The failure of the Assisted Home Ownership Plan 1973

The early 70's was a time of high inflation and house prices rose like crazy.  With house prices outpacing incomes, there was an "affordability" problem.

So of course, the government took it upon themselves to "help" the market.

1970- Innovative Low Cost Housing Plan- Federal plan aimed at low income housing
($200 million). Funded nearly 10,000 low income ownership units.
1970- Lenders were allowed to make high-ratio conventional loans providing they were insured by a private or public mortgage insurance provider.
1971- Assisted Home Ownership Program- $100 million program provided loans at below the CMHC direct lending rate. Borrowers taking advantage of this program also could chose longer amortizations.
1971- Amendment to the Income Tax Act that excluded principal residences from capital gains tax.
1972- Gross Debt Service Ratio increased to 30 percent from 27 percent.  Also, before 1972, only half of spouses income used for GDS ratio. Now all income used.
1973- Assisted Home Ownership Program ( AHOP) 5 per cent down, 35 year amortizations, lower interest rates for first time buyers. 8 percent interest rates, compared to 11 percent for conventional loans. By the mid 80's, 11% of these loans defaulted.

More on the Assisted Home Ownership Program.

From John Miron, House, Home, and Community: Progress in Housing Canadians, 1945 -1986

AHOP was a brave and and pathbreaking departure; it married large initial monthly subsidies to a mortgage design that differed radically from the standard, and it made new home ownership accessible to more families.  Under AHOP, initial monthly payments on a new dwelling unit were cut by the use of a mortgage payment design under which payments gradually increased over time.  Underlying this design were the assumptions that the rate of inflation would not fall, that the inflation premium on interest rates would not change upon rollover, that incomes would rise with inflation ( hence, the payment-to-income ratio under AHOP would remain affordable), and that house prices would rise ( hence home owner's equity would not fall)

These assumptions were not realized.  This bad luck with imperfect design resulted in more defaults than had been foreseen.  Of the 161,000 units funded by assisted home ownership programs over the period 1970-8, some 18,000 had defaulted by 1985, an 11% rate.

What most people do not realize is that in 1983 the minimum down payment increased from 5% to 10% in response to the unprecedented volume of claims on CMHC's Mortgage Insurance Fund. Very high interest rates and the AHOP program were factors in the large volume of defaults at this time.

While no one can properly predict the future, we have ample evidence in the past that assisting people into home ownership that had trouble getting into home ownership by themselves, has not always worked as planned. 

While there is not a national assisted home ownership plan, almost every city in Canada with a population over 30,000 has partnered with CMHC to "help" people into home ownership.  In Saskatchewan we even have Moose Jaw with an affordability problem.  And of course in Saskatoon we have the  Mortgage Flexibility Support Program
The people using this program are people who are of lower income and first off the chopping block if the labor market turns sour.  The more people that are "helped" into home ownership, the more that the housing market becomes vulnerable.

So are we repeating the same mistakes as before? 





 

The housing crisis in Regina (The real problem nobody wants to talk about)

On May 15th and 16th Regina hosted a housing summit to discuss the problem of affordable housing and the possible steps to address this problem.

From the cbc

Fougere is hosting a housing summit and, on Monday, he took part in a ground-breaking ceremony that highlighted one element of the housing needs in his city.

A project in Regina's core neighbourhood, set for completion in December, will see eight bachelor-style apartment units built. The apartments are meant to provide housing for young people who can't find anywhere else to stay....

Calvin White, who was working on the project Monday, said that rental rate is important considering what he has experienced in Regina.

"Outrageous," White said about some of the rents he has seen. "There are some places [at] 18-hundred bucks, for rent. I don't how people can afford that. $450 here. That's pretty affordable."

 

First, some background on why Regina has this affordability problem.



Apartments converted into condos

From the cbc "Condo conversions popping up all over Regina, Saskatoon ( 2008)

The wave of condominium conversions that has recently rolled over Saskatoon appears to be continuing in Regina.
 

What is interesting is that from 1997 to 2007, while population increased by about 3,000, Regina had a net loss of 500 apartment units due to condo conversions.  From 2007 to 2012 population increased by 23,500.  But from 2007 to 2012 this is how many apartments were built.

2007	58
2008	141
2009	256
2010	253
2011	355
2012	727

For a total of 1790 units.  But in my estimation, with that type of population growth, Regina should have built somewhere near 3100 apartment units. Anyone surprised this is the outcome?

Now Regina has had in place since 1994, some rules regarding condo conversions.  One is that the vacancy rate cannot be under 3% in order for a condo conversion to go ahead.  If it is under 3%, the approval process gets tougher, but condos can still be converted.

So in a quick nutshell, too many condo conversions and not enough apartment units being built for population growth over the last decade.


2nd reason why there is a housing affordability problem

 

Chart is pretty well self explanatory.  Rent growth is from apartment units such as boardwalk and do not take into account private rents.  Some estimations put private rent growth somewhere in the range of 70% to 100%.  Compare that with weekly wage growth of 30% and you are gonna have problems. 

