April showers...

April is fast drawing to a close.

We probably won't get the final numbers until Monday, but indications are that it was a fairly typical April. Prices look to be up a point or two over March, and sales figures are looking like they'll be in the normal range for the month, 1750-1850... which would actually be an improvement over the winter which saw sales well below average, and welcome news for those trying to sell

For those of us looking for indicators of long-term trends though, we're kind of stuck in a holding pattern. Observing it all, it seems somewhat counter intuitive since asking prices keep coming down, but the averages continue to hold. But perhaps that's an indicator of what's selling more than market direction. Or maybe it's the incredibly low interest rates. Who knows, maybe we really have hit bottom... nah.

If this year is anything like last year, it won't be until the second-half of the year that we'll find out whether prices will sink or swim... until then we're stuck waxing philosophic, arguing banalities and over-analyzing indicators.

Not that over-analyzing indicators cannot be fun... one of which is the Teranet/National Bank House Price Index. We looked at this a bit back in January, so it's a good time for an update.

The overall trend looks to be down, particularly in the uber-bubbly Calgary and Vancouver markets. Everyone is down month-over-month. Montreal and Ottawa are up year-over-year, but as can be noted, they didn't appear to really have 'bubbles'... not anything like the western markets anyway.

It's still striking how similar our graphs look compared to what happened in the United State (graph prepared back in January).

New Home Prices

What's happenin' negazots?! It's been a rather dreary day here in the Alberta capital, so I figured I'd do a quick post on new home prices to fill the time.

I've gotten several requests to do this, but I've never been able to find real great historical data on it... still haven't, but the CMHC Housing Now reports have been including single detached prices going back to mid-05, so that's better then nothing.

This is through February, they release their March numbers on Thursday, so you can keep an eye out for that should you be interested in such things.

Here we have a graph of new single detached median prices, city proper and metro, as well as resale SFH median for comparative purposes. As we can see, city and metro prices tend to track quite closely.

A few interesting observations when comparing new with resale prices. The big one is how new prices have continued to climb the last year and a half while resale have been going down.

One would suspect some lag, as new sales tend to be largely bought on spec, often the transaction occurs several months before completion. Whereas resale tends to have relatively shorter possession periods. But lag doesn't account for the difference in this case.

We should note in late 2005, when prices were still fairly stable that new prices were about 20-25% greater then resale (I'd hypothesis that this was likely due to our propensity to build bigger and bigger homes over time, so was likely rooted in new homes having more square-footage)... thus one would expect this to remain, but we can see during the run-up that new and resale prices were about even.

I suspect this was the result of the aforementioned lag effect. As when resale prices settled down and plateaued in that $375K territory, new values eventually also plateaued around $450K.

That of course makes it all the more perplexing that when resale prices started falling last summer, new prices started going up. Really quite interesting, though they seem to have again leveled off.

Further puzzling as sales tallies have fallen off over the same period, like resale, the totals have been really quite poor for the last two quarters, and unabsorbed inventory keeps climbing. Not exactly a recipe for price escalation.

Though, as we've been hearing increasingly, it does sound like builders are starting to aggressively slash prices in the last month or two (which wouldn't be apparent in the above graphs as those figures only go through February). As of February new prices were 50-60%, which is obviously a whole lot more then the 20-25% pre-boom levels.

It'll be interesting to see over the next few months if that ratio starts to get any closer. If the rumblings of price slashes are true, it could happen quite rapidly as they attempt to clear out inventory.

We're #1!

It's been a tough week for the province... first we find out that the provincial government thinks our beaches and children are too damn ugly to use in advertising, so they have to co-opt some from England. Okay, and yeah, that foam finger is actually one for the Oakland A's, but what can I say, our foam fingers here in Alberta just don't stack up... err, I mean, its use was intentional and to give a more global focus... yeah, that's it.

If stock photography is good enough for the Province of Alberta, dammit, it's good enough for my blog! And, honestly, as a marketing type, whomever thought up that "It was intentional" defence, should be given a one-way ticket to Northumberland to find new employment.

Then, as Two-third pointed out, Alberta had the biggest decline in retail sales in the nation in February. Add to that Mark Carney lowering the bank rate and telling Canadians to start spending like crazy or he is going to unleash "quantitative easing."

So yeah, it's been a tough week... but fear not, the Canadian Bankers Association had news that is sure to erase all those bad memories. They released their February numbers, and Alberta is now leading the nation in mortgages in arrears.

So suck on that Atlantic Canada, we're the champs now!

As of February 0.48% of all mortgages in Alberta are now three months in arrears or more. Up from 0.45% in January, and 0.22% a year earlier. Alberta has seen something of a meteoric rise in this regard since bottoming out at 0.14% in 2007, at which point we were neck-and-neck with B.C. for lowest rate in the nation.

Arrears were up all across the country though, the national average now stands at 0.38% (up from 0.36%). Manitoba has the lowest rate in the country at 0.23%, followed by Saskatchewan (0.25%) and British Columbia (0.27%). At the opposite end of the spectrum, Atlantic Canada comes in at 0.46% and Ontario at 0.41%.

So what does it all mean... well, if you're looking for new business opportunities, I'd say repossession is going to be a real growth industry for the next year or two. Arrears are showing no sign of slowing down, and if people are behind on their mortgages, they're likely behind on all kinds of credit.

A lot of boys will be parted with their toys, so if you're liquid and in the market for quads, trucks, plasma tv's, etc... you can probably get a helluva deal.

Not that these are situations necessary to cheer... but that's reality. For those with cash in hand, recessions can be a great time to acquire assets, business, personal and luxury... unfortunately real estate is still grossly overpriced, give it time though, even that will one day correct, then it's vulture time!

