THE WORLD'S WORST MARKET TIMER
2017-04-21 1pm EDT | #Canadian real estate #Canada #Wynne #real estate #Toronto
Today’s post is about the recent Canadian government measures to cool the scorching Toronto housing bubble, but the lesson about government ineptitude will be universal, and I am confident, shared by everyone.
By now, most non-Canadians have heard of Toronto’s out of control housing market, but probably won’t know too much about the specifics. I tried to think up a good way to show the magnitude of the rise, so I made up a chart comparing Toronto’s house index to another housing market widely known to be insane. Fueled by the latest tech boom, San Francisco has experienced a breathtakingly stupid price rise over the past few years.
Well, here are the two cities side by side:
Yup, Toronto housing price appreciation has even outpaced San Francisco! It’s a gong show here in Toronto, no doubt about it.
Last year when Vancouver was facing the same sort of runaway price rise, their government instituted a 15% foreign buyers tax. Like true bureaucrats, they did not think about grandfathering in existing sales that had not yet settled, and instead slapped an out of the blue tax on foreign capital. Not surprisingly, foreigners decided there might be better places to invest than Vancouver.
Many of them came to Toronto.
I am not claiming foreigners are the culprit for Toronto’s out of control rising housing market. I actually think absurdly low interest rates, combined with unscrupulous dealings from companies like Home Capital Group, are more to blame. But Vancouver’s decision definitely sent more money scuttling to Toronto, at a time when supply was already tight. This extra demand sent prices soaring.
Yet this price increase happened in a vacuum. There was so little supply in the winter season that bidders took prices to absurd levels. It’s like when a stock bursts out to new highs and all the stops run in a sickening whoosh.
Real estate moves a lot slower than stock trading, but markets are markets. They all operate on the same basic principles. And what is the best cure for high prices? High prices!
The market would have taken care of this on its own. We were already seeing tons of new supply coming on the market this spring. It just doesn’t happen overnight.
Instead of letting high prices be the incentive for market forces to fix the problem, the government chose to get involved. I can’t say all their initiatives were terrible, but a few of them were beyond brain dead (even for the Wynne government - and that’s saying a lot!). Here’s prominent outspoken critic Garth Turner’s assessment of the situation:
At first blush, it looks like the condo market was the big loser in Thursday’s political assault on the free market. Rent controls on new units will virtually guarantee consistent long-term negative cash-flow for investor-owned apartments. Ouch. And since half of recent condo sales have gone to investors, you can imagine the impact.
The condo trade also relies heavily on assignment clauses - allowing buyers to sell their interest in a unit prior to closing. Given the fact it can be three or four years between making a deposit on an unbuilt unit and actually seeing it registered, assignments make sense. There are whole brokerages dealing in nothing but. So now with intense scrutiny and the CRA involved, any gains are likely to end up being taxed as income. Double ouch.
In case you missed it, Ontario did about what was forecast here. A non-resident (foreign buyer) tax of 15% - or $240,000 on the average detached house. Rent controls on every unit, ensuring landlords cannot stay ahead of inflation. Letting cities tax under-used properties - about $1,400 a month on a 416 SFH.
I am sympathetic to renters who were being priced out of the market, and I understand the frustration of having prices run away from you. But I know that when government gets involved in such a heavy handed manner, it will end badly. The law of unintended consequences will bite them in the ass.
They sat around watching this problem develop for years, and then when it finally spiraled out of control, they rushed in to “fix it.”
It reminds me of the late 90’s when Nortel (and Bell which owned piles of Nortel) comprised more than half of the TSX 60 index and more than 40% of the broader TSX 300 index. Nortel kept exploding higher, and the Canadian stock indexes became an uninvestable farce. Fund managers were getting their ass kicked by the index because most of them could not invest more than 10% in any one stock, yet Nortel kept pushing the TSX indexes to the moon. After the screams from the investing community finally became deafening, TSX index officials acted and created a cap limited index. By the time they got around to implementing it, what do you think happened? You guessed it. Nortel topped and soon that cap weighted index was the last concern on the minds of fund managers.
