Edmonton Housing Bust

Had a request to overlay the sales stats discussed earlier with week, with prices… so lets knock that out. It’s hard to decipher these graphs if I pack too much in, and I’ve already done similar stuff for the last decade anyway, so I figured I’d just do the 90′s (and ’89 just cause I have it) today. So, without further ado…

As we can see here, prices were pretty tame in the 90′s… at least compared to what we’ve just been though. I guess I should have scaled that better, oh well, too late now. It’s hard to draw too much from this graph anyway, but if you look close you see that overall in years where sales looked to be increasing from the prior year, prices also rose… but when sales seemed to decline year-over-year, prices tended to only hold, or even go down a bit themselves.

Also prepared this little analysis, the sales data is the same, but the price data is adjusted… firstly it’s converted into a 3-month moving average to smooth it out, then it’s measured as the month-over-month change in that moving average. This again shows prices also share something of a seasonality, as price gains tend to be strongest in the spring/summer months, months that also tend to see strengthening sales tallies from month-over-month. Conversely, when sales start their seasonal declines, price growth drops, and come the fall usually go negative.

A month ago I did some digging, and pulled together a good set of data from the ’90′s… so today I figured we’d take a look at some of those numbers today, and since sales is a hot (or not so hot, perhaps) topic at the moment, we’ll start there. Here’s a look at sales going back to January 1989 all the way through June 2010 (final numbers, not the preliminary number announced earlier this month).

It’s interesting to look back in time. Compared to the volatility witnessed in the last few years, the 90′s were almost stoic, but they had a few notable periods. If you look closely at 1992, while they had comparatively high sales throughout the entire year… coincidently, that was actually of something of a CMHC inspired boom of it’s time, as that January was when CMHC lowered the downpayment requirement from 10% to 5%.

As we move forward we see sales then start to decline, eventually bottoming out in a rather dismal 1995. This was the result of a large inventory spike (we’ll try to examine that another day) that started to build in ’93, bypassed prior record highs (6,332 – June ’82) before peak inventories eventually settling in the mid-to-high 7,000′s in ’94 and remained their until ’96, and didn”t finally return to normal levels until ’98. This seemed to be a major aftershock of the building boom in the late 70′s/early 80′s, and that it took 15 years to finally totally play out is kind of a sobering thought considering our current situation.

Interestingly, ’96 also witnessed the a then record 1,400 sales in a month that May. It was credited at the time as being the result of an influx of military families coming to the city. Whatever it was, ’96 seems to be the turning point, and from there on sales started to gradually grow, and eventually get inventory back to manageable levels. Then of course we get to the last decade, which we’ve discussed in great detail already, so I’ll spare you further dissection… for now.

Having this new data, also allowed me to do some better seasonality calculations. Above is a graph of monthly sales as a percentage of annual sales. I used the median figure, but the average was pretty much the same, and included one standard deviation above and below to give you an idea of the typical range.

That doesn’t mean much without context though, so lets add in this years sales though the first six months of the year (once again, these are the final figures, not the preliminary ones, so these are not undervalued), and the trend lines are projected based on that. We see we had above average sales for the first four months, especially in April… but it’s since fallen off in a big way, and if the trend continues could dive below one standard deviation from the expected course.

This doesn’t make any statement about a months sales nominally vs that month historically, merely how they compare to sales levels experienced that year vs the expected curve.Though, for what it’s worth based on normal seasonality and the sales through six months we’re on pace for only about 17,000 on the year… but that would require we have levels somewhere close to the median line, if we stay where we are currently we’ll come in well below that. Even at 17K, that is still 2K below the EREB’s latest revised forecast, and 4K below their original forecast for 2010.

This past week I’ve been digging through some newspaper archives, mainly I was looking for stats and possible story ideas (and did pretty good on both fronts), but also found it fascinating reading through the articles and getting a sense for the flavor of the time.

The further I went back, the less and less that became available, but there was multitudes there from the 90′s, and looking back at the time in hindsight knowing what we do today it was rather remarkable, as even though it was very stable compared to either the 80′s before it, or the 00′s, the high and lows within it were no less celebrated or bemoaned by those living it.

But I’ll save discussing the 90′s for another day, today I’m going to discuss another article I stumbled across… actually, just one item from it. It was an article that appeared in the Globe and Mail on July 7th, 1982, titled “Vancouver house prices plunge” and actually discusses the various markets around the country. This was a very tumultuous time as the title suggests.

Interest rates after years of slow but steady increases just months earlier had spiked to levels previously thought unimaginable (5-yr Fixed Mortgage rates in September ’81 hit their all time high of 21.43%, up almost 7% from just a year earlier) and while off the peak were still extremely high, this of course had a cooling effect on housing in several markets.

