Bank of Canada cuts lending rate to record low of 1%

From CBC:

The Bank of Canada on Tuesday cut borrowing costs to a record low as it warned the economy will shrink this year. In a further move to bolster the sagging economy, the bank reduced its key overnight rate by half a percentage point to one per cent. The bank has now trimmed 3.5 percentage points from the overnight rate since it started its latest cycle of cuts.Tuesday's cut reduced borrowing costs below 1.12 per cent, which had been the lowest point set back in 1958.

More rate reductions may also be in the offing, as the Bank of Canada said more stimulus could be needed to boost the sagging economy."Major advanced economies, including Canada's, are now in recession and emerging-market economies are increasingly affected," the bank said."Canadian exports are down sharply, and domestic demand is shrinking as a result of declines in real income, household wealth, and consumer and business confidence."

Bank sees recovery in 2010

The Canadian economy is expected to contract by 1.2 per cent in 2009, but the bank sees a recovery in 2010, when the economy is projected to expand by 3.8 per cent.Back in October, the bank projected growth of 0.6 per cent in 2009, and 3.4 per cent in 2010.The bank will provide more details on its outlook for the economy on Thursday, when it releases its Monetary Policy Update.

The bank also signalled that inflation fears have abated. The so-called core inflation rate is expected to fall to 1.1 per cent in the fourth quarter of this year, while the overall inflation rate is expected to dip below zero for two quarters in 2009 because of lower energy prices."With inflation expectations well-anchored, total and core inflation should return to the two per cent target in the first half of 2011 as the economy returns to potential," the bank said.

The major Canadian banks quickly moved to reduce their prime rates to three per cent. That differed from some of the past moves by the Bank Canada, when the big banks either delayed lowering their prime rates or did not pass along the full cut. The banks cited the tight credit markets as the reason why they were not passing along the cuts to customer borrowing rates.

Borrowing is getting cheaper if you can qualify and you are willing. It doesn't seem like the willing qualify these days and the qualified seem unwilling!

B-b-b-b-baby, You Just Ain't Seen Nothin' Yet

The Vancouver real estate market, along with the rest of BC and Canada, has now entered the full blown correction stage. Nobody is denying the reality that prices are falling and that it is very difficult to sell a home right now. Vancouver real estate prices have retreated nearly 15% in the past 7 months and Canadian prices as a whole have retreated 5-6%, depending on the data you use.

Many prognosticators, extrapolators, eternal optimists, and kool-aid drinkers have concluded that the worst is behind us in terms of price drops and I will now tell you why that is far from being the case.

Quite simply, there is TOO MUCH DAMN SUPPLY for the level of demand we had last year nevermind the level of demand we see today in the midst of a full blown credit contraction and recession. Shockingly ;-) people don't really want to commit themselves to a 35 year payment schedule, with payments double their current rent, when their job prospects are weak or at risk.

For those of you who are now planning on waiting until 'the market recovers' to sell your home, you may be waiting many, many years. The real estate market is not like the stock market, where crashes and recoveries can happen over a period of weeks or months. The real estate market takes years to exhibit the same market movement so get honest with yourself and don't let your realtor give you some mumbo-jumbo about a spring market rebound because the facts just don't bear that point of view out.

So the question becomes - When will we see more demand and less supply - ie. a recovery?

The answer of when a recovery will come is not complicated and actually we can make an educated estimate of when supply and demand should come back into balance. When supply and demand come back into balance, the worst of the price drops should be over and we can reasonably expect a 'recovery' of sorts, or at least no more big price drops!  This doesn't necessarily mean a return to the rapid price appreciation of the bubble years nor does it mean that we will attain the lofts heights of 2007 pricing again soon, in fact, it is likely that we will not see spring 2008 peak pricing for at least a decade and if we adjust for inflation, my children may never see that day.

In the current supply / demand situation, with well over 15 months of inventory in every major BC real estate market, we will see price drops in the order of -2% or more per month. This has been true of the past year.

For argument's sake, let's just say that the demand in the current real estate market does not deteriorate further and again let's imagine the looming supply of new homes under construction that will complete in the next 18 months is reasonably around 20,000 units. With current existing home inventories in the Greater Vancouver area and the growth in listings that is typical for the first half of the year we should see approximately 25,000 units for sale by the time May or June rolls around. Sales will likely be in the 1200 to 1500 per month range giving us a months of inventory metric well over 15 months again.

