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Tuesday, February 19, 2013

Could Software predict the Rise and Fall of Real Estate?

For decades economists have been trying to predict the rise and fall of stock market prices - and some have even postulated that it would be possible to create computer models using software which would predict how stock market prices would go up or down over both the short and long term.

But the problem with making such predictions is that there are too many factors and you can't predict accurately where things are going to go. Especially with the stock market, which is notoriously volatile.

Even with real estate it is difficult to make predictions for the future unless there is a large factor that is guaranteed to happen.

Many people turn to experienced economists to try and get predictions. But even they can be wrong when it comes to their doomsday predictions or predictions of sunny skies and smooth sailing. Its like trying to predict the weather - even the expert meteorologists suck at predicting when it will rain.

For example in 2011 economist David Madani sent shock waves through the Toronto real estate industry when he predicted that Toronto’s overheated housing market was due for a 25% correction which would result in much lower prices.

Two years later, prices have continued going up to the current point where prices have now stagnated.

David Madani is still waiting expectantly for Toronto's housing boom to falter.

Meanwhile myself, I must admit I am doing the same thing. In 2012 I predicted Toronto's condo market would collapse approx. 40% by 2015-2016 due to the over-abundance of condos that will come on the market around that time. I will be waiting expectantly to start seeing some downward movement in condo prices in Spring 2015... But that is 2 years and a couple months away, so I've got plenty of time to wait.

David Madani says he remains convinced that the most prolonged housing boom in history, fuelled largely by low interest rates, is headed for a hard landing, particularly in Toronto’s “overbuilt” condo sector. So he is looking at the same big factor I am looking at... But why was he predicting that back in 2011 and when did he think it would happen?

Well he thinks things will start to change this year - Spring 2013.

“What’s critical is what happens in the Spring,” says Madani. “If we continue to see increases in active listings as sales continue to decline, then we’ll start to see more obvious signs of prices dropping.”
The March-to-May period is traditionally the peak buying and selling season and a barometer of consumer confidence when it comes to real estate. But he is banking his prediction on a mighty big "if" that something will happen in 2013 when many more solid-minded economists are saying nothing major will happen with the prices until 2014 at the earliest.

It is true that many veteran real estate watchers can’t agree where the market is headed. There is simply too many factors to consider - and chief among them is consumer confidence, which is an often unknown factor that you cannot predict which way it will go until the time actually comes and then we see changes.

Which begs the question - could we design a piece of computer software to make predictions for us instead? If we feed enough - ENOUGH - data into the computer concerning prices, interest rates, sales rates, mitigating factors etc. shouldn't it be able to predict what the sales and prices in the near future will be?

It wouldn't be able to predict long term changes, but it might be able to predict small term changes based on current trends in the market - and using historical data we could check the accuracy of predictions.

The average sales price of a GTA home was up 4.1% in January 2013 over a year earlier, up to $482,648.

However we should note that it has actually dropped from the benchmark price by almost 1.5% just in the last six months, according CREA figures.

It really is the issue of bidding wars - a blood sport for those who can't really afford it - and some Torontonians are bidding way too much and banking on the economy to stay good and housing prices to continue going up. Sellers in Toronto have become so used to having bidding wars that they are now holding out for high prices - while buyers are realizing that they are better off waiting for deals.

So the question is, who will blink first? Will buyers give in and buy anyway? Or will sellers give in and finally lower their prices?
“Buyers and sellers remain in a standoff,” says John Andrew, Queen’s University business professor and real estate expert. “Sellers are holding out for their prices and buyers are waiting for deals. I think it’s too early yet, but there will be a correction.”
Thus predictions of slowdowns and dropping in prices has buyers interested - and sellers worried.

If someone were to make real estate software which could accurately predict when a slowdown in sales will happen - and when prices will drop - and how much prices will drop, well then that would make many real estate agents, buyers, sellers and economists sit up and pay attention.

But no such software exists.

Indeed, when you talk about real estate sofware usually people think of property management software - or online real estate databases (MLS)... things like that.

Even if someone - eg. an university professor with some serious computer skills - were to create a computer model that predicts future real estate prices then other real estate experts would step forward to naysay and claim the software is bugged and faulty, trying to point out inaccuracies in the software's predictions.

And they would be right to do so. We use such software to predict weather patterns, and it still fails despite people trying for decades to get it to accurately predict the weather.

But we have reached a point wherein the computer model is "reasonably accurate". Its off a little, but its pretty darn close to the target.

So I have to wonder, if we can do that for the weather and its reasonably accurate, maybe it is time we try and do that for predicting real estate prices?

Tuesday, February 5, 2013

Canadian Mortgages Vs US Mortgages

The Canadian mortgage market has been sitting on the edge of a precipice ever since the American market burst in 2007. Six years later skeptics and pundits alike are still trying to predict when the housing market and the corresponding mortgage market will burst in Canada.

6 years later in 2013 the proverbial dam still hasn't burst.

If you want to buy a home in Canada you should first arrange financing and think in terms of whether you can actually afford this mortgage - or whether it is better to wait until real estate prices come down in 2015-2016 - when the dam is expected to finally burst.

