“Those
who cannot remember the past are condemned to repeat it”
This blog has, unfortunately, reached its
naturally ending point. Initially I wanted to write one blog post addressing
all the issues we went over and quickly realized it would have been more than
50 pages and maybe 3 people would have read the whole thing, assuming they
weren’t drinking copious amounts of alcohol while doing so. I am a firm believer that if you are going to
make an argument or offer an opinion, at least back it up with something. As you may have guessed, each of these blog
posts required many hours of research, reading and analysis to make sense of
complicated issues and to write it in a manner than is easy for all of us to
comprehend.
We covered the most crucial topics and,
with any luck, you could deduce that the opinion expressed here was truly
contrarian – a rejection of the popular narrative that all is well in Kansas
and real-estate prices will go to the moon.
Let’s re-examine the facts one last time: our incomes have not budged
much in the last 30 years. We earn about the same yet everything costs more
like housing, transportation, schooling and utilities. To finance our lavish
lifestyles, we borrow money - a lot of it.
Our personal debt levels are at such
extreme levels than 1 in 2 families
would default on their loan obligations if their paycheck was late by just a
few days. Most Canadians could not write
a $500 cheque as they simply do not have the money in their bank account. A
recent study found that half of Canadians have only $200 at the end of every
month which leaves little to no room for emergencies or sudden expenses. Bankruptcy
proposals are increasing, foreclosure rates in sunny Alberta are increasing and
the average Canadian is relying more and more on lines of credit and credit
cards. The amount of mortgage debt has
exploded as credit became easy to obtain. Just turn on your TV, open a
newspaper or look at the ads posted to traffic light posts – easy money on
demand. We have some perverse belief
that the way to deal with extreme levels of debt is to acquire more of it.
Mortgage lenders are throwing money around
like a bag of confetti since they are protected by the CMHC in the event you do
not pay them back. The CMHC is the
ultimate moral hazard machine. CMHC is also OK if you borrow your down payment.
For those lenders who don’t utilize mortgage insurance, you can easily borrow
the entire down payment by bundling the mortgage with a sketchy underground
lender. Second and third mortgage are so easy to obtain now you don’t even need
to prove your income or assets. There are now advertisements for NINJA loans
(no income, no assets, no job, approved!) which was the exact same toxic
product peddled in the USA before their housing implosion.
CIBC is now offering “teaser loans”. Yes,
those loans which our politicians told us never existed in Canada and could not
exist because of strict regulations (you may laugh now).
There are mortgage brokers out there who
will create phony T4 slips, employment letters, tax returns and even bank
statements all for a few thousand bucks so you can obtain a bigger mortgage
than you would have qualified for.
Mortgage fraud is growing rapidly and it unclear just how pervasive it
is. Home Capital Group is a prime example of mortgage fraud and it just swept the
problem under the rug hoping no one would notice. As the saying goes, if you
find one cockroach in the kitchen, odds are high that many more lurk behind the
walls.
Many of you are probably thinking at this
point “ok, maybe there was fraud, but these loans are not in delinquency.
Delinquency are less than 0.3% in any event”.
MCAN is a company like Home Capital and they go after the same type
borrower – subprime. Most of these
companies keep very low reserves in case these loans go bad. A 2-3% failure
rate would likely sink the company. How
are these high-risk loans performing? Let’s look at MCAN’s latest financial
disclosures:
Subprime's
dirty secret - major problems with insured mortgages. Quelle surprise!
It's not just me that thinks we have
completely lost our minds when it comes to obscene housing valuations, easy
credit, and fraudulent loans. The hedge
fund guys in the US and many short sellers coined a new term for our subprime
loans: “Brampton mortgage”.
Apparently, most of the shenanigans when its comes to lending originates in
Brampton; however, it’s tentacles have now reached all over the GTA. In case
you’re wondering, these smart people call us “crazy” for engaging in such
reckless behaviour over the past decade.
Seemingly, none of us opened a newspaper or turned on the news as to
what happened in the US from 2007-2012.