This means that 2009 will not be a positive year for prices in the local real estate market. In fact, assuming the trend shown in the chart above holds true this year, we should see continued price declines of 2% or more per month. If there is a further influx of inventory via new home completions or existing homes coming onto the market, or a further deterioration of demand, things could be much, much worse.

In regards to prices, here are my best case, reasonable case, and worst case scenarios for 2009:

Best Case - average of 2% declines per month, inventory does not exceed 25,000 units, sales hold up at 2008 levels, benchmark price finishes the year above $525,000.

Reasonable Case - average of 3% declines per month, inventory does not exceed 30,000 units, sales fall modestly from 2008, benchmark prices finishes the year above $475,000.

Worst Case - average of 4% declines per month, inventory exceeds 30,000 units, sales fall dramatically from 2008, benchmark prices barely finish the year over $400,000.

If these predictions seem alarming, then you haven't had a good look at the facts yet. There will be no recovery until 2011 at the earliest. For those of you looking to sell a home this year, get real, and drop your price to be the lowest in your neighbourhood, otherwise it isn't going to sell. For those of you looking to purchase, wait, or drive a very hard bargain, and be prepared for further price drops. If you are a developer, cut prices hard, 30% or more, and finish up your projects fast. If you are a city that happens to have a huge development full of unsold units on your hands, get rid of them, FAST.

Real estate prices will be 20-40% lower than now only 12 months from now so move fast if you're selling and move slow if you're buying.

Good luck because You Ain't Seen Nothin' Yet.

Big Developer Blinks and Offers Sizeable Discounts

From CBC News:

A Vancouver real estate developer is making an unprecedented move to offer a liquidation sale of $350 million worth of its condominiums throughout the Lower Mainland.

The marketing strategy by Onni Group of Companies is aimed at selling off hundreds of condos in its inventory.

About 375 unsold condominiums in cities such as Richmond and New Westminster will be offered at 20 to 40 per cent off, a real estate insider told CBC News.

It is not known whether the big discounts are based on prices when the condos were completed or current market values. Onni was to hold a media event Thursday to announce details.

Onni's marketing tool might nudge some reluctant homebuyers off the fence, said Tim Silk, an assistant professor at the University of British Columbia's business school.

"If you see the units being priced below comparable units, then you might see people jump in," Silk said Wednesday. "But there's still that hesitation of, 'Have we reached bottom?' "

Home prices in the Vancouver real estate market dropped almost 11 per cent between December 2007 and the end of 2008, according to a special price index updated earlier this month by the Real Estate Board of Greater Vancouver.

And the number of homes sold in 2008 fell more than 35 per cent from 2007 sales of more than 38,000 homes.

Good luck Onni. Onni blinks first in the 2009 showdown. This is likely the right move as they get the most free press and don't have to hang on to as much inventory through the year.

Wake up to the rest of the developers - drop your prices now and you may get to survive this cycle and live another day.

Calamity on the Creek

I enjoyed reading the updates on the Olympic Village fiasco at Frances Bula and Condohype.

What I found striking in reading Bula and other journalists is that what they consider the 'worst case scenario' for the condo market is actually *still* pretty much in the lands of hopes and dreams. The scenarios they seem to be running are things like 20% off pricing, or waiting 2 or 3 years until the market 'comes back.' What I find striking is how people that are intelligent and presumably well-informed seem to be unable to clearly see where this market is going.

Here's one thing that Frances said:

Being a fence-sitter, as my loving critics like to call me, I find myself as unconvinced by those who say (with considerable glee) that the housing market as we knew it will never EVER return to anything near what it was as by those who thought condos would keep selling like cheap underwear at Wal-Mart.

What does she mean by 'what it was'? Yes, people will continue to buy and sell condos. At some point, sales will rebound. They will in fact again sell like underwear at Walmart. But at what price? Does she mean 2007 pricing? Of course, in nominal terms this will happen at some point, but not any time soon.