Sidenote: I'm trying something new with the comments, because the amount of people posting as "anonymous" was out of hand and you never knew whether you were dealing with one person or six. So please enter some kind of handle to identify yourself as if you want to comment.

I'd rather avoid forcing people to register with Blogger or OpenID, but if this doesn't work that's what we'll have to do. So, if you have any comments or questions, fire away.

What is a 'bust'?

So, just what is a 'Bust'?

Don't google that.

The first hits you'll get will probably be of the Russ Meyer-esque definition... and don't get me wrong, big fan of that variety, but looking up that sort of thing while others are around can invite trouble from HR, or even worse, the MRS.

I'm talking about market busts, and in this case, housing market busts... and for the most part, these are safe for work.

There is no one universally accepted definition... which is also true for 'booms' (or 'recessions', or 'depressions', as we've seen of late), so that's probably why there is such spirited debate about such things.

I did some googling of my own, and found all sorts of numbers thrown around, but it seemed most were in the 10-15% range peak-to-trough.I ended up stumbling upon a couple pretty good long term studies that I think I'll go with.

One was from the IMF and published in 2003. It studied 20 busts from 1970-2002 in 14 industrialized nations. It's findings were that to qualify as a 'bust' the peak-to-trough contraction must be at least 14% in real dollars (inflation adjusted).

Also perhaps of interest, on average they lasted about 4 years, and the average correction was 30% (again, in real dollars). There is actually a lot of really interesting findings in there as it compares equity to asset bubbles, and it's quite prophetic when you compare it to what's happened in the U.S. of late.

The other study was by the FDIC in the US, and was published in 2005. It studied US markets from 1978-2003 and they concluded that to be a 'bust' the peak-to-trough contraction must be at least 15% in nominal dollars.

This may not sound like a big difference from the IMF definition, but the distinction between real and nominal dollars is actually a significant one. Which I'll display later when I compare our current situation with the bust in the 80's. Personally I'd lean towards using real dollars, especially over the long term, but there is an argument to be made for the use of nominal dollars, particularly in the short term.

First we're going to take a look at the IMF definition. Here we see the various price measures here in Edmonton and their percentage declines since peaking respectively when adjusted for inflation.

From this graph we can see that for all measures have satisfied the IMF definition of a 'bust' already... so, if you didn't think the name of my blog was correct, how are them apples!

Now the FDIC definition. This graph yields an interesting observation... both condos and single-family homes have surpassed the threshold and are therefore busts... but somehow the overall residential average (which those two make up), has not.... how does that work?

Basically the answer is proportion. When prices were peaking, the ratio of condos/SFH's selling was much higher for whatever reason *coughspeculationcough*... since then the ratio has dropped, thus, more SFH's and fewer condos are counting towards the average... and when you have more higher priced units selling and fewer lower priced ones, it's brings up the overall average.

So, even though the residential average hasn't passed the threshold just yet, everything that makes up the average actually has. So, by the FDIC measure too, Edmonton qualifies as a bust.

Clears as mud? Good. And we wonder why so many people hate statistics!

Now, as promised, a comparison with the 80's bust. Since we're were just talking about nominal prices, we'll stay there and do them first. To compare apples-to-apples, we'll stick with talking the residential average as I don't have the other price breakdowns going back that far.

Here we see the 80's bust took about four years to go from peak-to-trough, and the total contraction was 29%. We can also see that our current bust is tracking very closely thus far.

Also interesting to note the volatility in the prices. The overall trend is down, but there are a ton of spikes along the way. Evidently there is a lot of bouncing left in a dead cat. So, for those eager to call bottom don't get too excited... even a couple or three consecutive strong months are not unusual, and can be quickly erased. Bottoms are only revealed long after the point.

Now the comparison using real prices. As we can see, by this measure the 80's bust was much longer and much deeper.

Took 100 months before finally hitting bottom, over 8 years (though I suppose one could argue that it effectively hit about two years earlier, the absolute bottom wasn't struck until month 100), and the total contraction came in at a whopping 48%.

We can also see that our current bust appears to be tracking faster, passing the 14% threshold two years earlier.

An interesting note is that for the 80's bust, the real peak actually occurred two and a half years before the nominal peak. Real prices had already dropped about 13% before nominal prices peaked. This could happen because at the time there was very high inflation, and also something of an extended plateau in price.

This is in stark contrast to our current peak, where inflation was relatively low and there was no plateau to speak of... thus real and nominal peaks were simultaneous.

In conclusion, it appears that by most measures we are not just heading towards a bust, but have already arrived. And it's not one of those things that bouncing back above the threshold undoes, once you cross the line, it's done.

Like virginity in many ways, you can argue about the criteria, like it should be nominal dollars not real... or I was drunk, and it was Mexico... or it should be 14% not 15%.... or it was just the tip, just for a sec, just to see how it feels... but wherever you draw that line, once it's crossed, it cannot be uncrossed.

Population and Migration

I've been meaning to take a look at this for a while and finally got off my fat ass and did it... or I guess technically, sat on my fat ass and did it... um... I digress.

So, today I'm going do another reader request and to take a quick look at population/migration and it's effect on real estate prices. Many speculate that it was high migration and growth that not only triggered the run up in prices, but also argue that it should sustain that level of prices. We'll see if that theory stands up and earns my unpatented stamp of approval, or not.

Lets start with population. Here is a look at Edmonton's reported population from 1962 to present, charted against the inflation adjusted residential average price in Edmonton.

As we can see there, the population curve is quite gentle and consistent. Contrast that to the price curve, which the late 70's bubble is quite pronounced, as is the spike in prices witnessed of late.

It could have likely been deduced from the first graph, but here is some further derivation to back up that overall population growth doesn't appear to have much impact on prices. Prices are very volatile, and largely appear to move independent of population.

