Posted on 03/31/2008 9:55:05 PM PDT by 2ndDivisionVet
Imagine listing your home for sale, but there are no buyers. You drop the price. Again. And again. The house across the street's now for sale. And the one two doors down, plus a dozen others in a two-block radius. Nothing's selling, and every time one home is reduced, all are affected. This property used to represent wealth. Now it's a wealth trap. Most of what you have is here, and with each day passed, it diminishes.
Imagine your first home - a dream in granite and stainless. You bought it from the region's largest builder, for 1.5 per cent down - enough to cover closing costs - and mortgaged the rest. Months later, the economy turns abruptly. Your spouse loses his job and the monthly payments - mortgage, taxes, utilities - are crushing. You decide to sell, but the realtor tells you the market's also turned. Your mortgage is now slightly greater than the value of the home. After paying commission, you'll have no house, no equity, and still owe the bank more than $20,000. How could this have happened?
Far-fetched? Hardly. For millions of middle-class Americans, this is a reality as housing values collapse in the first nation-wide housing meltdown since the Depression. In some markets, prices have crashed 30 per cent. In Phoenix, there are more than 20,000 new homes, vacant, unsold and unwanted. In suburban Detroit, million-dollar properties can't fetch buyers at $300,000. Downtown, prices plunged in the first two months of 2008 by 54 per cent, to a median of $22,000.
In Florida and California, homeowners establish web sites to try and sell their homes. Three million American families now have mortgages larger than their home values. Comfortable upper middle-class families with six-figure homes find their wealth evaporated as their properties languish on the market. So many foreclosed homes are for sale, it's estimated prices will not recover for years. In fact, a recent Credit Suisse report says prices must fall another 40 per cent in Miami and 26 per cent in Los Angeles before they become affordable.
The real estate disaster now in full flower to our south is a fascinating, gripping spectacle. It's time we looked closely. Because, one way or another, it's coming here.
Canadians, strangely, believe this country's immune from the housing contagion sweeping America. The myth results from three powerful forces. Denial tops the list, no doubt the result of having more than 80 per cent of our net worth in one asset, the family home. Add to that the excellent communications job done by the real estate lobby -- mortgage-lending bank economists and the CEOs of real estate marketing companies -- who claim home values will rise forever. Finally, our belief the Americans screwed up by giving subprime mortgages to unworthy people so they could buy unaffordable homes.
But this is not so. In researching my book, Greater Fool, I was reminded again of why all booms end badly. The inflating real estate market to the south became unsustainable when average prices exceeded the ability of average families to buy homes. This inflation in turn was the result of policy decisions made after 9/11 which gave America (and Canada) the lowest interest rates in a generation. Debt was cheap, and volatile stock markets represented unacceptable risk. So, real estate became the asset of choice.
If you have any doubt, watch a few past episodes of Flip This House. It's good real estate pornography.
Prices roared to new levels and to sustain the fire, mortgage lending practices went lax. No-money-down deals were common, and home loans with discounted rates were extended to buyers who now qualified, as the bar for home ownership fell. This all made sense while the market advanced, since growing home equity gave even dodgy buyers new money to use for refinancing loans as the introductory ones matured.
But as interest rates increased, the American economy softened and realization spread that real estate was overvalued, the bubble burst - and with a vengeance.
So, how different is the Canadian experience?
Not enough.
In the period between 2000 and the market crash in 2006, U.S. home prices increased 74 per cent, while household income rose by just 15 per cent. In Canada, real estate prices jumped 70 per cent by the end of 2007, with family incomes ahead 14 per cent.
In other words, we've seen an almost identical pattern of real estate excess - familiar to anyone caught in a bidding war, or staring in disbelief at a new MLS listing. The average home in Toronto is now over $400,000, while in Vancouver it tops $700,000. Last year homes in Saskatoon raced ahead more than 50 per cent in value. A young couple in suburban Toronto with a $450,000 price limit ended up buying a $700,000 home after losing 16 competing bids.
