Bad Karma- Consequences catch up with you, eventually

India is now the new diabetes capital of the world. Cases of hyper tension, diabetes and its subsequent consequences are common place here. But the street vendors and high end shops that sell low quality sweet junk and other similar Trans fat full crap are doing bustling business, even in these recessionary times. A local friend of mine has a cousin, who has been diagnosed with end stage renal failure and is expected to undergo a transplant in the next few months.
Yet, few people are concerned. I’m told that 20 years ago end stage renal failure was less common and people used to get worried over such prognosis. But not anymore. There are millions of people who have bee diagnosed with end stage renal failure and other complications that arise from hypertension and diabetes. Yet, both these chronic diseases are taken lightly. Why? If you are wondering what all this has to do with Alberta or Canadian real estate, please bear with me. At the current rate, roughly 1 in 10 people in Delhi have been estimated to be affected with Diabetes. A combination of bad genes, bad diet and lack of exercise has made this disease an epidemic here.

This is as much a social phenomenon as much as it is a public health problem. People are no longer worried about diabetes, hypertension or kidney disease because it’s normal to do so. The consequences- a drastically shortened life span and poor quality of remainder of life are not given much thought.

What does this have to do with Alberta real estate? A lot, in terms of the underlying psychology.
The Western economies have been afflicted with similar diseases. The severe addiction to debt- zero down housing, cars, massive funding for student loans, consumer credit, multiple credit cards-is similar disease. The consequences, which could especially be ‘at some point in future’ are not given a lot of thought. Especially because everybody else around you is doing it. The underlying human psychology is built primarily around ‘fight or flight’-things get our attention only when we see an imminent danger. Deleterious consequences especially that might happen at a time in the not so visible future are generally disregarded as ‘pessimist thinking.’
The sharp rise in housing sales this year in Canada is equivalent to the behavior of a diabetic patient who has been advised by the sane doctors to curtail the carb consumption, yet he increases his insulin dose and goes on a carb eating spree. Because at this very moment he doesn’t see any ill effects other than a few higher than normal medical test numbers. And this is considered ‘normal’ because he sees a lot of people around him doing the same thing. But in the slightly long term (anytime after immediate today), there will be repercussions. More debt today will result in greater pain tomorrow. Slower growth, higher taxes, higher unemployment and more bailouts. All leading up to end stage renal failure which might require a very painful transplant. Unfortunately, we do not know the treatment from this end stage debt bubble collapse.
Too bad, it is very hard to dissociate yourself from the less responsible in the society. We’ll be paying a price for the zero down mortgages, 35 to 40 year amortizations, and continued rise in prices. Even though we were responsible and did think of ramifications of our actions.

On a different note, I’m back in Alberta after spending a few months in India. Blog entries will become more frequent now.

Weekend Open Thread

I woke up this morning to hear not so positive news on so many fronts. The chicken are coming home to roost now and the years of credit excesses, leverage, denial, 'Greenspan Put' and speculation are clearly hurting the mainstream economies both in Canada and the US.

• US unemployment rose by over a whopping half a million. Worst since 1982. Bye Bye Goldilocks economy. Bye Bye quick recovery.
  
• Canadian unemployment rose by 77,000, a much worse number than the US if we account for population.
  
• The West is fairing better at this time, but it's only a matter of time. Layoffs are occurring at GE, Jacobs etc and the full effect of the ensuing commodity bust is only starting to getting felt.
• Oil is at $43 and more importantly natural gas is below $6. A fall to $25 and $4 will kill the economy of West in a replay of 1982. But 1982 will look like a picnic as compared to what's unfolding right now. Just for perspective, the 1982 recession was 18 months long. This recession is already 12 months old and until recently leading economists did not even admit that there was a recession. And Canada is only in a 'technical recession' as per our esteemed leaders. Expect things to get much worse on the employment front with a double digit unemployment rate a very real possibility.
  
• With manufacturing tanking and the commodities bust about to show its ramifications, what's going to happen to the real estate? Not a very pretty picture.
  
