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October 15, 2018 | Gravity

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Well, remind me to never again write about climate change. Or Trump. Cannabis. The stock market. The UN. Bonds. The Fed. Gold or guns.

Dogs seem okay, though. Plus hormones and real estate (sometimes). If I stray into other subjects and I’m sure to be ripped a new one by all the macroeconomists, political scientists and Nobel Laureates who have pilgrimaged to the steerage section of this pathetic blog. We are blessed to have you all in one place. Just like a Texas juvenile detention centre. Fun!

In a moment, some insight from a realtor, of all people. First, this piteous letter just arrived:

The last time I e-mailed you, you posted my e-mail on your website and basically made fun of me for not being financially responsible. I am e-mailing again because my situation has changed and I want some advice.

I’m looking for a plan for a young couple to cruise into retirement. Can you help?

We are currently living in Calgary. I am a teacher (28) making roughly $85,000 a year; take home cheque is roughly $4450/mt. She (27) is a nurse making $65,000 a year; take home cheque is roughly $1600/bi weekly.  We have about $16,500 total in TFSAs and $7,000 in an emergency fund in a savings account.

We own a 1000 square foot bungalow purchased last year for 375,000 ($350k mortgage). Houses around selling for that still. We also own a condo purchased in 2015 for $300,000 ($210k left on mortgage); similar units now listed for $260,000. We currently rent it out for $1400 a month. We are losing $220/mt (Condo fees, cash call, insurance, tax, etc.).

We both have a car payment student loans. I want to sell both places, take the loss and start renting. I am very worried about our future. I do not know what to do about the condo. I cannot see our renter renewing her lease when she could find another place cheaper. We also want to have kids soon.

Help me with my life Garth! Be the good man you know you can be.

Seriously. This dude came here once for advice (‘should I sell my Calgary condo?’), was warned and scorned, slunk off and ignored it. Now he’s back, looking for a path from age 28 to retirement. And he throws his miserable financial carcass upon my goodness. Sheesh.

Obviously this is a nice little example of how the nesting instinct can destroy your finances. Calgary is a rotten real estate market and has been so for most of a decade. These unfortunates not only bought a house with 5% down, which will deliver a loss when sold, but they also hung on to a loser condo. Now they gutted their savings, the unit’s worth way less, plus they’ve been shedding about $750 every month ($220 in cash flow loss and $90,000 in equity making zip). After a sales struggle and commission, the losses will deepen.

All in, real estate will deliver at least $120,000 in net losses, little of it deductible. Once all is sold they’ll clear maybe $5,000 in equity from the two properties after commissions and mortgage break fees. Given their level of savings, this escapade will set them back at least five years. Now they want children and retirement. Thank their lucky stars they’ve snared government DB pensions. But they’re still pooched.

And, finally, I have no idea what he’s asking of me. A blessing for stupidity? If he’d listened to the advice of a year ago, sold the condo, took a small loss, rented and saved, life would be more promising. Calgary ain’t coming back for a long time. More importantly, these kids don’t have the resources or cash flow to be buying properties.

The Big Mistake? Being human. People cannot admit to ever having made an investment mistake, so they hang on. Stocks, condos, MICs. Even when the red ink flows thicker monthly. By refusing to sell, take a loss and get out, they gamble further. It rarely ends well. Especially now. The housing bulls are facing their greatest challenge in a generation. It’s debt.

Instead of using ten years of cheap rates to tackle, eradicate, reduce and crush their indebtedness, Canadians did the opposite. They’ve borrowed their snouts off. Household debt at $2+ trillion is bigger than the entire economy and most of it (67%) is in long-term mortgages – destined to reset at higher costs. Now the era of emergency rates is over. Maybe for good. Meanwhile the asset most of that debt was used for (real estate) is under pressure. It’s a vise. Relentless. Will tighten again in nine days.

Toronto realtor John Pasalis posted a nice chart-based summary of this mess:


Click the chart to enlarge.

Real estate’s historic 3% appreciation rate soared to 7% as the Bank of Canada dropped its key rate to 1%. Then as oil collapsed in 2015 the bankers shocked everyone by crashing the rate 50%, to just half a point. Housing became a speculative mania as debt soared off the charts. After all, if you could borrow at 2% and grab a house that was appreciating at 30%, why not?

“It didn’t matter that any rent that could be gained wasn’t high enough to cover the carrying costs of the home (mortgage, taxes, etc.) because the value of the home was increasing by more than the money they were out of pocket each month.,” Pasalis points out.

The period of loose credit and very low interest rates led to a surge not only in house prices but a surge in debt as many of these investment properties were financed entirely with debt. In many cases, home owners were borrowing $150-$200K against their existing home to use as a down payment on the investment properties they purchased.

But every housing bubble is almost always followed by a tightening of credit. Policy makers typically increase interest rates and/or tighten the qualifying requirements for any new credit in order to cool down the growth in household debt. This is precisely the trend we have seen since the summer of 2017.

The Bank of Canada began to increase their overnight in the summer of 2017, eventually increasing it by a full percentage point in one year. Then, on January 1, 2018 the Office of the Superintendent of Financial Institutions introduced a stress test on mortgages that required all uninsured mortgages to be approved under a new “stress test” interest rate which is roughly 2% higher than the contract rate of the mortgage.

So here we are. Mortgage costs rising in the last few days. The central bank moving next Wednesday. More hikes coming in the first half of 2019. As the Toronto broker points out, a couple earning $125,000 three years ago could afford an $800,000 house. Today they can spend $625,000. In a year that could be $580,000.

There is nothing. Not economic growth. Not Trumpenomics. Not immigration. Not buyer incentives. Nothing that can compete with the lethal combination of debt and rising rates. The letter at the top of this column is the future. Don’t make it yours. Gravity’s back.

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October 15th, 2018

Posted In: The Greater Fool

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