I suspect the same will happen with the Ontario government’s real estate measures. Prices were already set to slow, and now that the government has intervened, the top is virtually assured. Like your pal that has terrible market timing but you are afraid to tell him because it might ruin your best contrarian signal, governments are the ultimate fade.
Don’t believe me? Have a look at the chart for Home Capital Group. The canary in the coal mine of Canadian real estate has been struggling for air at the bottom of the cage for some time now.
It is ironic that the day the Wynne government announced their measures to cool the housing market, Home Capital Group, one of Canada’s largest alternative real estate lenders, was being taken out back and unceremoniously shot on news they were under investigation by the Ontario Securities Commission for misleading investors. Now here’s a thought - instead of putting in all sorts of new rules to curb housing speculation, how about enforcing the existing ones?
I am straying dangerously into the territory of ranting about what should be instead of focusing on trading what will be. In fact, I am pretty sure I have crossed the line.
So in the hopes of redeeming myself, let’s examine whether there is a trade in here. Assuming I am correct in that the Ontario government has just rung the bell at the top of the Canadian housing bubble, then how do we profit from it? As you can see, the market has already sniffed out the highly leveraged stocks like Home Capital Group. Now some will argue that this is Canada’s Bear Stearns hedge fund moment. Remember back to 2007 when two highly levered Bear Stearns hedge funds ran into trouble with their mortgage backed portfolio? Although many argued the problem was contained to Bear, it quickly spread and soon enough become a nationwide contagion.
Many U.S. hedge funds and other speculators who have heard stories of the vast fortunes made by those betting against American real estate are convinced Canada will replay exactly the same way. These hedge funds are shorting Canadian banks assuming the rot will spread throughout the whole economy. Heck, I even heard of one prominent newsletter writer who thinks he will be covering his CIBC short in the single digits.
Although I have learned to never say never, I doubt Canada will repeat the U.S. playbook. There are so many reasons, but at the crux of the matter is that Canadians are boring. We just don’t run from one side of the boat to the other with the same determination as our American neighbours. Real estate cycles are long drawn out affairs. The American boom/bust was the exception, not the rule.
The bursting of Canada’s real estate bubble will be much less of a pop than most expect. Instead of playing for the big dramatic win, I think a safer way to capitalize on these new developments is by shorting the Canadian currency.
Now that the government has released these targeted measures to curb real estate appreciation, it takes a lot of heat off the Bank of Canada to raise rates. At the margin, this allows the BoC to be much more dovish.
There is a lot more to currency speculation than forecasting interest rate differentials, but for a long time, Canada’s economy has been kept aloft through real estate strength. We have come to think our shit doesn’t stink, and that somehow our economy will be magically able to continue to outperform.
As real estate softens, I doubt this will be the case.
I am a little bit of a US dollar bear, but I am becoming even more bearish on the Loonie. Maybe buying British Pounds, or even Euros, against CAD is the way to play it.
Whatever you do, make sure you keep in mind that the world’s worst market timer (the government) just cried “Uncle.” The proper trade is to assume they will make a mess. A big one.
You know, I thought the Ontario government’s actions were bad news. But now that I reflect on it, maybe it’s not that terrible. When the decline in Toronto real estate comes, the Ontario Liberals will own it. And the public will be furious with them. See, it’s not all bad…
Thanks for reading and have a great week-end,
PS: I usually try to keep my political opinions to myself, but I can’t help it when it comes the Ontario Provincial Liberals. I think the Wynne, and the previous McGuinty government, are the biggest bunch of corrupt inept politicians to ever run a modern government (see here). If I offend you, then please feel free to reimburse me for my share of the tax money the McGuinty government blew with their outrageous behaviour regarding the power plant scandal, and I will issue an apology.