For those needing a refresher, consult the graphs in this post. Towards the end they get to Edmonton, and the Edmonton Real Estate Board happily touted that while price increases had slowed, they were still going up as of June, even in spite of interest rates. Then there was this paragraph.

The number of sales last month for residential property on the multiple listing service in Edmonton was off by more than half from what it was a year ago. There were 373 houses sold in June compared to 802 in June, 1981. The number of places up for sale was nearly the same in both periods – about 1,800. ”Be positive. Now is a good time to buy. If people can hang on for a year or two (with high mortgage interest rates), real estate will be a good long-term investment,” said Bob Weist, an administrator with the Edmonton Real Estate Board.

Yeah… be positive! It’s a good time to buy! Just ignore those interest rates, real estate only goes up!

As it turns out… not so much.

Now, it’s easy to look back now and nit-pick knowing that after those June ’82 numbers it was all down hill of real estate in the city of Edmonton. And, this is also coming from an industry flack whose job it is to pump the stuff, so we still have to take it with a grain of salt considering the source. But what really takes such a statement from being merely bad, to being spectacularly bad, is that it was just weeks later that interest rates also fell off the cliff. So not did this turn out to be the absolute worst possible moment lock in price wise… but you double it up by locking in at a horrendous interest rate.

Rather than a great investment, it’s more like financial hara-kiri.

Just for example, to finance an amount equivalent to the average home, $94,042, with a 25 yr amortization at 19.1% interest, would cost $1510 a month. That may not sound all that bad to us today, but remember this is 1982, and the median family income in Edmonton is $26,680… thus the cost to service such a mortgage would cost a staggering 68% of a households annual salary. Forget about eating, you’d be lucky to pay your taxes… which is probably why sales had already slowed to a crawl, no one could buy anymore.

And after 5 years, and over $90,000 worth of payments, you will be the proud owner of a whole $1,313 in equity… or you would have that much if the house wasn’t worth just $80,000 ($14,000 less than you paid for it)… leaving you about $12,700 underwater. In other words you’ve spent over $90,000, and all for the privilege to still owe the bank $92,700, on a property now only worth $80,000. I don’t know about your guys, but that would be the last time I went to the EREB for investment advice.

Over the entire life of that mortgage (using actual numbers and 5yr terms), it would cost just over $300,000 over the 25 years to pay that off… and adjusting for inflation it comes out to $447,000 in current dollars. So you’re probably saying to yourself at this point, that seems steep, but you’re not sure what to make of it. Well, lets compare to a few other scenarios.

Lets say, instead of buying immediately in the wake of Bob’s statement, you wait six months. At this point prices have dropped off a little over 4K, but the biggie is interest rates have dropped almost 5%, to 14.34%. Your monthly payments (for the next 5 years) are now down to $1104… a saving of over $400 a month for the exact same place, that’s HUGE. Over the life the mortgage this would cost you $257,000 to pay off nominally (or $371,000 in real dollars)…. a savings of 16% (or 20% in real terms) just for sitting on your wallet for a mere six months.

Not bad, but lets say you waited a whole year. By now prices are down 9K, and interest rates have settled in at 12.98%… now it’d only cost you $957 a month to carry the debt. So, you’re already not only paying a whopping $553 less per month, but more of what you are paying is going towards equity rather than debt servicing. And the savings you’d have over the life of the loan are now 27% nominally, and 33% inflation adjusted.

And it only gets better as time goes on as prices continue to soften and interest rates drop. Lets go four years out to the summer of ’86. Average price now is $78,500, interest rates are now below 11%, and you’re monthly payment would be mere $762, almost half of what it would have been if you foolishly bought when Bobbo and the EREB told you it would be a good idea… and over the life of your loan it would cost $201,500 nominally, and $260,000 inflation adjusted. Some mammoth savings.

(I’m sure some of you smart cookies wondered to yourself just how can I have projections for the entire 25yr life inflation adjusted of a mortgage started in 1986 as it wouldn’t have expired just yet and we don’t know what going to happen with inflation through 2011. Good catch. The answer is, I assumed a continuance of our current 1.8% year-over-year inflation to continue through expiration. I assume that will be close enough to actual, and even if things did go completely crazy any impact would be negligible at this point anyway).

Maybe you’re wondering, what if I was just that genius and/or lucky to hit absolute bottom price wise. Well, that would have been February ’86 when prices dipped to $68,253… and in that case you could have skated away with an interest rate at 11.94% and a monthly carrying cost of $716. Less than half what it could have been. And over the life of your mortgage it would have cost you $184,000 nominally, or $241,000 inflation adjusted. In other words, buying that “good long-term investment” would have cost you 63% more nominally, or a whopping 86% in real dollars.

