Money is so cheap that we are not creating homebuyers, we are creating option holders who are playing with other people's money. They're buying the biggest home possible and maximizing debt,"
"The strategy is if the market goes up, great, but if it goes down, you're going to see an awful lot of people walking away from their homes."
How high is too high?
TONY WONG
BUSINESS REPORTER
John Talbot is so sure that the housing market will collapse that he rents a home. If real estate prices do crash in his area he has the option of buying a house at a cheaper price. At least that's his strategy.
Luckily for Canadian homebuyers, Talbot lives in California, not Toronto, where home prices have risen an astounding 75 per cent alone over the last five years in the San Francisco Bay area.
That's not quite the case in the Toronto area, where house prices have also increased, but not as dramatically. In his book, The Coming Crash In The Housing Market, Talbot outlines a nightmare scenario for some homebuyers in the United States with lessons that can be extrapolated for the heady Toronto market.
"We have a real estate bubble happening in many parts of the world, and although Canada has not had the kinds of swings some other countries have had, major cities like Toronto could be compared to some American cities," says Talbot in an interview from his home in California.
Americans as a whole have seen real price increases (after inflation has been factored in) of 27 per cent from 1995 to 2002. Toronto is at 19 per cent, but pales in comparison to Dublin at 195 per cent and London at 136 per cent.
"In 10 years the world will be made up of those who cashed in on the technology bubble at its peak and sold their homes when housing prices were still high, and those who took the ride and came back down again and had nothing to show for it," says Talbot.
One big factor driving the housing market is mortgage rates that are at 50-year lows.
"Money is so cheap that we are not creating homebuyers, we are creating option holders who are playing with other people's money. They're buying the biggest home possible and maximizing debt," argues Talbot.
"The strategy is if the market goes up, great, but if it goes down, you're going to see an awful lot of people walking away from their homes."
Home prices are artificially high and are due for a major correction because inexpensive money and aggressive lending policies such as no-money-down mortgages cause buyers to jump into the market prematurely or buy more home than they can afford, he argues.
When mortgage rates drop from 8 to 6 per cent, for example, the qualifying formula suggests that you can now afford a house with a 25 per cent greater price. With more buyers able to afford more house, housing prices go up as a result of increased demand.
"The homeowner sees no benefit to the rate cut as his lower interest costs get eaten up by the higher house prices," writes Talbot in his book.
If mortgage rates go higher, a "double whammy" happens, he says. For one, some buyers will not be able to afford the increased payments, so they'll give up their home and place it on the market, creating more listings and driving down the price of the home.
At the same time, the pool of potential buyers shrinks because they can afford less under the higher rates.
What is alarming to Talbot, a former vice-president of investment banking for Goldman, Sachs and Company, and who has lived through a few market crashes, is that people are talking about real estate today like they did about Internet stocks only a few years ago.
"Propelled by loose credit and the belief that there will always be a greater fool to pay an even higher price in the future, homebuyers seem to have placed no limit on the prices they will pay. The fact that housing has gone up every year recently has lulled homeowners in a false sense of security that what went up cannot come down," Talbot says.
While he doesn't place Toronto in the category of San Francisco, where the average price of a home at the end of 2002 was $530,000 (U.S.) ($710,000 Canadian) compared with about $300,000 in the Toronto area, there are some parallels.
Many Canadians still remember the big housing bubble of the late 1980s, when average house prices shot to a high of $289,000 in 1989 only to come crashing down by more than a third to a low of $198,000 in 1996.
Since then prices have recovered, with the average price now surpassing the peak of the 1989 bubble.
But the memories of that bubble still linger for many Torontonians, some of whom are now just putting their homes back on the market to recoup the losses of earlier years.
Meanwhile, some are wondering if a second bubble is on the horizon.
"Canada is in general in much better shape than not only the U.S., but most parts of the former British empire," says Talbot.
Because Canadians have not seen the same kind of dramatic run-up as in many parts of the world, there is "much less to fear of a possible downturn," Talbot says. Still, there are some warning signs. Some analysts feel too many condos are being built. But most analysts see very little at issue with the overall health of the housing market.
If mortgage rates were to "zoom up to 10 per cent, we would have a collapse tomorrow, no question, but that's not likely to happen," says Toronto-based housing economist Frank Clayton.
"While it is certainly possible to have a housing bubble and subsequent crash, something we've already seen in Toronto in the late '80s, I sincerely doubt something like that will happen in this market," says Doug Porter, senior economist at BMO Nesbitt Burns.
"The typical house owner in Toronto should not be losing any sleep."
For one thing, compared with some of the steep increases in other cities around the world, housing price increases here in Toronto in comparison have been "remarkably restrained" says Porter.
Ted Tsiakopoulos, senior market analyst for the Canada Mortgage and Housing Corporation agrees. He says that the Toronto housing market has anywhere from "one to two good years left" before the cycle ends.
