The Friday Rant: Even A Broken Clock Is Right Twice A Day

When I was taking my real estate courses in 2003, an older, wiser friend of mine said, “You’re picking a baaaaaaad time to get into the business, buddy!  The market is about to crash!  What are you gonna do when prices drop fifty percent?”

The average Toronto home price is up 148% since then.

I’ve heard nothing but talk about the collapse, and the bubble, since then, and prices have done nothing but go up.

On Wednesday, BMO’s chief economists said that we’re “in a bubble,” and like many before him he may very well prove to be wrong.

Let’s look at his comments, and examine whether or not his economic fundamentals are still applicable in 2017…

BrokenClock

Do you know the difference between theory and practice?

You should.

It’s an important one.

When I was in business school at the turn of the millennium, all I wanted was some practice.

I couldn’t stand the theory anymore.  It was all we had ever learned in school up to that point.

Half of “doing well” in high school was simply memorizing.

French?  Pfff.  That’s memorizing words for a test.

Math?  Yeah, it’s not easy, but it’s all theoretical, and as most kids lament, you’re not very likely to use trigonometry or draw parabola’s out there in the real world.

Science?  More memorizing, until you get to chemistry, then it’s just more math.

When I was in fourth year university, I took a course called “Securities Analysis.”

Call me naive, but I thought we might actually, you know, analyze some securities.

In the end, all we did, was more math; more theory.  We didn’t once open the newspaper to look at stock quotes, nor did we ever even mention “Research in Motion” or “Nortel.”

I eventually put all my theory to good use.

I remember when the first X-Box came out in December of 2001, I figured it would be a hot item, and there would be a shortage.  Simple supply and demand.

So I spent $5,000 on X-Box’s, games, controllers, et al, (ten packages at $500 per) and started hocking them to consumers around North America on a new website called “E-Bay.”

Low-and-behold, when some guy in California couldn’t get an X-Box for his kid for Christmas, he was willing to pay five-times the retail price, so long as it arrived at his doorstep before December 24th.

All my friends at school were busy memorizing for their next test…

Another parallel, to where I’m going with this today, can be found in a soliloquy by the great Robin Williams in the movie Good Will Hunting:

You’re just a kid.  Yon’t don’t have the faintest idea what you’re talking about.  You’ve never been out of Boston.  So if I asked you about art, you could probably give me the skinny on every art book ever written.  Michelangelo; you know a lot about him.  Life’s work, political aspirations, him and the Pope, sexual orientation, the whole works, right?  But I bet you can’t tell me what it smells like in the Sistine Chapel.  You’ve never actually stood there and looked up at that beautiful ceiling.

Well folks, I think there are a lot of “experts” on the Toronto real estate market, who have never been out of Boston, and who have read a lot of art books, but have never stared up at the ceiling in the Sistine Chapel.

This occurred to me a couple weeks ago when I was having lunch with an impromptu sort of “networking group” downtown.  Just a group of guys who meet once in a while to chat.

One of the gentlemen is, as you may have guessed, an economist.

I sat across the table from him, and knowing I was a real estate agent, we never really met eyes.  I felt like he was gearing up for something, and eventually, he let loose with his thoughts on the Toronto market.

It was the same stuff we’ve been hearing for a decade; same stats, same metrics, same rhetoric.

I heard him out, and I gave him his fair shot to talk.

And when I didn’t really offer anything in response, he was somewhat surprised.

We continued chatting, and at one point I mentioned that I had recently lost an offer on a townhouse where there were double-digit bids, on Carr Street.

He then said, “Where’s that?”

I couldn’t believe it.

In my mind, I can picture every nook and cranny of the Carr Street townhouse complex.  I know it like the back of my hand.

I said, “You’re not exactly Google Maps are you,” and he went on the offensive.

“I don’t need to know real estate, to know about real estate,” he said.

“And if I told you I had a loft listing coming up at the Robert Watson Lofts on Sorauren Avenue next week, and it’s going to get double-digit bids, what would you say to that?” I asked him, not looking for a confrontation, but rather some clarification.

Proud as could be, he told me, “I don’t have the faintest idea where that is.”

And that’s when I realized that so many of these “expert” economists are simply looking at the market in theory, and they’re completely out of practice.