Here's how I see it. No, prices will not fall forever and they won't fall to zero. Instead, with speculators out of the market, the bottom for prices will be set by cash-flow investors and/or rent vs. buy residents. If these people need, say, a 7% gross yield on investment, then in order to get $1000/sf (which is the number bandied around as break-even for the Olympic Village), we need to see rents at (1000*.07/12)=$5.83/sf per month. This means that a 1000sf condo rents for $5830. Now, the Oly Village might be nice and ultraluxury and all that, but I think it will be awhile until incomes rise to allow $5.83/sf.

Now, maybe one of these assumptions is wrong. Maybe speculators will return to the market and blow a new bubble. Could happen, but I doubt it will happen in the next few years. Maybe investors don't need 7% gross. I don't know. But I'm pretty sure that, while not forever, it will be a l o n g time before rents justify $1000/sf.

Look. It's as simple as this graph. Forget the politics. Forget the legal mumbo jumbo. Forget Bob Rennie's new age condo spin. What people are apparently still not getting is that a 'return to normal' does not mean returning to 2007. It was 2003-2007 that is the anomaly; not 2008-09.



[note: updated graph to Q3 2008. Data here.]
UPDATE: Here is Gary Mason in today's G&M. My impression of Mason is that he is a hard-nosed, cynical journalist. Yet he is still caught in the hype:

The city may be able to take the long view and hold on to unsold condominiums until the economy and real-estate market turn around and the value of the units returns to something resembling what they were expected to be about now.

Then again, that might not be for another six or seven years. No one knows.

See, his worst case scenario is that the market recovers to 2007 wish prices (not actual prices, but the 2007 presale wish prices) in 6 or 7 years. Not. Going. To. Happen.

The Ownership Premium

No analysis blog would be complete without a paradox and I believe there is none more relevant now than the so-called "ownership premium" that owner-occupiers place on property values. I would like to offer an alternate view of the so-called "ownership premium" that has been discussed on this blog and others in the past years.

The "ownership premium", sometimes called the "control premium", is a premium that a potential buyer will pay for the right of owning (and "controlling") a property compared to renting. Here is an example thought process of how the premium concept works, from a buyer's perspective:

jesse is renting a condominium for $1200 per month but is on a month-to-month lease. With a wife and young child, jesse does not want the uncertainty of renting month-to-month and his wife wants to customize the suite, something not always possible when renting. jesse looks at the condo for sale next door. If he were to buy it at market rate, the total costs of doing so far exceed that of continuing to rent. After factoring in all expected costs and trade-offs, jesse decides he is willing and able to pay a monetary premium to buy. But – and here's the thing – he doesn't have to.

The alternate view of the ownership premium looks not at individual circumstances but at the overall market comprised of owner-occupiers and investors competing over the same product. Here, for simplicity, we can look at condominiums that have a healthy mix of both owner-occupiers and investors. If owner-occupiers will pay a market premium to own, the investor must compete by also paying the same premium. This has the effect of reducing the investor's yield and instead must rely on capital gains to compensate for the poor yield.

In speculative bubbles, low rental yields go virtually unnoticed because everybody is "making money" on capital appreciation. Investors can compete head-to-head with owner-occupiers because rental yield is dwarfed by capital appreciation. The "ownership premium" train of thought becomes justified, even amongst many investors who justify it as a premium for scarcity and control of how the property is used. During bubbles, the premium continually increases.

However, when a bubble deflates, total return is not about capital appreciation but net income from rents. At this point the investor will require higher rents or lower prices to make the investment worthwhile. Housing markets around the world are starting to revert to where cash flows make sense again and this means lower prices. Rising rents are next to impossible when there is an oversupply of dwellings and wages are flat to falling with rising unemployment. The ownership premium, for investors, is once again meaningless.

This does not mean that the ownership premium for owner-occupiers is a fallacy. It exists and is real. In addition, for many others, the mobility and lower responsibility offered by renting means their personal premiums are negative. The point is that it doesn't matter. When a significant portion of a market is focused on monetary returns ex intangible benefits – i.e. investors –they will eventually and invariably set the price. It also doesn't mean anyone is necessarily wrong for paying a premium but ones doing so should not use it to justify high prices and instead realize they made an investment with a lower monetary return.

Edit: the "ownership premium", as described here, is in its essence describing one's personal preference to own or rent a property -- the "intangibles" of ownership. It is not to do with more tangible premiums related to speculation of future price gains or expected increased utility by densification. The point is the intangibles of ownership do not in themselves justify higher prices.

