Greatest Fools by Garth Turner

Ever been to Leaside? Some wonk paid $160,000 over asking for a place there last week, I heard.

The mid-Toronto neighbourhood is populated with 1930s-style brick houses without garages built on lots the width of two cars situated on streets with plumbing problems. A couple of blocks away is a huge industrial area where munitions were made during WW2. The dirt was so toxic it had to be hauled away before big box stores could be built. And a good chunk of Leaside’s finest street was once a garbage dump.

But hey, it’s desirable. Upscale. Expensive. Most listings are now north of a million and, local realtors tell me, they’re in hot demand.

Welcome to the parallel universe. As I have been detailing lately, the greatest fools in real estate are not those who bought at the height of the bubble in late 2007, they are the ones buying now, at the pinnacle of denial.

Let me give you a few more reasons why this is going to end badly. You can add them to relentlessly rising interest rates, the demographic tsunami, chronic unemployment, destruction of the national manufacturing base, inevitable tax increases and an energy price crunch.

Canadian household debt has red-lined. The country’s accountants have just warned that families now owe $1.3 trillion, most personal debt on credit cards and LOCs. Sadly, 85% of us have unpaid credit card bills. Worse, a third of all families could not handle an unexpected $5,000 expense. Even worse, one in ten families could not pay a $500 bill.

Two points: First, it seems almost nothing was learned by anyone in the near-death experience of last autumn. All the reasons we rushed headlong into a credit disaster are still there. Second, how are we going to have any kind of sustainable real estate recovery (especially when rates start rising again), when so many consumers are tapped out?

Meanwhile, corporate profits are non-existent, meaning any recovery will be essentially jobless. Look at BMO. Earnings down more than 40%, and 1,100 people being laid off. As I said days ago, consider GM dealerships, where 14,000 people are facing a black hole. GM, by the way, will be bankrupt by Monday. And this week we heard of record numbers of Canadian collecting pogey last month.

The news Stateside just darkens. Home prices in the latest Shiller-Case report, out Tuesday, were down a withering 19% - the greatest drop ever. This signals the bottom has not even been hit yet, after more than four years of meltdown. Said economist Robert Shiller: “There are very few V-shaped recoveries in the history of real estate, and this one is likely to be even slower…”

More troubling is the next wave of mortgage defaults, the “options ARMs” – variable rate loans which allow buyers to pay less than they owe, with the remainder added to the principal. After a time, the loans are reset to reflect the increased debt, plus higher interest rates. It means for many people monthly payments could double even as the value of their properties has plunged. Yeah. More foreclosures.

BTW, there are $314 billion in option ARM mortgages coming up for reset in the next two years. It’s estimated that as the mortgages are adjusted, most homeowners who have then will have negative equity equalling 20% to 40% of the home’s value.

Meanwhile, as you know, Canada’s finance minister has admitted the annual deficit will be more than $50 billion. Three years ago the budget was in surplus by $15 billion.

So, arrive at your own conclusions.

These are mine:

* The current real estate buzz will destroy the wealth of those now buying, especially in multi-offer situations.

* Current first-time buyers will face a double threat of rising mortgage rates and collapsing values over the next two to five years. They will truly wonder why they took such a gamble and how helicopter parents, friends and ‘experts’ could have been so wrong.

* In two years there will be virtually no move-up buyers. High-end houses will be nailed. Bye-bye Leaside.

* Houses in Canada are essentially over-valued and will correct sharply. Given our foundation of debt, the bottomless pit of US property values, unemployment, stagnant incomes and deteriorating national finances, the lunacy of paying current prices will soon be apparent.

* And as all of the above comes together in the next dozen or two months, supply will swamp demand.

Those shelling out full price in the Spring of 09 will look as equity cowboys did in the Spring of 30.
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