Analysis of New Home Price Index

While some people are celebrating the spring with the signs of the shoots, bottoming of the real estate market, rebound in oil prices, it could just be another case of triumph of hope over reality. Patience is the name of the game and those who are sitting without any interest in the markets can afford to wait out. There's no urgency. There's no rush.
The fluctuations in median/mean prices of new homes in Edmonton and Calgary could just be noise though the incontrovertible fact is that prices have been falling for almost 2 years now. That is if you bought anytime in 2007 or 2008, you are in the red.
The new home price index in Alberta gives an interesting perspective as it represents a more controlled set of sample space. In the index, they get information from the same representative builders/contractors who sell largely same/similar homes.

"The New Housing Price Index (NHPI) is a monthly series that measures changes over time in the contractors' selling prices of new residential houses, where detailed specifications pertaining to each house remain the same between two consecutive periods."

The new house price Index is down to 230.8 in Calgary from a peak of 248.2 in 2008. The Edmonton index has fallen more rapidly to 213.1 from a peak of 236.2 in 2008. Please not that the monthly peaks could be higher than the values I have as I did not want to give $6 to StatsCan for getting the montly data that should really be freely availalbe. And if that is the case, then the over pricing will be even more spectacular.

Given the humble readings of 137 and 147 for Edmonton and Calgary in 2005, one can easily see the 'bubble' there. From 100 in 1997 to around 150 took over 8 years, yet the index gained another 100 points in less than 3 years. And for all the arguments about increasing population etc, Alberta's population grew just as fast in 1996-2001 than it did between 2001-2006.

Why did the prices rise so much and so fast? For the same reasons it rose in just about all parts of the world. Easy credit. Speculation. 'Real Estate always goes up' mantra.

That game is over now, except in the minds of a few who are invested heavingly in real estate, either via vocation or investments. For us, we are losing our affinity to this province as we don't work in the Energy sector and our small business is taking off in a big way. As and when we decide to expand, we don't want to be based in Alberta for reasons we witnessed in the last few years. So we really have no interst in the market, except as an observer.

On a broader scale, what we are seeing now is a desperate attempt to revive the 'decoupling myth'. That's why the rush to commodities currencies, oil and everything else. OPEC has so far cut about 3 mbpd production and yet we keep on talking about supply constraints. Everyone (banks, hedge funds etc) is trying to play the same old game(lower dollar, higher commodities, rising stocks) because this is the only game they know. But alas! the numbers tell something else. Chinese exports are still falling hard (down 23% YOY) and it seems most of the stimulus China is providing is going into building more new factories even when the power consumption and utilization is all going down in the existing factories. But that's the only thing the Chinese government can do since it doesn't have any banksters to bail out.

Returning to the index of new home prices, if the prices were to keep pace only with inflation of 3% per annum, then we would see price index of roughly 143 or so in both Edmonton and Calgary, last seen in 2005. I recall that several long time investors who bought during mid 90s bust in Alberta sold in 2005 because the market was getting frothy at that time.

For a new home that is now selling at around $400k in Calgary, it's inflation adjusted price based on 1997 base of 100 should be $400*143/236 or around $242k. Remember, 143 is the inflation adjusted index based on an anuual inflation of 3% since 1997.
A similar home in Edmonton should sell for $400*143/213 or around 268k.

Which means, we are not even half way through the declines yet, assuming there's no over swinging of the pendulum to ther other side.

Recession, Oil Prices and Incogurence

Let's start with the headline of today-the Canadian recession. It's here and is gathering steam. The annualized quarterly number isn't so bad as compared to numbers of other countries, but let's not forget the lag effect. And if you recall, right until the end of October, most people were talking about recession as a 'US problem and not Canadian one.'
But if we were to annualize the December numbers, then our GDP shrank by a whopping 12 per cent. The GDP for November declined by 0.7 per cent. So for the last two months of 2008, the GDP declined by an astounding 10.2 per cent, a pretty bad showing indeed.
But this is a headline you are unlikely to find anywhere in the mainstream media as most people want to believe in the 'We are different', 'we are decoupled', 'our banks are solid' stuff.