Included in this graph is the percent change of both Edmonton and Alberta populations, I didn't include Alberta's population in the first for scaling purposes. Alberta's, like Edmonton's population, generally fluctuates between 0%-5% growth year-over-year (FYI, the spike in Edmonton's population in 1964 was due to their annexation of Jasper Place).

Thus we will conclude that overall population growth has no direct relationship with residential real estate prices. Now, onto migration.

That is a graph of net migration into Alberta since 1962, and it's two primary components, interprovincial and international migration. As we can see, interprovincial appears to be the primary driver of net migration. From here on out we'll just deal with net migration, I just wanted to give you all an idea of what how international and interprovincial figures stacked up.

Now here is a graph of net migration and year-over-year price change (bear in mind those migration figures are for the entire province, not just Edmonton). If there was a relationship between the two, one would expect that migration would be the leader, but as can be seen in 70's through the 80's it was actually price that lead through the first bubble. We can also see that through the 90's, even with fairly good migration, prices really didn't seem to respond.

There are some periods that may appear to support a relationship, like in the late 80's and in '05 and '06, but on a whole it doesn't appear there is any direct relationship. It's also interesting to note that the recent spike, which reached record level in 2006, still doesn't appear to be anything exceptional, and migration retreated quickly in 2007 and 2008 back to historical norms.

This leads me to conclude while there is likely some short term effect of migration on price, but in our recent boom its effect was probably over blown. I would hypothesize that the shortage of inventory and rental units experienced was more rooted in speculative buying then actual increased demand.

As we've seen an explosion of listings since the peak, particularly of condos and smaller homes, largely of which have been sitting empty. This appears to support the hypothesis that we saw a great increase in properties bought, and then held to be flipped at a later date.

This sort of behaviour was also evident in the rental market, where the number of total units dropped from 75,267 in 2005 to 67,907 in 2008. These were largely due to condo conversions. That kind of contraction will of course increase demand, even if the population increases. The number of occupied units actually only increased about 775 from '03 to '06, then dropped by over 4,000 in '07 and another 3,000+ further in '08.

Beyond that, our current situation where we find the city seriously overbuilt and with another 10,000 units in construction. We can't get to that point without demand being perceived as much higher then it is in actuality.

So, while a rapid increase in migration could likely pinch supply short term, the escalation of prices we experienced here was more rooted in speculation and good old irrational exuberance.

And as far as long term price support goes, not a chance. As I've said before, Edmonton isn't Manhattan, we can build for as far as the eye can see in every direction and generally it's not any problem getting materials or labour... any short term situations where demand outweighs supply, will quickly be corrected... or as we've witnessed, over-corrected.

At least that's my opinion.

EDIT: Had a request for the graphs of change in net migration vs change in price, so here they are. I had already prepared them, but they got cut from the original post to keep the length down.

Hindsight is 20/20

Over the last while I've been reading through the archives of the Edmonton Real Estate Blog, just to get a feel for the zeitgeist of boom here in Edmonton.

Hindsight being 20/20, it's quite interesting to read through it. I've currently read up to early 2007, so as a reader today we are privy to the added context that the bubble is about to burst soon.

The old adage that those in a bubble don't seem able to recognize it until it burst also rings true... and while it would be easy to sit back and take pot-shots, it's worth noting that two or three times during 2006 Sheldon as much as said that the market was on the cusp of a bubble and if things didn't slow down, and we'd be repeating the bust in the early 80's. He seemed to recognize it, but didn't really want to acknowledge it's arrival.

One post that did strike me as quite interesting, and worth examining is this one by his cohort in February 2007, 5 Signs of a Housing Bubble in Edmonton.

So, I'll give Ms. MacLennan's take, then my rebuttal.

A housing bubble is characterized by rapid increases in the valuations of real property such as housing until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This in turn is followed by decreases in home prices that can result in many owners holding negative equity, a mortgage debt higher than the value of the property.

So lets compare this information to Edmonton. Here is our real estate bubble checklist:

1. Rapid price increases...check.

I'm with you so far

2. Prices reach unsustainable levels relative to incomes...nope

Um, actually they did... in a big way in fact. Incomes and prices tie into affordability, which comes up again in point 4. But to make the point quickly, incomes may have rose 30% by some measures, but home prices doubled over the same period. I believe this graph summed it up nicely.

3. Price to rent ratios...nope - prices have increased faster than rents, however, the vacancy rate is at an all time low and rents are increasing quickly.

She seems to kind of qualify her answer, admitting they actually had decoupled, but that it was just a matter of time before rents eventually caught up. It could be argued that that would be a reasonable assumption at the time... but, we know now that assumption turned out to be incorrect, rents never caught up, and now both they and prices are dropping.

4. Prices are too high to be affordable...nope - see this article on how real estate is now more affordable than it was in the 80's. Mortgages are still easy to get, and although you can't buy the big house on the hill in Edmonton for the bargain basement prices of a few years ago, housing in all price ranges is still selling and selling quickly.

There is one big flaw with citing that article. It was comparing prices from exactly 25 years earlier... as exactly 25 years earlier, we just so happened to be at the height of the last bubble (graph). I'd imagine those in the real estate field at the time could relate that the aftermath of that bubble popping wasn't pretty.

Bottom line, prices got out of line with affordability then, and were again at the time of that post being written. That things are selling well during a boom really shouldn't be a surprise, and certainly in no way dispels the presence of a bubble.

5. Homeowners with negative home equity...big nope - this is what is currently facing homeowners in the US. The majority of first time buyers took out "exotic" mortgages (aka 0% down, 40 year amortizations etc.) giving them no equity in their homes, and when prices did fall a few percentage points they ended up with negative equity. These mortgages do exist in Canada, but only make up a small percentage of the mortgages being taken out these days. The other reason so many Americans have negative equity was a huge surge in re-financing, which spurred consumer spending boosting the economy further which all fell apart when housing prices slipped only a few points. Again, the picture here in Canada is much rosier.

