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rebeccahpedersen · 8 years ago

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

TorontoRealtyBlog

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…

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…

The post The Friday Rant: Even A Broken Clock Is Right Twice A Day appeared first on Toronto Real Estate Property Sales & Investments | Toronto Realty Blog by David Fleming.

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