Sunday, August 11, 2013



Waterfront condos along the Toronto Skyline looking east from the air.  
toronto condo

2008 Meltdown or Japanese Bubble?

Just as its international laughing-stock mayor crashes into the annals#of drunken village idiots, one wonders if foreign Condo buyers and speculators are being spooked with fear by the comedy of this mayor and brother team - jokers responsible for managing Canada's largest city?

#(1.3 Million Tweets - just in New York City alone - Read More)

Do foreigners wonder if Cocaine King-Pins are affecting the city's affairs or is their concern over the quality of  local bar-keepers' advice? This correlation between the Buffoon's crashing career and the Condo market also comes with lively international gags, laughs and digs on venues like, The Daily Show and Jimmy Kimmel. Comparing these clowns to Mike Bloomberg's team in New York City is disheartening - clumsy sandlot players groping for big league status.

For sure, somebody is smoking something funny - somewhere!

Aside from the Mayor's obvious absurd behavior and limited capacities, what have been the grass-root factors driving the overbuild and economic bubble that exists in Toronto's Condo market? Five key reasons are pinpointed; starting with The Bank of Canada foolishly following the US FED into the "low-interest-rates-for-too-long-trap," It was absolutely unnecessary for the Canadian economy, financial and real estate markets to have rates lowered in tandem with the FED. Canada was certainly not hit nearly as hard as the US by the 2008 Market and Real Estate Meltdowns. Yet it is now in an economic predicament (trap) that  is almost impossible to exit.Why Canada was needlessly placed in the same situation as the Japanese, Europeans and Americans will require clear analysis and answers down the road. 

The Japanese have, without luck, spent the past two decades worth of policy-making efforts focusing on ways to restore an anemic economy to normalcy. Hard to do when the downward laws of present value mathematics are applied to financial and real property assets. These headwinds work directly against you. The Japanese and FED know that when interest rates are increased from a low 2% level to 4%, then the downward inverse happens to the values of both financial and real estate assets. They lose 50% of their value. That's why Uncle Ben's QE policy actions have the FED buy $85 billion of longer-term 30-year treasury bonds - every month!  They cannot afford to have the mathematical-finance losses of these bonds, caused by rising interest rates, realized and recorded on the books of banks, pension funds, insurance companies and institutional or individual portfolios. It could prompt a disaster bigger than 2008 Meltdown, by far. 

Another reason? Lower interest rates, along with the relaxing of credit conditions, terms and government guarantees for mortgages made it much easier for marginal borrowers to acquire credit. These combined factors are historically the usual suspects behind any asset bubble driven by credit. And they copy the reasons sparking both the Japanese and American real estate bubbles. Remember behind the scenes, Banks need to grow their assets much faster than GDP to pay ridiculous Banksters' salaries and bonuses. This crony need has been evidenced through-out the world along with relaxed credit standards, easing rates, corruption and negligent oversight.

So relaxed mortgage lending practices with easing rates created systemic credit-origination programs that rapidly built bank assets, thereby also triggering those unjustified bonuses. Leading to a flood of liquidity, by way of mortgages into property markets, that will be collateralized by ghostly hard asset values. Assets whose values hook directly to low interest rates, but dramatically vanish when these rates spike upwards. The ensuing losses of aggressive lending are then socialized and shared with the rest of us. Bankers will nonetheless still keep their hard-earned (sic) bonuses.* Hmm. 

This too may be considered a crony exploitation of mathematician's rules by governments, banks, developers and other institutions, as lower rates create falsely inflated asset values. These new asset values have little; if any, relationship to growing national or regional GDP or any other economic output or growth measure. A sure sign of a pending credit collapse occurs when total Bank assets grows twice, thrice or even faster than the GDP growth rate - telling us that Banking practices are are both excessive and unrealistic. Moreover, recent examples of excessive Bad Banking practices and related painful outcomes have been blatantly littered in global financial reporting for two decades, including countries such as Cyprus, Iceland, Japan, America and Ireland, with China, Spain, Italy, Portugal and many others not far behind. Begging questions about the competencies of Central Bankers, governments and financial executives, who should know by now that they have been building a fragile financial house of cards.What does it take to learn? More importantly, who pays for these misdeeds or who is going to  jail?  

