The dangers of scapegoating

An unfortunate side effect of unsustainable speculative bubbles is the short-term distortions it produces between the balance sheets of the bold and the timid. As distortions continue and late-comers realise they missed the boat (or simply weren't old enough to board it), there will be feelings of unfairness and an innate desire to look for palatable root causes.

vreaa has written on this:

The speculative mania in Vancouver RE had its roots in the early part of last decade. Vancouver housing was already pricey by Canadian standards, the good-weather premium was baked in. Things really took off after 2003, when very low interest rates allowed home prices to divorce themselves from fundamentals such as local incomes. This effect occurred in all major Canadian centres, it was a monetary and not a local effect. Through 2004, 2005, 2006, 2007, local Vancouver speculators threw themselves onto the fire, borrowing large amounts to buy primary-residences and ‘investment’ properties at prices that were only justifiable if you thought that prices would continue up forever...

...Canada’s policies of multiculturalism encourage people to celebrate their differences. This is hunky-dory when everybody is rich and has adequate resources; it is easy to celebrate your neighbour’s good fortune when you are experiencing similar luck. But, if you put the economic screws on a society that has been encouraged to emphasize difference, it is probably more prone to developing ethnic fault-lines than a society that puts more effort into celebrating similarities.

There has been more and more media prominence given to foreign buyers recently. Local politicians such as Peter Ladner are pointing to this group as the cause of our lofty prices. We are concerned that many are going to be getting their wires crossed by associating foreign buyers with the existence of the bubble. There is a very real subsequent risk that many of those who suffer the consequences of the imploding Vancouver RE bubble will mistakenly blame foreign buyers and, by extension, specific ethnic groups, for the whole phenomenon, and for the inevitably devastating outcome.

A wonderful post by vreaa. A derivative danger to capital inflows piled on top of an already frothy market is to find scapegoats for what is primarily a locally-driven problem, as occurred in 1994.

Nonetheless there are signs that foreign capital flows are causing asset price distortions, and not just in Vancouver. As mentioned in a previous post, the Bank of Canada understands that foreign capital investment within Canada must be weighed against the underlying business case. On this front Vancouver seems prime as a case study of ignoring this guideline.

I share with vreaa the concern that some individuals will inevitably look to incorrectly attribute the problems of high prices to actors in abstract -- oft distant groups -- and not to the underlying issue, namely pouring into poorly-yielding investments, whether funded from foreign or local capital sources, the proverbial elephant in the room.

Teranet Index - January 2011

Home prices up 0.4% in January

Canadian home prices in January were up 0.4% from the previous month, according to the Teranet-National Bank National Composite House Price Index™. It was the second consecutive monthly rise, following on three consecutive monthly declines. January prices were up from the previous month in four of the six metropolitan markets surveyed: 0.9% in Vancouver, 0.5% in Toronto, 0.4% in Halifax and 0.3% in Montreal. Prices were down 0.6% in Ottawa, a fifth straight monthly decline, and 1.0% in Calgary, a fifth decline in six months. Thus the correction of late last year turned out to be short-lived for the country as a whole - three months - and longer-lasting in Ottawa and Calgary.

The 12-month gain in the composite index slowed to 3.9% in January, the seventh consecutive month of deceleration. The largest 12-month rise was 8.2% in Halifax. It remains to be seen whether this lead will last, since the small number of transactions normally recorded in Halifax in December and January could make its reading less stable. The 12-month increase was 6.4% in Montreal, 5.3% in Ottawa, 5.1% in Vancouver and 3.9% in Toronto. Only in Calgary were prices down from a year earlier, by 3.4%.

Data for February from the Canadian Real Estate Association show generally balanced conditions in major urban markets. Relative to the average, conditions in Calgary were better for buyers and conditions in Vancouver better for sellers, a finding consistent with the movement of the Teranet-National Bank indices for these markets. The Toronto market is no longer tightening. Between January 17, when the federal minister of finance announced that the maximum amortization period for an insured mortgage would be reduced to 30 years from 35 years, and March 18, the announced effective date, the resale market may have been influenced by the prospect of this change.

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 Group
National Bank Financial Group

Teranet - National Bank House Price Index™ thanks the author for their special collaboration on this report.

Bifurcation of the BC Real Estate Market

No, bifurcation isn't a an intestinal disorder although it could cause some consternation (not constipation) among some observers who expect uniform behaviour across various real estate markets.

Based on market behaviour since the 'flash crash' of 2008/2009, we could draw a clear line between the urban market of Greater Vancouver and the rest of the province. The City of Vancouver and its immediate suburbs have witnessed a frenetic pace of home buying activity and consequent price rises.

This is in a pretty marked contrast to the real estate markets of the Fraser Valley, Vancouver Island, and the rest of BC. While prices have risen substantially in the area covered by the REBGV this past year, they have fallen or remained relatively flat in many markets including the Fraser Valley, Chilliwack, Okanagan, Northern Interior, etc. thus bifurcation.

Why?

