Underwater, but Will They Leave the Pool? NY Times

http://www.nytimes.com/2010/01/24/business/economy/24view.html

Economic View
Underwater, but Will They Leave the Pool?
By RICHARD H. THALER
Published: January 24, 2010
Even if they owe more on their mortgages than their homes are worth, many people feel obligated to repay their loans. But what if those borrowers walked away?

Ubergeek Post Update December 2009 - Price Changes and Months of Inventory in GVREB

Here is a quick update on the work mohican and I did in spring 2008 around refining mohican's work tracking price changes and months of inventory. Remember that the best fit was to track half-over-half (i.e. 6 months over 6 months) price changes to a three month moving average of months of inventory (total active listings at the end of the month divided by the sales in that month).

Here is mohican's scatter plot for half-over-half versus 3 month moving average MOI, updated inclusive December 2009 data:



The correlation still exists, and another small step closer to the designation of "law". We can see how well the model has behaved.



Months of inventory was extremely low through the second half of 2009, an odd event in history when unemployment is rising. There was a step-change in affordability due to low mortgage rates, coupled with a lack of tightened requirements for loan qualifications. Are there other plausible reasons for low inventory and high sales? Last year's about-face happened across Canada but unique local factors still play a role.

What will 2010 bring for BC housing? There are several portents.

- There are musings on the wind of tightening mortgage requirements which will have some impact on demand.
- Interest rates are predicted to rise the second half of this year. We'll see. Low interest rates will reduce the chances of a price collapse but will not prevent prices from falling.
- Rental demand looks to remain weak. With the Olympics finishing in 45 days or so we may see some extra rental supply and, perhaps, extra for-sale supply as well.
- Unemployment is unlikely to decrease through 2010. Government budgets, at all three levels, are under stress. The pool of money grows increasingly thin, as one would expect as the world continues to de-leverage, though the process appears to be a drawn-out affair.

Seafield Update

This is a quick follow-up post to the post I made on the RTO decision (PDF) last year to raise rents at an apartment complex in the West End. A relatively exhaustive series of blog posts is covering the decision. Start here.

In my analysis I was intrigued the RTO decision interpreted the law that it needn't use any evidence forwarded by tenants in making its decision to markedly increase rents above the annual cap. It turns out, according to the Supreme Court of BC, you can't do that. The law was meant as a way of ensuring that extreme cases of low rents could be fairly addressed. Unfortunately, the law has been difficult to interpret and follow. This case highlighted how much variance there is in rents, even between comparable units. Variance in rents is due to dwelling location, amenities, and quality, and quality of tenant; the law does not address the latter factor in any way.

What will this decision mean? Well, for rents that are significantly below market, there is some argument for ensuring the law is kept in some form. The alternative is a situation where the rental cap is removed and there is a continual push on the Legislature to do just that. On a street level it likely won't have much impact at all. This part of the law that allows above-cap rent increases is rarely used because of the significant amount of research and time required to make a valid case.

Removing the rental cap has its own problems, most notably that landlords can use it as a way of eviction. There are provisions for preventing this but are not universally enforced. The other method BC landlords often resort to is moving in to the property for some months -- the law says it must be at least 6 months -- but it is the prerogative of the evicted tenant to confirm this and complain to the RTO. We heard about this situation for a recent Olympic rental.

The biggest myth around rental caps is that it keeps rents below their fair market value. This is patently untrue according to all the data I have seen. The data we do have on rents come from CMHC (see UBC Sauder School of Business graph (PDF)). Average rent is increasing in line with average income, about 1.8% per year, which is less than the rental cap of around 3-4%.

No matter what the laws and protections awarded to both tenants and landlords, we do know that the vast majority of tenants are not subjected to looming eviction or massive rental increases (or even rental increases at the cap for that matter...). When a business relationship -- which the tenant-landlord relationship is in its essence -- goes sour and trust is lost, the boundaries of law, fairness, and morality are tested on both sides. I know of both tenants and landlords who seem to be perpetually in some sort of conflict with the other. I wonder if it's worth the time and cost.

Financial Post - Mortgage shoppers opt for caution

Garry Marr and Paul Vieira, Financial Post

Published: Thursday, January 14, 2010

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• Online investing's changing face

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• CIBC World Markets Corp.

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• Canadian Association of Accredited Mortgage Professionals

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Peter J. Thompson/National PostA survey commissioned by the country's mortgage brokers suggests Canadians are exhibiting prudence when borrowing from a home.

The housing industry fired back yesterday at comments from Ottawa that the sector might be overheated with a new report that shows Canadians have become conservative in their mortgage choices, leaving little chance for delinquencies.