• The bust is here. It can't be wished away and most readers of this blog knew what was coming. Yet a few delusional ones bought and even had the chutzpah to lure others into buying by making specious arguments. With a grim employment picture, it won't take much convincing to anyone to put off buying homes. Or will it? When people have sleepless nights before signing on the mortgage papers and committing themselves to a debt for 25 years, we'll know the market has become normal.
  
• Finally, the loonie is down to 77 cents and change. The true companion of $25 oil would be a 65 cents loonie. So much for the collapse of USD.
• And here's a little bit of humour on this otherwise gloomy news day(from Calculated Risk blog comment post):
  

Lawrence Livermore Laboratories has discovered the heaviest element yet known to science. The new element, Governmentium (symbol=Gv), has one neutron, 25 assistant neutrons, 88 deputy neutrons, and 198 assistant deputy neutrons, giving it an atomic mass of 312. These 312 particles are held together by forces called morons, which are surrounded by vast quantities of lepton-like particles called peons. Since Governmentium has no electrons, it is inert. However, it can be detected, because it impedes every reaction with which it comes into contact. A tiny amount of Governmentium can cause a reaction that would normally take less than a second, to take from 4 days to 4 years to complete. Governmentium has a normal half-life of 2 to 6 years. It does not decay, but instead undergoes a reorganization in which a portion of the assistant neutrons and deputy neutrons exchange places.

Have a great weekend everyone.

Is the beginning of the second leg down in prices?

Residential Sales plummeted across the board in Edmonton and Calgary last month. The first drop in prices last summer was preceded by a sharp contraction in sales volumes from the bubble level sales.

While condos in both Edmonton and Calgary saw a sharp drop in prices, an across the board massive drop in value hasn’t occurred yet. Like a ten per cent fall in SFH values in Calgary or Edmonton in a month.

With the psychologically important oil prices below $50 and environmental pressures mounting in the face of an ultra liberal government, oil sands might not be the saviour of Alberta Real Estate after all.

If sales fall further in December from the levels seen last year, it’s possible that we are now going to see the second leg down for the real estate prices. And if the macro economic picture and commodity bust unfolds as I’m afraid it might, the spring bounce that so many sellers and realtors are counting on (yet again) will be more ephemeral than a mayfly.

Global Demand Slowdown

...is happening at a fast pace. Canada has been one of the biggest beneficiaries of the boom in China, India and other fast growing emerging economies. But it looks like something is finally beginning to give in after years (or decades) of relentless growth.
Here's an interesting link on how Chinese importers are defaulting on Iron Ore purchases from India:
"Our exports are in deep red as there is no demand from China," said Rahul Baldota, president of the Federation of Indian Mineral Industries and managing director of miner MSPL Ltd.
Exports in the first half of September dropped to 1.99 million tonnes from 2.7 million tonnes in the same period last year.

FT is also reporting on the same item as well.

At least a few in Canada are taking notice of this:

That may sound like a manageable slowdown, but if China's economy hits any serious roadblocks, it won't take long for Canadian investors to start feeling the pain, given that nearly half of the benchmark S&P/TSX composite index is made up of resource stocks.

Island of Alberta should remain intact in the financial maelstrom though. Just ask any realtor or mortgage broker trying to lure the 'greatest fools' into a 0 down 40 year mortgage.

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.

Inflationary Scenario

Quite a lot has happened in macro economic world since I wrote the ‘deflationary scenario’. While there are still quite a number of deflationary proponents holding there ground, the mainstream economists and pretty much all the central banks are getting perturbed over rising commodity prices. And for once, their words have some meaning as demonstrated by Bank of Canada holding interest rates steady, increasing the probability of rate increases in future. Just a couple of months ago such a scenario would have been unthinkable amidst all the talk of the global credit crunch.

Clearly, Central bankers in Canada, UK and the US are afraid of 1930s style deflation, but they are also not comfortable with the 1970s style stagflation. I guess they are stuck at a Morton’s fork point- raising rates will further worsen the housing market and create problems but keeping status quo will further raise prices making things much worse for them.

The implications will not be salubrious for the health of Alberta and Canadian real estate. Inventory is at highest levels ever seen, sales at levels close to the lowest levels for this time of the year. Meanwhile, new product is still coming to the market at a pace far faster than markets can absorb. Meanwhile, the nouveau landlords are learning some painful lessons on the 'joys of becoming a landlord.'