Quite simply, I think it just comes down to supply and demand. The Greater Vancouver real estate market has inelastic supply and demand that is relatively stable. When the market is hot, supply becomes even more constrained as holders of real estate hang on for further gains rather than listing. Demand is increased as potential buyers feel like they are 'getting left behind' and the ratios of supply and demand drive prices higher. This, of course, can work in reverse, which is what we witnessed during the 'flash crash' of 2008/2009 and I expect we will witness a rather severe and perhaps more prolonged version again soon.

What do you think? When might this happen?

Note: The Landcor 2010 Report paints the same picture: https://www.landcor.com/market/reports/2010_Residential_Sales_Summary.pdf

Psychology of a Bubble

I stumbled upon this excellent post on the Irvine Housing Blog.

I suggest reading through when you have a few moments to review some of the important markers of a bubble market, how people rationalize purchasing in a bubble, and how it always ends.

Here is a great quote and some useful visuals:

The efficient markets theory does explain the behavior of asset prices in a typical market, but when price change begins to feedback on itself, behavioral finance is the only theory that explains this phenomenon. There is often a precipitating factor causing the break with the normal pattern and releasing the tether from fundamental valuations. During the Great Housing Bubble, the primary precipitating factor was the lowering of interest rates. The precipitating factor simply acts as a catalyst to get prices moving. Once a directional bias is in place, then price-to-price feedback can take over. The perception of fundamental valuation is based solely on the expectation of future price increases, and the asset is always perceived to be undervalued. There are often brave and foolhardy attempts to justify these valuations and provide a rationalization for irrational behavior. Many witnessing the event assume the “smart money” must know something, and there is a widespread belief prices could not rise so much without a good reason. Herd mentality takes over.

Yawn!

To be blunt, I'm bored with following the real estate market.

It moves terribly slow and the human emotions involved are heated, to say the least, and can be largely irrational. This is frustrating so I've been taking a break.

During this break, I haven't been missing anything so I've concluded that it isn't worth very much effort or time for me to involve myself too much in this blog anymore. It was interesting and I still certainly hold my conclusion that real estate in the Vancouver area is grossly overpriced considering the rental yield.

Additionally, I have been enjoying being a dad to my two little boys and my work has been exceptionally busy so I just don't find I have the time to devote to doing a good job on the analysis part of the blog. There are others who have picked up the mantle of providing monthly charts and statistics so I feel my work in that respect is largely irrelavent.

Anyway, I'm not shutting the blog down. I'll be around and I still plan on posting interesting articles or videos that I stumble across. I just thought it was fair to post how I've been feeling lately.

FVREB August 2010 Statistics

The FVREB releases stats today. Here they are.

A notable note is that the price of the residential benchmark is down -0.3% from August 2007.

Flat prices for 3 years is starting to take the wind out of the sails of the relentless pumpers. The psychology is changing and the fall should be interesting.

Charts to come later.

I'll Just Sell

In my work, coming face to face with hundreds of people each year, discussing finances and attitudes about finances, I find it very interesting how people approach potential financial pitfalls and opportunities.


One situation I have often come across quite often is the approach toward real estate ownership and financial risk management. The risks I speak of are common to all people: Death, Divorce, and / or a Loss of Income. One of these things can happen unexpectedly at any time and how you prepare for these events is of critical importance in your and your family's long term financial health. Relating specifically to real estate ownership, what happens to the family home when one of these risks turns into reality. How will the mortgage, taxes, maintenance, fees get paid?


Death - a common answer with a couple is "I'll just sell if Bill dies." or "We'll find a way to make it work." - a poor strategy to be sure and one frought with risks. What if the sale price is below what you need? What if it takes 6, 12, 18 months to sell? Where will you live? Will you be in any state to move and uproot in a time of emotional turmoil? Will you have the financial capacity and physical capability to make the necessary payments are do the necessary maintenance? Life insurance is a more appropriate strategy and the costs of that insurance should be added to the monthly budget.


Divorce - this clearly never happens to anyone and certainly isn't going to happen to the couple in front of me! "We'd just sell and split the proceeds." is the typical answer but this is also full of pitfalls. What if one person is emotionally attached to the property? What if one person wants to sell for much more than the other person and there is a stalemate about the sale strategy (very common)? Will you be in any state to move and uproot in a time of emotional turmoil? The key to managing this risk probably lies in the mate selection process but more practical advice would be that couples shouldn't overextend themselves beyond what either of them is comfortable taking on by themselves if it became necessary.

Loss of Income - Job loss or a disability can happen any time as well and despite the loss of income, the bank, strata, government still wants to be paid all at a time of diminished capacity to meet these demands. The common answer here again is "I'll just sell." but again will you be able to sell? Or more appropriately, will you be able to sell it quickly at the price you want? This is really the key question, since you can always sell your home if price isn't a consideration, but it always is. If you lose your job or become disabled, do you have enough of a financial cushion to make all of the necessary payments for 12 - 18 months or longer? Again, disability insurance can be helpful here but it is no solution for job loss. The best advice to to have a large cushion of savings that you can draw on if necessary. Retirement savings withdrawals are possible as long as you commit to replacing the funds as soon as possible so that you do not derail your long term retirement plans.