Third, the bubble mindset took hold, while messengers conveying forewarnings of looming disaster were promptly silenced. Buyers/borrowers believed that they would be left out in the cold if they didn't act and buy as soon as possible. Lenders/Bankers
 jealously feared missing out on the unsavory mega-bonuses earned by their peers. They all fed on one another, hence creating  a foggy-headed-group-think's shared view of reality. So as prices climbed, their respective urges to react grew, particularly for first time buyers and top Banksters. Patience was lost with other virtues - as everyone also forgets how other nation's real estate markets were recently  brought to the brink of financial collapse, by the unbridled emotionally-charged lending of bubble markets. And so every bubble echoes that same old tune, "This time is different; we're much smarter now!"  - Indeed!**  

Four, Canada by many measures ranks amoung the richest nations in the world because of its high resources per capita ratio. A metric that is a much better indicator of long-term economic sustainability than GDP. At the other end of the list, are poorer resource-depleted countries like Nauru, Greece, Egypt, Syria and Cyprus, who are in the midst of unprecedented social-economic-political collapses. Simply because their populations had outgrown their geographic resource base, thus exposing them to unstable conditions. Sophisticated foreign investors and speculators have been attracted to Canada and Toronto, because of relatively stabler economic, social and political circumstances and prospects. Their additional speculative demand, as demonstrated by agent's accounts of foreign buyers possibly acquiring up to 50% of some projects,
 also acts to push Condo prices even higher.

The fifth reason - firstly, includes excess immigration, in the face of chronic unemployment issues, that provided an influx of people spurring the demand at the lower and middle-end of both the rental and Condo markets. It is estimated that a good portion of the Canada's immigration flows move into the Toronto region. By some accounts, this figure including illegals, exceeds over 100,000 annually - putting pressure on the rental housing market. But what also motivated more buyers to purchase was the low and poor quality inventory of the rental-housing stock. Add in the further demand caused by the trend of young single-professionals and retirees, who wanting to forgo commuting rigors from the suburbs by moving to the conveniences of inner core living. Both these demographic dynamics created further demand that spurred the rush to build out Condo supply.

To summarize, the Condo boom can be related directly to the combination of lower mortgage interest rates, relaxed credit terms, foreign capital inflows, demographic shifts and emotionally charged buyers and lenders caught in the typical bubble market mindset. Will it burst? Well, if past credit and real estate bubbles are any indication of what is to come, the answer is already written on the wall. Meaning the rules of present value mathematics cannot be negotiated, legislated nor convinced to change in any way. They are absolutes, with outcomes that are more than certain when rates begin to rise.

Practically, it means that when interest rate rise sharply, so do mortgage payments - and there is little doubt that they will revert back to the historic mean of 6 to 8% sooner, rather than later. Unlike US lenders that offer mortgages with 30 years terms and amortizations, Canadian borrowers take on greater risks when they sign a mortgage where the best term may be five years. Therefore, within the next five years the possibility that increased payments of 50 to 100% could drown buyers in debt-service cash outlays, forcing the premature sale of their properties is a likely concern. Sales may be forced  to occur at prices much lower than purchase costs, as the market adjusts selling prices to cash flow affordability under higher rates. Events similar to 1981-82 recession when mortgage debt exceeded property sales values could make matters worse. Such events were recently and similarly experienced by many homeowners in the crushing 2008 US Meltdown.   

Condo owners face another cost concern in the next five or so years, as condo fees are reportedly rising by 10 to 15% in recent projects. Simple number crunching of these increases indicates that these costs would also double over this period. Now you can see where this is headed when both condo fees and mortgage payments double - recent buyers are going to need to double their salaries just to stay even. Not likely when the economy is growing at less than 3% - meaning that something is going to have to adjust in order to keep property cash flows affordable. 

By default, the price and value of mortgages are usually reduced. By how much? Well, using these above cost numbers, a 50% downward adjustment would balance the personal cash flow back to realistic levels. Taking today's average Condo selling prices of $376,000, already off 18% in 12 months, (Huffington Post - Urbanation Realty Research) down to a depressing $188,000 figure. Suggesting that real estate prices should also act in a pattern aligned with the declining value of long-term bonds. However, there is no QE bail-out plan from somebody's Uncle Ben to save these not-to-big-to-fail unfortunates caught in the depreciating outcomes of higher rates. Surprised?     

