Why are US Home Sales so Bad?

This week, many US news agencies reported that home sales are down, prices are weakening, and it's all deeply confusing. Since interest rates are falling, shouldn't home sales be rising? Isn't that what Economics 101 teaches us?

Pundits give many possible reasons for this strangely low level of sales: lack of available credit, bad seasonal weather, weak consumer confidence, weak jobs outlook, tough mortgage lending standards, and more. I believe all of these excuses are nonsense.

Banks are willing to lend, and have the cash to do so. Consumers have the highest credit ratings they have had in years. And, bad weather doesn't account for nationwide weakness.

The reason US home sales are low is because people with excellent credit and good jobs simply have no reason to buy. This explanation is far too simple for economists to embrace, yet it is true. Take, for instance, the conversation I heard on Friday:
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Banker: "I haven't seen you in a while. Did you buy that property in Phoenix you were looking at?"

Client: "No, not yet. Prices are great down there! But, they're not going up. I heard on the news they might still be dropping. I don't think there's any rush. I think I'll just sit tight."

Banker: "I agree."

Client: "The prices sure are great, though."
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I hear conversations like this every day.

Thousands of investors are waiting to "jump in," but there is simply no incentive to buy right now.

At some point, of course, prices will take off like a rocket ship - that is, slowly at first, gaining momentum steadily (once people realize prices are rising again) until going at full speed. However, no one knows when that point will be. It could be years.

Strangely, and counter-intuitively, I believe that in order to spur home purchases, the Fed should do exactly the opposite of what it is doing. That is, it should steadily increase interest rates. Last year, when the Bank of Canada announced that it would be raising rates, there was a frenzy of buying activity (which has since slowed, since they are now lowering rates). Contrary to every economics paper every written, I think the reality of rising rates would kick-start a home buying recovery.

In any case, my advice (as I have pointed out previously), is that if you want to buy real estate and are able to do so, do it now. Interest rates are extremely low, prices are extremely low, and with a large number of homes on the market you can choose whichever property your heart desires. Buying at a time like this will never be a bad investment.

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"Space is big. You just won't believe how vastly, hugely, mind-bogglingly big it is. I mean, you may think it's a long way down the road to the drug store, but that's just peanuts compared to space."

Douglas Adams

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See also:

If Mortgage Rates Keep Falling, Why Are Home Sales So Bad?

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US Home Prices Drop Again

But is that bad?

In a story on CNBC, Home Prices fall for 8th straight month, David Blitzer, chairman of the Index Committee at S&P Indices, is quoted as saying, "There is very little, if any, good news about housing. Prices continue to weaken, trends in sales and construction are disappointing." When I read the same statement, I thought it was good news. Why the difference?

Everyone uses mental models in their daily life - whether they are aware of it or not. A mental model is a way of thinking, usually learned from the culture one grows up in, but often changed by education. A clear example is that in the West, most people believe that the mind/soul and body are separate. University educated individuals tend to use the scientific method to discover things, rather than logic or meditation.

Fictional character Sherlock Holmes famously uses “deductive reasoning” to solve crimes. Deductive reasoning is eliminating anything that must be false in order to find the last remaining item, which must be the truth. It is said that Sherlock Holme's author, Sir Arthur Conan Doyle, learned this technique from his university medical professor, who used it to diagnose patients.

Warren Buffett’s business partner, Charlie Munger, commonly uses “inversion.” Inversion is looking at every problem from the opposite direction from the normal one: for example, instead of asking, “How can we improve customer service?” Munger might ask, “How can we have terrible customer service?” The opposite of that answer is the way to have great customer service.

In Iraq, US soldiers and politicians often become annoyed because the Iraqis do not think of the relationship between cause-and-effect the same way we do. That is, they view the relationship between cause and effect as weak. If Iraqis take a day off to play cricket instead of building a new water pipeline, they don’t necessarily see the connection to having no clean water later that month. This difference in thinking is so frustrating for American troops that there is a whole series of military intelligence "lessons learned" documents devoted to it.