On Wednesday, BMO’s chief economist, Douglas Porter, gave us the following quote:

“Everyone may have a slightly different definition of what a bubble is, but most can agree it’s when prices become dangerously detached from economic fundamentals and start rising strongly simply because people believe they will keep rising strongly, encouraging more buying.”

Now I’m not going to slag this guy.  He’s doing his job.  And he’s been around.

You can Google him and check out his LinkedIn profile.  Welcome to 2017.

He has a Masters in Economics.  That’s impressive, and he’s probably incredibly intelligent, far smarter than I am, and having risen to chief economist at BMO, he’s a rockstar in that profession.

But does he know where the Robert Watson Lofts are?

And does he know that last night, there were 28 bids on a 1-bed-plus-den, 1-bath condo at 75 Portland Street?  Does he know where Portland Street is?  Does he know the demographic of the area?

I want to break down two parts of that quote, and tell you why I think economists are looking at our market the wrong way.

The first part is about “economic fundamentals.”

I honestly do believe that in 2017, and in this market, the “economic fundamentals” are misplaced.

There are two measures, and two so-called economic fundamentals in particular, that I speak of.

The first, is “debt-to-income ratio.”

Canada’s debt-to-income ratio is floating somewhere around 170%, give or take.

That means, on average, for every $1 Canadians make, they owe $1.70.

But to use this metric to suggest a real estate collapse is near, is completely misguided.

Why?

Because it doesn’t come in two ratios: one for home-owners, and one for non-home owners.

Excuse the generalizations here, folks.  But the guy making $2,000,000 per year and owning a house in Rosedale doesn’t have $3,400,000 in personal debt.

In fact, the guy-and-gal who bought a semi-detached house on Glebeholme Boulevard and make a combined $160,000 per year in income don’t have $272,000 in personal debt.

But the poor schmo with the crappy-paying job?  Yes, he has mounds of personal debt.  And he will never own a home.

To apply the overall debt-to-income ratio to the housing market, and allowing people to draw the inference that buyers of a $900,000 house, making $120,000 per year, also have $204,000 in debt is so misleading!  And that’s what I feel many experts, economists, and market bears do when they say, “Canada’s average debt-to-income ratio is 170%, this isn’t good for the real estate market.”

The second economic fundamental I want to look at is the ratio, or the comparison, of average income to average home price.

Many people have pointed out on my blog before that real estate prices should no longer be tied to incomes, and I couldn’t agree more.

It makes sense, in theory.  And there’s that word again.

But in practice, you’re assuming that buyers of Canadian real estate use Canadian income; their own Canadian income, and that’s not true in 2017 for two reasons.

1) The foreign buying in Toronto is massive.  I’ve never seen anything like it thus far in 2017.

2) Business at “The Bank of Mom & Dad” is booming.

So to look at the average Canadian salary and the average Canadian home price, and suggest that “The real estate market is unsustainable because these two averages aren’t increasing in tandem,” completely ignores the change in both society, and the world today.

This isn’t a planet, it’s a globe.

And global buyers are out all day, every day.

There’s so much money floating around the world, looking for a place to land, and much of it right now is landing in Toronto.

So when you look at how much money an average Canadian makes, how is that any way applicable when you’re not asking how many tens of millions a family from Hong Kong has to buy houses in Lawrence Park and keep them vacant for the next two decades?

And how many 60-something year-olds lament, “My child can’t afford to buy a property in this market,” and then write a cheque for $100,000?

How can we look at how much money an average Canadian makes in relation to average real estate prices, without considering how much money the average buyer gets from their parents?

That whole “increase in average incomes should run in tandem with increase in average real estate prices” is an idea that made sense in the 1960’s, but in 2017, you can throw it right out the window.

The second part of Mr. Porter’s quote I want to look at is the following:  “Prices start rising strongly simply because people believe they will keep rising.”

This is known as The Greater Fool Theory, and is applicable in any market where the only reason people buy at such high prices is because they believe that prices will continue to grow even higher.

But is that the true “reason” for buying in Toronto?

Because I don’t think it is.