When the reality of mathematics starts to hit Condo-owners' pocket books, it should also turn the market's emotions upside down, just as it eventually did it in the US and Japanese property bubbles. Beware - emotions can be just as unpredictable in a down market. Bubble markets have historically acted in a sharp and nondiscriminatory manner when they turn southwards, taking no prisoners along the way.

Will foreign investors continue to pour money into Toronto's Condo market and thereby offset the fall off  in domestic demand? That is a wild card, as their needs and capital flows shift depending on the state of global threats, opportunities and risks. So foreign investment flow is not dependable; in fact,  there are a number of signs causing a concern their interests may be waning. One, immigration into Toronto has been slowing; affecting mid-market demand and sales. And the at top end, where foreign speculators tend to invest, there is a listed 20-month inventory of million dollar properties. 

Foreign investment interests may be further affected by the the Middle East's continuing spread of unrest; possibly disrupting shipping lanes and supply, leading to world oil prices quickly spiking two or three fold. Retail sales across North America have shown further signs of softening since last February, when Walmart reported dismal revenues. Indicating consumers' disposable cash flows are tightening - is the Real Unreported CPI catching up?. Lastly, China a major source of foreign capital is also facing its own economic and credit bubble issues affecting real estate and investment demand globally.

In the long run, however, both Canada and Toronto, should prove to be much more attractive to foreign capital interests, as over-populated countries continue to run out of the resources needed to fuel and sustain their economies. Timid foreigners should logically seek our much calmer waters as these turbulent global times of growing social unrest and political upheaval naturally unfold.

Another unlikely plus favoring longer-term Condo prices is the rising global price of oil. Some experts believe that world prices could reach $500 a barrel in the next 10 years, or as mentioned, sooner should the Middle East's issues not be contained and resolved. In turn, causing more and more people to return back to the city as the cost of transportation, amoung other things, becomes prohibitive. However,the benefits of this may be lost to higher condo fees and food costs, as they embed rising energy prices; squeezing the available disposable income of prospective domestic buyers. 

In the end, the nearer-term prices in the condo market will be pressed downwards by the financial mathematics of global interest rates - possibly triggered to rise at any time by political-economic events. Cooler heads should ultimately prevail, but nearer term foreign investment may either act to stabilize or join the rush to the gates. Demographic trends should in all likelihood remain positive, particularly as global peak-oil prices continue their expected upward trends. Increasing shortages of many other key raw materials over the coming decades will further increase the cost of living away from urban centres. (Scarcity - Humanity's Final Chapter) Suburbia faces great perils, as a return to the city core emerges under these shortages and trends.

What else is next? Will the Condo market spill into other real estate markets? How will stock markets react? How will this affect Banks, property developers, construction, retail and other related industries?  The answers to these questions depends on what happens to interest rates, and how much and how soon they increase. Canadian rates are patterned after the FED that in turn the US Central Bank's policies could be affected by events in Europe, China and/or the Middle East. Geo-political implosions are growing more likely with each passing moment - all how much bets are off should social unrest and political upheaval escalate severely, drawing huge premiums on most commodities with perhaps crippling premiums on key oil resources. In short, the answers to these questions are negatively biased considering growing pressures to move rates upwards. It is impossible to leave them at such low levels, forever - that defies the Law of Averages. Mathematics, as mentioned, never shows up for negotiations.   

Meanwhile, Toronto is yet to be globally ranked on International Business News' Top Ten lists of leading Financial or Geo-Political centres. There is room to improve. And should Toronto elect a world-class mayor, it would be a start to building a positive impression with global investors that the city is positioning for higher world-class rankings - to be managed by first class professionals. 

And that would be good for both the city's Condo and other real estate markets, along with many other civic needs and priorities - a much better path than global leadership serving up endless material for joke writers on late-night comedy shows! Seriously!  

First Financial Insights

August 12, 2013

* There is an old financial adage - " it is much easier to rob a Bank with a pen than with a gun - and it's legal too!" 

** Toronto's Condo market experienced boom- bust cycles before; the last major bust, that brought major developers to their knees, occurred during the 1981-82 recession. Every generation appears inclined to repeat  past mistakes - no matter what.


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