One of the scenarios that was often discussed on this blog was a disruption in the oil sands development in Alberta (environmental issues, commodity bubble bust etc) leading to a significant deterioration in the Alberta real estate market. The inflationary scenario, if it bears fruition, will lead to a direct impact on the real estate market. It could make properties that are ‘barely breaking even’, bleed cash profusely. As interest rates go up, a lot of speculators and double property holders who are somehow holding on to their properties in anticipation of a rebound of prices to Spring 2007 levels will likely capitulate.

Rising interest rates could expedite the widespread decline that has been so far avoided.

How likely do you think is a rise in interest rates?

Guest Post- Why I am bullish on Alberta real estate!

As mentioned in my last post, any bull or bear who is interested in making a guest post to this blog is more than welcome. Of course, your identity will be kept anonymous if you wish to do so. This post was contributed by a poster who particpates on this blog as 'linnaeus'. Contributions are welcome at albertabubble@gmail.com

Let me start off by saying there is no attempt at spin here. I am not a real estate agent. I grew up on the edges of the business since one of the things my father did to support us was house appraisals and he started teaching me how to do it while I was still in elementary school. Eventually I did appraisals on my own.

We currently rent in a gorgeous neighborhood where we can walk or take the bus everywhere. We pay less than fair value because the house is old and not in very good shape. We also own farm land I lease out and am looking at buying more. We are planning to take the income coming off that land and buy a house in Sherwood Park. We are also looking at buying an apartment building in Edmonton (older) and restoring it. That isn’t a money making proposition, the finished development will be a community housing co-op.

I am proud to say I am one of the green fraudsters that carioca canuck rants against. I work hard at trying to reduce my footprint on the earth, recognizing it is still much larger than the world average. However, I am also a small business owner who hopes someday to be a large business owner. I have lived in the sun, on the beach. I hated it. Give me snow and sub zero temperatures any day Brent.

I say all this because based on a long observation of this blog I know most of the responses to this post are going to be negative and a frighteningly high percentage of them will be ad hominem attacks, so I am trying to make all my biases crystal clear up front.

So what is my argument for being bullish on Alberta real estate?

One of the services I have provided almost from the beginning of my business life is reliable forecasts for real estate in various communities throughout western Canada.

In more than thirty years of forecasting real estate I have learned that forecasting is never a simple linear process. I am sure this shows in my posting which tends to consist of various versions of don’t be so sure you know what is going to happen. There are two prime determinants of real estate price. The first is employment. High employment tends to lead to high prices. The second factor is related to employment being people’s expectations for the future. If people are optimistic then prices generally rise. If people are pessimistic prices fall.

I think people in Alberta remain pretty optimistic about the future and employment is at an all time high. Could that change? Of course it could. A deep and prolonged US recession certainly would penalize Alberta’s economy, especially if the Canadian dollar remained at par or above in comparison to the US dollar.

I don’t think it will change. That is because Alberta’s economy is poised to out perform the rest of Canada and the US. Everybody’s economy is slowing. It is just we are maintaining our relative edge over everybody else. That will lead to Albertan’s being relatively optimistic which will keep the wheels turning here.

It doesn’t matter whether you are a CEO or a secretary you make many life decisions based on your sense of optimism and in Alberta the majority of people think the sun is going to rise tomorrow and go right on shining. The CEO’s will continue, by and large to try and raise capital and push forward with development of their business because they think, on average everything is going to be okay. That is just human nature. Ironically, the more optimistic we are, the more our relative advantage is going to grow and the more optimistic we will become. The believe things are better here draws both inter-provincial immigrants and those immigrants will contribute to the on going growth.

Demographics will also play a role in driving Alberta’s economy forward. Baby boomers, of whom there are quite a few in Alberta, will continue to look at second homes in vacation spots. They will also continue to retire. This will lead to labor shortages which will lead to more people moving here.