My impression is that people are very comfortable with the fact that in the past few years real estate has been an asset with good liquidity and rising prices so these concerns seem unfounded when coming from their financial planner, especially when their friends and family are able to sell their houses quickly and for more than they were asking. The question is, was that normal? Should we expect a much different market in the future with dramatic implications for personal risk management? Many people wonder how they can build up an emergency fund, savings or pay insurance premiums when they are stretched to the limit with mortgage payments. My advice is that you should get out of that situation as fast as possible because you may not be able to sell at the price you need.

Rational Thought Not a Factor in Home Purchases

By The Canadian Press

Referencing RBC Study.

TORONTO - Recent first-time homebuyers say they felt pressure to enter the market as they contended with jitters about rising home prices and higher mortgage rates.

The Bank of Montreal says as many as one-third of respondents in a homebuyers survey believe their expectation that housing prices would increase, and interest rates would soar, left an impression on their decision to make a purchase in the short term.

"There's definitely a sense of urgency among home buyers," said Lynne Kilpatrick, senior vice-president of personal banking at BMO.

"While we encourage Canadians to pursue their home ownership dreams we recognize it's easy to get caught up in the emotions of the purchase and this can lead to stretching one's budget too thin."

The results come as Royal Bank released its own homeownership survey on Wednesday which showed that a majority of Canadians expect to see higher mortgage rates over the next year.
RBC's annual homeownership survey said 64 per cent of Canadians expect high rates, with about the same number of mortgage holders concerned about higher rates.

Economists expect the Bank of Canada to raise interest rates by between half a percentage point and a full point over several months beginning this summer to fight inflationary pressures in the economy.

With many Canadians taking on larger and larger mortgage debt in expensive markets across the country, higher rates could create financial problems for some homeowners.

In the Royal Bank survey, three-quarters, or 73 per cent of homeowners, feel strongly that homebuyers need to think ahead to ensure they will still be able to make their mortgage payment if rates rise.

The bank says six-in-10 mortgage holders say they have taken advantage of current low interest rates to pay more principal on their loans.

Eighteen per cent of homeowners say they've made a lump sum payment on their mortgage and 16 per cent have doubled their payment to reduce their principal.

While 84 per cent of mortgage holders believe they are doing an excellent or good job of paying down their mortgage, 49 per cent say their mortgage is larger than they thought it would be at this stage in their life.

Marcia Moffat, RBC's head of home equity financing, says the best advice for homeowners is to review their mortgage holdings with a financial adviser to position themselves for any changes.
BMO's senior economist Sal Guatieri added that a cooler housing market is "just around the corner."

Optimal Monetary Policy during Endogenous Housing-Market Boom-Bust Cycles

This paper uses a small-open economy model for the Canadian economy to examine the optimal Taylor-type monetary policy rule that stabilizes output and inflation in an environment where endogenous boom-bust cycles in house prices can occur.

The model shows that boom-bust cycles in house prices emerge when credit-constrained mortgage borrowers expect that future house prices will rise and this expectation is neither shared by savers nor realized ex-post. These boom-bust cycles replicate the stylized features of housing-market boom-bust cycles in industrialized countries. In an environment where mortgage borrowers are occasionally over-optimistic, the central bank should be less responsive to inflation, more responsive to output, and slower to adjust the nominal policy interest rate.

This optimal monetary policy rule dampens endogenous boom-bust cycles in house prices, but prolongs inflation target horizons due to weak policy reactions to inflation fluctuations after fundamental shocks.

Personal Finance and Buying a Home

Something that I haven't quite got my head around is how so many (thousands per month) people can seemingly 'afford' to purchase homes in the Vancouver area considering the prices at which local homes seem to be sold at. Greater Vancouver benchmark for all dwelling types is just about $520,000 as of June 2009.

Let's look at a sample first time home buyer.

Let's imagine John and Jenny want to get started on the property ladder after getting married last year. They have saved $10,000 over the past couple years and they have about $25,000 in their RRSP accounts which they intend to use toward a property purchase under the Home Buyer's Plan. Jenny's parents have offered to help them purchase their first home as well with an extra $20,000 'loan' to be used toward a down payment that may never need to be paid back. They don't have any credit card debt but are making payments of a combined $900 per month on two car loans which have 3 years left on them. Combined down payment = $55,000.

John makes $60,000 per year working in the technology field and his job prospects are very good given his education and work experience. Jenny works in sales and her income has averaged $50,000 per year over the past two years. Although she does okay at work, her job prospects are sketchy as the company she works for has seen business drop off considerably and has laid off a few people in the last few months. Gross Annual Income = $110,000. Net Monthly Cashflow = $6,000.

They are wondering what they are able to afford (apparently they don't have a budget) so they go talk to a mortgage broker about their situation. The mortgage broker punches some numbers into the computer and comes up with a preapproval amount of $430,000. John and Jenny are amazed, they wonder what they have done to make the bank love them so much! This pre-approval emboldens them.

