The truth is out there...
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I'll be honest. I don't know what the heck is going on in the Canadian housing market. Are house prices overvalued? Is this a nationwide bubble or just in pockets? Will the market crash? How severe? And when? I don't know. So, I thought, why not call the one guy who seems to have the answer - Marc Cohodes (Home Capital's notorious short seller)...
But before we get to my phone conversation with Marc, at his chicken farm in sunny California, here's some housing data:
Current Average Prices for DETACHED Houses -
- Toronto: $1.5 million
- Greater Toronto Area (GTA): $1.2 million
- Vancouver: $1.6 million
- Metro Vancouver Area: $1.5 million
Is this a dream? They're all MILLION DOLLAR PLUS houses. Pinch me.
Back to reality. Let's conduct an experiment and use CIBC's mortgage calculator. Imagine that you're a young family, new to the market, and want to buy an AVERAGE $1.5 million detached house in Toronto. And we're not talking about the top of the range (best neighborhood) house. It's just an "average" house. A 20% down payment on that average $1.5 million house would be $300,000. And so the mortgage amount would be $1,200,000 (= $1,500,000 house price less the $300,000 down payment). Oh, and by the way, CIBC's online mortgage payment calculator has a limit of $2,000,000 (not kidding - we're getting so close...).
OK, so we'll choose the 5 year fixed closed mortgage (4.79% posted rate) with a 25 year amortization period. Then click "submit"... and... we get a whopping $6,837 in monthly mortgage payments. Now, let's say we're the average Torontonian family; our average HOUSEHOLD/FAMILY income would be around $75,000. But that's just "gross" income. We need to subtract federal and provincial income taxes from $75,000, which leaves us with just $60,000 in take-home-pay. Can that "average" income afford an "average" detached house in Toronto? Hell no! Buying a $1.5 million house in Toronto right now would mean forking up $300,000 / 20% down payment (good luck!) and then paying $82,000 in mortgage payments every year for the duration of the mortgage!!! (the actual figures may vary based on differing mortgage loan factors but you get the point). That's WELL above the average Torontonian family's cash-on hand / equity (for down payment) and take-home pay ($60,000). Plus, families still need to pay maintenance costs, hydro, as well as eat food, and clothe themselves to survive (no duh)...
Indeed, houses are extremely out of reach for so many people right now, including me. In 2014, I bought a new 600 square-foot condo located in Regent Park, a former "slum" neighborhood east of downtown Toronto that's being completely re-developed with market condos. I wanted a good deal so that I could affordably enter the Toronto real estate market at the time (remember, I didn't have a trust fund waiting for me). Daniels' gentrification is expected to be complete in 2020. Anyway, let's say that you (the "average young family" in our experiment) give up on buying a house in Toronto. Well, years ago, one could find cheaper housing alternatives in the Greater Toronto Area (GTA). But guess what? "Cheaper" today means $1.2 million in the GTA for a detached house. There goes that alternative. This example is pretty much exactly the same in Vancouver ($1.6 million) and its surrounding housing market ($1.5 million) for detached houses.
So, WHO can actually afford all of these MILLION DOLLAR PLUS detached houses in Canada's most populated cities (Toronto and Vancouver) and their surrounding regions? What's going to happen to all of the disenfranchised "average" Canadians who want to buy a house but can't because they're priced out of the market? How much foreign capital is ACTUALLY being pumped (laundered?) into the housing market (and what happens when that foreign demand slows)? Are rich foreign students actually using "gifted" money from parents as down payments, with no income of their own in Canada, to obtain mortgage loans at Canadian banks? Do some Canadians have an insatiable drive to "trade up" their house every couple of years? Am I seeing more McMansions sprout up in the newer GTA suburbs? Are Canadian Banks' underwriting and lending practices really that sound? Have we overextended ourselves in debt (mortgage and consumer - Canadian household credit is above $2 trillion dollars and mortgage debt is 75% of that)? Can house prices go up forever; and does this mean I'm going to live in my 600 square foot condo for the rest of my life? What's going to happen to all of those real estate agents (including the part-time-agents who have full-time jobs but make client calls during work and then show houses at night)? If I attend one of the many "Get Rich By Investing in Real Estate Seminars" happening in Toronto can I actually get rich? Should I tell my parents to sell their $1 million+ house in Mississauga, cash out, and live like royalty in some warm country? Can the speculators / house flippers sell to a "greater fool" forever? Should I listen to those TV commercials and actually take out a HELOC on my home (because I feel so "house rich")? Can house prices really rise faster than salaries forever? What happens to the variable rate mortgage holders when the Bank of Canada finally raises the overnight rate? Who's left holding the bag if/when there is a crash in the Canadian housing market? These are all the questions I'm asking today. Something's gotta give... or so I think.
These three guys - Marc Cohodes, Hilliard MacBeth, and Carson Block - all think that a Canadian housing crash is coming.