Greed and stupidity has led to a housing affordability problem. I am not denying that. Housing prices relative to people’s income needs to correct and dramatically. Having crunched all the numbers and spent days debating what the difference in housing purchasing behavior in Edmonton and Calgary means I have concluded that there is going to be a long period of relative stagnation in real estate in both cities (though played out in different ways).

In Edmonton we are seeing a search for value on the part of buyers. There is a tight clumping around the median price. That median is slowly sliding lower for sfh and rising slightly for condos but in both cases price per square foot is falling. Many sellers are responding by letting their houses delist and buyers are responding by adopting a wait and see attitude. Inventory is rising but only slightly. Completed deals tend to be on properties that offer value relative to what the market was doing six months ago. This has all the hall marks of a long flat line in prices that one day will again meet the long term trend lines for housing affordability. It is in no way a bust and quality is still finding buyers. Statistically this is very different from what happened in Florida or Arizona. The market is, however, over built with many new properties coming on line. This over build will lead to a more pronounced drop in price per square foot and probably median prices in the short term. Rents remain at about half of comparable mortgages and while average asking rents are going up so are vacancy rates. Commercial real state development has, after a very brief spurt, all but petered out again.

Simply put, stagnant status quo is the order of the day in Edmonton. This is a blue collar town and a deeply conservative one in terms of fiscal thinking. While things are stagnant there is very little panic. Over time inflation will bring us back to earth.

In Calgary a more interesting picture is emerging. Commercial real estate development, despite a huge over build goes racing ahead. Median and average prices are both going up. This is because completed sales, while few, tend to be clumped in the upper percentiles of real estate value. Relatively little low end real estate is moving. This is all typical of a market that is susceptible to significant short term correction. In other words, Calgary may be on the edge of a collapse in value, a crash, a bust. New listings are high, delistings are low, sales are very slow and the rich are selling out. It looks a lot like Arizona and Florida.

Why then am I bullish on real estate? First of all you don’t buy real estate, or shouldn’t, to resell it tomorrow. It is a long term hold, a place to live in, to call your own, or to use as a vacation getaway. It can also be an investment, particularly if you are a landlord. At the moment I wouldn’t be buying property to rent in either Edmonton or Calgary and neither would any other shrewd business person, the return would be awful, especially in comparison to the return. I am looking at buying a house to live in as I said above. However, if you bought a house more than two years ago and are renting it out I can’t imagine any reason you wouldn’t be happy right now.

That is because no matter how bad the depths of a recession, even a depression reach several decades from now Alberta’s economy will be back here on this mountain top. In the meantime the mountain will have grown and be higher than ever. This is because we won’t be a half trick pony, not a one trick pony either but one of the world’s most dynamic and diversified economies.

I am a devotee of the concept of peak oil. We are going to run out one day. The closer we get the more valuable the tar sands are. However, much more importantly the more valuable Alberta’s other resources become. We have coal which can be burned clean if we want to invest the money. We have sun, we have wind and already we are exploiting these resources in small ways, ways that will grow over time. Most importantly we sit on, and most people don’t know this, vast geo-thermal reserves. Under the ground in Alberta is enough power to fuel the entire world. Then there are gigantic iron deposits, and other non-precious metals the energy under the ground in Alberta could be used to turn that into steel and other products. There is a large uranium resource available in Alberta if we decided we wanted to exploit nuclear energy. Our forests are a resource we could rebuild, renew, and manage for many centuries to come as a stable economic engine. Agriculture keeps reinventing itself and will in time learn how to get by without current petrochemical inputs and it is here I think Alberta will become a leader in energy efficiency.

What I am trying to say is increasingly we live in a world of high energy inputs and Alberta has the energy. This is indisputable. We need to manage it smarter and learn to avoid these outrageous booms and busts. We need to figure out how to develop it while protecting the environment. These are not impossible targets. Humans have an amazing capacity to learn and adapt.

Bluntly but, the future belongs to Alberta, unless we really screw it up. As long as we aren’t total morons in the long term real estate in Alberta will re-engage the long term trend lines and then slightly outperform it. What happens in the short term is quite another matter.