They call up a realtor and begin looking at homes in the $400,000 to $500,000 price range. The realtor shows them several condos and a few townhouses which meet their criteria and they settle on a nice townhouse and make an offer for $450,000 which is accepted and the deal is drawn up.

John and Jenny put $45,000 down by using the parent's money and withdrawing from their RRSP accounts under the Home Buyer's Plan. They have paid CMHC and legal fees of $9,000 which gets added to their mortgage so they owe a total of $414,000 and they have decided to amortize over 35 years (they will be 65 when it is finally paid off if they stick to the original plan with the original rate) with a 5 year term and a rate of 4.5%. They will be making principal and interest payment of $1,950 per month, they have added life insurance to the mortgage ($50) and are paying property tax monthly with their mortgage payment ($200). They now get to pay strata fees of $200 per month as well.

Let's have a look at John and Jenny's monthly budget.

John and Jenny's total monthly obligations are:

Mortgage - $1,950

Life Insurance - $50

Taxes - $200

Strata - $200

Car Payments - $900

Food - $600

Fuel - $400

Home and Auto Insurance - $400

Telephone/Internet/Cable - $300

Clothing/Other/Misc - $300

Entertainment/Vacations - $500

RRSP contributions - $200

Total = $6,000

This couple can have a 'reasonable' lifestyle based on these numbers but let's look a little closer. Let's test this for several common risks:

Death - The mortgage is life insured, the survivor would be financially okay so long as the life insurance remains in place.

Divorce - They are in bad financial shape if this happens. Neither one of the two could afford the townhouse if they split up and the townhouse would need to be sold quickly.

Children - They are in bad financial shape if they have kids. Not only would they have extra monthly expenses, which they don't have room for in the budget, they would also have less income for a period of time as it is typical for the mother to take some time off work after giving birth. Even if mom went back to work there are daycare costs, which are not small.

Job Loss - They are a financial disaster if one of the two loses employment of any extended period of time. They would be forced to make some significant life changes and likely sell the home.

Interest Rate Rise at Renewal - If interest rates rise by 100-200 basis points they would be extremely rough financial shape. Unless they had an increase in income, they would likely be forced to re-amortize the mortgage and/or make other lifestyle changes. If rates increased more than 200 basis points, they would not be able to maintain their current lifestyle in any shape or form.

1) 100 basis point rise to 5.5%, maintain original amortization, payments rise to $2180 / month

2) 200 basis point rise to 6.5%, maintain original amortization, payments rise to $2420 / month

3) 300 basis point rise to 7.5%, maintain original amortization, payments rise to $2670 / month

Time - This is the most insidious risk of all and the least recognized. As a financial planner, I see many people who have put themselves into this type of scenario and they manage to muddle through life, manage to pay off a modest home by retirement and save a very modest sum of money. They retire at 65 and have a fairly low standard of living since they have no real significant savings and no pensions. If none of the above risks occured and they both managed to work a full career, get regular raises, contribute to CPP, receive OAS and have some modest RRIF withdrawals, they would make it through life without severe financial hardship but as a debt slave. The bank would have made over $400,000 from them in interest payments and they would have never saved much. They would live month to month their entire life and financial freedom would be a mere dream as they play the lottery each week hoping their number is drawn.

The reality is that the risks noted above are very real and for John and Jenny's situation to work out they need everything to work perfect, with no hitches, glitches or problems. This seems unlikely to me. It would be far better for them financially to leave themselves more room in their monthly budget so that they could:

1) Live / survive with only one income

2) Maintain mortgage amortization if interest rates rise

3) Speed up mortgage pay down by making extra payments as they receive raises if things work out well.

4) Increase their personal savings to RRSP and/or TFSA to ensure they have money for the unexpected and for retirement.

There are only two ways for John and Jenny to make the above work in a sustainable manner:

1) Continue renting and saving aggressively

2) Buy a much cheaper home and aggressively pay down the mortgage

What are your thoughts? Do you know John and Jenny? I do.

REBGV Sales are the Story

The local real estate market has been goosed this spring by the super low interest rates available to your average home buyer.

Sales in the REBGV jurisdiction were very high at 4259 for the month of June.

Active Listings fell to 13,252 units.


Consequently the Months of Inventory fell to a mere 3.11 for the month of June. A dramatic fall from January's levels.

As sales have risen and inventory has fallen, prices have gone up.

The correlation between Months of Inventory and Price Changes is still very strong.

It will be very interesting to see how future price changes play out. We will see if this spring market is a temporary phenomenon like so many other spring markets around North America.

Unemployment levels, interest rates, and many other factors play a big part in the local market and it will be interesting to see which way things turn.