M0ving on to oil...
There's something about oil that probably used to be the case with gold. I think several gold bugs are oil bugs now. Garth Turner for example. I like what he writes, at least most of the time, but I'm surprised how he can hold two incongruous viewpoints at the same time. He subscribes to the Peter Schiff hyperinflationary school perhaps.
On one hand he talks about falling economy, a potential depression, falling demand, job losses, massive unemployment and yet in face of that he also talks of $100 oil and a rising stock market. How is that possible? Unless he expects the recession to be short and mild, profits are not rising. And unless job recovery quickly takes hold, there will be a severe demand destruction for oil. The Chindia story is pretty much on hold, if not entirely dead, with Indian economy growing at barely 5 per cent or so in the last quarter. So what will cause a sudden spike in the oil prices? And if oil does indeed rise to $100, then at least one part of Canadian economy will continue to function nicely and that is Alberta. The oilsands investments will resume, the Canadian government and Alberta government's revenue projections won't be so bad and maritimers will flock to Alberta again. Happy days will return to Alberta and the speculators will rejoice once again. But in the face of grimmest economic news in the generation, is it likely to happen? I don't think so.

In similar vein, the oracle of Omaha who seems to be losing his way, says in his annual report that oil prices in $40 or $50 range are too low. Is he just trying to rationalize his purchae of ConocoPhilips? Or is there anything deeper in that statement.
If you recall Mr Buffett visited Albertan Oil Sands in August/September last year. At that time he had remarked (paraphrasing)"You could be the best mining engineer in the world but if you are not sure that oil prices will stay high, then oil sands investments may not be worthwhile."
Again, if thinks $40-$50 oil is not a good price, then why didn't he invest in oil sands? I find that Mr Buffett is now singing the same songs as the mainstream media about inflation, 'cash is trash', 'buy and hold forever', 'stocks are for long run' and so forth. Which is quite a departure from his old days of value investing that was clearly visible during the dot com days.

In other news, the Feburary Calgary Real Estate numbers don't stink too much. Sales, prices, days on market and pretty much all metrics are down with respect to last year.

Who could have thought this? Suncor making loss

It's probably an aberration as the prices plunged a lot faster than they had time to adjust their cost base. But it doesn't' bode well for Capital spending that a lot of Edmonton and Fort McMurray bulls had their expectations tied to.

The board this month approved a revised 2009 capital spending program of C$3 billion, with about one-third of that for “growth projects” and the remainder for the “base business,” Suncor said in the statement. An October plan had targeted spending of C$6 billion this year, 21 percent less than in 2008.

And as we have said numerous times in the past, clinging to historical highs is stupid. Suncor CEO admits,

“I think there’re some people hanging on to the history of it rather than the go-forward basis,” George said during the call.

What's the plan B for Alberta's future prosperity?

What will Oil and Gas Bust do to Alberta real estate?

Several months ago, there was a poll on this blog that talked about the ramifications of lower oil prices on Alberta. The consensus then was that anything below $50 would be bad. If $50 were bad, what would $25 oil do to Alberta? And what will be the impact of $3 or $4 natural gas?
Many educated commentators on this blog have long made the case that the Alberta real estate boom had less to do with the commodity prices but more with the rampant construction activity and easy credit/speculation.
But we can't deny that at least there was some component of the increased demand from people who moved to Alberta in search of work. Now that it looks an oil and gas bust is a fairly probable if not likely event, what will happen to all the new Albertans who moved here just for jobs? They will likely move to places (in east or west) that have somewhat more diversified economies.
I've a few friends who moved to Calgary in EPC companies from all over Canada during the last few years. The EPC companies (Colt, Jacobs etc) recruited massively in the last few years in anticipation of the hundreds of billions of oil sands spending that everyone was counting on. With almost all the upgraders now canceled or indefinitely delayed and the spectre of $25 oil seriously threatening mining projects in Fort Mcmurray, I expect massive layoffs in EPC sector soon.
And that is just the start. Even though there are still lots of jobs in Calgary, almost everything in province is built around oil and gas. We have discussed in the past how our half trick pony energy industry manages to kill everything in the boom years that is developed during the bust years.