And the Canadian response to this affordability crisis? It's called the 40-year mortgage, which lowers monthly payments by extending the amortization 15 years beyond the traditional quarter-century and, in the process, grossly inflates the total debt to be repaid. In other words, this loan (now accounting for over 40 per cent of all new borrowings) allows people to buy homes they would not otherwise afford.
Meanwhile, down payments have become almost optional. One of Ottawa's largest new home builders routinely allows young couples to move in by paying just closing costs, and financing the other 98.5 per cent of the purchase price. With virtually no equity in the home and substantial carrying charges, any market downturn means they owe more than they actually own.
So, how exactly do American subprimes differ from Canadian 40-year mortgages? How are mortgage lenders here more prudent when they allow appraisals based on postal codes, rather than actual home inspections? Why should Canadian real estate values, as inflated now as were those to the south two years ago, hold when our families are no better off? As a global economic slowdown and an American recession take hold, what impenetrable barrier is wrapped around this country?
Meanwhile, what about the future? Won't nine million house-rich and pension-challenged boomers be forced to dump billions in real estate over the coming decade? Won't runaway energy costs and the uncertainty of climate change breed a popular taste for smaller, more efficient, more urban housing, rendering four-bedroom, three-car-garage suburban palaces unsaleable?
Most of all, won't those who understand what's clearly coming, and sell now, rejoice that they found a greater fool?
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Garth Turner is the MP for Halton, Ontario. Greater Fool: The Troubled Future of Real Estate is his eighth book, published by Key Porter Books. www.GreaterFool.ca
I remember 40 year mortgages showing up in 2005, but they weren't that popular here in the United States. Appraisals based on postal codes?! I would've doubled the money I was making back then if I'd had that!!
Ping!
The first part of the article is well written and interesting. It is not just the U.S. that has this problem. Housing prices all over the world are seeing the same down-turn.
Even the real estate market in China is seeing sharp price drops.
Just saw today that the U.S. is looking at $1 trillion to hold up the market so it can recover from the crash. How is it Canada thinks it has escaped this.
Nothing wrong with buying a $50,000 puppy by giving the seller two $25,000 kittens for it.
Once you actually pay $50,000 in real money for it, though, don't expect a Greater Fool to come around and buy it from you for $50,000 in real money.
Houses that could only be afforded temporarily with gimmick, "No Down-payment, Interest Only" loans were house that were priced way above what the market can bear.
Well, I think it’s great. I bought a smallish house in CA in 1993 for $200K, now it is worth $700K but falling. But I don’t care, because what I’ve wanted to do for the past 5 years is move to a bigger house (since I have 4 kids now) in a better school district, but have been unable to as every house like that in the Bay Area is a million dollars now.
So if prices fall, I can finally afford a bigger house. I don’t care that the value of my current house is dropping, as it ran up in value so excessively to begin with. Plus we only have 8 years left of a 15 year mortgage with a tiny interest rate—the thing is almost paid for anyway. We didn’t get equity loans or anything like that either.
So I think this real estate “crash” is great for those of us looking to upgrade or for those looking to finally buy their first house.
My guess is that they are hanging on to hope that the housing boom in Canada stopped in time to avoid a crash, and they can sneak by with stagnation in housing prices for a while rather than a crash.
Their housing market is overvalued, and it will correct itself, but if they are really, really lucky they can get aways with it correct itself by simply not growing for a while rather than a crash followed by a recovery.
As for me. I'm in a situation where I may be moving to the suburbs of Detroit due to family reasons, not because it is somewhere I particularly want to live.
The nice thing about a bad housing market is that if you have saved up some money, and you have some time and patience, there are likely some incredible deals to be had.
Hopefully the market where I live now is a little more solid, and I can get an acceptable price for my current home. I bought it early in the boom, and put a good amount of money down, so I'm not worried about owing more than I can sell it for, but it would be nice to have a good down payment for my next home.
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