Incorrect, we just hadn't got to that stage yet. As we've seen, negative equity was possible (as some people already find themselves in that situation), and that was the original condition.

If this had been posted a year earlier, the contention about 'exotic' mortgages would have largely been true... In February 2006 you needed at least 5% down and could amortize no longer then 25 years. But by February 2007, we had all kinds of 'exotic' mortgages, and 60% of first time buyers were taking out 40 year amortizations. I imagine a large chunk of those were the 0% down variety (frankly, I'd consider any 40yr mortgage as 'exotic', but I digress).

In the US only about 22% of mortgages were "subprime" where as here in Canada 7% were "subprime"... but those were not including 0/40's. As I explored in this entry, our non-prime lending was just as bad here in Canada, as it was in the US. As prices creep further and further down, we're increasingly finding out we are just as susceptible here North of the 49th.

Now, I don't want to come across as picking on her, as two years later we are obviously privy to a lot of information she was not, and many of her assumptions were widely held at the time... it was appealing, who doesn't like to think they're on a gravy train with biscuit wheels?!

What I wanted to do was to take a definition of a "bubble" from during the boom as well as the contemporary thought of the time... then re-examine it from our current context and what we know now... and it now appears that it's quite arguable that we in fact filled all five of the criteria for a 'bubble'.

I'm sure in two years some of the thing I have written here will be laughable... heck, there is stuff I wrote three months ago that I now cringe about and know they're going to be wrong. Alas, that's the beauty of blogging, once you hit publish it's out there for better or for worse, typos and all.

The 'Burbs

I was doing a quick search of Google News local real estate stories, and stumbled upon this story from Sherwood Park talking about how prices had dropped $120,000 since their peak in July 2007.

They appear to be privy to some figures that are not publicly available, so I can't speak about that claim. I've been trying to piece together as much data as I could on the prices in the suburbs, and while I've gotten a fairly complete collection, it's still a bit patchy at this point. So, won't be any graphs in this post, but hopefully by this summer I'll be able to at least do some good ones for decline from peak.

While I don't have the complete data, I do have enough to offer up some interesting examples.. and it gives me an excuse to reference an flick from Tom Hanks bad comedy career phase. So, in some cases the peaks I note may not be the absolute peaks reached by the market, but they are close as I have all the second half '07 figures, and the Edmonton market peaked in mid-07.

So I'm going to take a quick look at the respective bubbles, first the prices five years ago (March 2004), the highest value I have for them in 2007, then their values as of March 2009.

St. Albert
March 2004 Average - 226,074
March 2004 Median - 209,900

Sept 2007 Average - 497,380
Sept 2007 Median - 477,500

March 2009 Average - 376,944
March 2009 Median - 354,500

St. Albert saw prices more then double during the bubble, and since then have seen prices both average and median prices drop over $120,000 respectively, roughly 25%.

Sherwood Park
March 2004 Average - 235,700
March 2004 Median - 227,725

August 2007 Average - 468,400
March 2007 Median - 439,000

March 2009 Average - 400,074
March 2009 Median - 390,000

Sherwood Park has actually had a surprisingly good March, as in January the average and median prices were 376,545 and 353,500 respectively. Even with that they have seen average price drop almost 15%, and median 11% since peaking.

Spruce Grove
March 2004 Average - 185,417
March 2004 Median - 173,899

Sept 2007 Average - 420,990
Sept 2007 Median - 416,000

March 2009 Average - 328,509
March 2009 Median - 314,500

Spruce Grove is another entrant in the six-figure club, seeing their median price already fall $101,500 since the peak. Their average had also passed that mark in December, but has since rebounded a bit. Spruce Grove was also the bubbliest of the larger 'burbs (populations over 20,000), seeing their median price go up 139% and average 127% during the bubble.

I also have notes on some of the smaller suburbs, so instead of typing all that out, I'll just give you some of the overall highlights.

Bubbliest Suburb (Percentage) - Morinville - Average +166%, Median +183%

Bubbliest Suburb (Dollars) - St. Albert - Average +271,306, Median +267,600

Biggest Percentage Decline - Stony Plain - Average -25%, Median -35%

Biggest Dollar Decline - (Average) St. Albert -120,436 (Median) Stony Plain -149,000

So while the city/region as a whole hasn't eclipsed the 100K mark in decline from peak, at least four of it's suburbs have the dubious distinction, St. Albert, Spruce Grove, Stony Plain, and Morinville. There may already be more in fact, but as I said, my dataset is not complete just yet.

In any case, I figured this information might be interesting to some out there. It's also very relevant since the suburbs are so intertwined with the city and make up such a large part of the CMA population.

Seasonality

Hope you all enjoyed your long weekend. If it was anything like mine, it was likely full of sun and way too much refined sugar.

If you've been reading the releases coming from the various real estate associations, you may have noticed they are now talking up the month-over-month sales and price figures more so then they have in the past.

Traditionally they usually focused on year-over-year figures... but as those are coming in as declines as of late, they are referencing those less and less. Something of a marketing move, as they're in the business of stimulating sales, and hearing about prices and sales going down doesn't make their message very receptive to buyers or sellers.

As a result of this, it's also increasingly being pointed out that month-over-month gains are actually normal in the spring, as real estate for whatever reason has a lot of seasonality. So today I'm going to take a quick look at the traditional seasonal movements of prices, sales and inventory.

The 100 value is the relative value in January... and from there it behaves like percentages. So 110 = 110%... so if the price was 200,000 in January, that value would be equal to 100... so 110 would be 110% of the January price, so 220,00.

