil prices or trade/mcjobs. I also suspect that it will be the BC Real Estate market that will soften and then fall before Alberta experiences any real weakness.
If the MSM in Canada start talking about a US recession and a consequent Canadian recession, the falling housing market in the US, a lot of people are going to get worried. And I don't think very many Canadian banks will continue to dole out those 40 year zero down mortgages for too long.
A bull market that took over ten years in the making won't change direction or even weaken overnight.
And I will try my best to be around when all this unfolds-not so much for Schadenfreude
but for the experience it is going to provide to any observant student of markets.

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.

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.

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?

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.