If the commodity bust really unfolds as I am afraid it will, expect the following:

• Sharp fall in provincial government resource revenue (this will be impacted more by natural gas prices) leading to fall in government spending, hiring freezes and potential layoffs in government. Let's hope it won't be 1992 all over again for government employees.
  
• Very few oil sands projects will continue to produce leading to sharp fall in profitability of oil and gas sector and consequent retrenchment of workforce.
  
• Since everything in Alberta is built around the energy industry, everyone ranging from accounting firms to staffing agencies will be impacted.
  
• A sharp slowdown in construction employment sending the transitory labour force home.
  
• Rental vacancies climbing and reaching 10 per cent or more.
  
• Flippers, speculators and others in the same genre who have been saved so far by a strong rental market will start hemorrhaging cash and will run to exits.
  
• Start of noticeable foreclosure activity in Alberta at this stage.
  
• Combination of layoffs, falling employment, tighter credit, foreclosure will pull the prices further down.
  
• And the vicious cycle will continue.

Of course, this is not a chronological forecast of things that are about to unfold but a likely scenario that can play out in several different ways but will most likely feature most of above mentioned items.

In most of the posts in the past, I avoided making a case for collapsing values in Alberta real estate based on the fundamental economic factors. But the dreadful bust scenario is now knocking on the doors of Alberta and the last few years of greed, speculation, excesses, lack of public policy will only exacerbate the problems.
It looks like the fat lady has sung on Alberta's most recent boom.

Anyone who is thinking of buying at this time is either too rich or too stupid.

What Now?

I’m not a big fan of doomsday scenarios, but what has transpired in last week is nothing less than astonishing. The markets worldwide are in free fall. Loonie just lost 10 cents in a week (my call of going into USD was pretty good I think). The shine is about to wear off of the strength of the Canadian economy. The commodities will fall further and could push Western Canada into a deep slump. Ironically, Eastern Canada could benefit again in the backdrop of a weaker loonie. This scenario is increasingly likely to play out as the deflationary forces strengthen their grip on world economy and hapless central bankers and debt ridden governments and consumers watch the show like meek spectators.

Master Card recently recorded a 9.5 per cent fall in US gasoline sales in September 2008 versus last year’s numbers. Canadian sales held up a little better and were down only 5.4 per cent in August. I won't be surprised if sales fall further off in the coming months. October is likely to be worse. People who have just taken a 50 per cent of more haircut on their 401k and RRSP’s won’t exactly be jumping out to vacations and burn gasoline in gas guzzlers. Don’t expect Asia to be savior either-Japan is falling into its gazillionth recession in the last 20 years, China is slowing down and India isn’t fairing too nicely either.
As unemployment rises further in the US (some people are forecasting a double digit unemployment rate by the time everything settles), there will be further reduction in gasoline and commodity demand. This demand destruction will outstrip any, if at all, demand increases from the emerging economies.

The big questions are- if the clock rewinds to 2004 in terms of asset prices, commodity prices and job opportunities are you sufficiently prepared? Can anyone even imagine another bust in Alberta when most of the people around you are drowning in debt and falsely insulated by the 'home equity' gains. Or by the illusion of 'secure jobs' in the Oil/Gas industries and pretty much everything else that services it. I can't think of any industry that will pick up the slack employment wise if Oil and Gas sector fizzles again. The government depends too much on the tax and royalty revenues that basically stem from the oil and gas industry.
Too bad that Alberta manages to kill all the diversification that occurs during the bust years in less than 3 years of a boom…