From thesaurus.com:

Main Entry: fool
Part of Speech: noun
Definition: stupid or ridiculous person
Synonyms: ass, birdbrain, blockhead*, bonehead*, boob*, bore, buffoon, clod*, clown, cretin*, dimwit*, dolt*, dope*, dumb ox, dunce, dunderhead, easy mark*, fair game, fathead, goose*, halfwit, idiot, ignoramus, illiterate, imbecile, innocent, jerk*, lamebrain*, lightweight*, loon, moron, nerd*, nincompoop*, ninny, nitwit, numskull*, oaf, sap*, schlemiel*, silly, simpleton, stooge*, sucker, turkey, twerp, twit, victim
Antonyms: brain

In the vein of thinking about people for who may be the greater of the above synonyms (greater fool), let's discuss this article from the Globe and Mail which highlights a reputable survey from Bing Thom Architects (press release) that has been done regarding the Vancouver housing market. This survey dispels some of the myths surrounding the Vancouver condo market.

Foreign Owners - nope
Vacant condos - no, not really
Investors - yup, yup, yup - 50 to 60%+ of condos are owned by investors

The question is, why do these investors continue to hold onto a low yielding investment like a downtown condo?

The answer is that they believe that the price will rise in the future. In other words, they hope to find a greater fool in the future whom they are able to sell to.

No, there isn't anyone else to blame except local speculators, ahem, investors, who have bid up prices and snapped up developer units at an unprecedented pace over the past few years.

Here is a snippet from the press release:


In addition to an estimate on empty condos, the study found that:
• Condo ownership is a relatively new form of housing for Vancouver. Over 88 percent of condo units in Downtown Vancouver have been built since 1990.
• Less than 40 percent of downtown condos have more than one bedroom.
• The majority of condos are not occupied by the property owner.
• The majority of non-owner occupied condos are owned by BC residents, with a scattering of foreign owners, predominately from the western US states such as California, Washington, and Arizona.
• Owner-occupied units are typically worth $30,000 to $40,000 more than nonowner occupied units, and the more bedrooms the unit has, the more likely it is to be owner occupied.
• A family with one child in the City of Vancouver earning the median income of $75,000 a year would have great difficulty in finding and paying for a condo bigger than one bedroom, even if condo prices were to fall 25 percent below 2008 assessment levels.

That last one is a doozy and despite better career prospects that is why I don't live in Vancouver with my wife and two children.

A Deception so Great

" We are never deceived; we deceive ourselves."
- Johann Wolfgang Von Goethe

An old adage is that if two people tell you you’re drunk, you’re drunk. After repeated conversations with friends, co-workers, and family, I can safely say that I am nicely and completely hosed. Most of my social circle does not believe as I do Vancouver house prices are going to drop at least 40% from their peaks in 2008. From this, being a humble sort, it would be incredibly arrogant of me to think them collectively wrong.

Here I offer the wildly arrogant possibility that maybe -- just maybe -- “they” are wrong.

Vancouver is a city obsessed with real estate. Many cultures immigrating here cherish it above little else; prices have risen significantly in inflation-adjusted terms for a generation; the majority of homeowners have huge swaths of equity tied up in property. It is hard to make the case for why the real estate party is closing down for a long time. I have tried, of course, citing low immigration, low median incomes, flat rents, huge looming inventory, dependency upon construction employment, a global recession, negative savings rates, significant similarities to US markets now crashing hard, arguments with which real estate “bears” are familiar. All my arguments, it is rebutted, are short term phenomena which will pass in a few short years and Vancouver will continue with its price appreciation as it has done since it was founded.

I believe Vancouver is in a bubble. Not a house price bubble (though we are), but a bubble of collective dissonance when it comes to how to value real estate. The 800 pound gorilla in the room is the simple question: why are properties worth what they are?

There are several ways to answer the question. The first most obvious answer is simply that properties are worth what someone else is willing to pay. Fine, but that doesn’t get to the heart of “why”. Why is that someone else willing to pay? Who cares, we say. Who are we to second guess motives of buyers? Maybe there is a new batch of rich buyers who care not whether an investment produces a reasonable income stream, maybe population growth is forcing land prices up, or maybe future income growth will more than compensate for the prices we pay today.

Maybe so but the analysis of the data suggests we should care a great deal why others are willing to pay and not just stop at our whimsical assumptions about what Vancouver is. Rich immigrants? Not too many. Population growth? Not that high. Income and rent growth? In real terms, try the opposite. Running out of land? The number of residential projects under construction is near all-time highs. It is clear to me that the image of Vancouver being a playground of the rich with high immigration, rising wages, and a limited land supply is for the most part illusory.

If we go back to the question, why is property worth what it is, using the actual data, the results are all the more concerning for real estate bulls.

There is a strong case that Vancouver real estate, like other cities around the world, has been riding a generational bubble. It has fostered a “can’t lose” attitude, where stomach-churning drops are assumed to quickly recover to new highs. In the past 25 years Vancouver has spent relatively short periods in the price valleys with relatively long periods of over-valuation. This is classic speculation with a twist. The length of speculation and perpetual volatility has perversely led to survivorship bias and, due to the relatively slow movement of property markets, deification of successful real estate investors embedded in local social circles. The speculation has not been the flash in the pan we all connote with other booms but a slow and seemingly secular trend to permanently high prices. It has fostered an air of invincibility around real estate investing, still heavily present today. How about those stories we hear of flippers losing their shirts on presale assignments? They are merely unfortunate and limited casualties in the machinations of the city’s real estate juggernaut. It has been a mistake to count out the Vancouver real estate owner, say the successful surviving real estate gurus.