Not my idea of a good investment… but it’s not my job to sell houses…

Again, it’s easy to sit back and take pot shots and normally I don’t bother (though I do enjoy it more than a little)… but just looking back at that statement, and knowing the timing of not just prices, but interest rates, and how they were both literally on the cusp of collapsing, makes it not just a bad call, but an epically bad call. One for the ages. One that probably even makes the likes of Jim Joyce or Jorge Larrionda feel a little bit better… probably doesn’t do much for England, but at least Armando Galarraga got a ‘vette out of it all.

I guess the point I’m trying to make is that when locking into decisions that are going to play out over decades, we need to be aware of the dangers up front. The future is uncertain, hell, right now the current is uncertain, and incorrect assumptions can have disastrous consequences.

We may not be facing the risk of high interest rates right up front like they were in 1982, but we must recognize the danger of locking into high levels of debt while rates are low… cause they can go up, and if they do your level of debt remains… and high leverage and high interest rates are a lethal combination. Heck, even just buying assets at inflated prices in the absence of interest rate considerations can be a financial life sentence.

To paraphrase someone much brighter than I, our economic cycles are long, but our memories are short.

You may have noticed that a few of the blowhard bloggers out there have recently been making the call that the market beginning to turn. Of course any moron can just up and prattle away with such declarations, but I aim a special sort of moron and actually examine things a little deeper.

So I figured it was a good time to take a look at just what such a turn plays out like. Edmonton (and Alberta) are in a bit of a special situation as our bubble hit earlier, and actually topped out in 2007 (leaving us in something of a suckers rally at present), which gives us the unique perspective of having seen this movie just recently, thus some excellent data on just how it works.

Not that there is a lack of comparison others out there, with the implosion of the US housing bubble there are umpteen cities that have had serious housing downturns… but we like to think “it’s different here” and thus need a local example (even though, statistically, what happened down there was a carbon copy of what happened here where the market turned).

Anyway, talk is cheap, lets build. Here is a look at what happened in 2007, as well as dashed lines representing historical averages to give up an idea of typical seasonality in regards to sales and inventory levels.

What we see here is as the year begins inventory is a fair bit lower than normal, while sales are a fair bit higher… obviously this is a “sellers market” and is ripe for rapid price escalation, as witnessed. This continued through the winter months, but come spring we started to see a divergence as inventory started to grow rapidly. Come May, sales were still strong and prices peaked at $400,000… but inventory for the first time in almost two years was above the historical norm, and still picking up steam.

Through the summer we see sales fall off significantly. As we can see from the dashed line, this is a quite normal seasonal movement.. it’s the degree to which indicates that the market has became fatigued, as the line drops from well above historical norms, back to them, and even below.

Inventory on the other hand goes ballistic. To get an idea of just how drastic that curve is, bear in mind that prior to May ’07 the record high for inventory was 5,077, and the dashed line indicating that 3-4,000 is the norm. By September they were pushing 10,000 (9,918 to be exact), a mark they would blow past a year later for what that’s worth.

What’s interesting to watch is the behavior of price. Price is also often seasonal, and peaks in the spring, but its downward fluctuations are typically limited to $3,000-5,000… not $25,000-50,000. Obviously seasonality only accounts for a small fraction of the seen declines, and the market conditions (including consumer sentiment) has a far larger impact.

The significant price declines didn’t even hit until August, but that time inventory was already over 9,000 and starting to level off… and sales had already returned to “normal” territory over a month earlier. This is obvious evidence that price fluctuations tend to lag the actual market conditions in such situations.

Which brings us to twenty-ten. Here, even with merely average sales volumes, and inventory very high and growing, we’re still somehow seeing price gains. Rather remarkable behaviour on the surface, but it’s a testament to what low interest rates and a ton of hype can do. Of course no one bothers telling the consumer that inventory is actually still at obscene levels, there is no money in that… that’s all in generating transactions, and you can’t instill a sense of urgency in people if they think the market is flooded. After all, marketing and sales is all about eliciting action right now.

Which I guess is kind of the point of this entire post, that being that we shouldn’t be fooled by price movements even when we perceive the market to be weakening. Prices are prone to throwing in a few head fakes, especially during the blow off phase of the market. Declining levels of buyers can actually make the market more susceptible to price gains in the waning days of a rally.

So don’t be fooled if prices still drift up a little, it’s just the blow off… all indicators are pointing down, and showing no signs of changing.

Greetings freaks and geeks, hope you’re all ready for the long weekend. Before you go, here is the affordability update I promised.