Here we see how prices typically move through the year. The blue line is the historical trend, and as you can see it usually shoots up about 7% in the first half of the year before leveling off, then drops off a couple points in the summer, and ends the year up about 5%.

We can also see that over the last year we've severely deviated from the norm. In 2008 it tracked normally through March, then fell off slightly through spring and then really dove throughout the second half... and 2009 thus far has been an extension of that.

Here's a look at how prices behaved during the boom relative to historical norms. In this case normal seasonality barely registers as a speed bump, and while the boom was on through mid 2007, normal seasonality was no predictor what-so-ever. Which has also been true thus far in the bust.

Basically, seasonality is no indicator of prices during a bubble. That said, it is noticable that during the downturn, spring still does appear to be the strongest period, and falls off from there. Which seems to indicate the second half of 2009 could witness a very big decline.

Here we look at sales. Similar pattern, but in much larger proportions. Sales continually improve through May (typically more then doubling the January tallies), then going back down the rest of the year.

In 2008 we can see that it tracked a closer pattern in sales then prices. This also holds true though the boom, so while the scales may change, the general seasonal pattern remains.

It's also notable that 2009 appears to be gaining very strongly, but this may be more of a result of an overly poor January. Again though, it is tracking quite closely to the historical seasonality.

Finally we'll take a quick look at inventory levels. Again we're seeing levels track fairly normal curves, 2008 went a bit higher, and 2009 is shaping up to be lower.

On the other hand, during the the boom, and the onset of the bust it looked quite different. In 2006 inventory actually tracked the opposite pattern, and declined through to the summer. This obviously caused a inbalance of supply and demand, and really fed the skyrocketing of prices.

Then in 2007 it was a very different story when inventory tracked normally, then picked up, then did some skyrocketing of its own. Which then caused a glut of inventory, and halted then reversed prices. Obviously a very volatile period there in 2006 and 2007.

So, as we can see, we should not be surprised by sales increasing in the spring, and the real estate boards out there should enjoy trumpting month-over-month gains while they can, cause come summer they're going to have to find something else as both month-over-month and year-over-year figures will be poor.

As for some April predictions, I've been working on some different models but they're hardly perfect... but I'm a glutton for punishment, so lets throw out some numbers and see how I do.

As mentioned before during a bubble prices are kind of anyones guess, but I imagine they'll hold their prices in April. Active Inventory I'm going to say will end April around 7,900. Sales I'm going to peg at about 1,700 for April.

Though that could be a ways off, on one of the local agent blogs they are citing the EREB claiming 574 sales already this month, which by my calculations would put us on pace for almost 1,800 on the month (there were 1,830 last April)... though in the paragraph prior they talk about how much things have slowed sales wise and gave quite a low tally for the week.

So, in conclusion... who knows?! Time will tell.

Be careful what you wish for

Of late we seem to be hearing increasingly from people predicting runaway inflation... sometimes almost cheerleading for it. For those who bought at the height of the bubble, this may seem on the surface to be an attractive viewpoint as it could quickly erase the downturn in prices.

I'm not really sure anyone that bought at the top should be quick to embrace heavy inflation though... because there is a nasty flip side to it, and that is interest rates. No matter how high inflation goes, interest rates go higher.

Over the last couple decades, it seems all the rage for fiscal policies to be fighting inflation, keeping it in the 1-2% range whenever possible... as a result mortgage rates have dropped from the double digits down to the 5-8% range for much of the last decade or so.

One must only go back to days of more moderate inflation like the mid-80's when inflation was around 4% YOY, and interest rates were regularly 11-12%. Even just a return to moderate inflation could spell disaster for many of those first-time buyers who entered during the boom.

The problem lies in that so many people extended themselves to the max to finance these places, and "get in before they were priced out." To them rates going up a couple points could be too great a cost, much less if they doubled.

Even with the gains in salary that comes with inflation, the interest costs at renewal would be too much. To give you an example, lets say a couple bought a SFH in '07, and financed $400,000 (which depending on the month might only get you the median home in Edmonton FWIW). 5-year fixed mortgage rates at the time were around 6%, and while they didn't have a downpayment, at least they were smart enough to do it with 25 year amortization. Their monthly payments would be $2,577, and like many others, they borrowed to the max of what they qualified for, and could afford.

So they're set through 2012. Lets say that by then inflation has went up to 4% (which historically is quite moderate if not low), but with it interest rates have also shot up to 12%. Now their mortgage is up for renewal, and lets assume the bank is willing to do business with them.

If they want to have their home paid off as planned, their payments will go to $3,960 a month... a 54% increase over what they were paying before. Even with inflation increasing salaries and a raise or two along the way, many wouldn't be able to swing that.

Even doing a complete refinance and taking the maximum term of 35 years, rather then the 20 they had left, they would still have to pay at least $3,600 a month. More than a thousand a month more then before.

Gawd forbid they were amoung the 67% of first time buyers at the time that had a 40 year amortization. Those poor souls would see their payments jump from $2,200, to $3,920 a month, and they wouldn't even be able to stretch out the term any longer. They'd also still owe $386,000 on the house.

Ultimately for all the good inflation would do to incomes to increase buying power, interest rates would more then offset that and would actually cause prices to further decline in the short term. At 12%, for the median house to be affordable at $400,000, the median household income would have to be over $160,000 a year... as of 2006 the median household income in Edmonton was $63,000.

At the end of the day, inflation or no inflation, the average household has to be able to afford the average home... otherwise who will buy it? It's basic supply and demand. Prices may break from affordability from time to time, as we've seen, but eventually they will return. They must.

Mortgages - Fixed Rate Mechanics

Some of you may recall a month ago I did an entry on why weekly and bi-weekly payments really were not as good as they were cracked up to be. Today I'm going to be my second piece in the mortgage series, this time looking at fixed rate mortgages and their mechanics.