We are now in the throes of another wave of high volatility with a decided trend downwards. At first glance it looks the perfect storm: oversupply, low sales, high prices, a global recession, and tighter lending, all point to prices falling more. Even with these insurmountable odds speculators will still be playing in the market, ever aware of Vancouver’s amazing ability to rebound from previous crashes. I hear it constantly: prices have dipped and will stabilise in 2010, the recession will be over by the end of the year, in-migration of rich families will eat up the excess inventory quickly, et cetera. Almost certainly there will be people buying this spring anticipating new highs within a decade. The same will happen in 2010, 2011, 2012, and on, all the way down and up again. This does not mean these buyers would support prices from falling but it does mean there are still bulls in any active market (by definition, in fact).

I have heard several comments from those bearish on local real estate that prices supported by rents and incomes will happen in but a few years, amounting to a truly meteoric, though not unprecedented, fall from grace. I am not so sure. The mood of Vancouver is so tilted towards the sanctity of real estate investing I find it only convenient to think a handful of years of a bear market changes this thinking. If anything I see years of pain to change how people value real estate, likely more than five or even ten: the “stickiness” of prices we hear so much about. This does not preclude significant price drops in the next few years -- I personally think it likely -- but to really get to a point where affordability is restored could take much longer.

So why is real estate priced as it is? What would we say after a crash and the subsequent fallout? I can hear it now: real estate, in its essence, is but a utility, providing a service for a fee like a car. Affordable, not unaffordable, housing supports income and economic growth. Property is only worth what income it produces. Dare to dream, drunk jesse.

The past generation has done well from real estate investing and I believe its perpetual success has fostered a deception -- a cognitive dissonance -- about what real estate really is and how it is valued. The deception is so complete it is terrific. While high prices may continue, there is a real and plausible possibility of a slow and painful trudge towards lower prices for a long time.

Denial - It's Not a River in Egypt

The Nile River is a long river, in fact, it is generallly regarded as the longest in the world. It represents a very large drainage basin, covering much of North Africa.

Likewise, DE-NIAL can be the drainage basin of your finances if you aren't careful. According to Wikipedia, denial is a defense mechanism in which a person is faced with a fact that is too uncomfortable to accept and rejects it instead, insisting that it is not true despite what may be overwhelming evidence. The subject may deny the reality of the unpleasant fact altogether (simple denial), admit the fact but deny its seriousness (minimisation) or admit both the fact and seriousness but deny responsibility (transference).

So today, many of the people you see around you are in denial about the reality of the Canadian real estate market. They are so uncorfortable with the fact that prices have fallen and are falling further that they outright deny the fact. Sometimes they admit that prices have fallen but minimize the impact that it will have on Canadians or themselves. Sometimes they just admit that prices are falling and that it will have a big impact but walk away from their 3 spec condos.


Yes folks were are in the denial stage. Next stop 'fear' - - I'm scared.

Good luck!

A Letter From Warren Buffett

From the NY Times.

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.
Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Warren E. Buffett is the chief executive of Berkshire Hathaway, a diversified holding company.

EVERYBODY PANIC!

The TSX was down over 10% this morning for whatever reason fancies the average investor. The Toronto market is down over 30% in the past 4 months and the S&P500 is down over 30% in the past 12 months. I'm sure some new doom is sure to envelope our country, shuttering our businesses and turning us all into stark raving mad lunatics.

Well maybe it isn't quite that bad and to this observer of human behaviour, it seems a little overdone now. I have recognized that timing the market bottom is an impossible feat but there are two things that are common about market bottoms:

1) Despair and hopelessness. Check.

2) Massive redemptions of mutual funds. Check. See story here.

Canada faces housing bust: Shiller

Jacqueline Thorpe, Financial Post Published: Wednesday, October 01, 2008

The Canadian housing market could face a similar housing bust to the United States, particularly in more bubbly markets as Vancouver and Calgary, said Robert Shiller, the University of Yale professor who predicted both the 1990s stock market boom and bust and the US housing slump.

Mr. Shiller, co-founder of the S&P Case/Shiller Home Price Index, said psychology is the primary driver of bubbles and it appears that Canada has been caught up with home buying fever just as the United States and other countries around the world.

Asked whether that meant Canada could face a similar bust Mr. Shiller said: "Yes, especially in places that went up a lot like Vancouver and Calgary. I don't think Toronto has been quite as extreme."

Mr. Shiller said there was a natural connection between the United States and Canada.

"I would be surprised that the bubble that appeared in the United States and elsewhere didn't appear in Canada," he said in an interview with the Financial Post. "It's psychology, I think that drives it.

Mr. Shiller, whose book Irrational Exuberance came out in March 2000 just as the tech bubble peaked, said it was essential for the U.S. government to pass a financial bailout, though he believes the United States is facing a "severe recession," regardless.

"I'm concerned problems are deeper than can be handled by the bailout but that doesn't mean the bailout doesn't do some good," he said.