The Canadian Association of Accredited Mortgage Professionals surveyed its members, who issued more than 40,000 mortgages totalling $10-billion during 2009, and found 86% of loans went into fixed-rate mortgages. Of those, more than 70% had fixed rates for longer than five years.

Jim Murphy, chief executive of the Toronto-based group, said the report's results show the risk in the marketplace "is clearly manageable." He left little doubt about one of the reasons his group compiled the research.

"It was done in response to some of the musings at yearend by first the Finance Minister and then governor of the Bank of Canada," Mr. Murphy said.

Mark Carney, the Bank of Canada governor, has warned about rising levels of household debt, which is reaching record levels. He has said consumers may be failing to account for higher interest rates in the foreseeable future, leaving households "increasingly vulnerable" to any economic shocks.

Shortly after Mr. Carney's remarks, Jim Flaherty, the Minister of Finance, was asked by reporters whether he was considering tightening mortgage requirements.

"If we had to we could, and it is something that we are watching and monitoring. But so far there's relative stability in the sector," Mr. Flaherty said.

The CAAMP survey addressed the overall debt concern and found "the vast majority of people who took out their first mortgage last year borrowed less than they could afford to, as their gross debt service ratios are far below allowed maximums, even at the higher interest rates that are used to qualifying them for their mortgage."

Mr. Murphy said his group's report has been forwarded to the Minister's office which continues to look at whether it should apply any brakes to the housing market. About 18 months ago, the government did limit the maximum amortization period to 35 years and demand consumers have 5% down on all government-backed loans.

Stephen Dupuis, chief executive of the Toronto-based Building Industry and Land Development Association, said the study by the mortgage brokerages confirms conservatism is still ruling the housing market. He said first-time buyers, the most vulnerable to any change in rates, continue to overwhelmingly get long-term fixed-rate mortgages. While rates may be much higher in five years, he said the income of first-time buyers tends to climb by the time they get their second mortgage. "There has been a massive overreaction," Mr. Dupuis said, about calls to shorten amortization periods and increase down payments.

Mr. Dupuis added that while 2009 purchases in the Toronto area rebounded sharply from 2008 lows, sales are still well off levels reached in 2007. The same is true for much of the country. There is little doubt any move to tighten regulations will have negative consequences on the market, said Benjamin Tal, senior economist with CIBC World Markets. He estimates at least 25% of the new purchases would be affected by a change in the down payment.

"The industry is fighting back and asking the government to look at the data before making any decision," Mr. Tal said, referring to the latest salvo fired by the mortgage brokers.

---------

FINDINGS

- Eighty six per cent of these home buyers chose fixed rate mortgages.

- Among borrowers who chose fixed rates, a significant number opted for longer terms

- less than 5% chose terms of two years or less.

- Twenty per cent took three year terms, 5% four years, leaving 70% with a fixed rate for five years or more.

- The vast majority of people who took out their first mortgage last year borrowed less than they could afford to, as their Gross Debt.

Source: CAAMP

Read more: http://www.financialpost.com/news-sectors/story.html?id=2445180#ixzz0ch64D7Yd
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An Argument for Permanently Higher Prices

The BC housing blogging scene is filled with posts both bullish and bearish on future prices. This particular blog has been, since its formation a few years ago, predominately bearish on the general BC real estate investment climate. In the interest of mixing things up I thought I'd present what I consider to be a valid argument for a permanent shift in higher prices in the Vancouver area.

First a little theory. A value analysis of real estate relies on determining a property's net asset value, the sum of its future discounted cash flows. I derived the formula here in 2008. To recap, a property's value is its net operating income (NOI) divided by the capitalization (cap) rate. The important thing to note about the cap rate is that it is, in theory, inflation-independent. The cap rate in essence is a measure of the inflation-adjusted cost of capital plus some risk factor.

Risks owning a property would include property damage, lost income due to a poor choice of tenants, demographic changes, et cetera. In the past few years the cap rate has noticeably decreased. The obvious reason for this is speculation however it is, every once and a while, worth investigating if part of the increase is indeed a secular shift towards lower cap rates. How could this happen.

Since a property's value is effectively inflation-independent we should investigate other possible ways higher prices can be justified. One possibility is that mortgage rates are permanently lower, effectively meaning the expected returns from other investments of similar risk have also decreased. This is deflation and, ultimately, will leave cap rates unaffected. We are starting to see the potential beginnings of falling rents in Vancouver. Many parts of the US are experiencing rental deflation, something unheard of since recording began after World War 2.