Now to examine David Blitzer’s comment: "There is very little, if any, good news about housing. Prices continue to weaken, trends in sales and construction are disappointing." Under normal circumstances, this statement would be perfectly logical. In a normal economic cycle, all these things indicate a weakening economy. David is inferring that low sales, low construction, and falling prices are bad – the traditional economist’s view. But is it truly bad? Or is David using a “fossilized mental model” – one that is not relevant for the situation?

The US had a housing bubble: that means there were unrealistic prices, oversupply, and sales to people who were not qualified. The remedy for a housing recovery is therefore lower prices, no new construction (until excess inventory is gone), and low new home sales (since foreclosures will be sold first). In other words, today's statistical weakness is exactly what the housing market needs to recover. At this point, strength in any of these numbers would be negative.

The banks can only release foreclosures onto the market at the same rate as the market is ready to absorb them. Since the banks control the flow of this inventory, new home sales and price stats are meaningless: any increase in market strength will be met by the release of foreclosures to match.

Prices are low enough that when the housing market does return, it will do so with a roar. Just like the bubble on the upside, the longer US housing numbers stay weak the more sudden and dramatic the recovery will seem.

Several months ago, I wrote that it was a good time to buy US real estate. Since then, in most cities home prices have fallen by about 3%. I do not apologize for this imperfection.

No one knows exactly when the market will recover, yet one thing is certain – buying quality real estate at a time of low interest rates and low prices will never prove to be a bad investment. Don’t try to catch the exact bottom.

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"Don't try to buy at the bottom and sell at the top. This can't be done - except by liars."

Bernard Baruch

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Lessons from Aristocrats - Housing

An elderly client visited my office recently to inquire about the interest rate for a personal loan. The purpose of the loan, he said, was to purchase a new water heater to replace the one that had just broken in his home. The man’s home…a 2.5 million dollar Tudor-style mansion.

This incident reminded me of something that happened to me when I was a college student. I had answered an ad for a basement suite, and was surprised to find myself standing in front of a hundred-year-old residence complete with carved oak staircase, vaulted ceilings, a library, a study, and an observatory. The owner, who had fallen on hard times, had recently converted the damp basement into six rental suites with a shared kitchen, suitable only to college students who will accept this type of accommodation. I kept looking anyway.

Most aristocratic families have, in their history, a successful ancestor who builds a massive family residence to showcase the family’s success. Winston Churchill’s ancestor, the 1st Duke of Marlborough, for instance, built a massive residence named Blenheim Palace.

Subsequent generations develop businesses, pawn heirlooms, gamble, steal, and whatever else is necessary in order to maintain the family estate, some generations more successfully than others. At some point, the family gives up trying to maintain the entire building and moves into a single section, leaving the rest to decay.

Eventually, the family mansion is donated to charity or opened to the public as a tourist attraction, since poor people will pay money to see how rich people live. Sometimes this eventuality takes hundreds of years, and sometimes it occurs within the builder’s lifetime.

The Marlborough family has thus far kept their estate. Due to Winston Churchill’s book royalties, his family has preserved Blenheim palace intact. Before Winston became a famous author (and later politician), the survival of the family residence was in doubt.

In Canada, people have the peculiar habit of moving into larger and larger homes as they become more established, until finally, after the children leave the nest, they find themselves in a home with far more space than they need. In due course they retire, and spend six months of every year in the warm southern United States, living in a camping trailer and enjoying it because it’s “easy to maintain.”

For aristocratic wannabes (easily distinguished by the phrase, “I do a lot of entertaining at home”), remember the lesson you can learn from the mistakes of real aristocrats: buy a home that you can comfortably afford, with rooms that you will actually use. The idea of having 10 extra rooms will bring you much more pleasure that actually owning them.