Despite homes being the largest purchases most people make, and mortgages often being a households largest monthly expense, I'm never ceased to be amazed at how many people really don't have a sound understanding of how they work. So this is my little attempt to shed some light on them.

We're not going to get into the whole buying high/low thing today, just examine the basic structure of mortgages and how they work.

A lot of people are likely familiar with graphs like the one above if they've taken out a mortgage... at least I'd hope they would be, at the very least your bank or mortgage broker should have tried to explain one to you regardless of what type of mortgage you have.

It shows you how over time your equity builds exponentially, while your principle owing correspondingly decreases. The values of these and the proportions paid off can change substantially depending on the variables, but the general pattern remains the same.

The basic gist is that it shows you how little equity you make up in the early years, but as time goes by, more and more of your payments go toward equity rather then interest. Just from this example you can see you make up more equity in the last 9 years then you do in the first 16.

While it's a pretty pattern, the only number in there that matters to me is the amount owing. The equity really doesn't mean a lick. All that matters is what you owe.

When your mortgage comes up for renewal, at that point it matters what the bank thinks your place is work matters in relation to what you owe... or if you are selling it matters what someone is willing to pay for it... but the rest of the time, what you think your home is worth, or what your neighbours house sells for, or what the cities median price is, really doesn't mean a damn thing.

Alright, end of rant. Now lets get on to how 5 year fixed rate mortgages work, and I think the best way to do that is to work through an example. So lets say we purchased an "average residence" in Edmonton in January of 1988, with a conventional 25 year amortization, 5-year fixed terms. These a probably the most popular type of mortgages in Canada.

In January 1988 we bought a house, and paid $77,792 for it, which was the residential average at the time. In reality we would have needed a significant down-payment, but for the sake of this example we're going to ignore that and say we financed the entire thing. Down-payments are really not material for what we're doing here today.

So we walk into the bank, finance $77,792 at the going rate for a 5-year fixed of the day at 11.73%. Which result in monthly payments of $804 for the next 5 years... at which point our mortgage comes up for renewal.

Here is a graph kind of incorporating the first two graphs. We have the monthly payments and we see the amount owing declining, telling us what we owe the bank as of each January. We now find ourselves in January of 1993, and owning the bank $74,271... which means we haven't made up a whole lot of equity in the first five years, less then 5% in this example.

This doesn't give us all the variables needed to give us our next payment though (ignoring that you can already see in on the chart), for that we need the interest rates...

If the interest rate in 1993 was still 11.73% like it was five years earlier we would still be paying $804 a month... but fortunately for us, interest rates came down!

Now the 5-year fixed rate is 9.47%, we owe the bank $74,271 and now our amortization is down to 20 years... so for the next five years our payments will be $691 a month.

Skip ahead to 1998, our term is up and we do it again, we owe $66,274, rate are down again, now at 6.9% and amortization is 15 years... so we'll pay $592 a month.

Do it all again in 2003, $51,213 at 6.26% over 10 years... equals $563 a month.

Finally we get to 2008, only five years left, the last renewal! $29,272 owing, the rate actually rose slightly to 6.81% so we'll be paying slightly more, $577 a month.... but come 2013, that house will be entirely paid off.

What I want to show in the graph is that with our style of mortgages, even with fixed rate ones, every five years your payments will change depending on the going mortgage rate of the time. In our example we were very fortunate in that interest rates just kept on going down, so the monthly payments kept dropping for the most part.

What the fixed rate mortgage shields you from is upward fluctuations of interest rates. As you can see from the graphs, the only interest rates that mattered to us were in the shaded areas, but outside of that they shot up and down quite a bit.

Just take our first renewal for example... if it hadn't came up until 1994, we would have saved even more since rates dropped over 2 points in that year... but if it had came up in 1995 we would have paid even more since rates spiked that year. So, it can kind of be luck of the draw when your mortgage comes up for renewal, but over time it tends to even out.

The advantage of fixed rate mortgages is that you know what you'll be paying every month, you don't have to worry about your payments swinging as they would with a variable rate. The drawback is that you often pay a premium of a point or two more for this stability when you lock in.

So, should interest rates shoot up, at least your protected until your next renewal... should they stay about the same, you lose out because you're paying a premium for the fixed rate... and should rates go down, you really lose out because you're not only paying a premium, but you're paying it on top of a higher rate.

Over the last quarter century we've seen rates consistently dropping, which have made variable rate mortgages very attractive... but today, the thing to keep in mind that that we've reached a point where rates really cannot get any lower... which means they can only go up, and it's when rates are rising that fixed rate mortgages are not only safer, but often cheaper.

So it really depends on what you're comfortable with, and whether you feel the premium you pay is worth it.

The last thing I want to touch on is the differences between Canada and the US when it comes to fixed rate mortgages. As mentioned before, traditionally 25 years has been the normal amortization period, and 5-year fixed the most popular terms.

South of the border, it's a little different. There, 30 year amortizations are the most common period, and 30 year fixed the most common term. That's right, with one of those you know exactly what you'll be paying the entire life of your mortgage.

So using the purchase from our example above, and the going rate for 30-year fixed mortgages in January of 1988, we would have been paying $715 a month (for a better apples-to-apples idea, if the term was 25-year fixed it would have been $737 a month).

So, as you can see, by doing it with traditional Canadian 5-yr terms, we saved a lot of money... but this is because interest rates were dropping. If rates were going up, we would have done a lot worse. Basically it just boils down to that we're more exposed to market fluctuations here in Canada, and that can be both very beneficial, or very detrimental.

One interesting thing you may have noted is that in 1988, the US 30-year fixed rate is actually lower then the Canadian 5-year fixed rate. This seems counter-intuitive as generally when you go into a bank, the longer the term you ask for, the higher the rate.