Monday Market Turmoil

Despite the biggest boondoggle of this century getting passed quickly and becoming law, world financial markets are tumbling. Nikkei down 4.5 per cent. Indian stocks down by almost 6 per cent. Oil below $90 (who could have thought that?). A lot of people were speculating that Fed would cut again, but when you have so few bullets left in your armor, you do not want to waste them every time the markets fall by 5 per cent in a day. The days of Greenspan put were so good....
But finally it looks like Fed has found its match or better still. And that is deflation.
If global deflation does materialize, it will be very painful for everyone, but especially for those who carry debt. Commodities will be hit hard.
The last thing you should want to do is get into a zero down 40 year mortgage, but a lot of people seem determined to lend to people who can't save even $20k for their down payment. Yes, we don't have sub-prime in Canada.

Deflationary Week

The WSJ has a very interesting graphic on how various investments did in the last week. It was massive wealth destruction across various asset classes.



We can safely add the TSX and Canadian dollars to the asset classes that were mauled quite badly.



The most common opinion out there is that the bail out package is inflationary. But a few people, including those from the Austrian school say that the bailout package is of very small scope as compared to the massive deflationary spiral that has been unleashed by the global credit contraction.

And while those who called for oil prices to fall below $80 or so were called lunatics just a few months ago, Merrill Lynch has now released a forecast for $50 oil if the global recession materializes.

Alberta Real Estate bulls and 'Fundamentals are strong in Canada' proponents had better be prepared to handle the destruction of their favorite underlying factors(commodity boom).

Impact on Alberta Island Continues....

As Petro Canada tries to talk itself out of Oil Sands project.
The other day I was a reading a post somewhere that the recent fall in prices shouldn't impact most energy companies inasmuch as they base their investment decisions over long terms- 20 years or more. And then I suddenly wondered the giant rush to develop oil sands- an energy inefficient, economically risky and environmentally unfriendly way to make oil. All based on expectation that the prices will remain in high double digits or triple digits from here to infinity.

And since most new oil sands projects are based on the same expectations that Calgary condo projects are, the inimitable Warren Buffett in his recent visit to Fort McMurray said:
"Because you could be the world's greatest mining engineer, but if you were wrong about the price of oil in a big way, it would negate all that knowledge."

"So I can tell you that ... if you had $120 oil from now till, you know, 50 years from now, that the tar sands would work out very well. But I don't know the answer to that."

Finally, "The stage is set for Petrocan to walk away from this project. There are any number of deeper-pocketed, more visionary energy companies that will make $14-billion-plus bets on the 50-year potential of the oil sands. If control of Fort Hills comes up for grabs, watch EnCana, Canadian Natural Resources, Suncor or one of the foreign energy giants to step up."

Make that a $21 billion project (new cost), seriously impaired credit markets, slowing or contracting global economy, falling energy prices and we'll see how many brave company boards exist out there to venture into such a project.

Credit Destruction

…is here and in full force. It’s most certainly a deflationary event. The credit markets' tale of wanton and greed of last couple of decades is now ending with a bang and I’m not sure if we have reached the grand finale. Oil is already below $100, peak oil, China etc notwithstanding.
Not incidentally, China, which was growing at a blistering pace of over 10 per cent growth for the last gazillion years has eased its interest rates for the first time.
If we witness wealth and credit destruction of historic proportions, expect commodities to tumble to unimaginably low levels. Most financial institutions in the world have their balance sheets seriously impaired and the banks fighting for their survival don't make loans on overvalued, deprecating assets (aka housing).
If you think the housing sector is about to recover in the US and Canada will escape unscathed, wake up.
Enough said on this early Monday morning. A lot more influential people around the world will chip in much more valuable stuff.
Your comments?

Is this a good trade-Long USD, Short Alberta Real Estate?

The loonie has fallen by more than 15 per cent from its top that was reached last November. Alberta real estate prices have fallen by an almost similar amount since reaching their peak last summer. I expect that loonie and the Alberta real estate prices will continue to fall for a while.