You might point out that I just said foreign investors were buying up property in Toronto, and as investors, they must think prices will rise.  Yes, they do.  But many of these buyers are looking for generational wealth.  They’re buying properties to set up their children’s children.  These are not flippers.  They are not fly-by-nighters.  They’re not buying hundreds of acres of farm land in Orangeville so they can build a McDonald’s drive-thru.  They’re keeping this property long term.

So yes, they think prices will continue to rise, but they’re not buying in 2017 to sell in 2019.  That is the Greater Fool Theory.

And what of the domestic buyers?

What of John & Kathy?

John & Kathy aren’t buying “because they believe prices will continue to grow higher,” but rather because they’re looking for a place to raise their family for the next 15 years before they reassess if they can move up, or move on.

Do you think that 28 bidders for that property at 75 Portland Street were looking to keep it as a really, really low-yield, cash-flow-negative, $865,000 investment property?  Or do you think they were young people, with money from their parents, looking for a place to live?

If net migration in Toronto (which is probably near an all time high both with larger immigration numbers as well as inter-Provincial migration) continues to fall well behind housing completions, then every passing year, the deficit grows larger and larger.

I just don’t know if economists and “experts” know what’s really going on out there.

I would love for them to get in the trenches, and see what it’s like.

I would love for BMO’s chief economist to pretend he’s a 27-year-old trying to carve a path in this city, and go out to look for a townhouse.  Spend some time fighting to get through the front door on a Thursday night with three other sets of buyers.  I would love for him to scour MLS, every day, looking for housing options, only to come up empty.  I would love for him to make offer, after offer, after offer, losing to other buyers who have lost before that.

I would just love to see some original thought, instead of “It’s too hot, it has to end.”

Because we’ve been hearing that for so long, that it’s lost all meaning.

And if economists are going to continue to talk about debt-to-income ratios and average incomes in relation to average real estate prices, then they may as well go home and use a VHS cassette to tape a program on Netflix…

31 Comments

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  1. Rickdeckard says:

    I’ve been a lurker here but have to say Mr. Fleming your writing has really improved. This is an excellent article – one that should be in the Toronto Star or Globe and Mail. The media splashes headlines that misinform and mislead and blame foreigners but never the most obvious answer – which is there isn’t a lot of great cities to work:live in Canada with the diversity and lifestyle that Toronto offers. Simple supply and demand, and the supply picture, especially homes, has been stagnant for many years. By most international measures, as you’ve highlighted in previous articles, Toronto is still a bargain in comparison.

  2. Steve says:

    The financial wealth of the average immigrant into the country today is significantly higher than the wealth of the average immigrant a generation ago . Unlike the immigrants of the 70s and 80s who came here with nothing, some of the immigrants come here today with deep pockets. So when we say there are hundreds of thousands of immigrants coming into the city , even if only 10% are wealthy (I personally think it is higher) is a significant number that can significantly change the landscape of the market in the cities they live in (typically Vancouver and Toronto) ………(even if they may have little to no income )

  3. Marc bastle says:

    I personally like the idea of a whole new generation of debt slaves and I would encourage more of their ilk to participate. These people fill my coffers and will continue to fill my family’s coffers forever.

  4. Joel says:

    A few things to point out here: A large portion of high earning individuals do so through corporations and pay themselves smaller dividends. This is going to skew the average income down.

    Assuming the top 50%(probably lower) of earners are the ones currently looking to purchase, they are able to take on the higher debt. Having $500/month after debt repayment (mortgage included) vs having $5000/ month left over makes a big difference.

    While people are not all purchasing because they are looking to sell for more in the future, they are rushing to purchase in order to not be priced out of the market. While not the same, it is similar. With the media hype and constant attention on the Toronto market many people are rushing to get into the market. If there was a stabilized inventory many would wait until it made more sense for them.

    Torontonians want to buy before the Chinese buyers price them out of their own city. This creates higher prices and a self-perpetuating rise in prices.

    While I don’t think that Toronto is in a bubble, I do think that we should not be cheering a 20% yoy rise in the cost of a home. That is an unhealthy number and certainly unsustainable. The average Joe is much more likely to become desperate and over extend themselves in this market when they think that they are missing out on 20% a year leveraged compounded gains. It’s hard to blame them either.

