What Can Go Wrong?

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young woman driving on highway while reading / writing text on smart phone.

In 2007, as it was imploding, 16.5% of California’s economy was related to real estate. Houses in LA, California, Laguna Beach and San Diego had never cost more. But in places like Stockton, an exurb of SanFran, the crumble was starting. Today Stockton is bankrupt.

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The results are obvious. “The middle class is hollowed out,” said Governor Jerry Brown in delivering his latest austerity budget a few weeks ago. In fact, 1% of the people there now have 22% of the wealth, and 40% of all students are classified as ‘low income.’

This is what can happen when average people get house horny, borrow to buy inflated real estate, and believe it goes up forever. Like in BC. In fact just last week provincial labour minister Pat Bell said at least 6,000 of the latest 16,000 job losses in BC were due to “a real estate slowdown in the Lower Mainland.”

But it’s not just delusional British Columbia.

On Friday, when half the country was being buried in two feet of snow, the latest (January) housing starts numbers were released. They sucked. Down 19% from December, and plunged by 30% from levels of last summer.

In fact, starts have been declining almost every month, and by significant amounts – as condo projects in Toronto are abandoned and sales of single-family homes evaporate. Remember what I told you a few weeks ago – new house sales in Toronto (condos plus low-rise) crashed 52.1% in December from a year earlier.

But won’t they recover later this year? Not according to the issuance of residential building permits. They tumbled another 11% in December from the month before, and have fallen by a fifth in just sixty days. These are serious numbers. If I were in the building business, I’d be shopping for a new job. But not as a realtor.

Allan specializes in plaster work, drywall and stucco, with a shop just south of Vancouver, four trucks and a crew of 14. Well, until about last August. “There are three of us still working,” he told me on the weekend. “I’m eating, but my guys are completely screwed. Nobody’s coming back on the ticket for a long time.”

These days it’s estimated about 8% of the entire Canadian economy is comprised of direct real estate activity. When you combine that with real estate-related finance, insurance and renting, the share jumps to 22% – or six points higher than California before the crash. By comparison, all the manufacturing in the nation amounts to 13% of the economy, while mining and oil and gas combined total 4%. Of course, when people stop buying and building houses, the dominoes topple, which is why economists are a bit whacked by these latest numbers. Experience in other countries shows us there’s a direct line connecting lower housing sales and higher unemployment.

In short, real estate is poised to slam economic growth. Not good, considering growth in the final months of 2012 was only around 1%. Some economists, like David Madani, of Capital Economics, think the evolving housing bust has already reduced growth by about a quarter point. Sounds tiny, but it equates to tens of thousands of jobs, and as many troubled families. Madani was quoted on the weekend saying he thinks growth in the first quarter of 2013 could actually be reduced by half. Yup, because of real estate.

So what?

So six years after the US started showing us what happens when house lust is encouraged, we’re apparently on the same path. Goosing an economy by dropping rates and lending standards, encouraging debt and rewarding people for buying stuff they can’t afford, is hardly a strategy to be proud of. But those were the main planks of F’s ‘economic action plan’ – measures he’s since been throwing overboard as the consequences crystallize.

Second, all those people who stray into this blog to say their neighbour’s house just sold for above asking so Garth Turner is an idiot, may be right. But not about the real estate part. There’s absolutely no doubt where we’re headed. Over-extended people don’t borrow more to buy trophy houses, no matter how cheap money is. Tumbling sales and soggy prices don’t reverse just ‘cuz it’s April. A society where seven in ten families already own homes is not exactly an under-developed market. Most people are loaded with debt, have disturbingly little in liquid assets and keep 80% of their TFSA money in savings accounts.

Face it. Real estate ownership’s no longer a financial strategy. And in those places where it’s turning illiquid, housing’s a risk if you have too much of your net worth tied up. So the two groups in greatest peril are the equityless, mortgaged condo kids about to lose it all, and the house-rich, asset-poor Boomers in particle board McMansions they thought were retirement plans.

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If you can’t see this looming, find another blog. You’ll be back.

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avatarGarth Turner - The Greater Fool posted Sunday, February 10th, 2013.

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