The Sting

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consequences

The nightmare scenario goes like this: a nation of house hornies spends four years Hoovering up all the real estate it can absorb at ever-higher prices. Wages and salaries flatline, but mortgage rates are cheap, so household debt explodes. Before long seven in ten families own property. This has never happened before.

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Everyone says house prices will rise forever, but they don’t. They wobble and start to reverse. Saddled with fat mortgages and new fears, people trim spending, and punt that new flat screen. In an economy 60% comprised of consumer spending, the consequences sting.

And that brings us to this week: 900 jobs lost and 15 stores shuttered at Best Buy. Another 700 people on the street at Sears.

Why should anyone be surprised? Some things are so predictable.

And the real estate recoil has just begun. The newest numbers from Toronto’s forest of condo towers are just dreadful.

  • In the last three months of 2012 sales of new units crashed 47%, from the same period a year earlier.
  • There are now 18,366 brand new, never-lived-in, unsold condos for sale.
  • At the same time, 207 new projects containing 56,866 more units are currently under construction.

Supply is overwhelming demand, sales are falling off a cliff and inventory is stockpiling. How is this not a formula for lower prices in the months ahead?

In fact, it’s already happening as thousands of formerly virginal, first-time sellers meet Mr. Market.  A year ago there were 216,000 existing condos in the GTA and now there are 11,000 more. But sales are falling – by a significant 26%. That means more supply yet less demand, and prices are already cracking, down 3% in the last four months.

In fact a resale condo that was worth $400 a foot in 2011 when a lusty young couple bought it is now priced at $397. That sounds like nothing until you realize that buying a $400,000 unit in Toronto costs $10,000 in closing costs, while selling it takes $20,000 in commission. So, count a minimum loss of $30,000 on a unit often snapped with 5% down – which means the virgins lost 150% of their money and paid more to live there than a tenant would have.

That’s quite a shock when your mom (who gave you the down payment) told you it was a great investment.

There’s no question where this is taking us. I told you more than a year ago to expect asset deflation (real estate, cars, smart phones, gold) at the same time as price inflation (food, gas, daycare, insurance). This coincides with a societal redefinition of wealth – a shift from stuff, to liquidity.

Old school is thinking the best financial move is to buy a house and pay it off as fast as possible, trash the mortgage and let your equity grow. New school is knowing your equity will probably shrink and 3% home loans are stupid cheap. So better to invest in a balanced portfolio, make 10% and be diversified. Better still, rent a condo and let the landlord subsidize you, then stick the difference in your TFSA.

The days of routinely making big capital gains on houses are gone. In fact as the virgin sellers in godless Toronto are discovering, their ‘investments’ can turn illiquid fast. A year ago the sales-to-listing ratio for condos was 52.4%. Lately it’s 40%. Imagine that – pay more than the renter next door to live in an identical unit on which you have lost tens of thousands, and can’t sell. Now tell me why workers showing up at the Best Buy store in suburban Victoria Friday morning were shocked to find the doors locked.

Why should anyone be surprised?

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avatarGarth Turner - The Greater Fool posted Thursday, January 31st, 2013.

1 Comment for “The Sting”

  1. YOU said “There’s no question where this is taking us. I told you more than a year ago to expect asset deflation (real estate, cars, smart phones, gold) at the same time as price inflation (food, gas, daycare, insurance). This coincides with a societal redefinition of wealth – a shift from stuff, to liquidity.”
    It’s no secret you hate gold…and I almost agree with your analysis…BUT OIL and GOLD run together. These are assets that rise in monetary inflation. Were screwed, they pulled all the levers, interest rates in the tank. Centrals printing / monitizing like there is no tomorrow. Thats cause the string can only be pushed so far…good luck with your paper…

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