    I am not one for government intervention on the housing market and think that the average person is going to have to make decisions as to whether or not home ownership is responsible for them or not. I do think that the government needs to put a better plan in place in regards to encouraging the increasing of density and improvement of the transit system.

    It also bothers me that the banks’ economist talk about the bubble and the risk of the housing market in Toronto, while the marketing department spends millions in order to try to get your business of the same asset they are considered over valued.

  5. adam says:

    Doug Porter clarified his bubble remark today –
    “A market bubble is in the eye of the beholder, and even when a bubble is
    identified it can grow much larger and possibly for many years. Alan Greenspan
    spoke about irrational exuberance in U.S. stocks in late 1996, and the tech bubble only
    burst in early 2000 after a near-quadrupling of the Nasdaq after his warning. Our only
    goal of calling Toronto’s housing market a bubble was to reinforce the message
    that it had become divorced from economic fundamentals and was becoming
    potentially dangerously overheated. This is not a near-term call on the market—in
    fact, given the outlook for interest rates and an improving underlying economy, there’s
    nothing obvious to meaningfully slow the market at this point.
    And to those who question whether it is a bubble, we can only hazard to guess that they
    haven’t been looking to buy or sell a home in the past year and are blissfully unaware
    of the reality on the ground. A random sample of homes that sold this month alone
    shows a median selling price of 25% over asking, with not one staying on the market
    longer than eight days. Even pigs are flying in this hurricane of a market.”

    1. jeff316 says:

      I’m glad he clarified somewhat, though that is still pretty iffy. We may indeed have a housing bubble, but his original and current statements sure are full of qualitative statement and catchy adjectives that do more to gather attention than inspire confidence.

      1. Carl Warner says:

        Exactly: “to gather attention.”

        As Paul Krugman (a Nobel prize winning economist) frequently points out, the more often you see an “economist” on TV, the less seriously you should take what he (there are very few “she” economists on TV) says. And yes, he realizes that he is now one of the more visible economists.

        1. Mike says:

          Interesting.

          Before Doug Porter, BMO’s Chief Economist was Dr. Sherry Cooper. She was let go to write her books. When they didn’t sell she took on the job of Cheif Economist of Dominion Mortgage. http://www.macleans.ca/economy/a-housing-market-thats-too-hot-to-handle/

          I mean she works for a company that just provides mortgagees, that’s it. Has 20-years+ experience with lenders; hired because she knows the market.

          I don’t know is she could tell you where certain condo’s were either.

  6. That Guy says:

    I agree with you entirely, David. The debt-to-income ratio in particular is a straw man. Even alluding to the ratio that Ralph Cramdown posted that homeowners with mortgages owe 246% of their annual income, this doesn’t account for the asset associated with that debt. The only debt on a mortgage is the interest you will pay, whereas the remainder of the mortgage is just a liquid form of the home you own. Yes, a major housing correction would end in people owing more than their homes are worth but even then, the average stake in one’s home is above 35% already.

    Focusing on all debt the same way is dangerous. If I owe $100k in unsecured credit cards, I’m probably going to be facing bankruptcy very soon. But if I owe $100k in a mortgage below 3%, I can have it paid off in a year or two and am still regarded as a healthy borrower. I hate to be “that guy”, but if you can only quote numbers and theory, you’ll be just as wrong as every other economist has been for the last 25 years.

  7. Julia says:

    My 2 cents: #1: you make a great case for a tax on foreign buyers, at least in my view, this can’t come soon enough. #2: why would a couple with a fairly low combined income of $120k be buying a $900k property? Are they putting down $600k in cash on it? This seems really crazy to me….

    1. That Guy says:

      If they bought for $900k and put 20% down, their mortgage would carry for about $2850/mo.

      Property taxes aside, that’s only 28% of their monthly income which is very reasonable. Especially if mom and dad help with down payment then this is a slam dunk purchase and I’d take it on any day 🙂

      1. Izzy Bedibida says:

        That $2850/mth is almost 50% of an average earners take home pay. My marriage ended because I refused to take on such a high debt load, and completely drain the bank accounts to make the down payment obligations. Ex-wife thought that I was denying her happiness by not going in on the “forever house”.
        Many posts back I mentioned a few friends who did not “have the luxury of buying a domestic pint” because everything they made went into mortgage payments are getting divorced over mortgage payments eating up everything . One went into a bidding war to avoid a divorce.
        In his neighborhood, most people are becoming ENDIE’s, and marital strife is high. No economist or any of the surrounding metrics appear to talk about this. What are the hidden social costs of this?