He said a bailout might help restore some confidence to the stressed financial system.

"What creates a crisis is a lack of confidence," he said.

He said the housing crisis was primarily a policy failure by U.S. authorities.

The U.S. government was "totally blind" to it, regulators failed to monitor the mortgage industry properly and the U.S. Federal Reserve had very low interest rates at a time of the greatest housing bubble of all time.

While homeowners should take some personal responsibility for the debacle, they were being goaded into the fevour by an establishment that endlessly pushed an ownership society.

"They were doing what was considered right at the time," Mr. Shiller said.

Mr. Shiller said human nature seems to predispose people to spectacular excess, fanned by a voracious news media.

"Until we had newsapers and other media we had no bublbles, he said.

While ups and downs in the market can lead to creative destruction the current housing crisis has morphed into a system problem.

"The problem is that perfectly good firms are in trouble," he told the Financial Post in an interview at the Ontario Economic Summit.

A bailout may not be palatable, government assistance is required when the system fails.

The trick is to reduce conditions that fan bubbles.

In his current book, "The Subprime Solution," Mr. Shiller proposes several measures to reduce bubble conditions in the housing market including better information for prospective buyers and broader markets that trade risk better, such as the housing futures he has developed on the Chicago Mercantile Exchange.

There should also be new retail products such as "continuous workout mortgages," that go up and down with the value of the home equity and mortgage equity insurance.

Mr. Shiller, who would not give a precise forecast on the outlook for U.S. home prices, nevertheless said futures markets are predicting more price declines of 10% or more. His Case/Shiller index earlier this week showed home prices down 16.3% year-over-year this summer.

He expects things to get worse for the U.S. economy in the short-term.

"We're going to have a severe recession, most likely," he said. How quickly the economy recovers depends on policy.

"Unfortunately the bailout has hit a snag," he said. "There is resentment of rich Wall Street people. I am worried that the sense of trust, in confidence of each other is being damaged."

Mr. Shiller said he does not have another bubble in his sights as the U.S. economy will be "damaged for years."

"The housing bubble was of record proportions," he said. "Maybe the next big bubble will be your children's or grandchildrens...The excitement we had in the 1990s and in 2000 in the housing market is a fragile thing and it won't come back for some time."

It's a Random Walk

From Investopedia:

Random walk theory gained popularity in 1973 when Burton Malkiel wrote "A Random Walk Down Wall Street", a book that is now regarded as an investment classic. Random walk is a stock market theory that states that the past movement or direction of the price of a stock or overall market cannot be used to predict its future movement. Originally examined by Maurice Kendall in 1953, the theory states that stock price fluctuations are independent of each other and have the same probability distribution, but that over a period of time, prices maintain an upward trend.

In short, random walk says that stocks take a random and unpredictable path. The chance of a stock's future price going up is the same as it going down. A follower of random walk believes it is impossible to outperform the market without assuming additional risk. In his book, Malkiel preaches that both technical analysis and fundamental analysis are largely a waste of time and are still unproven in outperforming the markets.

Malkiel constantly states that a long-term buy-and-hold strategy is the best and that individuals should not attempt to time the markets. Attempts based on technical, fundamental, or any other analysis are futile. He backs this up with statistics showing that most mutual funds fail to beat benchmark averages like the S&P 500.

While many still follow the preaching of Malkiel, others believe that the investing landscape is very different than it was when Malkiel wrote his book nearly 30 years ago. Today, everyone has easy and fast access to relevant news and stock quotes. Investing is no longer a game for the privileged. Random walk has never been a popular concept with those on Wall Street, probably because it condemns the concepts on which it is based such as analysis and stock picking.

It's hard to say how much truth there is to this theory; there is evidence that supports both sides of the debate. Our suggestion is to pick up a copy of Malkiel's book and draw your own conclusions.

I'm Bored

Well, I'm not really bored generally speaking since work and life are very busy. I am bored of following our real estate market. It just seems so fatalistic at this stage of the process. We've seen this happen before in a myriad of places at many different times.

• Inventory rises amidst general exuberance about real estate
• Sales fall amidst claims of a 'seasonal' slow down
• Prices stagnate with claims of a rebounding market in the fall/spring/summer whatever
• Developers slash prices and introduce sales incentives with the general populace in denial
• Prices fall modestly as some sellers who must sell come to the realization that price matters!
• Inventory rises further and sales fall even more as the general public becomes aware that real estate does not always go up in value.
• Prices fall dramatically.
• Eventually people will avoid real estate investing and discussions like the plague.

The script has been written, auditions are complete, the set is ready, everyone is in place, quiet on the set and 'ACTION!'

Shareholder Letter from Bill Miller

The following is a letter to shareholders of Legg Mason Value Trust: Second Quarter 2008

Dear Shareholder,

A group of us were standing around a few weeks ago when Warren Buffett wandered over. Chris Davis had dubbed us the Value Support Group, as we all adhered to that approach to investing. we were commiserating over how badly we had done in this market, how valuation appeared not to matter and had not for the past couple of years, how it was all about momentum and trend, and how we were all losing clients and assets over and above our losses in the market. It seemed like we needed a 12-step program to cure us of our addiction to buying beaten-up stocks trading at large discounts to our assessment of their intrinsic value.

