The view from the top is fantastic


I’ve been following a story on a website I frequent about a fellow named Chris. In late March, he listed his house for sale in Toronto for $1.9 million. After a bidding war involving 10 buyers he accepted an offer for $2.5 million, with no conditions. He was ecstatic. He immediately took his winnings and bought another house with no conditions. Then something odd happened. More about Chris later.

We’ve all heard of the crazy prices being asked and gotten for houses in Niagara over the last couple of years. Prices for resale houses went up 24% from March 2016 to March 2017. Most new construction is priced in the $500,000-and-up range. That’s more than 10 times the inflation rate and 12 times the rate of wage growth. New houses are springing up on every serviceable lot builders can find. Even here, in Pelham, we are witness to this seemingly endless price and demand appreciation. Jobs in all kinds of industries in the Golden Horseshoe are being expanded to meet this demand. Builders and renovators are hiring. Building material suppliers are churning out products. Appliance and furniture sales are growing. Banks are recording record mortgage lending. Real estate agents are proliferating—48,000 in the GTA alone. Governments are collecting all sorts of fees, from land transfer taxes to GST to development charges.

“It will never end,” or “It’s different this time,” are the common claims.

Boomers are retiring here. Immigrants are pouring in. Foreign money is buying everything in sight. It’s the best investment you can find. Real estate never goes down.

Individuals and even governments, like the Town of Pelham, are making huge bets on this belief.

There is a term in investing called “recency bias.” Simply stated, it means that if an item has gone up in value in the recent past, investors mistakenly believe that it must continue to go up. If the item, say housing, has gone up by 10% or 24%, as in Niagara, or even 33%, as in the GTA, in the last 12 months, then it’s “safe” to assume that this appreciation rate will continue.

Obviously, as you read this, soberly and calmly over a cup of coffee, tut-tutting at everyone else’s gullibility, you realize that this form of investment thinking is dangerous. People who rely on property as an investment will buy on the anticipation that they will sell in a year or so at a sizeable profit. Then they re-invest their “winnings” in a more expensive property and repeat this seemingly endless cycle. Other sellers from the GTA move to cheaper areas, like Niagara, and price the locals out. (From Niagara you could move to Kapuskasing, I guess. I understand their Lumberjack Festival is pleasant.)

Real Estate has become a no-brainer for an entire generation, and I mean this literally. A recent survey by the CIBC found 54% of Canadians think house prices will never go down. Never! The cost is irrelevant if the price appreciation is always upwards.

Governments become reliant on this cycle as well. Every housing transaction carries costs to the purchaser. Moving expenses, lawyer fees, land transfer taxes, real estate commissions and higher mortgage payments are a few. Governments collect fees throughout the process. Housing is the biggest economic driver in Canada. Another effect house appreciation causes is the so-called “wealth effect.”

My house is worth more so I’m worth more, so I’ll borrow some more money. Credit card debt and home equity loans abound. Canadians are really in debt. For every dollar earned we owe $1.67. As a Town we will owe $37-$47 million. As a nation, consumers owe $2.2 trillion, most of which is mortgage debt.

Another psychological effect found in this mania is the fear of missing out, handily expressed as “FOMO.” People panic when they see their peers getting things they want. You’ve seen this with kids wanting certain toys, shoes, jeans, phones, when their friends get the newest and best. FOMO-afflicted young adults want a house, any house, no matter the cost.

Around the Region, towns have been building community centres and arenas. St. Catharines has a new arena and performing arts centre. Port Colbourne has a community centre; NOTL, a new centre. Welland has a new arena and West Lincoln is building a new centre.

Then there is Pelham.

Unlike the towns mentioned, Pelham missed out on the free money offered by the provincial and federal governments. This grant money was given out during the Great Recession of 2009-2014 to keep the economy afloat. It’s gone now and no longer necessary, but Pelham decided to toss the dice anyway and go it alone. Other Niagara towns saw these investments as draw for future development. Pelham didn’t want to be left out. FOMO.

There have been periods like this before, but not recently. In 1981 mortgage rates topped out at 21% for a 5-year term. You read that right—21%. This caused a crisis for millions all over North America, Boomers to be precise. When they had to renew their mortgage they discovered that they couldn’t make the monthly payments. The market was flooded with houses for sale and prices crashed—35% down in Toronto. Rates started to fall and by 1985 they were around 10%. People started buying again. Houses doubled in value by 1989 but interest rates started creeping up to 14%. Many panicked and thought, here we go again. The market fell. In inflation-adjusted dollars, the price of the home you bought in 1989 didn’t reach that price again until 2009, 20 years later.

Twenty years is a long time to wait for an investment return.

Twenty years is a long time to pay off debentures with only tax dollars as the source for payment.

There are a few reasons the housing market continues to rise. Canada has had very low mortgage rates for 10 years. Cheap money equals expensive houses, while expensive money equals cheaper houses.