According to CIBC economist, Benjamin Tal, there are many rational reasons why the Canadian mortgage market continues to sit on the edge of a precipice - and is firmly entrenched there, waiting for the eventual avalanche.
 
Tal admits that all is not well with Canadian housing. It is floundering and there is a lot of doubts and lack of confidence in the market, and yet Canadians keep buying homes and condos anyway because people need a place to live and they're tired of waiting for the market to collapse. Patience is a virtue, but everyone has their limits for how long they will wait.
 
"Any comparison to the American market of 2006 reflects deep misunderstanding of the credit landscapes of the pre-crash environment in the U.S. and today’s Canadian market.”says Benjamin Tal.
In a nutshell the Canadian and USA mortgage markets differ in the following ways:

The U.S. mortgage interest tax deduction - This American tax benefit played only a limited role in stoking the U.S. housing bubble. The absence of this rule in Canada means that Canadians can't claim mortgage interest on their income taxes, and thus they have to be more prudent and careful about whether to buy a house and get a mortgage.

Lender recourse - Canada’s recourse system (which keeps people on the hook after foreclosure) does “not provide a full shield from a substantial fall in prices,” says Tal. In the USA, only 12 states have no-recourse law. According to some sources the probability of mortgage default is actually up to 20% higher in non-recourse states - meaning Americans in the USA were more likely to default on their mortgages - which meant the banks would take bigger losses.

When you default on a loan (any kind of loan) in Canada, lenders send the hunting dogs after you in the form of really annoying phone calls from collection agencies and letters from lawyers - but if you don't have any money or assets or a job, they really can't do anything to you. And worse comes to worse, you declare bankruptcy and have bad credit for 7 years.






Canada’s low arrears rate - Canada’s minuscule default rate is pretty stellar and is slightly less than half that of the American average default rate (pre-2006). However we should note that Canada's other debts (credit cards, student loans, lines of credit) have skyrocketed since 2008, suggesting that many Canadians are paying off debtors by borrowing money from other sources - and eventually that money has to be paid back.

In contrast in the USA: “In a short eighteen-month period in 2007-08, the serious mortgage arrears rate in the US surged by more than 300%," says Tal.

So Canada hasn't reached that point yet. But we could if Canadians continue to pile on consumer debts with credit cards/etc.

The American arrears spike was also largely caused by legal underwriting that was either near-criminal or even outright criminal on the part of the banks giving out mortgages. 

Rate Sensitivity - Canadian mortgages are more vulnerable to interest rate hikes than the average American because our terms are far shorter (5 years versus 15-30 years).

Less subprime - The American crash and "Great Recession" was largely the result of subprime mortgages and risky floating rates. Canada still has subprime mortgages but they are comparatively rare because Canadian banks are more cautious about who they give mortgages to.

However this doesn't completely protect Canada. Foreign investment in Canadian real estate has created a bubble in major cities, and if something ever happens to hurt the bubble then those markets will collapse in a flash. If a collapse happens in Canada it won't be subprime mortgages, it will be foreign investors pulling out all at once which will sink the ship.

Negative Equity - One-third of American mortgages in 2005-2006 were already in negative equity. Over 50% of the mortgages had less than 5% equity, thus “making [Americans] highly exposed to even a modest decline in prices,” says Tal.

In Canada however only 15-20% of new mortgages have less than 15% equity. Plus negative equity is virtually non-existent in Canada, and out of fear such mortgages were phased out pretty quickly by Canadian banks.

No teasers - Millions of Americans got teaser mortgages with rates that reset a few hundred basis points after 2 or 3 years. So they would start a mortgage thinking they got a deal and could afford it, but when the rates reset they were screwed and couldn't afford the home they had purchased - and were locked into it so they had no choice but to default. Over $2,000,000,000,000 dollars worth of mortgages were reset in 2006-2007 alone.

Canadian banks don’t give teaser rates. Borrowers must prove they can afford the normal higher rates in advance.

Tighter housing supply - New Canadian housing starts have exceeded household formation by only 10% in the past decade. That means that Canadians have a comparatively small number of available homes whereas the USA was building new homes like crazy, building so many that it was outpacing demand. The USA was outpacing demand by 80% right before the crash.

Note: In Toronto and Vancouver the new condo market is outpacing demand by approx. 40%, and those condos will be finished being built by 2014-2015, which means Toronto's condo market should implode by that time.



Debt-to-income Ratio - The debt to income ratio doesn't really matter as long as the economy in Canada stays stable. Yes, Canada's debt to income ratio is really bad and is growing worse... but as long as the economy and employment rate stays the same Canadians should be okay.

Better credit - Canadian credit scores have improved since 2008. In contrast during the four years heading into America's Great Recession, the ratio of “risky” borrowers rose by 10+ percentage points and comprised 22% of the market. Many Americans simply had really bad credit, largely due to a floundering economy during the Bush era.

Yes, Canada hasn't been touched yet. But if we keep piling on household debt and spending beyond our means the collapse will come eventually.


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