I think there are so many people in Alberta who purchased housing when it was affordable that the 80,000 property owners that will be feeling the pinch can’t drive the price down to the levels of the late 1990s, there just aren’t enough of them, and even some of those will struggle through. Is it going to be pretty? No. Is it going to be catastrophic? I very much doubt it. Will real estate ultimately rebound? Absolutely.

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.

Revisiting Fundamentals

Edmonton market has slowed down substantially as the forthcoming numbers will attest. Calgary is holding better for the moment, but we’ll see how it holds in the coming months.

Inventory in both cities is now over 10,000 including the commission free listings. Based on my rough calculations, at the current rate of sales, Edmonton has at least 5 months of inventory and Calgary has around 4 months worth of product.

In Edmonton it’s hard to see ‘Sold’ Signs on listings even months after the listings go up. This is just a couple of months after the Edmonton Journal story that mentioned houses were “Going, going….Gone.”

The new mantra will be “Sitting, Sitting….Trying to Rent, Trying to rent….Rented”

And for once I do agree with Sheldon, that a number of listings have changed from COMFREE to a realtor. I’ve seen it happen in a few places, but I can’t say that the change brought any positive results, yet.

So why is this market imploding? On paper Alberta is doing wonderful, except for perhaps the Natural gas industry. Oil is still at historic highs and barring some catastrophic event, it looks likely that all the oil sands investments are going ahead full steam. People are still moving to Alberta, though not at a vigorous pace seen last year. But net migration is still positive. Interest rates are going up, but nothing major there either. The Alberta story is still intact. Yet, the housing prices have stopped rising. They are falling across the board in Edmonton and in certain product types in Calgary.

I guess that this market has run out of bigger fools. As I’ve harped on numerous occasions in the past, this market got the huge boost based on

• Low inventory
• Sudden surge in Demand from real people
• Dramatic surge in speculator interest who believe that housing prices will increase by at least 30k in 2 months holding period.

Otherwise, is there any reason why on a fundamental basis prices should be so high in Edmonton, Calgary or of all places in Lacombe? It’s all a short term phenomenon that is going to die in the coming months and years. With our without any major ‘shock event’ occurring.

To recapitulate, why I think this market is overpriced:

• Abundance of land. All cities in Alberta can expand for hundreds of kilometers in all directions. There is no shortage of land. The current increases in prices are purely speculative.
• Abundance of building materials. The shoe box houses and condos that are built here do not require raw materials that are shipped from across the world. The bulk of raw materials come from our own province and from BC. Timber prices have fallen significantly since the US housing slowdown and this trend is likely to continue.

On the flip side, the primary fundamental reason for the rise in prices is related to the non-availability of cheap labor. As and when that happens, one of the major fundamental factors will have corrected itself and the market is likely to fall.

Of course, other than these fundamental factors, there are other reasons based on the market condition itself. Pretty much all the good news is already priced in to the real estate prices. Every builder and his cow know that there are going to be upgraders built in the area. So does every new ‘investor’. Unaffordability is severe. Price to rent ratios too high.

The bulls and speculators are all holding on hoping for a magic turn around in their favorite season. They are counting on a sudden surge in sales that will reduce the inventory from all time highs in a few months. It may not happen. They should all prepare a plan B.

Can the MSM really influence the market

...by hiding bad news? In financial terms, that would tantamount to withholding information from buyers of a product/service. Or the case of information asymmetry. But if the 'participants' themselves are the masses, we should not be surprised. They probably really want to hear nothing bad, other than the usual squabbles between liberal and conservatives. But I am digressing here.

There wasn't really any news coverage in the last few days of the mortgage fraud in Calgary that we covered yesterday.
The Mainstream media are covering only the positive stuff:

• jobless rate down

• Trade surplus up

• Analysts shrug off housing starts slowdown

I wonder to what extent can this type of coverage continue to keep people away from reality. Is this really deliberate attempt to not focus on any potential negatives of the housing market?
After all, it's really a very symbiotic relationship between banks, Realtors, builders and mainstream media. Everyone from this group gains if the housing market is strong, except for the poor buyer who gets the opportunity to get enslaved by a 40 year mortgage.
In the US too, things went on like this for quite a while before the MSM finally began reporting stuff more transparently. They had to as things just could not be pused under the carpet.
I wonder what will bring the day of reckoning to Canada. When will the bad news be 'big' or 'bad' enough that it will have to be reported. We'll have to wait and find out.