"We are certainly close to the end of the cycle, but we're not looking at a major pullback," says Tsiakopoulos.
"In some cities in the U.S., where the economy is being driven by specific sectors such as technology, then you're seeing consolidation in those cities, which makes it sensitive to a downturn.
"But that's not the situation in Toronto. We have a very diverse economy here," argues Tsiakopoulos.
"We're by no means in a bubble. Our market is being driven by fundamentals." One reason why is that we have far less to fall than some major cities, and that may be due to cautious Canadians who are still suffering from the hangover of the housing bubble of 1989, says Clayton.
x Instead, "Our recession was much more severe, it came later and lasted longer, and we have long memories of what happened," says Clayton.
Down the road Clayton sees a relatively healthy housing market, driven by about 100,000 immigrants annually who settle in Toronto and the surrounding area, which translates into 40,000 households. "As long as we have good immigration and the job numbers hold up, then the housing market here will be healthy," Clayton says.
Meanwhile, Toronto housing analyst Will Dunning revised his forecast for resale homes substantially upward this week after figures showed June was a record month for resales.
While most analysts figured that last year was the peak of the housing market, Dunning is forecasting 75,000 resales this year, up marginally from 74,759 last year.
"A new record might be set this year," says Dunning. However, the analyst says there will be little change in house prices for the remainder of the year since most of the price increases have already occurred in the first six months.
While author Talbot agrees the Canadian housing market is in better shape than its counterpart in the United States, he says we shouldn't be complacent.
The availability of cheap money for example, exacerbates a growing debt problem, no matter what side of the border you're on. One Canadian mortgage broker, for example, advertises a mortgage product that guarantees 107 per cent financing. The mortgage pays 100 per cent of the value of the home, 3 per cent cash back and a 4 per cent service charge with no money down.v "When you have those types of enticements it's easy to leverage yourself to the hilt, and that's when you can get into trouble," says Talbot. "If you are not currently a homeowner but are looking to buy, maybe it is time to change your mindset. Our analysis shows that maybe you do not have to be in a rush to buy a home. Many young couples feel that if they do not buy right now, they will be priced out of the market forever."
Talbot recommends that if you are concerned that house prices are getting "toppish," then there a bunch of ways in which you can protect yourself, including: Sell your home. You can rent temporarily in hopes that house prices will indeed collapse. If you do rent, do not be afraid to splurge on the monthly rent, as it is only temporary. You should get a fairly good deal in renting today because vacancy rates have gone up substantially and rents have not kept pace with housing prices. Move into something cheaper. This will reduce your exposure to residential real estate and decrease your exposure to future price declines. It will also allow you to pocket some emergency money if times get tough.
Move from a high-priced area to a lower-priced area of the country. This is a tricky one, since not everyone can just pack up and go. Some major metropolitan areas such as Toronto have made major gains in real estate prices, while other smaller centres haven't had the same kinds of gains. If your job is mobile, you might want to consider selling your home if it is in an area that has had good gains for something comparable and cheaper in a smaller centre.
Manage your debt better. "When a mortgage banker offers you more money for a house than you can afford to pay back, just say no!" says Talbot. "Quit thinking of mortgage money as free money and see it, for it really is a threat to your family's well-being and your livelihood," if you end up in default.
To avoid spending more than you can afford, try to stay within a budget of not paying more than three times your total annual household income.
You should also try not to borrow more than 80 per cent of the value of a home. Be prepared for a potential price decline of 20 per cent. If prices decline by that much then your home won't go "underwater" - that is, the mortgage won't exceed the value of your home.
Hedge your exposure. If you cannot part with your primary residence then maybe it's a good time to sell your vacation home. If you own an investment property, consider selling if you think the market has peaked in your area. If you own your own business and office space, perhaps you can do a sale-and-lease-back arrangement, where you sell your property but rent it back so your exposure is limited.
Plan for the worst. Homes are typically forfeited when unexpected events happen such as a job loss, a divorce, or medical emergency. "Big mortgage debt does more to create co-operative and friendly work environments than if we put Valium in the office cooler," jokes Talbot. "People under threat of mortgage foreclosure cannot afford to be anything but model citizens."
To plan for the worst at work, make sure you don't have a great deal of your own company's stock in your investment or retirement portfolios. As employees of Nortel and Enron learned, corporate bankruptcy means "the last thing you want to find out on the last day at the job is that your retirement portfolios have also taken a beating."
And finally, reassess your priorities. There are other ways of maximizing your sense of well-being than by maximizing the size of your home.
"It is wonderful that people take such pride in their homes. It's another thing when it becomes an all-consuming part of your life. Keeping up with the Joneses can be a full-time job."
A home is a physical structure. It is not a family.
"People risk their lives to go back into burning homes to save pets. In the history of the world, no one has gone back into a burning house to save a sofa or washing machine," argues Talbot.