TD for example, their current advertised rates are 5-yr fixed at 5.45% and 10-yr fixed at 6.7%. Pretty typical.

Same actually also holds true in the US... this is really more a statement about the rates in the US just being more competitive, cause today you can get a 30-yr fixed from Wachovia for 4.75%... lower then our 5-yr fixed. So if you didn't think it was bad enough that they can deduct mortgage interest from their taxes, they also get much better interest rates. So, if you've ever wondered why our banks are so profitable, there is a big part of the answer, Canadians pay a whole lot more interest.

Oilberta Redux

Earlier this week I did an entry on the relationship between oil prices and housing prices in Edmonton, and there were some interesting findings which led to new hypothesis'. There was also some good ideas that came up in the resulting discussion.

So tonight I'm going to take a bit of a deeper look at possible relationships with housing prices... or maybe I'm just doing it because that last one got lots of comments and I'm an attention whore... it's really hard to say.

In any case, beyond just oil we're going to look at natural gas, stock markets, and several other possible indicators. Be forewarned, there is going to be a ton of charts and graphs in this one, so if that isn't your thing, well, you're probably on the wrong blog. Anyway, this one will be a big'uns.

Like the last entry, I'm going to use Toronto as my control sample. Partially because Toronto isn't exactly known for oil and gas (well, other than hot air... I kid, I kid), and it's also the city I have the next best data set on.

This time we're going to be using yearly averages rather than monthly, so you'll notice the graphs look a bit different. As real estate tends to be a bit of a lagging indicator and prone to a fair bit of seasonality, yearly may actually be the better measure. I also have the yearly averages for Toronto going much further back, so that should improve the findings.

And here we have a plot of oil (West Texas Intermediate) and natural gas (Henry Hub) over the same period, also yearly. You'll notice they chart fairly similar paths. You may be thinking to yourself that this graph doesn't show prices getting as high as you recall, or diving last fall, but remember, these are yearly averages and/or spot indexes. These won't look nearly as volatile as daily, weekly or monthly figures... for example here is the the monthly figures semi-transparent over the yearly ones.

As discussed in the prior entry, oil and home monthly prices in Edmonton had a high correlation... but they also had a very high correlation with Toronto prices. Which led me to conclude it was a spurious relationship.

These correlations remain using the yearly figures over a longer term... and are also present with natural gas. Though that shouldn't be surprising, as noted earlier, oil and gas followed quite similar paths and actually have a correlation of 0.89 from '72-'08.

Over the full term, '72-'08, Edmonton had a correlation of 0.90 with oil, and 0.86 with gas. Toronto came in at 0.71 with oil, and 0.82 with gas. While the gas values came in quite close, there was a fair difference in oil.

This appears to be a timing issue though, as over the last 10 years both cities came in at 0.89, and over the last 20 years Toronto came in at 0.91 and Edmonton at 0.92.

On the natural gas front Toronto actually came in higher over the shorter terms, 0.84 to 0.79 over the last 20, and 0.80 to 0.63 over the last 10. Quite a large difference there on the latter.

As a result, I would again hypothesize that the correlations are due to a spurious relationship, due to a common lurking variable.

Here are a couple scatter points to illustrate the what we're looking at.

You'll notice the R² value is lower than the correlation. For those unfamiliar, R² is the coefficient of determination, and is the correlation squared (so, obviously its symbol would just be R).

In those graphs you can see the general trend formed over time. The higher the correlation, the tighter the plot points correspond with the trendline.

You may be wondering if there is a relationship between year-over-year gains... and to answer that in a word... no. Regardless of the city and the commodity (or any of the multitude of other indicators discussed later for that matter) any relationships are negligible at best.

To give you an idea of that, lets contrast the above graph of Edmonton vs natural gas prices to Edmonton's year-over-year price change plotted against those of natural gas. You'll note in the earlier graph that the points are often grouped and you can see an overall trend.

Now note in this year-over-year graph that the points are all over the place with no apparent rhyme or reason. The R² is also almost 0, which just reinforces that there is little or no relationship.

As I have said before, I think the relationship between oil/gas and real estate is a spurious relationship due to a common lurking variable... and I've theorized that variable could be the greater economy and/or financial markets as a whole.

To further explore that line of thinking, I compiled a couple spot indexes for the NYSE Composite and S&P/TSX Composite. Here is a look at how those have performed over time.

These being composite indices they give you a good idea of the overall stock markets. With the NYSE being the largest stock exchange (by dollar value) in the world, and TSX being the dominant one in Canada they should be pretty good indicators for our situation.

The findings also may support my earlier musing, with both having significant correlations with real estate prices in both Edmonton (NYSE-0.87 TSX-0.92) and Toronto (NYSE-0.88 TSX-0.89).

To go a little deeper even, I consulted a Statcan report of the leading business indicators. These include ten different measures (including the S&P/TSX index) from various sectors of the economy.

Here is a list of the others, average work week-manufacturing, housing index, United States composite leading index, money supply, new orders-durable goods, retail trade-furniture and appliances, durable goods sales excluding furniture and appliances, shipment to inventory ratio, finished products, business and personal services employment.

Here is a look at just a few of those and how they've charted out.

I'm not going to look any deeper into these specifically, I just wanted to give you guys an idea of what they graphed out like. All the measures listed above appear to have a decent correlation on one level or another with real estate prices, except the average work week one which didn't appear to have any correlation.

What I found most interesting was the composite of those ten different figures. As it covers many different sectors of the economy, it gives you a measure of the economy as a whole. As such, I'm going to focus primarily on that single measure, and here is how it graphs out.

And here is a scatter plot of the composite vs Edmonton real estate prices.