So for all those ‘bitter renters’ who have been saving their money and putting it in GIC or some other investment vehicle, would the following trade be a good idea:

- Convert your GIC into USD and wait for loonie to fall further.

- In the mean time, the Alberta real estate prices are likely to fall as well.So while there is no explicit 'shorting' of Alberta real estate, the waiting itself is good enough to get the benefits.

Of course, I was so consumed by other things that I didn’t have time to do the conversion of any of my Canadian dollars into US dollars in the days of parity and beyond. The net result will be a possible double gain.

Of course, the above will go against the conventional wisdom that says US dollar is toast et.al.

But our currency is strongly tied to the price of crude and in face of clear demand destruction and recession in pretty much the entire developed world, the prices could tumble even further in the short to medium term.

Of course, with conversion to USD, you’ll likely earn less interest rates and lose the CDIC insurance benefits.

What do you think?

Inflation or Deflation

The steep fall in commodity prices in last few days, especially for gold and oil was not entirely expected. At least by the inflationists. Is it possible that this is the beginning of the unwinding of the ‘great commodity bubble?’

The simple scenario could play out this way- If we get deflation instead of inflation, commodities are going to fall. It may take a while for them to unwind, but they will fall. How fast and how hard is difficult to say.

On the other hand, commodities will be a good play if inflation or inflation expectations remain high. This has been the primary reason for recent run up in gold, oil and other commodities.

Should the US enter a severe recession, the demand for oil is likely to fall quite a bit (the 3.2 per cent YOY fall is an example). The BRIC economies have been around for a long time and still consume less than the US.

What will happen to the real estate prices here if the only support Alberta prices have got disappears? The answer may not be pretty for some people. Especially those who are leveraged and have huge debts. We are in uncertain times, and no body really knows how things are going to unfold in the coming weeks and months.

What do you think is the oil price above which ‘nothing terrible’ will happen here? What is the threshold below which we could be in the same territory as the last bust?

Is all the good news already priced in?

Thanks to everyone for wonderful comments.

Despite all the oil sands work and hype, the government will be collecting fewer royalty dollars in the coming years.
So even though a worldwide peak oil in terms of production may be a bit away, Alberta has almost certainly experienced the peak in terms of royalty collections.
Here's an analysis of the same phenomenon.

"It's tempting to ask, why worry? Oilsands production is expected to last 40 to 50 years. But the oilsands will never yield the rich flow of petrodollars pumped into the treasury by conventional oil and gas.Despite the fact that production is rising dramatically, oilsands royalties will go down, from a high of $2.3 billion last year to $1.1 billion in 2009-10.Even when production triples to three million barrels a day in 2020, royalties will be stuck at $1.1 billion, the same level as 2004-05, according to one report."

So any long term investors in Edmonton and Alberta real estate should give it some thought. What will a fall in this inflow do to government spending? And this is the story at almost highest historical oil/gas prices. What will happen if the prices were to fall in half? Slowdown? Recession? Who knows.

As I've repeated on numerous times in this blog: Oil Sands is the Alberta's story for the recent runup in prices. But doesn't everyone in the world already know about Oil Sands? Haven't Edmonton and Calgary prices become the highest in Canada after Vancouver? As for quality of life and its wonderful offerings in Edmonton, even Oilers are having trouble in retaining talent in Deadmonton!
What will a little slip in oil and gas sector do to Edmonton and Calgary? Can it take Edmonton back to where it was just a few short years ago.
Even if some of the very recent predictions for lower oil prices do not become a reality, for how long will the mad rush of oil sands developments continue? And how many jobs will be left once the capital spending phase is over.

The obvious question is: Is anyone getting into real estate even thinking about some of the above things, before buying a crappy $400k home on a 40 year mortgage?
For most people, it's the same story:

Alberta=Oil or Oil Sands=Higher Oil Prices=Higher Real Estate prices=Buy Now or be priced out forever

But I guess it's a sign of our times. Most people have drunk the 'real estate always goes up' serum and fairy tails spun by its effect still appear real.