        1. Max says:

          Hey, Izzy, pipe down, will ya? We’re not talking common sense or reality here; we’re talking about real estate in Toronto.

        2. Joel says:

          I think it would be safe to say that there are some serious problems in all of these marriages beyond mortgage payments.

          1. Izzy Bedibida says:

            In my circle, the catalyst for marital strife was mortgage payments eating up everything with nothing left over. Now the beautiful “forever” house turning onto a dark prison.

      2. Julia says:

        Net monthly income on $120k annual salary is roughly $6000 a month so a monthly mortgage of $2800 not counting property taxes comes in at arount 50% of take home pay…. that is really high…. What about food, home maintenance, entertainment or future child care costs? I really feel this is irresponsible…

        1. Chris says:

          $3000 is a significant amount left over each month. That’s $36,000 per year for food, entertainment, child rearing, saving, etc. Consider the median individual income in Canada is ~$28,000 per year and it doesn’t sound so crazy.

  8. Mike says:

    What do you mean the guy in Rosedale making $2,000,000 a year doesn’t have personal debt of $3,400,000? Of course he does, if not more.

    Lets take the COO of BMO who makes at least $2,000,000 a year and has his Rosedale home for sale for $10,000,000. You’re going to tell me that he’s just going to let that asset sit there? Of course he’s going to take a loan against it at 2.5% invest it securities and earn 6% and deduct the cost of his loan from his tax. That’s why he makes at least $2,000,000 a year.

    Now in the event of a downturn he can cash in his stock and pay down back the loan. He’s using leverage to his advantage. Interest rates go up, he rebalances his portfolio and continues to benefit from the spread. Smart money.

    The problem is all the dumb money out there. People who wanted to own a house and have put everything they have into it. The people who lost out on 5 bidding wars and were determined not to lose again. The increase in prices have outstripped inflation.

    I also loved this part, “If net migration in Toronto (which is probably near an all time high both with larger immigration numbers as well as inter-Provincial migration) continues to fall well behind housing completions, then every passing year, the deficit grows larger and larger.” Yes, because Doug Porter would never have considered that the pay him millions each year but that escaped his grasp. Oh and it’s not just Doug Porter writing the report, he has at least a dozen associates gathering data for him, sitting through the meeting. People who are either looking for a home in Toronto or know people who are. I’m sure they wouldn’t have mentioned that. The probably didn’t even talk to a real estate agent or two.

    But what does Doug Porter know about real estate, I mean he only works for a company that made a couple billion last year selling mortgages. Of course it’s in his interest to downplay the real estate market,

    Same with that Brian Porter over at Scotia, he says that the Toronto market is over inflated and as such as is restricting mortgages in the Toronto market. Maybe he’s secretly buying condos and wants everyone to sell them to him cheaply. Because restricting mortgages in the largest market in Canada can’t be good for business.

  9. Kyle says:

    Instead of trying to infer risk and affordability as it relates to mortgages/housing by taking some agglomerated number of total average household debt (which also includes credit card, car loans, student loans, LOCs, etc) and dividing it by average income for everyone in Canada. A far better indicator of how much risk to real estate there is in the form of mortgage debt is the arrears rate (i.e. what percentage of mortgages were 90 days or more behind in payments). The latest level for Ontario is 0.13%, or 13 households per 10,000. This is the lowest level we’ve seen since March 1990

    http://www.cba.ca/Assets/CBA/Files/Article%20Category/PDF/stat_mortgage_db050_en.pdf

    1. Ralph Cramdown says:

      Who defaults when prices are at record highs? They just sell the house, or refinance with a subprime lender, whose defaults aren’t captured in the CBA stats. Defaults don’t really tick up until after prices start falling. Observe:
      https://fred.stlouisfed.org/graph/?g=cJDJ

      P.S. I barfed up an economic principal a few months back, but he was so putrescent that I couldn’t tell whether it was Karl Marx or Danny Kahneman.