You'll note that the points all plot fairly close to the trendline. Also interesting to see the snakelike pattern, which is present in the the natural gas plots earlier, but are not as clear as in this one.

Here is the time series for the leading indicators and Edmonton's real estate prices. We can see there is far less variability in the composite than in housing, but they both are clearly trending up. This also reveals itself in a high correlation between the two, 0.92. The relationship also remains very strong regardless of the term, something that cannot be said for oil or gas which vary from very strong to moderate depending on the period.

Here we see the same composite graphed with Toronto prices. Again they look quite similar, and real estate remains the more volatile. The correlation for these two come in at 0.90.

FINALLY, we've arrived at the last graph. Here is the Edmonton prices plotted out with the composite, oil and natural gas prices for comparison. Yes it's a bit of a mess, but I tried to make it as understandable as possible considering the multiple axis' values. But I think it's a good visual anyway.

I'm sure some will take exception with the scaling, but I tried to be as fair as possible and match up the various lines with housing prices long-term as best as possible. So just as a disclaimer, scaling can be misleading, so take it for what it's worth and remember these can be made to appear to back up any conclusion.

Alright, here we can see the relative volatility of the four indicators. Oil and gas being the most so, then real estate, and finally the composite which is very smooth and relatively straight. It's this smoothness is probably what yields the consistently high correlations, as all the prices increase over time.

I suppose one can see any number of things from the graphs, but I feel that these findings largely back up my earlier hypothesis that housing prices are probably more closely tied to the overall health of the economy, than to individual commodities.

While positive correlations exist between home prices and oil/gas in Edmonton, the same correlations exist in Toronto, a market without such resources close at hand... therefore implying a spurious relationship between the two factors.

While oil and gas certainly effect financial markets and the economy as a whole, throughout Alberta and Canada, it is still but one factor, granted one of the bigger.

That said, I'm not sure a direct causal relationship between be proved between the economy and real estate either. The economy is too complex for even an army of economists with lifetimes to study it to truly understand... much less one half-assed blogger.

So again, I conclude that while oil and gas certainly has a big effect on the local and national economy, I feel they do not have a direct causal relationship with real estate prices. But I don't think any single indicator can claim a direct causal relationship. Real estate prices are effected by hundreds, if not thousands of variables... earnings, supply, demand, seasonality, land, labour, materials, just to name a few.

Oil and gas prices would certainly effect several of these, but there is a limitless interplay amongst these variables and countless others, and the effects of all these just cannot be quantified in an acceptable fashion.

That the same correlations exist between oil and gas prices and cities in both producing and non-producing regions indicate that real estate prices drill a lot deeper. Pardon the pun.

March numbers are in

The EREB came out with their March numbers this morning, and all things considered, they were remarkably unremarkable. Sales and inventory are pretty much right on the money considering seasonality, and prices more or less stayed about the same. Though compared to last years sales and prices are down about 10-12% across the board.

Does not seem like there is any underlying explosion of sales or listings to come this spring, the 1,380 sales is right in line with what seasonality would suggest considering the January and February figures. Also true for the 7,476 currently in inventory. I'll be doing a post in the next couple days discussing seasonality, so that might be interesting to some of you, I'll also include a few projections just to see how I do.

So the bulls will probably be disappointed there is no ground swell of demand bubbling under the surface... and I'm going to have to stick a fork in my earlier thought that inventory might reach or even surpass last years. Sales will continue to rise through May before falling off, and Inventory start to clear out until September. We've barely entered spring, but given the stats through three months and all numbers staying well within their standard deviations, I'm not thinking there are any surprises likely to come on the sales and inventory front.

Prices on the other hand are not following their typical season paths (typically up 4-6% over January prices in March), though that is no surprise, seasonality really doesn't apply to prices when dealing with bubbles. Things held pretty tight month-over-month but are everything is down about 10% year-over-year.

Condo's come in slightly lower at -12.4% year-over-year (about $32,000), but actually saw a small uptick over February... thought that shouldn't really be surprising since they took such a dive in February, dropping almost 5%. It's not unusual to have a small bounce after such a sharp drop.

Speaking of sharp drops, townhouses really fell off the face of the earth in March, dropping a remarkable $32,404, or 10.5%. These make up a very small protion of the total residential picture though, so they are more prone to big swings... I had also mentioned last month that their prices had oddly held year-over-year... not anymore.

Anywho, here are the hard numbers:

Sales = 1,380
Since March '07 = -41.5% (-797)
Since March '08 = -11.4% (-177)
Since last month = +28.4% (+305)

Active Listings = 7,476
Since March '07 = +190.4% (+4,902)
Since March '08 = -21.0% (-1,988)
Since last month = +5.3% (+379)

Single Family Homes Median= $334,000
Since peak (May '07) = -16.5% (-$66,000)
Since last March = -9.7% (-$36,000)
Since six months ago = -8.6% (-$21,764)
Since last month = -0.3% (-$1,000)

Residential = $309,032
Since peak (July '07) = -12.9% (-$45,686)
Since last March = -10.1% (-$34,728)
Since six months ago = -4.9% (-$15,873)
Since last month = +0.0% (+$62)

Single Family Homes = $349,716
Since peak (May '07) = -17.9% (-$76,312)
Since last March = -9.8% (-$37,916)
Since six months ago = -3.4% (-$12,381)
Since last month = +0.7% (+$2,407)

Condos = $230,469
Since peak (July '07) = -15.2% (-$41,439)
Since last March = -12.4% (-$32,554)
Since six months ago = -8.6% (-$21,764)
Since last month = +1.6% (+$3,612)

Townhouses = $276,776
Since peak (Oct '07) = -24.8% (-$91,118)
Since last March = -10.4% (-$32,132)
Since six months ago = -12.3% (-$38,914)
Since last month = -10.5% (-$32,404)