It’s real estate week here at Financial Uproar. HEY! I heard all those groans of disappointment. You can just take your bad attitude and go home. What’s that? You’re already at home? Never mind then.
The Canadian real estate market has officially entered crazy territory. Pockets of the market are starting to resemble the hottest parts of American real estate, from circa 2005. Check out this chart of prices in Canada’s largest 8 cities:
Take a second there and scroll back up to that graph. The average price of a house in Vancouver has gone from $350,000 in 2002 to over $1,000,000 today. To put that into context, a million bucks is almost 15 times Vancouver’s median household income of $67,550. A million bucks is still an important milestone for people who are trying to accumulate wealth. A million bucks is the ransom Dr. Evil was looking to get for the ENTIRE WORLD, albeit in 1969. It is a considerable amount of money. And, even these days, it should buy you more than an average house in Vancouver.
Then, we have Toronto. Admittedly, Toronto isn’t quite as bad as V-city. A median home in the 416 area code will set you back a mere $600,000. That’s only 9 times 2009’s median income. Geez, Toronto is almost affordable in comparison. Just for the heck of it, let’s take a look at the income to home price ratio for other Canadian cities:
(Note: These are somewhat rough estimates using the graph and the info from the previously linked Stats Canada info on family incomes. But they are close enough to get the point across)
There are two areas in the country which are firmly into bubble territory. There are other areas that are also alarmingly high, (Victoria and Kelowna pop into my head) but I have no data to back up my assertions for those cities. So we’re just going to focus on Toronto and Vancouver.
Want more proof of a bubble? With a bubble usually comes all sorts of speculation. In the condo markets of Toronto and Vancouver, speculation is about as rampant as this blog is with unfunny sex jokes. Check out this video of a condo development in Vancouver that sold out in mere hours:
Did you notice the part where only 150 people showed up, yet they bought 450 units? All sorts of
investors speculators are showing up at these presales, with no intention of ever setting foot in their unit. They put down their deposit, wait a couple of years until it’s built, and then sell to an awaiting sucker. If you put 20% down for your deposit and the unit goes up 20%, you’ve doubled your money.
If you combine that with record low interest rates, (2.99% mortgages anyone?) loose lending standards, (cash back mortgages, stated income mortgages) upcoming tightening of banking regulations (currently being tossed around by OSFI, Canada’s banking regulator) and further speculation of Finance Minister Jim Flaherty announcing further CMHC mortgage insurance restrictions, and you have one mother of a housing bubble, at least in TO and Vancity.
This is all fine and good, but you want me to get to the good stuff. How do you profit from this gigantic bubble popping? How can the average Joe play this obvious trend? And just how do I get Taylor Swift to unblock me on the Twitter? Sorry, that last one just slipped out.
I have some ideas. Allow me to present them to you in a fairly organized matter, with only a minimum of all angry caps.
Canada has a fairly concentrated banking system. The Big 5 banks (CIBC, TD, Bank of Montreal, Royal Bank, Scotiabank) control something like 75% market share. They hold the majority of mortgages in Canada, with 2 out of every 3 mortgages held at one of the big 5. On the surface, this would be a good place to start if you were looking to bet on a collapse.
There’s only one problem. The banks are way ahead of you on this one. They aggressively have been unloading their mortgages in the secondary market, CMHC actually holds $300 billion worth of Canadian mortgage paper, along with insuring an additional $600 billion worth of mortgages. The big 5 banks have very little exposure to the high leverage loans that CMHC insures, and they’ve taken steps to minimize that exposure. They will weather the upcoming storm just fine.
First National is primarily an A lender. (meaning it lends money to people with good credit and has CMHC insure the majority of their loans) It had a subprime division, but closed it down during the crisis of 2008-09, and hasn’t reopened it since. It will probably suffer with a decline in home values, but not substantially.