      1. Drowzee says:

        To add to Ralph’s point, March 1990 was around the peak of the last housing bubble. So very low arrears may actually indicate high risk.

      2. Kyle says:

        LOL my bad, principle not principal.

  10. Kyle says:

    This blog post is bang on. I have an Economics background and frankly can’t stand how “Economists” and so-called “experts” bastardize it when it comes to real estate to support some bunk narrative. Economics is a social science that is meant to inform relationships and behaviours, and relies heavily on assumptions or holding certain variables constant (which frankly never happens in the real world), yet so many people seem to blindly barf up economic principals like they were unbreakable laws, with total disregard for whether the underlying assumptions are valid or whether the hypothesis results bare any resemblance to reality.

    In Science you test a hypothesis by comparing the expected results to reality. If it doesn’t hold then you reject that hypothesis. What you don’t do is keep repeating the same debunked hypotheses over and over for decades while saying just cause it hasn’t happened yet, doesn’t mean it’s not going to happen.

  11. Anonymous says:

    Great post David. I personally fall in the category of the two reasons you mentioned: foreign money from mom and dad. My parents are in Hong Kong where my high school friend just purchased a 330 square foot apartment for the equivalent of CAD$915,000. My parents just gave me roughly that amount, and we purchased a commercial property here in Toronto that has a cap rate of 4%. To them, real estate here is a bargain. I myself am a bit of a bear and when I tried to tell my father to hold off, he asked me to consider his position: what should he do with the cash when he is already heavily invested in the Hong Kong and US real estate markets as well as in stocks? I am sure that there are other people that share his view.

  12. Ralph Cramdown says:

    Debt to income ratio includes mortgage debt. And no, it isn’t the “poor schmo with the crappy paying job” who’s driving up the ratios. It’s your clients, and their parents.
    http://www.statcan.gc.ca/pub/75-006-x/2015001/article/14167-eng.htm#a6
    Debt to income ratios, by household income quintile: 0.76 (lowest income), 0.79, 1.36, 1.34, 1.24 (highest income)
    By homeownership status: 2.46 for owners with a mortgage, 0.38 for owners without, 0.31 for non-owners.
    Meanwhile, for the price of a dated 1960s 3 bedroom in Don Mills, you can get a 120 acre winery (also a bit of a fixer-upper) an hour from Rome and Florence:
    http://www.bloomberg.com/news/features/2017-02-09/monte-paschi-s-debt-hangover-vineyards-in-tuscany-it-can-t-sell
    Price is what you pay. Value is what you get.

    1. Ben says:

      But what are your running costs for that winery (property taxes on 120 acres, commercial mortgage rates in Italy, ongoing committed costs for maintaining and operating the winery, etc.) vs the 1960’s house in Don Mills?

      Sure the purchase prices are the same, but the monthly cost for the Italian winery could easily be more than 10x that of a Toronto house. The land is probably 100x the size, and given that there are no takers at this time, the winery is likely operating at a substantial loss. All in all a very silly comparison

  13. Jason says:

    Great article Dave! I saw Mr. Porter’s interview on BNN. He also admits that he doesn’t see anything in the next 18 months that would put a stop to rising home prices in the GTA. I respect his opinion more than other perma bears like Hilliard McBeth or David Madani since they have been calling for a correction for a long time. As an investor, I think this is a time to be cautious, but not overly pessimistic.

  14. Ed says:

    Is mortgage debt included in debt to income ratio of 170% ?
    Anyone?

    1. Jason says:

      No, it does not include mortgage debt.

      1. Jason says:

        I mean yes, it does includes mortgage debt!! 😉 I was reading an excerpt from a report that was specifically talking about consumer loans, but it does includes mortgage debt as well as non-mortgage debt and consumer loans.

    2. Drowzee says:

      Yes, it includes mortgage debt. To quote the Bank of Canada: “Rising indebtedness is sustained by
      strong growth in mortgage credit, and consumer credit (excluding home
      equity lines of credit) continues to grow at or slightly above the rate of
      income growth.”

      It’s from page 8 of this report: http://www.bankofcanada.ca/wp-content/uploads/2016/12/fsr-december2016.pdf

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