I called Marc last week. He's the guy who shorted Home Capital. I asked Marc, "What's going on in the Canadian housing market?" To which Marc replied, "The Toronto, GTA, and Vancouver housing markets will all most likely crash. People there don't make that much money to sustain a market. Only a small segment of the population makes $200,000+ to actually afford those houses. Remember, housing is shelter. But now Canadians are trading houses like they're stocks on the Vancouver stock exchange...a big storm is coming". Scary stuff. So, I then asked Marc, "What should the average Canadian do?". He replied: "Sell all of your Canadian stocks and convert your cash to USD." (This isn't my recommendation to you. It's just what Marc Cohodes said on the call.)
I also contacted Hilliard MacBeth. He's the guy who wrote the book, "When the Bubble Bursts: Surviving the Canadian Real Estate Crash". I asked Hilliard via email: "What do you think will finally break the housing market's back?" To which he responded:
"Regarding the proverbial straw that broke the camel’s back and its timing: These are questions that everyone asks, all the time, going all the way back to my first interview in September, 2014, with The Globe and Mail. Unfortunately, there is no easy and definite answer. In fact, it is impossible to predict what factor or factors will be the catalyst. And, in the end, will it really matter? The exact timing doesn’t matter except to people who are trading houses (or condos) like stocks and trying to squeeze the last drop of profit out of the price gains, with a plan to sell at the exact top? Anyone that is familiar with the real estate’s industry’s lack of liquidity for sellers will recognize immediately that there would only be a few sellers able to complete that difficult task, and those few would need a lot of luck to pull it off.
I conclude in the book that the way to adjust your exposure to real estate is to sell BEFORE the market peak, and before anyone knows that it is the market peak.
Since I can’t successfully predict the timing I prefer to focus on what we know and what we can do: First, it is a bubble, of massive proportions, and all bubbles burst at some point. Second, the unwinding of the bubble will take years, not months and so people should avoid getting too aggressive trying to buy while the market is falling in the first year or two. Third, there are significant exposures within investments related to real estate, primarily in finance, that many people are very heavily weighted in their investment portfolios. The Canadian banks are the best example of this concentrated bet that investors are not paying enough attention to." [end quote]
And finally, there's Carson Block, who like Marc Cohodes, is a successful short-seller. I was just about to contact Carson and get his opinion about the Canadian housing market when news hit Bloomberg: “I’m starting to believe that there could be some real problems with Canada, says Carson Block". "Particularly given what happened to Home Capital in recent weeks I kind of wonder if Canadian investors are really nervous...". Carson concluded the interview by warning that "the conditions seem to exist for there to be some pain inflicted on the markets. That suggests that Canada is the hottest market in the world for short sellers; if not, it could be."
Damn. If the "doom-and-gloom" guys like Marc, Hilliard, and Carson are right then things aren't so sunny in "sunny ways" Canada. But what about the experts sitting on the other side of the fence - Stephen Poloz, Benjamin Tal, and Evan Siddall? Let's take a look at their arguments:
In May at the Group of Seven meeting of finance ministers and central bankers in Bari, Italy, Stephen Poloz, Governor of the Bank of Canada, tried to clear up doubt about Canada's mortgage lending practices, including the crash ("run on the bank") of Home Capital. "We’d be looking for signs that there are problems with the [financial] system as opposed to preoccupying ourselves with individual institutions...the question would be: What caused this? Is it something unique to the institution itself, or is it something in the system?… I think this situation [Home Capital] is pretty clear on that; it’s idiosyncratic.”
And then also in May of this year, Benjamin Tal, Deputy Chief Economist at Canadian Imperial Bank of Commerce (CIBC), said “It’s clear that the Home Capital situation is not the ultimate test of Canadian housing. The situation is contained and the quality of the assets is solid. Any reference to that reality from the [central] bank will carry a lot of weight.”
And finally, meeting with reporters at the start of June, Evan Siddall, Chief Executive Officer, CMHC said “We don’t think this is a pervasive problem in Canada...it is a discrete issue...the quality of the portfolio remains quite high. There is no specific concerns really in that portfolio or any part of our business. We have a robust fraud mitigation system in place and it’s working.”
Pheww. This is a lot to take in. And I still don't know what to think. It's concerning. Should we listen to the experts? If so, which ones? It's the "crash and burn" guys vs. the "everything is going to be alright" guys. All I do know is that one side is probably going to be right... time will tell. But for now, "the truth is out there"... somewhere...
What do you think about the Canadian housing market right now?
– Robin Speziale
(If you want to chat, email me at email@example.com)
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Robin Speziale is the National Bestselling Author of Market Masters. He lives in Toronto, Canada. Get a copy of his latest book, Capital Compounders. Click Here.
Disclaimer: Robin Speziale is not a registered advisor. This newsletter does not contain financial advice or stock recommendations. Please conduct your own research and consult a professional.