Real-estate investing died in Toronto a
few years ago. All that remains are
speculators and Pitbull’s Voodoo Math – losing money every month. There are many people out there who are
carrying multiple money losing properties and paying the difference on their
line of credit or their credit cards. This suggests peak stupidity and
something that may one day make for a case study on speculative behavior at a
business school.
We are now so obsessed with real-estate
that many of us cannot max out our TFSA accounts every year which is a paltry
$5500. Most RRSP accounts have dwindling
balances as people need to withdraw from them to buy food. The fear of missing
out has turned us all into a bunch of deluded bricks and dirt fanatics.
The day will come when the last ones in
will be the greater fools. When that day
will come is anyone’s guess; it all depends on how many more irrational participants
are left in the system. As I stated
repeatedly, excessive greed will turn to fear. Mean reversion is inevitable; it is futile to
resist. History is full of examples.
Toronto
house prices from 1953-2016. Mean reversion occurred three times; are we due for
a fourth?
***
Comments received
Now would be an opportune time to share a
small sample of the comments received over the last couple months:
“You’re an idiot”
“I once thought you were a smart guy but
now I’m convinced my dog has more brains than you”
“My parents home has never gone down in
value, what are you talking about!?”
“Trudeau will never let home prices go
down!”
“You’re just jealous you didn’t buy
Toronto real-estate 5 years ago when it was still cheap!”
“Where do you get your blog pictures
from?”
I would like to thank everyone for their
thought provoking comments; they have not gone unnoticed. With respect to the last comment, almost all
the pictures came from Reddit. If you
haven’t been to Reddit, you should check it out sometime.
***
Realtors
I’ve been told that some of my comments
throughout this series appear to unfairly pick on real-estate agents, but that
couldn’t be farther from the truth. If at any point in your life you are
intending to buy real-estate, you need a qualified real-estate agent working
with you. I cannot stress this enough.
They will guide you in what is likely the most significant purchase of
your life. There are many pitfalls in real-estate and the consequences of
making a mistake are too grave to leave it to fate and HGTV. You need someone who is looking out for your best interests,
not someone else’s.
There are many legitimate, qualified
real-estate agents out there who do an excellent job. They work long, erratic
hours, many times without pay. When I purchase property, I will be using a
real-estate agent. My comments are to a very specific segment who
continue to perpetuate debunked myths. Unfortunately, their voices have
steamrolled over the rest of the industry, and, with any luck, you can now see
past those myths.
Yes, there are some bad apples out there
who will do and say anything to get the deal done, but that is with any
profession. I deal with a lot of shady
characters in my line of work, so I see it everyday. Many people complain that
real-estate agents make too much, their fees are too high, yadda yadda. Like
anything in life, you can negotiate. But remember, you get what you pay for.
***
“When
nothing is sure, everything is possible.” — Author Margaret Drabble
Let’s cut to the chase: no one can predict with any certainty
what will happen next with Toronto real-estate.
If prices continue at their current trajectory, a two-bedroom glass
shoebox will soon be worth more than 20 times the median family income and a wobbly
semi-detached off the Danforth will go for a cool $5 million. Does that make
any sense?
If you accept that incomes have not
changed much in the last generation, debts need to be repaid with interest,
shady lenders are loaning huge sums of money to people who don’t have the
ability to repay it, fraud has infected the money lending system, people are
flipping properties like tulip bulbs and beanie babies, and, most
fundamentally, we are in speculative mania, it’s probably best to think twice
before bidding on a property in Toronto.
If history is any guide, there will be a major
spike in listings as everyone rushes to “cash out” and this will be accompanied
by a sudden decrease in sales. Speculators will also list their holdings rather
quickly since many of them were simply banking on quick gains in prices, not in
the cash flow (or lack thereof).
A standoff will ensue between sellers who
are seeking top dollar that their neighbors obtained months earlier (recency
bias) and buyers will suddenly have many options to choose from. Bidding wars
will end abruptly. House prices tend to be sticky and will initially not move
much. However, if there are sellers who are forced to sell for whatever reason,
they will start to lower their asking prices. Once buyers learn that prices are
dropping there are two scenarios –
either they rush back in “before it’s too late and prices rise again” or
they avoid buying like a plague since no one wants to catch a falling
knife.