As you may have noticed, suddenly this spring the word ‘affordability’ magically returned to the lexicon of the real estate pumper. A word nary whispered a year ago, but suddenly it’s convenient again. The improved affordability is obviously a result of the historically low interest rates… as the other two variables, incomes and prices, haven’t done anything to improve the equation.

To get a gauge of how interest rates stack up versus how they have in the past here is a graph of the average 5-year fixed rate taken out through May.

As we can see, this is the first time we’ve dipped below 5% (4.62% as of May). Obviously not as low as some of the advertised rates the were circulating at the time, but it should remembered that those were not available to everyone, mainly just prime new borrowers, those renewing/renegotiating were often shit outta luck.

Also interesting to note just how rare it is that rates are under 6%. Even since monetary policies started targeting inflation to 2% in 1992, rates didn’t hit that level until 2003 until after the big shift post-9/11 and many nations lowered their inflation targets to 1%.

In any case, when combining the lower rates with the stripping of mortgage qualifying standards by the federal government in 2006 (over the course of that year borrowers went from needed 10% down and limited to 25 year amortizations, to 0% down/40 year amortization and 10 years of interest only payments), it’s not hard to see that it created something of the perfect storm for the price explosion we witnessed.

So, should be no surprise that another plunge of rates could manifest itself into another credit orgy as we’ve witnessed the last couple months, particularly in our culture of conspicuous consumption and instant gratification. This is not just unique to Alberta, this is right across the country, and even in the US where judging from the reaction apparently up to last month it was thought no one would ever buy a house again.

Here is a graph of the income needed to qualify for financing to buy the median single-family home in Edmonton, charted with the median household income in the city. This is using the 32% gross debt service ratio, 10% down and using $170 per month in taxes and $100 in heating.

I took a sampling of 20 homes listed at/near $349,500 (the median SFH price), and they had an average and median annual property tax of $2050, which is roughly $170 per month, and the heating number at $100 may be a bit low, but for the pumpers sake we’ll use it just so I can’t be accused of skewing the numbers, maybe assume you have a ton of insulation and a helluva efficient furnace.

As we can see, there has been a major improvement in affordability, though it’s still a bit above the latest income figures (2007), which considering how 2008 ended and 2009 has played out, it’s probably safe to say they aren’t haven’t gotten much if any higher (and quite probably have started going down).

So, according to household income of $66,113 (in 2009 dollars), 10% down, 4.62% interest rate and $270 a month in taxes/heating a household should be able to qualify for about $300,000 with 25 year amortization. So, obviously as good as things got, prices are still about $50,000 above where they really should.

Of course, from what we’re hearing 10% down and 25 year amortizations are concepts rarely grasped in real estate now-a-days. Recent surveys have been telling us that the average downpayment is a mere 6%, even amoungst those already in the market, and the vast majority of amortizations are of the 30 or 35 year variety.

Recalculating assuming 35 year amortization and 10%, and only then do we truely near something resembling affordability… again, that’s assuming 10%, which evidently very few already in the market can even muster, much less the coveted first-time buyers.

But compared to what we witnessed the prior three years, any semblance of affordability seems like a dream come true. The market was correcting price wise by itself though last fall, but since then the trouble is that it’s interest rates doing all the work, and few expect them to remain all these record low levels.

Recalculting affordability at current incomes and even 6% interest and affordability is again a thing of the past. Figuring in 25 year amortizations and 10% down, at 6% interest that would suggest the median home in Edmonton is overpriced by about $80,000… at 7% over $100,000… at 8% $120,000. You get the picture.

And do not think those interest rates are unrealistic, with governments running up massive deficits currently, they’re going to be flooding the bond market, forcing prices down and thus yields up… which we know, drives up borrowing rates. The ugly truth is rates even hitting the double digits isn’t out of the question.

For those hoping incomes will be able to make up the gap rather then prices, consider this. At current prices at May’s interest rates, to sustain these prices, incomes would need to be $76,500… at 6%, $86,000…. at 7%, $93,500… at 8%, $101,000.

Then compare that to the long term trend in incomes, which for 30 years hovered in the mid-50,000′s and only recently has broken well into the $60,000′s. Even if incomes managed to continue climbing, those gains don’t come overnight, and a return of even modest interest rates would still destroy any illusion of affordability and again leave prices to make up the difference.

Double disturbing in light of that people are coming in with increasing small down payments and longer amortizations. This just leaves them with negligible equity, and as a result even small decreases in prices leave increasing numbers of recent buyers underwater.

And for those thinking inflation might save you, take a look at that first graph and ponder the interest rates witnessed in the 70′s, 80′s and early 90′s… those are what comes with inflation, interest rates will kill you long before inflation will come riding in on its white horse.