Thursday, September 13, 2007

Scotiabank Gets Religion

Well, well, one of the big banks finally put out a report that says what many of us has known for quite some time - houses are too expensive for most people and the situation is unsustainable.

Here is the report.

Here are some quotable quotes:

"There is little doubt that current trends are unsustainable. The current housing boom is now the longest of the post-war era (going on nine years) and has seen one of the largest cumulative real price gains (more than 60%). Builders have become more cautious as mortgage rates drift up and cost pressures mount, but total housing starts are still well above annual household formation levels of around 180,000.

Moreover, there is growing evidence of overvaluation in home prices in some parts of the country — a precursor to a period of softening conditions. To identify which domestic markets may be more vulnerable, we have calculated the percentage deviation of real house prices from their long-term trend. While a relatively simple benchmark, it nonetheless provides an indication of current valuations relative to historical norms. Our analysis looks at 15 major markets across the country for which comparable data are available."

"Nevertheless, the further domestic home prices climb above underlying economic fundamentals, the greater the risk of an eventual correction. The 1976 and 1989 housing peaks were both followed by some adjustment in real prices. In the past, this adjustment has normally occurred though a period of inflation erosion as opposed to nominal price declines."

They also gave specific overvaluation numbers for each of the 15 major cities in Canada with Vancouver being 13% overvalued compared to some long term trend which I don't quite understand yet. I'll have to give it a more thorough read when I get the time.

In all the report is fairly balanced and is by no means a doom and gloom report. It takes national view and stays away from commenting too much on certain markets.


oh please said...

Just to add a little fuel to the fire, XCeed Mortgage, a Canadian subprime lender, has suspended dividend payments. Just five months ago company president Michael Jones said the Canadian subprime market would stay healthy, and that the undeveloped potential was 55 billion, as compared to the existing 70 billion dollar residential mortgage market. "This represents 300,000 families that are living in apartment buildings. They don't have mortgages with other financial institutions."

Subprime in Canada? Nothing to see here folks, move along.

Clearly it's getting harder for the niche players to find money to lend. How long before that starts hitting the mainstream banks, I wonder?

patriotz said...

Could someone please tell me how a market that is priced over 100% above cashflow breakeven is "15% overvalued"?

Canadian home prices are running hotter than they should be and, in some parts of the country, overvaluation will lead to slower price gains, a report predicted Thursday

"Slower price gains"? Alberta is already dropping, doofuses. This is "soft landing" happytalk.

Scotia is predicting a cooling, not a collapse. Fundamentals remain solid in Canada because of low unemployment, high immigration and tight apartment vacancies. Speculative buying is rare...

This report seems to have been cut-and-pasted from the stuff that was coming out south of the border a year ago. You're doing a heckofa job, Scotiabank.

si fu said...

"Speculative buying is rare..."

Remember this is a national survey. Vancouver spec buying is way out of proportion to Toronto for example.

Also, the trend line is the comparator for the relative market value, but I agree that more weight ought to be given to cashflow. The P/E number ought to count for something, even though housing is a slightly different sort of investment than stocks for the non-speculator.

mohican said...

oh please - good article find

patriotz - the report is pretty fluffy but i expect that from economists. Essentially their job depends on them giving milquetoast predictions so their employer can justify keeping their clients and prevent them from doing anything drastic.

I understand what they've done now with their trend analysis to give them a fluffy answer. They used real inflation adjusted home prices and a polynomial trendline in the 4th order. If they are going to use polynomial trend in the 4th order they should've used nominal house prices since the inflation adjusted numbers prevent the need for the polynomial trendline use.

I posted my chart on the last post of August - here .

patriotz said...

The 1976 and 1989 housing peaks were both followed by some adjustment in real prices. In the past, this adjustment has normally occurred though a period of inflation erosion as opposed to nominal price declines.

If you want to know what "some adjustment in real prices" looked like after the 1989 peak in Toronto, click here. Read that paragraph again and decide if that's just sloppy wording or an intent to deceive.

/dev/null said...

Mohican - their trendline gives me the willies too. To me the HP filter seems like a bad choice for this situation because the data series ends at an outlier (well, *I* think it's an outlier and that is what they're suggesting too) and the HP can get dragged around quite easily. If there is a substantial change in the next few years you'll see that in 2007 we were way more that 13% above trend.

Of course, if we have a soft landing then they're looking golden. :)

el bbub said...

Maybe speculative buying is rare, but speculative selling is uhmm... not!

solipsist said...

Could someone please tell me how a market that is priced over 100% above cashflow breakeven is "15% overvalued"?

Magical thinking perhaps?

"Fundamentals remain solid in Canada because of ..."

But, we have a declining birth rate, a disappearing "middle class", and oh yeah, today we officially slipped to the second biggest trading partner with the US. China is now the largest. The strong dollar (though against the U$ and other world currencies...) and the looming recession won't help things either.

Fluffy is right.

Clarke said...

I would be very reluctant to say Scotiabank has had a "road to Damascus" conversion after reading that article. The report was nice for concluding that things are overpriced. But, after putting together all the numbers, the authors promptly jiggle them to work out to a soft landing scenario.

If this is objective analysis, I am underwhelmed.

patriotz said...

"Soft landing" pronouncements from the usual suspects mean that they are really expecting a crash. "Slower price gains" should be read "declines". I.E. when they say dp/dt will fall, read that as p itself will fall. This is what I call "Lerean Calculus" or "predicting the past".

This is just CYA so that they don't lose all credibility when people notice prices have already started falling.

Sam said...

ha ha patriotz! Scathing and true!