JUNE 11, 2011
I had to make a short post to highlight a monumentally bad article over at the MoneyVille (Toronto Star) website. You can't make this stuff up. Reading this article is like passing through a portal to a parallel world...
I'm not sure what surprises me more...that a chief economist at a Canadian financial institution could make such questionable statements, or that one of Canada's largest media outlets could pass it on to its readers without so much as a critical analysis of the contents. Check that last point. When it comes to splendidly bad reporting on real estate, Moneyville seems to have carved out a niche. Please see these two gems for some additional comic relief.
Meet the author: Helmut Pastrick, chief economist for Central 1 Credit Union. The name should ring a bell. He's the guy who looked at a chart like this...
...and concluded that we have no consumer debt problem in Canada. Pastrick used impressive
mental gymnastics logic in outlining his case that consumer debt is benign, most notably in the assertion that it doesn't matter since it is being used to buy real estate, which "holds its value".
That mental prowess is once again on display in this Moneyville editorial (thanks to Data Junkie for the link)...
"Here are three reasons why buying a house is a good idea:
1. You build equity
The amount you owe declines with each mortgage payment. The difference between what you paid and what you owe is your equity and it is one of the most valuable assets most family’s have. The sooner you start, the faster your equity grows."
This point is true, though misleading in what it omits. Yes, one can build equity through home ownership over the long term. However, as I have often pointed out on this blog, renting can also be a great way to build equity provided the renter has the discipline to save and invest the significant cost advantages that renting currently provides over ownership, particularly in Canada's larger markets. It nonetheless highlights the prevailing notion that home ownership is a superior way of building equity, despite the fact that the costs of ownership compared to rents are at all time highs in all major cities in Canada. This is misleading information and one would expect that a chief economist would know better.....unless perhaps they work for a lending institution whose client base is centred in the bubbliest part of Canada (BC) and is at significant risk from a price correction.....or unless they live in an alternate reality connected and similar to our own, but where debt doesn't matter, trends never revert to their long term and stable means, and where the price of some assets can outpace the growth in their fundamentals in perpetuity.
2. It is an appreciating asset
Home prices decline when the economy turns down, but the long-term trend has been and will continue to be rising prices. The reason is supply and demand. As someone once remarked – “Buy land. They ain’t making any more of the stuff.” Land supply constraints for residential development exist in most markets.
Where to begin with this crap? First, let me suggest that while housing is hit hard during periods of economic contraction, the flip is also true. At the tail end of large, credit-induced housing bubbles, wealth effect spending and the economic benefits of the housing boom become more significant drivers of economic and employment growth, meaning that the economy can turn sour on the back of a housing correction. For more on this, check out these posts:
The author also notes that the reason for rising house prices is supply and demand. This is largely an erroneous statement and it highlights just how few people actually understand what moves house prices. As shown before, rising population causes real house price growth only when supply cannot be brought to market quickly enough to satiate demand. Our construction industry in Canada is generally highly responsive to increasing demand. Let's face it, where there is a buck to be made, someone will make it. So while demand increases with rising population, so too does supply. That is, unless you live in an area that has restrictive land use policies, such as parts of Toronto or Vancouver. In this case, rising population can cause house price increases beyong inflation and other underlying fundamentals. But here is the rub.
Demographia, the same research group that publishes the annual affordability rankings, has extensively studied the impact of restrictive land use regulations on house prices. Their conclusion: Cities with restrictive land use regulations are far more prone to boom-bust cycles. For a great read on that, check out this fantastic post by Australian economist Leith Van Onselen. The reality is that house prices are far more influenced by credit conditions. When the mortgage credit spigots are held wide open while CMHC lending requirements are loosened, THAT is what primarily moves real (inflation adjusted) house prices. As the great Australian economist, Steve Keen notes, "people don't buy houses.....people with mortgages buy houses".
Finally, the notion that houses are an appreciating asset is true over long enough periods of time. However, that assumes that prices are at levels consistent with underlying fundamentals like rents, per capita GDP, incomes, and inflation (which they most certainly are not at present). When house prices have outpaced such fundamentals, it suggests that future returns will be sub par while prices and fundamentals realign. At present, it would seem that a best-case scenario would be a decade or more of stagnant nominal real estate prices (meaning negative real return) while fundamentals catch up. Yet with overvaluation at unprecedented levels, it implies a very significant chance of a more rapid realignment of prices and fundamentals.....in other words, a housing correction.
Where this advice becomes dangerous is when it influences people to purchase real estate with little down (the majority of first time buyers). In the event of a price correction, negative equity means that a home becomes a prison, making it impossible for the owner to sell without coming up with additional money at closing to cover the outstanding mortgage. And since a housing downturn would be a major headwind on employment, it would serve to inhibit worker mobility and prevent new home owners from relocating to pursue other opportunities in the event that they did lose their job. This is a bad scene and one of the reasons why I advocate having at least a 10% down payment, and preferably 20%.
3. Demographics trends are favourable.
Meanwhile, there is population growth it producing demand. Canada has 34 million people now. In 1961 it was about 18 million.
BULL!... and DOUBLE BULL! Even if it were true that demographic influences represent primary factor in influencing real house prices (which they do not....as previously discussed), the reality is that demographics are set to be a headwind, not a tailwind on real estate prices. Please read the hyperlinks for more on that. Enough said!
And finally a few more choice tidbits from this ridiculous piece:
Yes, it will become increasingly difficult for first-time buyers to achieve homeownership since affordability will decline in the long term. Fundamental housing supply-demand forces will drive higher prices while incomes lag.
But this should not discourage potential buyers from their goal, but they need to adapt to those circumstances and be smarter with their money than I was.
I feel fortunate to have become a homeowner many years ago when the price-to-income ratio was considerably lower. The adage it is better late than never always applies to home buying.
Frankly this is some of the worst economic commentary you'll read anywhere. The notion that house prices will outpace income growth for the foreseeable future is utterly ridiculous, as is the subtle suggestion that the relatively stable price-to-income ratios of the past will never again be revisited. What we are currently experiencing is a deviation from long term trends driven not by demographics, but more predominantly by unparalleled loosening of credit conditions during a period of falling interest rates, coupled with a new and widespread mentality regarding the investment worthiness of residential housing as an asset class. Neither of these conditions can be sustained, and the reversion to long-term trends will not be pleasant regardless of whether that reversion happens rapidly or not. Unlike what Mr. Pastrick suggests, it is not different this time.