We can also look at the other risk factors associated with home ownership, namely suite damage, building quality, and poor tenants. It could be argued that building quality has recently increased due to technical innovations, effectively reducing the depreciation rate. From what I have seen this is unlikely as the drive for cheaper materials eats up any quality gain. In addition, during times when land prices are high, there will be a push to skim the edges of the building codes in the name of increased margins. I would be surprised if most new structures have a depreciation rate any better than properties built 30 years ago.

What if tenants are less risky? Here we may have something. Vancouver's demographics have changed in the past 20 years. Could it be that new residents to Vancouver are inherently more reliable tenants than those previous? There is some evidence to support this view. In Taiwan, China, India, and Hong Kong cap rates are a few % lower than the historical average in North America. Why is this? It could well be speculation but it could also be culturally there is less risk in renting. (It could also partly be more favourable tax regimes.) In addition a lower unemployment rate could mean a more stable (and one assumes a higher quality) tenant base than in previous years.

In summary Vancouver has low cap rates compared to the rest of the country. From what I see amongst friends and family there is a dangerous air of speculation on the city's future price appreciation. However we should not discount the possibility that renting property is becoming, on average, a less risky proposition due to a more stable tenant base. This is, if only in part, a valid reason for permanently higher prices.

October 2009 Teranet House Price Index

DECEMBER 2009

Slower monthly price rises in three out of six markets Canadian home prices in October were up 0.6% from a year earlier, according to the Teranet-National Bank National Composite House Price Index™. It was the first 12-month rise in almost a year. The reason for this turnaround after 10 consecutive months of 12-month deflation is that October was the sixth straight month in which the composite index was up from the month before. The monthly gain of 1.3% was the same as in September. Prices have now risen 1% or more for five months in a row. In October, however, the monthly rise varied significantly among the six metropolitan markets surveyed. Teranet – National Bank National Composite House Price Index™ Contact Us For general enquiries: info@housepriceindex.ca For licenses covering all index-linked products, please contact: Simon Côté 514 879-5379 Website www.housepriceindex.ca

In only two of the six were prices up more than 1% from the month before - Toronto, 1.6%, and Vancouver, 1.8%. The Calgary gain of 0.8% remained vigorous. But in the other three markets the rise was much more modest: Halifax 0.4%, Ottawa 0.3%, and Montreal 0.3%. In each of these three cities the monthly appreciation was the smallest since market bottom (except for one monthly decline each in Montreal and Halifax). Toronto is now the fourth market to top its pre-recession summit (August 2008). Toronto prices fell 11.3% over the eight months from that peak through last April and then climbed 12.9% (an annual rate of 27.4%) over the six months to October, recovering the lost ground and a bit more. In Vancouver, October prices were still down 4.1% from the peak of June 2008. In Calgary, they were down 11.3% from the peak of August 2007. These two cities were also the only markets still showing 12-month deflation - 3.6% in Calgary, 2.2% in Vancouver. Twelve-month inflation was 3.4% in Montreal, 3.1% in Halifax, 3.1% in Ottawa and 2.3% in Toronto. Teranet – National Bank House Price Index™ The historical data of the Teranet – National Bank House Price Index™ is available at www.housepriceindex.ca. Metropolitan area Index level October 2009 % change m/m % change y/y Calgary 155.54 0.8 % -3.6 % Halifax 124.02 0.4 % 3.1 % Montreal 126.43 0.3 % 3.4 % Ottawa 121.88 0.3 % 3.1 % Toronto 117.43 1.6 % 2.3 % Vancouver 144.47 1.8 % -2.2 % National Composite 129.52 1.3 % 0.6 % The Teranet–National Bank House Price Index™ is estimated by tracking observed or registered home prices over time using data collected from public land registries. All dwellings that have been sold at least twice are considered in the calculation of the index. This is known as the repeat sales method; a complete description of the method is given at www.housepriceindex.ca The Teranet–National Bank House Price Index™ is an independently developed representation of average home price changes in six metropolitan areas: Ottawa, Toronto, Calgary, Vancouver, Montreal and Halifax. The national composite index is the weighted average of the six metropolitan areas. The weights are based on aggregate value of dwellings as retrieved from the 2006 Statistics Canada Census. According to that census1, the aggregate value of occupied dwellings in the metropolitan areas covered by the indices was $1.168 trillion, or 53% of the Canadian aggregate value of $2.207 trillion. All indices have a base value of 100 in June 2005. For example, an index value of 130 means that home prices have increased 30% since June 2005. By: Marc Pinsonneault Senior Economist Economy & Strategy Team National Bank Financial Group Teranet - National Bank House Price Index™ thanks the author for their special collaboration on this report. 1 Value of Dwelling for the Owner-occupied Non-farm, Non-reserve Private Dwellings of Canada.