New Home Prices Falling

From the Financial Post:

New home prices fell in November for the second consecutive month-to-month decrease, Statistics Canada said Monday.

The average price on a new house declined 0.3%, the federal agency said, as demand continued to cool across the national real estate market in the fall.

The dip continues the first reverse in home prices in more than a decade, following the 0.4% decline experienced in October.

Yet the results varied from region to region, with some markets still witnessing considerable price increases.

St. John's recorded the largest annualized gain, with the value of a new home up more than 25% from 2007, a clip that narrowly outpaced Regina. The monthly increase in St. John's was 3.4%.
In a sign that Saskatchewan is beginning to feel the bite of a recession it has largely avoided so far, home prices were flat in Regina in November while in Saskatoon prices continued to come down.

New home prices were down 0.5% in Saskatoon "confirming a trend of deceleration in this city," Statscan said. "Builders continued to report difficult market conditions."

The drops continued further west. New home prices in Edmonton recorded a 12-month plunge of 7.9% - largest monthly decline since May 1985. Prices dipped 2.5% in Calgary. On a monthly basis, prices fell 0.3% in Edmonton and 1.1% in Calgary between October and November.

On the West Coast, builders cut new home prices in Vancouver by 1.7% in November, a trend continued in Victoria, Statscan said.

Markets in Eastern Canada, which have shown more stable supply-demand conditions, continued to rise, Statscan said. Compared with November 2007, contractors' selling prices were 4.3% higher in Ottawa and 2.0% higher in Toronto. In Québec, the 12-month growth rate was 5.4%, while in Montréal, prices increased 4.6%, the agency said.

No market east of Saskatchewan experienced a month-to-month decline in new home prices.

TD Economics: R.I.P. residential construction boom, 2002-2008.

Canadian housing starts largely unchanged at 177,300 units in December.

R.I.P. residential construction boom, 2002-2008.

After falling from 212,000 units to an upwardly revised 178,000 units (from a preliminary 172,000) in November, we got confirmation this morning that housing starts have indeed embarked on a cyclical downtrend. In other words, that the drop recorded in November was not a kink in the data or dismissible as purely weather-related or sheer volatility, which monthly housing starts figures can be prone to exhibit, especially in the multiple-family unit segment. The year 2008 will have marked the seventh consecutive year where total housing starts where higher than 200,000 units. Residential construction activity had already turned the corner a while ago, however, and today’s data help confirm this. After running at a pace well below the rate of formation of new household for an entire decade (1991-2001), housing starts ramped up significantly starting in 2002 to satisfy pent-up demand from that previous decade. It is our view that this pent-up demand has been absorbed. Consequently, housing starts will, over the long-term, have to come in line closer to the latest estimate of household formation rates, roughly 175,000. R.I.P construction boom, 2002-2008.

Is 175,000 units or so the new norm or level we should expect going forward? Not likely. In a recessionary context, we think housing starts in Canada will undershoot that benchmark for a while. On a national scale, our forecast calls for a bottom in housing starts near 140,000 units in the fourth quarter of this year – hence another 20% lower than the last recorded levels. On an annual average basis, starts will likely average around 150,000 units in both 2009 and 2010. From a regional perspective, the housing starts downtrend, while broadly-based, has been, and will continue to be, most severe in B.C. and Alberta. No province is immune from this, however, and we expect every province to record double-digit percentage dips in housing starts for 2009 when compared to the still lofty levels of 2008.

The employment data also line up well in confirming this long-awaited, and just as long in coming, downturn. During the first three quarters of 2008, the construction industry (as defined in the Labour Force Survey (LFS), which includes non-residential construction) was creating jobs at an average monthly pace of 11,200. A sharp U-turn occurred in the fourth quarter of 2008 to close out the year on a sour note, with jobs being shed at an average monthly pace of 15,300. Back-checking with the establishment payroll survey helps confirm that the residential segment, rather that the non-residential or engineering segments of construction, is indeed most likely responsible for the construction employment losses showing up in the LFS data. All said, it certainly seems as though an important chapter in which the residential construction industry was contributing to Canadian growth and employment in an outsized fashion, has come to an end. Lagging slightly behind the rest of the economy, residential construction has crossed over into the recessionary chapter, and looks unlikely to come out of it before 2010.

Pascal Gauthier, Economist, 416-944-5730