Home Trust is much more interesting. They specialize in B loans, lending to people with slightly bruised credit, self employed folks, and other unique situations that traditional lenders won’t touch with a 10 foot pole. (But a 9 foot pole? Totally different story) They will lend up to 85% of the value of the house, while CMHC insured loans go all the way up to a 95% loan to value ratio. Home Trust is currently trading near an all-time high, which is probably pretty good for someone looking to short it.
The bad news is, with these two stocks, you’d have to actually short them. Neither of them have call or put options, which can be the easy way to bet on a certain stock going down the crapper. Naked shorting is risky at the best of times, and if you did short these bad boys, you’d be responsible for paying the dividend on the shares you borrowed.
Home Improvement Retailers
One would think, once home prices start to stall in the 2 biggest markets, sales of home improvement retailers would suffer as well. Lots of house flippers, both amateur and professional, would exit the arena, since falling house prices are like Kriptonite to these guys. And where do these guys get their supplies from? NOT THE DUMP YOU MORON.
Both Home Depot and Lowe’s have exposure to Canada, but it’s irrelevant compared to their American business. That leaves Rona, which has already fallen close to 40% over the past year. The stock trades at a significant discount to book value and has been aggressively paying down debt. Sales are already suffering, an affliction they laughingly blamed on the weather.
I wouldn’t short Rona at this point, but it does have equity options listed on the Montreal Exchange, making it pretty easy to bet against the company.
The easiest way to short the Canadian REIT market is to buy a put option on XRE, the largest REIT ETF in Canada. I won’t get into details on the options market because I don’t understand much more than the basics. Using options to play the REIT market may be easy, I don’t think it would be that effective in shorting the market.
Most REITs have been around for many years. The majority of their property was more than likely acquired years ago, back when prices were much more reasonable. Plus, most REITs are exposed to the commercial real estate market, which is only loosely correlated to its residential cousin.
The biggest two REITs exposed to residential real estate are Boardwalk REIT and Canadian Apartment REIT. Between the two companies, they own 65,000 apartments across Canada. At first glance, they look like interesting shorting possibilities. Experts agree the condo markets of Toronto and Vancouver are especially frothy, and these guys basically own a whole bunch of them.
The problem is, as people lose their homes, they still need places to live. As we’ve witnessed in the U.S., everyone and their dog now recommends renting, ever since their housing collapse. Companies with a whole bunch of apartments acquired before the boom times may actually benefit as demand for rentals goes up.
Unfortunately, all the big players in the Canadian market are either privately held (Concord Pacific, Tridel Group) or subsidiaries of huge multinationals. (El-Ad Group) It’s a market dominated by privately held companies.
Terra Firma Capital and Tricon Capital both provide financing to condo developers, but they are both small companies that would be difficult to short. Google them if you want more info, you slacker.
If any readers know of any publicly traded developers, let me know in the comments. If there’s one of any substantial size, it may be the best way to play this.
Real Estate Brokerages
If the market slows to a crawl in the two biggest markets, that’s gotta be bad for the companies that sell this real estate, right?
Obviously, Century 21 and Remax are the two big boys, and they’ll be able to weather this storm, because they’re both primarily American companies. Canada’s third largest brokerage, Royal Lepage, is a big part of Brookfield Real Estate Services, a separate company from the monstrous REIT. It’s a relatively small company, with a market cap of around $130 million, and it pays an 8% dividend. However, it would most definitely be adversely affected by a real estate downturn.
Plus, a major downturn in Toronto and Vancouver would probably negatively affect the whole country, at least slowing down their sales. This is bad news for real estate agents everywhere, and bad news for the company dependent on their percentage on every sale.
Sell Your House And Rent
This is, by far, the best option out there, especially if you’re one of those baby boomers that keep asking me to fix their damn computers. (You know who you are) But, this post is already long enough, so you’ll just have to wait until Wednesday to hear more about that.
DUN DUN DUN! CLIFFHANGER ENDING!