March 22, 2021 | The Illusion

In speaking with Evan and Barb on Monday it was clear. Nobody is spared from this. They’re both 40, live in a rented flat (a nice one, leafy street, decent hood, Yorkipoo) and have interesting jobs. WFH and virtual these days, of course. “But the before times were good,” she says. ”They’ll come back.”

Savings are a little less than $200,000 spread across registered accounts. No pensions, and they worry about retirement. They also want a house. Downtown. These days even a slanty semi or a geriatric row house on a dodgy street will set them back close to a million and a half. So all the savings would be gone, plus a seven-figure mortgage and a monthly nut that would be north of five grand, or over twice the $2,000 they now pay. Oh yeah, and no retirement plan – all net worth in one asset and a fat debt destined to refinance at higher rates in the future.

We had The Chat. They were crestfallen. And there’s a good chance they’ll ignore me. After all, TNL@TB is ready to hand over a million in debt.

Did you see the latest Nik Nanos poll?

One year ago this month – when real estate slumped and prices sagged – 9% of Canadians said they expected house prices to rise in the next six months. This March – in the midst of a boom with values exploding – over 60% are convinced the market will surge. It’s the first time since he started polling 13 years ago, Nik says, this high a reading has occurred. And it takes place as mortgage rates creep up, the pandemic continues and inflated prices mean fewer and fewer people (like Evan & Barb) can buy.

Conclusion: high prices are begetting higher prices. The market is FOMO-fueled. It’s sucking in everyone, even those who would sacrifice too much and shoulder huge risk trying to play. This means real estate is ripe for more speculation, flipping and gamification. Affordability will continue to deteriorate. Household debt levels will bloat. The ultimate risk of a market correction grows as the masses crave property, even knowing it’s impossible for valuations to rise without end, or a period of reversal.

Human nature doesn’t change. Once upon a time we all wanted tulip bulbs, gold coins, shares in Nortel and Bre-X, GameStop and now houses in Tillsonburg and Port Hardy. In every irrational boom those who got in last – the greater fools – paid a huge price for their desire. But, is it different this time, like most folks think?

It seems so, thanks to cheap rates and low inflation. It’s the great illusion of our times.

US blogger Ben Carlson niftily explains that crashed mortgage rates can easily make high prices seem to disappear. In other words, it’s all about the size of your monthly not the grandeur of your debt. So loans in the 1.5% or 2% or 2.5% range make it feel like buying a hideously-inflated house ain’t such a bad idea – especially because (of course) prices always go up!

In the chart below he traces the steadily-rising US average house prices (way cheap by Canadian standards) while showing the downward trajectory of mortgages (Americans get to lock up for 30 years and refinance every time they drop. Sheesh.) In other words, prices can jump but people can still buy. And so they do.

Cheap loans make crazy prices look less so

Source: Ben Carlson

Now, this is ducky so long as property values continue to rise forever and/or mortgage rates stay low forever. Then you can own, increase net worth and service the debt.

However on this planet, that’s not going to happen. The cost of money will swell (already happening) and dwindling affordability means fewer qualified buyers. Meanwhile the fact two-thirds expect romping valuations ahead pretty much guarantees more speculation, FOMO, panic-buying, debt-binging and, yes, higher prices. Unless you were born after 2000, you know that every pendulum eventually swings back. Bad news for the unprepared.

And that brings us to this chart. What is different between Canada and the US? This…

But do buyers today understand the future risk?

Source: Bllomberg

American household debt has tracked relatively lower since the real estate market there blew up around 2006. Not here. In fact so far during the pandemic, we’ve borrowed another $120 billion on top of the trillion+ we already owed to mortgage lenders. This was done when (a) loan rates were the lowest ever and (b) house prices were at an historic high.

In the past year 12 major markets in Canada have posted 30% (or more) price increases. CREA says values across the country will rise, on average, another 16.5% in 2021. New buyers, like Evan and Barb (if they listen to the bankers) will be paying an unheard-of price for property, leveraged excessively, yet the pain will be masked with 2% financing. For a while.

If mortgages renew in five years (as expected) at 3.5% or greater, or property values flatline or drop, then heartache. The result for these two would be 60 months of living costs which were double that of renting, nothing saved towards retirement (five years closer) and a post-pandemic world where WFH, aggressive nesting, low inventory and insatiable demand were but quaint memories. The before times.

Garth Turner March 22nd, 2021

Posted In: The Greater Fool

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