Pile it high

Days ago this blog referenced a vermin-infested, uninhabitable piece of crap real estate in Victoria listed for a million. It sold. Over asking. In six days.

Last week a garbage-strewn house in Markham, disintegrating, filled to the ceiling with rotting garbage and so disgusting no showings were allowed went to market for just under seven figures. The mold incubator sold in four days for $56,000 above asking.

How do we account for such excess? When sellers make absolutely no effort, and junk sells for insane values after mere hours on the market?

Well, as we’ve been documenting, these are not normal times. Money is still cheap and plentiful. Governments are still priming the real estate pump, from cities giving out free down payments to the feds creating a house-only tax shelter. The pandemic is over – especially now that a Covid pill is coming. And inventory levels have collapsed. There’s only a one-month supply of houses in big cities like Van and Toronto and zero months in hick burgs like Guelph. Mortgage rates have jumped, causing panic-buying among the house-lusty newbies. And as the economy continues to reopen, with wages rising and inflation roaring amid property escalation, FOMO’s in full bloom. Buy now, or buy never.

So, houses no one can inhabit become objects of desire. Yates said it: “Love has pitched his mansion in The place of excrement.”

While this pathetic site has dissed FOMO and mocked those who swallow debt, imperil their families and gut their finances for… stuff… recent history (and a pandemic) has shown what can happen to an asset class when the masses embrace it. Cold Canada is now one of the most expensive places in the world to live. Billions in financial assets earmarked for retirement, for example, have been plowed into houses which have never traded for more. The higher things go, the more the desire to have them.

Irrational? You bet. But in the spirit of balance and adulting let’s look at the reasons house lust will continue and the market survive despite the danger posed by garbage heaps selling for a million dollars. Here are the reasons economists at one of the major banks (BNS) say this will continue:

• Our forecast is for rising short-term borrowing rates to go up 200bps over 2022–23 starting next summer. The underlying Government of Canada bond yield is forecast to rise by a total of about 150bps from this past September’s levels to the end of 2023 and so fixed rate mortgages will likely rise more slowly than variable rates.
• It will therefore take ~2 years to get back to interest rates that are more neutral and only about 50bps above pre-pandemic levels. Housing moderated but survived back then.
• It will then take years for the effects of higher rates to reprice existing mortgages given lagging effects on refinancings and renewals. During this period, we expect job and income gains to be offsetting from an affordability standpoint. The connection to how higher mortgage rates will feed into CPI involves much shorter lags of about 1–2 years.
• Households had to qualify at the stress test levels for rate shocks. That means qualifying at 5.25% or the contractual rate plus 200bps, whichever is higher. This therefore invokes an automatic rate shock in the qualifying process. Existing mortgages should be well positioned to meet this shock.
• For new mortgages, it’s unlikely that the best offers on mortgage rates now plus 200bps will come to sharply surpass the existing 5.25% stress test qualifying rate as higher fixed borrowing costs are factored in. We’ll be monitoring whether OSFI and the Minister of Finance will see fit to adjust how the stress test operates conditional upon housing’s evolution.
• Of course, if existing mortgage borrowers after qualifying then turned around and spent the difference in interest payments at the stress test threshold and the actual contractual rate at the casino then that’s clearly not so good. The evidence suggests households generally behaved more rationally. The saving rate of 14% in Q2 has moved sharply higher during the pandemic due to risk aversion and goods shortages.
• Further, large cash and liquidity balances on household balance sheets are now 16% higher than they were before the pandemic struck.
• Home equity on the Canadian household balance sheet is very high at over 76% of the value of the real estate assets which is a record high and offers substantial padding around price risk.
• The household debt service burden has fallen during the pandemic partly due to lower rates and income supports and Canada has fully recovered lost jobs. It will likely take years to get back to pre-pandemic debt service burdens alongside phased-in rate hikes.
• Housing supply remains very tight. Cooler demand can be accommodated by tight supply conditions.
• And last but not least, Canadians have a long and well understood history of paying our mortgages. Pandemic-era policies helped keep households whole on cash flows and avert earlier fears on what would happen to delinquencies.

Valid points? Mostly, they are. The bank has a conflict-of-interest bias, of course, since mortgages are a key source of revenue. But the key message is that folks will continue to do what they’re doing, supported by relatively cheap loans, accommodating politicians, an ocean of pandemic support money and the fact most families are pouring the bulk of their net worth into one thing. The stakes are huge. The bulk of the population has baked-in motivation to keep the party going. Real estate, the people cry, cannot fail. As they march toward that distant cliff.

Sigh. The credo here remains. If you truly need real estate and can afford it without creating risk to your family, then buy. But when fetid piles of trash sell for above-asking in hours, million-dollar mortgages become common and every kid expects a condo but wants a house, do not be complacent.

About the picture: “You published a picture of River when she was 6 months old. She’s now 9 months, and huge. Guarding the prairie homestead in Red Deer, AB. Either that, or just lazing around waiting for her next treat. She’s at the top of the class in her puppy training school – or so my son and his girlfriend tell me.  Life seems good in Alberta.”