"The strategy is if the market goes up, great, but if it goes down, you're going to see an awful lot of people walking away from their homes."
How high is too high?
TONY WONG
BUSINESS REPORTER
John Talbot is so sure that the housing market will collapse that he rents a home. If real estate prices do crash in his area he has the option of buying a house at a cheaper price. At least that's his strategy.
Luckily for Canadian homebuyers, Talbot lives in California, not Toronto, where home prices have risen an astounding 75 per cent alone over the last five years in the San Francisco Bay area.
That's not quite the case in the Toronto area, where house prices have also increased, but not as dramatically. In his book, The Coming Crash In The Housing Market, Talbot outlines a nightmare scenario for some homebuyers in the United States with lessons that can be extrapolated for the heady Toronto market.
"We have a real estate bubble happening in many parts of the world, and although Canada has not had the kinds of swings some other countries have had, major cities like Toronto could be compared to some American cities," says Talbot in an interview from his home in California.
Americans as a whole have seen real price increases (after inflation has been factored in) of 27 per cent from 1995 to 2002. Toronto is at 19 per cent, but pales in comparison to Dublin at 195 per cent and London at 136 per cent.
"In 10 years the world will be made up of those who cashed in on the technology bubble at its peak and sold their homes when housing prices were still high, and those who took the ride and came back down again and had nothing to show for it," says Talbot.
One big factor driving the housing market is mortgage rates that are at 50-year lows.
"Money is so cheap that we are not creating homebuyers, we are creating option holders who are playing with other people's money. They're buying the biggest home possible and maximizing debt," argues Talbot.
"The strategy is if the market goes up, great, but if it goes down, you're going to see an awful lot of people walking away from their homes."
Home prices are artificially high and are due for a major correction because inexpensive money and aggressive lending policies such as no-money-down mortgages cause buyers to jump into the market prematurely or buy more home than they can afford, he argues.
When mortgage rates drop from 8 to 6 per cent, for example, the qualifying formula suggests that you can now afford a house with a 25 per cent greater price. With more buyers able to afford more house, housing prices go up as a result of increased demand.
"The homeowner sees no benefit to the rate cut as his lower interest costs get eaten up by the higher house prices," writes Talbot in his book.
If mortgage rates go higher, a "double whammy" happens, he says. For one, some buyers will not be able to afford the increased payments, so they'll give up their home and place it on the market, creating more listings and driving down the price of the home.
At the same time, the pool of potential buyers shrinks because they can afford less under the higher rates.
What is alarming to Talbot, a former vice-president of investment banking for Goldman, Sachs and Company, and who has lived through a few market crashes, is that people are talking about real estate today like they did about Internet stocks only a few years ago.
"Propelled by loose credit and the belief that there will always be a greater fool to pay an even higher price in the future, homebuyers seem to have placed no limit on the prices they will pay. The fact that housing has gone up every year recently has lulled homeowners in a false sense of security that what went up cannot come down," Talbot says.
While he doesn't place Toronto in the category of San Francisco, where the average price of a home at the end of 2002 was $530,000 (U.S.) ($710,000 Canadian) compared with about $300,000 in the Toronto area, there are some parallels.
Many Canadians still remember the big housing bubble of the late 1980s, when average house prices shot to a high of $289,000 in 1989 only to come crashing down by more than a third to a low of $198,000 in 1996.
Since then prices have recovered, with the average price now surpassing the peak of the 1989 bubble.
But the memories of that bubble still linger for many Torontonians, some of whom are now just putting their homes back on the market to recoup the losses of earlier years.
Meanwhile, some are wondering if a second bubble is on the horizon.
"Canada is in general in much better shape than not only the U.S., but most parts of the former British empire," says Talbot.
Because Canadians have not seen the same kind of dramatic run-up as in many parts of the world, there is "much less to fear of a possible downturn," Talbot says. Still, there are some warning signs. Some analysts feel too many condos are being built. But most analysts see very little at issue with the overall health of the housing market.
If mortgage rates were to "zoom up to 10 per cent, we would have a collapse tomorrow, no question, but that's not likely to happen," says Toronto-based housing economist Frank Clayton.
"While it is certainly possible to have a housing bubble and subsequent crash, something we've already seen in Toronto in the late '80s, I sincerely doubt something like that will happen in this market," says Doug Porter, senior economist at BMO Nesbitt Burns.
"The typical house owner in Toronto should not be losing any sleep."
For one thing, compared with some of the steep increases in other cities around the world, housing price increases here in Toronto in comparison have been "remarkably restrained" says Porter.
Ted Tsiakopoulos, senior market analyst for the Canada Mortgage and Housing Corporation agrees. He says that the Toronto housing market has anywhere from "one to two good years left" before the cycle ends.