That’s what happened in 1989. Fear of missing out creates an emotional demand. If I don’t jump in and buy something now, I’ll never be able to, says the worried voice in the back of your mind. The Bank of Mom and Dad allows for young people starting out to buy a house they could not afford otherwise. Over a third of millennials have reportedly borrowed from their parents to buy a house and almost half say they overpaid, based on their income.

Some alternative mortgage lenders are suspected of lending to unqualified borrowers at higher rates—similar to what happened in the U.S in 2007, just prior to their housing crash. One of these lenders, Home Capital, is in serious trouble. The bank part of their business is experiencing a quiet, low key, Canadian-style run on the bank. The mortgage lending part of Home Capital is reportedly not lending anymore.

Foreign investors are blamed for high prices but records in from TREB, the Toronto Real Estate Board, published last week, show only 2.3% of home purchases were by foreigners and 90% of them live in the home they buy.

The buyer starting to get noticed is the speculator—people who buy houses and condos, flip them and move on.

This is apparently a thing with the millennial crowd—a means of retiring by 45. They may own multiple properties, rent them out or leave them empty. A recently approved condo development in Welland, designed for students, was marketed squarely at investors. Developers regularly market developments to speculators. They show profit charts with “guaranteed” returns.

If financial advisors were to guarantee returns, they would lose their licences. Real estate promoters are not so regulated. Flippers are presently under the provincial and federal government microscopes. You don’t pay capital gains on your primary residence when you sell, but you do on any other property you sell. Some speculators have been slipping through the cracks, but the tax man is filling in those cracks.

TREB also reported a 33% spike in listings and a drop in sales for April. A turning point, or just a pause?

Many decisions made by local governments are based on expected growth over periods of time. Growth today means more houses and retail businesses tomorrow.

Pelham, for example, is banking on growth to help pay for the new projects being built and yet to be built. Thousands of new residents are expected over the years ahead. This form of recency bias is not supported by the facts.

In 2006 Pelham had a population of 16,155. By 2011, 443 more people had moved here. By 2016, another 512 had moved in, bumping us to 17,110. This is a growth rate of just 6% in a decade.

The period began with a growing housing market, was stopped in its tracks by the 2009 financial crisis, then resumed around 2015, a couple of years after the GTA market picked up. Last one in usually means first one out. The lesson from this is that growth, like housing prices, is not guaranteed.

Buying a house is the largest financial investment most people make. Like the stock market, the housing market rises and falls on fear and greed. For many, their house is their home and all this doesn’t matter. For a small number of others it matters a great deal. It only took 8% of new homeowners in the U.S. to default on their payments to crash the entire housing market. Very few areas escaped unscathed. In 1997 the average house in Las Vegas was worth $200,000. By 2007 the price had jumped to $400,000. Today the average price is $212,500.

What it may take to turn the market sour in Canada is unclear. It may already be starting with the collapse of Home Capital or the recent provincial limits on foreign ownership. Rent controls certainly cut into a speculator’s bottom line.

Wise investors diversify their investments. They place their money in a number of areas—stocks, bonds, cash, GICs, and even some real estate are common investments. Foolish investors buy one or two stocks, like Nortel or Bre-x or a house or two, and expect great rewards. Wise towns invest in business development and new, good job creation, and some housing growth, while foolish towns place all of their faith in only one type of growth, risking their FOMO mutating into a SNAFU.

Back to Chris, who sold his $1.9 million Toronto home for $2.5 million.

The purchaser, a FOMO sufferer, appeared on Chris’ doorstep a week later, begging to get out of the deal. Chris refused; he had his own new house to pay for. The purchaser went silent. Chris’s lawyer warned the buyer of the consequences, still silence. Chris was forced to re-list his house in late April. He had one prospective buyer who offered $400,000 less with conditions. The house still sits, unsold. If Chris sells the house for less than the original buyer agreed to, the buyer will be sued for the difference, plus real estate commissions, but that will be costly and easily take a year or longer to sort out. The buyer had succumbed to another common malady—Buyer’s Remorse.

Speaking of which:

Pelham Community Centre Progress

According to the latest information from CAO Darren Ottaway, the following update is for April.

Construction is on time and on budget.

The first $9.6 million will be spent by June. (Paid through property tax increases starting 2016 and lasting until 2046.)

The next amount, $12.1 million, will be borrowed from Infrastructure Ontario for Phase 2. (Paid for by ongoing development charges.)

Tender packages have been released for Phase 2, the largest and most important phase. This tender will determine costing for a number of items that will affect future decisions, including brick type. This tender will determine what, if any areas, require value engineering.

According to the CAO, the 9,000 sq. ft. issue was identified prior to the commencement of construction. There will be no change to the footprint of the PCC. Given that a contingency figure was built-in to the original budget, there will be no change in overall expenditure already approved by Council.

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The Voice of Pelham
Pelham's independent news source from the heart of Niagara.