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"Few rich men own their property; the property owns them."
Robert Ingersoll, speech, New York, 29 October 1896

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Canadian Real Estate: Stick a Fork in It

IT'S DONE.



The Canadian housing boom is officially over.

In addition to the myriad of anecdotal stories from real estate agents and mortgage specialists who tell me that the market “has shifted in favor of buyers,” banks are finally experiencing the inevitable decline.

Back in July, I mentioned that the mortgage pipeline was drying up, and that the results should soon hit the banks. Well, they have. According to my contacts at three of Canada’s major banks, new mortgage and refinance business has fallen off a cliff. Pre-approved mortgage applications – an indication of sales beyond 30 days - are virtually non-existent. Any of this may be confirmed by a casual visit to a local bank or credit union, which reveals empty reception areas and bored lenders.

In an effort to kick some life back into the markets, major Canadian banks reduced their mortgage rates twice in the past two weeks, but it had no impact whatsoever. In light of these circumstances, I suspect the Bank of Canada will rethink its intention to slowly raise interest rates.

At the same time as the Canadian media was announcing that home prices have dropped, sales have slipped, and housing starts fallen, the Canadian Real Estate Association was busy announcing that home prices will continue to rise. I love the CREA. When sales and demand increase, they announce that real estate prices will rise. When sales and demand drop, they announce that real estate prices will rise. You can say a lot about the CREA, but you can’t fault them for inconsistency.

I suspect that several months will pass before the severity of the downturn becomes fully apparent. By then, it should be so obvious that not even the CREA will be able to ignore it.
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Further reading:

The CREA's Use of Spin (The Frost Report)
The Canadian Real Estate Market - Trouble in the Pipeline (The Frost Report)
Housing Starts Slip in July
Shaky Days in the Housing Market
Homeowners Sell, Start Renting Instead
CREA's Resale Housing Forecast

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Canadian Consumers – Spending ‘til it Hurts

Canadian consumers are confident – really confident.

The credit crisis, which caused home prices to plunge and unemployment to soar in the U.S., was merely a blip on the radar screen in Canada. It isn't that Canadian homes weren't overpriced, or that debt levels weren't high: it's just that low interest rates re-inflated the bubble before it ever had a chance to pop.

Since the credit crisis began, the Bank of Canada has been playing good-cop-bad-cop with consumers. While stating clearly that the reduction in interest rates was intended to stimulate the housing market & related purchasing to help pull the country out of recession, the BOC has been simultaneously warning Canadians not to stretch themselves financially by taking on too much debt.

In Dec 2009, Bank of Canada Governor Mark Carney warned Canadians so bluntly about the dangers of debt that it garnered the headline, "Bank of Canada warns of debt peril" on CBC news. In January 2010, with the housing recovery well under way, David Wolf (on behalf of Bank of Canada’s Timothy Lane) noted that “the current rebound in the housing sector is taking place in tandem with a very rapid rise in household indebtedness.” In February, Finance Minister Jim Flaherty issued another strong public statement, warning Canadians about using their homes as ATMs and against the dangers of variable rate mortgages. The advice made headlines for a few days before being confidently ignored.

Instead, like cattle running to the slaughterhouse, Canadian consumers are engaged in a “buy now before its too late” real estate shopping frenzy. Terrified of being priced out of the market - or of missing today's low interest rates - consumers are buying whatever they can (barely) afford, as quickly as possible. They do so knowing full well that the properties they are purchasing are expensive or even overpriced, yet with confidence that prices will further soar.

The short-lived recessionary ride convinced Canadians that their economic system is better, their banks superior, and real estate investing acumen greater than the rest of the world - and that therefore “it can't happen here.” The rise of the CDN$ relative to the USD has only added fuel to the fire.