"We are certainly close to the end of the cycle, but we're not looking at a major pullback," says Tsiakopoulos.
"In some cities in the U.S., where the economy is being driven by specific sectors such as technology, then you're seeing consolidation in those cities, which makes it sensitive to a downturn.
"But that's not the situation in Toronto. We have a very diverse economy here," argues Tsiakopoulos.
"We're by no means in a bubble. Our market is being driven by fundamentals." One reason why is that we have far less to fall than some major cities, and that may be due to cautious Canadians who are still suffering from the hangover of the housing bubble of 1989, says Clayton.
x Instead, "Our recession was much more severe, it came later and lasted longer, and we have long memories of what happened," says Clayton.
Down the road Clayton sees a relatively healthy housing market, driven by about 100,000 immigrants annually who settle in Toronto and the surrounding area, which translates into 40,000 households. "As long as we have good immigration and the job numbers hold up, then the housing market here will be healthy," Clayton says.
Meanwhile, Toronto housing analyst Will Dunning revised his forecast for resale homes substantially upward this week after figures showed June was a record month for resales.
While most analysts figured that last year was the peak of the housing market, Dunning is forecasting 75,000 resales this year, up marginally from 74,759 last year.
"A new record might be set this year," says Dunning. However, the analyst says there will be little change in house prices for the remainder of the year since most of the price increases have already occurred in the first six months.
While author Talbot agrees the Canadian housing market is in better shape than its counterpart in the United States, he says we shouldn't be complacent.
The availability of cheap money for example, exacerbates a growing debt problem, no matter what side of the border you're on. One Canadian mortgage broker, for example, advertises a mortgage product that guarantees 107 per cent financing. The mortgage pays 100 per cent of the value of the home, 3 per cent cash back and a 4 per cent service charge with no money down.v "When you have those types of enticements it's easy to leverage yourself to the hilt, and that's when you can get into trouble," says Talbot. "If you are not currently a homeowner but are looking to buy, maybe it is time to change your mindset. Our analysis shows that maybe you do not have to be in a rush to buy a home. Many young couples feel that if they do not buy right now, they will be priced out of the market forever."
Talbot recommends that if you are concerned that house prices are getting "toppish," then there a bunch of ways in which you can protect yourself, including: Sell your home. You can rent temporarily in hopes that house prices will indeed collapse. If you do rent, do not be afraid to splurge on the monthly rent, as it is only temporary. You should get a fairly good deal in renting today because vacancy rates have gone up substantially and rents have not kept pace with housing prices. Move into something cheaper. This will reduce your exposure to residential real estate and decrease your exposure to future price declines. It will also allow you to pocket some emergency money if times get tough.
Move from a high-priced area to a lower-priced area of the country. This is a tricky one, since not everyone can just pack up and go. Some major metropolitan areas such as Toronto have made major gains in real estate prices, while other smaller centres haven't had the same kinds of gains. If your job is mobile, you might want to consider selling your home if it is in an area that has had good gains for something comparable and cheaper in a smaller centre.
Manage your debt better. "When a mortgage banker offers you more money for a house than you can afford to pay back, just say no!" says Talbot. "Quit thinking of mortgage money as free money and see it, for it really is a threat to your family's well-being and your livelihood," if you end up in default.
To avoid spending more than you can afford, try to stay within a budget of not paying more than three times your total annual household income.
You should also try not to borrow more than 80 per cent of the value of a home. Be prepared for a potential price decline of 20 per cent. If prices decline by that much then your home won't go "underwater" - that is, the mortgage won't exceed the value of your home.
Hedge your exposure. If you cannot part with your primary residence then maybe it's a good time to sell your vacation home. If you own an investment property, consider selling if you think the market has peaked in your area. If you own your own business and office space, perhaps you can do a sale-and-lease-back arrangement, where you sell your property but rent it back so your exposure is limited.
Plan for the worst. Homes are typically forfeited when unexpected events happen such as a job loss, a divorce, or medical emergency. "Big mortgage debt does more to create co-operative and friendly work environments than if we put Valium in the office cooler," jokes Talbot. "People under threat of mortgage foreclosure cannot afford to be anything but model citizens."
To plan for the worst at work, make sure you don't have a great deal of your own company's stock in your investment or retirement portfolios. As employees of Nortel and Enron learned, corporate bankruptcy means "the last thing you want to find out on the last day at the job is that your retirement portfolios have also taken a beating."
And finally, reassess your priorities. There are other ways of maximizing your sense of well-being than by maximizing the size of your home.
"It is wonderful that people take such pride in their homes. It's another thing when it becomes an all-consuming part of your life. Keeping up with the Joneses can be a full-time job."
A home is a physical structure. It is not a family.
"People risk their lives to go back into burning homes to save pets. In the history of the world, no one has gone back into a burning house to save a sofa or washing machine," argues Talbot.
