Edmonton Housing Bust

Finally got a day off, and the girlfriend cleared out knowing my plans extended no further than vegging out watching football of all varieties this Sunday. So, with the house all to myself, it’s time to kick back, relax, and break out the really freaky porn! What? No! Never! Well, maybe latter… but first I’m going to tackle a subject I’ve been meaning to look at for awhile.

That being, why prices going down is actually a good thing.

There seems to be this naive prevailing wisdom that somehow high real estate prices are preferable and/or inherently good. I’ll agree that too a point they can be, insofar as it’s typically a sign of rising incomes, consumer confidence, and a healthy economy… but what happens when they go waaaaay beyond levels supported by fundamentals?

At that point high prices actually become a significant drag on the economy. Disposable income is suddenly getting eaten up paying for a house and servicing the debt. Say you’re the median Edmonton family, pulling in $70,000 a year and you finance a house for $350,000 rather than the $250,000 for that same house that such income levels would typically support. Assuming traditional 25 year amortization, and 6% interest… on $250,000 you’d be paying about $19,000 a year… if you finance $350,000 you pay about $27,000 a year (even if you stretch the amortization to 35, you still pay $24,000, and that $3,000 you save comes entirely from what would have been equity).

You’re basically spending $8,000 a year you could be spending on other things if the market wasn’t overvalued. That’s over 10% of your gross income, and probably around 15% of what your take home. Obviously you’d spend some of that frivolously, but even if you only saved/invested half of that the spin offs and potential earnings from putting that money too work for you would start multiplying quickly. And even what you’d be frivolous spending would be lost to the local economy, and rather than circulate there it’s benefiting the bank and not you.

There may be something of a short term “wealth effect”… but that doesn’t last forever, and it’s credit fueled too, so those chicken will come home to roost too. So, with overvalues homes, a lot of money is lost to the economy as a whole, and instead funneled though a select few. Banks love high prices, the more people borrow, the more they make… builders love it, gives them a nice fat profit margin… and agents and mortgage brokers work on commission based on the amount paid or borrowed, so obviously they love ‘em. But while a minority certainly benefit from overvalued homes, it comes at a heavy expense to the economy as a whole.

To make the point as simple as possible, the less someone has to spend on their house, the more they have to spend on everything else. Unfortunately that is a point not often heard, as there doesn’t tend to be much money in telling people how-not-to spend theres… there is plenty though in telling people how-to spend it, which is why the message of the profiteers is heard loudly, and all to often, unopposed.

Houses don’t really provide any future value for the economy. They provide shelter, and are essentially a consumable. Whether they sell for $1, or $1,000,000 they don’t change in substance. They can be profited from, but to do that you need to have bought low, sold high, and stayed out of the market… and the vast majority of people aren’t in that boat, most just buy-and-hold. They will often work their way up and/or down the property ladder a time or two through their lives, but that really doesn’t realize the owners any gains as long as they stay in the market, as whatever they sell may be inflated, but so will whatever they buy.

If you’ve owned in the city for 10 years, and intend to continue owning for another 10 years, what prices have done in the last few years makes no difference to you. What you owe the bank has remained the same… the only things that really matter is what the price was the day you first bought in, and what they are when you ultimately cash out and leave town.

Which brings me to my next point, being that price declines will not lead to an widespread economic catastrophe as some seem to think. Very few are actually exposed to downside risk. In the metro Edmonton area there is somewhere between 400,000-450,000 residences… and since prices reached the potential trouble territory where they got more than 15-20% out of line with fundamental supports like incomes, there have been about 100,000 sales when you figure in new construction and resales (whether through MLS or FSBO)… but the majority of those already established in the market, and whatever they overpaid would have been offset by someone overpaying for their old place.

There are only really three groups that could be in real trouble with a prolonged downturn in prices… speculators, reckless borrowers, and first-time buyers. Only maybe 1/3rd of those 100,000 sales in that trouble period went to any of these groups, which is only about 7-8% of the total market if every single one of them was in trouble… and I’d venture to guess those truly at risk is only half that again, so 3-4%.

These are numbers that while would certainly soften the market, and hasten it’s return to the historical mean… but in no means would it cause a complete implosion of the housing market, much less the great economy. You’ll see a whole swath of 20-, 30- and 40- somethings get their financial asses handed to them, but would hardly be enough to bring down the whole show.

At least that’s my take on things. In-my-not-so-humble-opinion prices going down is anything but “doom and gloom”… there may be some isolated cases of financial doom, there were some of on the way up too, welcome to capitalism… for the economy on a whole, prices returning to fundamentally supported levels is not just good, it’s necessary.

It may seem like more fun when housing was booming, but it’s really more like a cancerous tumor… and if we want a sustainable and healthy market, we need some kemo. Which doesn’t sound like any fun, but it is necessary, because the longer we go without it, the worse the disease gets… and that can be applied beyond just out housing bubble, to our even greater issue with credit in general.

The truth is, every month the price goes down, is a month the market is healthier than it was the one before.

As promised, here is the second part of the consumer confidence numbers from last week. These pertain to whether people feel it’s a good or bad time to make a “major purchase” and the findings are actually rather interesting. First we’ll start with the national numbers.

For the nation as a whole it’s interesting to note that for most of the decade leading up until ’08 obviously more people than not felt it was a “good” time to make a major purchase, but the trend was actually slowly declining. Even with interest rates generally going down over this time and driving down the cost of borrowing, the number of people who felt it was a “good” time to make a major purchase was declining… and we know that over this time Canadians haven’t been shy about spending.

Then obviously the financial crisis hit and the script was suddenly flipped, and we had a big spike in the number of those who felt it was a “bad” time to make such purchases. Once we got into ’09 though that number started to improve, until the “goods” and the “bads” were about equal and tracked closely for the last year. It’s interesting that the most major of all purchases, homes, had a banner year last year, but consumer confidence was actually lower than it had been for most of the decade prior the financial crisis.

Now we have the numbers for the prairie, and while they look similar to the national numbers, there are some subtle differences. Going left to right, we note that the level of consumer confidence pretty much held it’s level from ’02 to ’06… but interestingly, just as home sales and prices in Alberta (the primary driver of the prairie figures) took off in ’06 and ’07, the confidence numbers started to slide… and actually started to tank just before market peaked in mid ’07.

So, that downturn in consumers willingness to make major purchases showed up in the resale numbers… but there was no real apparent sign that there should have been a boom. Very interesting. Though I guess we should remember that in ’08 things were just getting cooking for Saskatchewan’s housing boom, while Alberta was really one the skids (Manitoba remained fairly balanced all the way through). So it would be interesting to know what the Alberta only numbers would have looked like.

Anyway, from mid ’07 to the financial crisis the “goods” and the “bads” were about equal… then we had the “bad” spike after the market collapse, the “goods” had a little rally last year as the credit orgy took root, but since it’s cooled and now “good” and “bad” are about equal again.

I must say, it’s curious that during the HUGE housing boom in ’06 and ’07, the number of people who felt it was a “good” time to make a major purchase actually waned… even with low interest rates and relaxed lending standards. Makes one question whether there is any correlation with this measure and real estate at all.

Anyway, it is something else to discuss and ponder this weekend before the June resale numbers come out for Edmonton. From the sounds of it the sales numbers will be soft, so it will be interesting to see what happens on the price front. It also looks like inventory grew, but by how much? So many questions. Have a good weekend guys and gals!