Where will the Markets go from here

Interesting discussion going on in the previous post about where the prices are headed. Here's my take on the direction on prices.
I don't really know where the prices will be in a year from now or even in six months.
Honestly. If I have learnt anything from my previous experiences, it is that Mr Market has his own mind. Markets will be 'irrational', 'stupid', 'crazy', 'maniac', 'wow', 'wonderful','bullish' or whatever you want to call it for as long as people are willing and able to pay the current prices. We could be very close to the top or we could merely be beginning. After all, Calgary can easily beat Vancouver in housing prices. And so can Red Deer or Grand Prairie. There's really nothing stopping the prices from going that high or 'crazy'.
At the same time none of the bulls or real estate agents know much about prices either, except for their guess on general direction. Late last year, bulls and Realtors were talking about an orderly 15% or so advance in the prices in 2007. We have already covered that much ground in the first two months. Could 2007 be a repetition of 2006? Why not. Or could this be the year when everything finally ends, like it did in the US last year? May be.
Nobody can authoritatively predict the future course of a market that has been disconnected with fundamentals for this long.
I remember during the equities bull market of 1990s, a lot of long term bears were frustrated and humbled for several years before the bear market finally began. A lot of them called the market top in 1996, 1997 and 1998. The 1998 Asian crisis was dubbed as 'The Correction' when it proved to be merely a blip and equities marched with vigour never seen before. Were the bears right in complaining about markets during 1996-1999? Absolutely. Were they too premature? You bet.
But will those prices reflect any fundamental value? That is the question, value investors ask. If Oil prices were to fall to $20 (not that any one's cow expects that to ever happen, but a value investor must ask such questions), would the investment still be worthwhile? Would they incur huge losses if that were to happen? Most momentum investors or flippers don't think in these terms. Most don't even understand the basics of real estate market.

Obviously, no self respecting value seeker in real estate (or any other) market would be buying in Alberta at these prices.

It will be interesting to see how far momentum will take us.

Are people becoming more cautious?

At least slightly, as per this news item.
May be the genuine home buyers are becoming more cautious because they really want a home. To live in. To raise a family.
The speculators on the other hand don't really care for fundamentals. It's pretty much a momentum play for them. If they buy a 30 year old townhouse after fierce bidding for $300 k, it doesn't really matter. All they want to do is flip it for $350 k or $400k in a few months. And they don't care much for the risk because they teamed up with a few other fellow flippers to mitigate their risk.
I've heard several stories where enterprising 'landlords' (some of who were not even born in 1980) team up with people of similar profile and start bidding wars.
The prices we currently have in Edmonton and Calgary are almost becoming highest in Canada. But on what basis? Especially in Edmonton.
What does this city really have? A few years ago when it was termed as 'Deadmonton' by a British reporter, a lot of denizens became angry. But they just couldn't really offer anything other than 'big sized trucks' and 'world's largest mall' in terms of refuting the 'Deadmonton' claim.
Edmonton is a good city to raise family. But it has very few job opportunities that can support the current housing prices. How many people can really afford a starter $400k home here? It doesn't even have the head office/corporate jobs that Calgary has. There are thousands of low end McJobs, but with those jobs you can barely afford to pay the rent.
The absurdity has to give in. When will it happen is the gazillion dollar question.

The Choices for a young family

As the mania continues in full swing in Alberta, what is a young family(or anyone looking to buy) supposed to do? I think there aren't really a whole lot of choices:

• Buy as Alberta is different, Real estate never goes down and blah...as per the case made earlier for price rises.

• Continue to rent and wait for sanity to return to markets. But rental market is tight and rents are rising in Edmonton, Calgary, Red Deer and pretty much rest of the province. This could tantamount to putting your 'life on hold' while market returns to some normalcy.

• Move to some more affordable place like London, ON or Ottawa. Or even Saskatoon. A lot would be dependent on the jobs available in a city and the career position.

What is the best course of action? What are your thoughts?

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.

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.

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.