In short, for Canadians the credit crisis has inspired a sense of economic godliness. Consumers have been aptly warned, but, due to fear and greed, have chosen to put on their rose-colored glasses and continue shopping.
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http://www.cbc.ca/money/story/2009/12/10/carney-financial-system-review.html
http://www.bankofcanada.ca/en/speeches/2010/sp110110.html
http://www.financialpost.com/story.html?id=2547222
http://www.fin.gc.ca/n10/10-011-eng.asp
http://research.cibcwm.com/economic_public/download/feature3.pdf
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"Living a life of simplicity is not simple. Rather, trying to simplify one's life is a constant challenge to embrace discipline - to edit out unnecessary items and to minimize desires that fuel their acquisition." Sri Chinmey

The Canadian Housing Bubble – The Denial Continues...

I could talk about the Big 5 Banks’ meeting with the Bank of Canada, where they expressed concerns about a potential collapse in real estate prices. I could talk about rising mortgage debt as a percentage of income. I could talk about condo developments in areas with an abundance of rental suites available. I could talk about the increasing incidence of fraud. But, I think the bare facts speak loudest.

This home in Vancouver –for sale at $1.18 million.


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“Right now, there is no compelling evidence of a housing bubble in Canada." Jim Flaherty, Canadian Finance Minister, Feb. 2010
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The Canadian Housing Market

The bubble is back.

Not content with a single housing bubble, Canadians have apparently decided to ignore reality and give it a second go, especially in Vancouver. Just a few days ago, my mortgage broker confirmed that, just like in the bubble years, multiple bids on properties are back with a vengeance. A typical, two-bedroom bungalow/rancher in the West Side is now priced at 1.3 million dollars, right back to where it was at the peak in 2008.

A few different factors are responsible for this brutal overpricing. First is the typical Vancouverite’s belief that theirs is the greatest city in the world. Granted, Vancouver is a nice place. But, everyone seems to believe the city is so spectacular that Olympic visitors will return to London, Paris, Tokyo etc. and immediately put their homes up for sale so they can move to Vancouver.

Second and more important is the Asian factor. In Vancouver a substantial number of immigrants, mostly from China, are buying residences primarily or completely in cash. Cash purchases are a big factor in propping up high prices; however, they are an even bigger factor in the decision making process for local buyers. Vancouverites are convinced that because of immigration, prices cannot drop; therefore, any price is justifiable, as one will always find a buyer at that new higher price (in economics, this is known as “greater fool theory.”)

Finally, the average Canadian is making a mistake typical for those who know little about finance: they are concentrating on monthly payment amount instead of amount of debt owed. To the financially naive, owing $500,000 at a 2.25% variable interest rate with a monthly payment of $1718 is better than owing $400,000 at a fixed rate of 4% with monthly payments of $1763. More importantly, people are not aware that today's 2.25% variable interest rate, and the resulting barely-affordable monthly payment, will soon be going up.

The governor of the Bank of Canada, Mark Carney, is trying his best to send out the warning ("It is the responsibility of households now to ensure that in the future, when the recovery takes hold and extraordinary measures are unwound, they can service their debts”), but it’s largely falling on deaf ears. While Americans have spent the last two years paying down their credit card and mortgage debt, Canadians have been busy racking it up. The Bank of Canada estimates that by the 4rth quarter of 2011, Canadian personal debt payments will reach record-breaking levels (shattering the previous record set in 2000).

Of course, after the housing bubble bursts for the second time, we’ll probably hear a chorus of, “It’s the fault of the banks. They shouldn’t be approving these loans in the first place!” As a banker, I can say without hesitation that trying to tell a customer they can’t afford to buy their dream home is like telling a child they can’t have ice cream: they throw a tantrum, threaten to run away (take their business elsewhere), and frequently do exactly that. If the next bank doesn’t approve them, they will keep trying until someone does, eventually lying about their assets or income if necessary. People don’t seem to realize that when your banker (who wants to give out loans) tells you that you can’t afford it, maybe you should listen.

And so, the bubble grows…