Falling prices will likely result in
lenders tightening their standards and offering less credit. In other words,
lenders will be hesitant to lend in a falling market since the underlying asset
may be worth less than the mortgage within a short time frame. Less credit
means, therefore, there will be fewer people who will have the means to buy. Fewer buyers + increase in listings will
result in prices trending downwards.
The extent of the mortgage fraud, shady
deals, and extreme leverage will be exposed as prices begin to decline. Most of
the public will be in utter shock to learn of what was going on behind the
scenes such as 100% financing, fraudulent loans, people buying several
properties and putting the monthly carrying costs on their credit cards, but
you, as a reader of this blog, will think “no surprise there”.
If you believe that incomes do not matter,
debt does not need to be repaid, there is no fraud in the lending system, we
are a world class city with world class incomes, we ran out of land, and it
really is “different this time” then you should double down and load up on as
much Toronto real-estate as you can. You will never lose according to Pitbull
and Tony Robbins.
Remember, no one can predict when we will reach a top and when we will reach
the bottom of the real-estate cycle.
***
Many people asked me why I spent all the
time and effort to write this blog and all I can say is this: I have been a
participant in several speculative manias over the years and I know the thrill
of making fast, easy money when the herd is moving in one direction. It feels great to sit back and watch your
money multiply faster than the money you make at your day job (just like those
tulip traders back in the Netherlands hundreds of years ago). By the same token, I also know the pain of
using margin accounts (borrowed money) and watching what was once a rapidly
appreciating asset one week turn into a never-ending nightmare the following
week.
Real-estate, however, is a different beast
as the players at the end of the game tend to be common folk who have little
idea how cycles and behavioural psychology work. They are the ones who go to
real-estate investing expos hosted by Tony Robbins and “learn” that the path to
easy riches is through borrowing obscene amounts of money through shady lenders
to speculate on assumed never ending house price increases. They are the ones
most afflicted by recency bias – what happened recently will happen again in
the future (rising prices).
These rookie speculators also bet the most
using borrowed funds that, if their bets are incorrect, can financially cripple
them and their families for decades to come.
This is not the case of borrowing $5000 or $10,000 to bet on a “hot”
stock; this is the signing of a legal contract to purchase a property for $850,000.00
using very little of your own money and agreeing to borrow the rest from shady
lenders. These shady characters will do
whatever it takes to get their money and will act more harshly than one of
those big banks. Remember, in Ontario we
have recourse mortgages meaning the lender can come after you personally in the
event there is a forced sale and the proceeds are not enough to cover the
remaining mortgage balance. Rest assured, they will bleed you dry.
What to do?!
When faced with any major life decision or
financial transaction, I always say make the best decision on the facts that
are in front of you. If you are missing
pertinent information, go out and get it yourself, no one will do it for you.
Do not be willfully blind to what is in front of you. Do not seek out
information that confirms what you know, seek out information that questions
your assumptions. If you see red flags,
do not ignore them! Satisfy yourself that your concerns have been addressed and
the risks are manageable. Do not accept
half answers or politician answers, you deserve better than that. Confirm what you are told is fact based and
not some leafy narrative. Then and only
then can you make an informed decision and sleep well at night regardless of
what the ultimate outcome may be.
Many of you reading this blog are friends,
colleagues, family members and others whom I have not yet met. I only wish the
best for everyone and sincerely hope everyone finds happiness wherever that may
be. There will be winners and losers regardless of what happens in this
real-estate market.
My intention was to broaden your horizons
and question your assumptions. The similarities to past events are
uncomfortably eerie; however, it does not necessarily mean it will repeat
itself in the same way. If all warning
signs are flashing red, you are free to ignore them at your own peril. I leave
it to you to decide what your risk tolerance is.
Thanks for stopping by.