Mason Hawkins said, "Warren, I'm an optimist. I think this whole thing can turn quickly, and surprise people. Are you an optimist?" "I'm a realist, Mason," the sage replied. Warren went on to say he was optimistic long term, and backed that up in a talk the next morning on the remarkable history of growth, innovation, and wealth creation the U.S. had produced over the past 200-plus years. He also offered a sober assessment of the current challenges we face, and said it would take some time to work through them.

He then made the perfectly sensible point that as we are all net savers, we should be happy if stock prices declined a lot more, so we could buy even better bargains. That is a point Charlie Ellis elaborated on in his fine book, Investment Policy, a few years back. As a matter of logic,
it is irrefragable. As a matter of psychology, I think most of us value investors think we have plenty enough bargains already, and may not be able to handle that many more. Or more accurately, our clients may not be able to. We are value investors because we are persuaded of the logic of buying shares of businesses when others want to sell them, and we understand that
lower prices today mean higher future rates of return, and high prices today mean lower future rates of return.

The best time to buy our funds or to open an account with us has always been when we've had dismal performance, and the worst time has always been after a long run of excess returns. Yet we (and everyone else) get the most inflows and the most interest AFTER we've done well, and the most redemptions and client terminations AFTER we've done poorly. It will always be so, because that is the way people behave.

John Rogers, the founder of Ariel Investments, came in to see us last week. John has been an outstanding investor for 25 years or so, but like almost all value types, is going through one of his toughest periods now. His assets are down, similar to the experience we've had. He said it was the most difficult market he'd seen, a judgment I would have given to the 1989-1990 market, up until the frenzy erupted over Fannie Mae and Freddie Mac, which sent financials to what looks like a capitulation low on July 15th. I am now in John's camp. A point he made that I have likewise noted to our staff is that this is the only market I have seen where you could just read the headlines in the papers, react to them, and make an excess return. I have used the mantra to our analysts that if it's in the papers, it's in the price -- which used to be correct. Indeed, it borders on cliche in the business that by the time something makes the cover of the major news or business publications, you can make money by doing the opposite. There is solid academic research to back this up. But in the past two years, you didn't need to know anything except to sell what the headlines were negative about (anything related to real estate, the consumer, or finance) and buy anything that was going up and that everybody liked (energy, materials, industrials).

I am reminded of what John Maynard Keynes, himself a great investor, said once about investing, "It is the one sphere of life and activity where victory, security, and success is always to the minority and never to the majority. When you find anyone agreeing with you, change your mind. When I can persuade the Board of my Insurance Company to buy a share, that, I am learning from experience, is when I should sell it." It has been explained to me that it was obvious we should not have owned homebuilders, or retailers or banks, and that I should have known better than to invest in such things. It was also obvious that growth in China and India and other developing countries would drive oil and other commodities to record levels and that related equities were the thing to own. "Don't you even read the papers?" was a common comment.

While I am quite aware of our mistakes, both of commission and omission, when I ask what is obvious NOW, there is little consensus. If there is something obvious to do that will earn excess returns, then we certainly want to do it. Is it obvious financials should be bought now, having reached the most oversold levels since the 1987 Crash, and the lowest valuations since the last great buying opportunity in 1990 and 1991? Or is it obvious they should be avoided, since the credit problems are in the papers every day and write-offs and provisioning will likely continue into 2009?

Is it obvious energy stocks should be bought on this correction in oil prices from $147 to $123, a correction that has wiped 25 points off the prices of companies like XTO Energy and Chesapeake Energy in just a few weeks? Or is it obvious that oil had reached bubble levels at $147, and that buying the stocks here, down 30% from their highs, is akin to buying homebuilders down 30% from their highs in 2005? If you had bought Tesoro Petroleum or Valero Petroleum when their prices broke late last fall -- remember the Golden Age of Refining story that took Tesoro from under $4 to over $60? -- you would be looking at losses in this year greater than if you had bought Citibank or Merrill Lynch. I do think some things are obvious: it is obvious the credit crisis will end, and it is obvious the housing crisis will end, and that credit markets will function satisfactorily and house prices will stop going down and then start moving higher. It is obvious that the American consumer will spend sufficiently to keep the economy moving forward long term. It is obvious that the U.S. economy, already the most productive in the world, will get even more productive and will adapt and grow. It is obvious stock prices will be higher in the future than they are now.

Sir John Templeton died a few weeks ago, full of riches and honors, as he so deserved to be. The legendary value investor got his grubstake by famously buying shares of companies selling for $1 a share or less when war began in 1939. He didn't know then that the war in Europe would spread to engulf the world, nor how long it would last, nor how low prices would ultimately go. He always said he tried to buy at the point of maximum pessimism, but he never knew when that was. He was, though, a long-term optimist, as is Mr. Buffett, as am I.

Bill Miller
July 27, 2008