The reason for this type of growth is that since 2006, there has been a change in how people view real estate in Regina.  They now see real estate as an investment first, and then a place to live in second.  People have used extremely low interest rates and easy lending to build up house prices.  Oh, by the way, did you know that mortgage credit grew 11% in Saskatchewan during 2012 while labor income growth was about half that?  You do now.  This part of the equation won't change anytime soon it seems.


My thoughts
This is a complex situation and there is no easy fix.  When one looks at mortgage financing, provincial and municipal governments have no power to control these, as mortgage rules and interest rates are set at the national level.  With this easy access to credit, ( forget those who think mortgage rules are tight, here is some history for them, best compilation on the web) home sales are in a way subsidized by credit as most fundamentals are showing warning signs of some overvaluation in Regina. Because of this there is also a significant better rate of return for companies to build houses, condos and townhouses for sale compared to apartment units as home sales are financed through credit and rents are financed through wages.

A few ways they could try and fix this:

• Restrict condo conversions. 
• About 30% of all future housing starts need to be rental units.  The city could make it mandatory for big developers to build 3 rental units for every 7 residential units.
• Incentives for these developers would need to be put into place so that these developers can get a decent rate of return and so that rental rates are affordable for renters

In the early 70's there was an affordable housing problem throughout Canada and there was no shortage of federal intervention such as:
1974- Multiple Unit Residential Program (MURB) a tax provision to shelter private investor income for rental units.
1975- Assisted Rental Program.  Provided a monthly grant to private landlords to help address rental shortages. Later versions in 1976 and 1978 included interest free loans to bridge the gap between market rents and economic rents.
1981- Canada Rental Supply Program- Federal program aimed to stimulate rental construction in the private sector. Interest free loans for 15 years, up to a max of $7500 per constructed unit.

But after the housing bust of the early 80's these programs eventually ceased to exist.

Even with all these suggestions, this housing affordability problem won't be fixed.  Why?  Because the real problem is that most people do not want to recognize or do not understand the true root of the housing crisis.  The real problem is that throughout history when there is an affordability problem for housing, then there is more than likely a housing bubble to some degree.  Nobody is talking about that.  As long as real estate is viewed as an investment first and a place to live in second, and credit growth continues to outpace income growth by a significant margin, there will be an affordability problem. 

My question is, how was the housing affordability problem in the 70's fixed?  Hint, it was not because of any programs that were implemented.

 

The Economist: Canada's Housing Market...A large bubble now looks set to burst

The Economist chimes in about global house prices here

Housing markets are notoriously prone to boom and bust. To judge whether prices are at sustainable levels we use two yardsticks. One is the ratio of prices to disposable income per person, a measure of affordability. The other is the price-to-rent ratio, which is analogous to the price-to-earnings ratio used for equities, with rents going to landlords (or saved by homeowners) equivalent to corporate profits. If these gauges are higher than their historical averages, property is overvalued; if they are lower, it is undervalued.

On this basis Canada’s market is especially vulnerable. A large bubble now looks set to burst. Home sales in March were 15% down on a year earlier. Buyers are in short supply. A recent poll showed that only 15% of Canadians are likely to buy a home in the next two years, down from 27% last year—the steepest decline in the 20-year history of the survey. After a big boom, the housing bust will be a wrenching affair.

By contrast, the recovery in the United States, where house prices are up by 9.3%, is based on solid foundations. Previous falls in prices have made homes cheap by historical standards. The recovery

Awesome infograph from Quickenloans

A great infograph from quickenloans.com.  Just a heads up, Phoenix sq footage is wrong.  I have yet to hear back from quickenloans but my guess is that the number should $153 not $1534.

Does Your Home Size Measure Up?

An infographic from the team at Quicken Loans.

Pacific Partners Real Estate Chartbook Update

Pacific Partners is out with their updated real estate chartbook.  Always good info from them.

 

On many levels an economic mean-reversion is taking place as a decade long bull-market in Canadian real estate has now stalled, coinciding with other faltering drivers of the Canadian economy.  Meanwhile, the US housing market has surged 8% higher in the last year and cities such as Phoenix Arizona have risen over 25%. This recovery has emerged after a six-year US real estate drudging that has left in its wake systemically high US unemployment and a global economic dependence on central bank-sponsored stimulus.

Unlike with the US, Canadian markets are undergoing a period of price weakness; home prices in major markets of Toronto, Montreal, Vancouver, and Calgary are all lower from their all-time highs as the chart below illustrates.  Notably, Canada’s three largest cities, Vancouver, Toronto, and Montreal are only into the first year of a potential lengthy period of price weakness.

However, even these early signs of weakness are significant because they are being accompanied by a systemic "drying up" of home sales volume. In some markets the volume drought has been large in magnitude.  Vancouver in particular experienced April 2013 sales which were the lowest April sales since 2001, or 20.9% below the ten-year April average (Vancouver Sun). This reduction in sales volume is not just in Vancouver. The Canadian Real Estate Association (CREA) reported 90 percent of the local markets that it monitors posting year-over-year March sales declines (BNN).  Why is the volume of home sales important? Sales volume contraction is often a precursor to price declines within any asset class, and particularly so in housing. We examined this fact in our previous chartbook publication by examining US housing sales volume changes leading up to the US housing crash (Chartbook Dec 2012).  

Check out the rest of their report here.  Loads of charts.

A smart investor would not buy a duplex

I was emailed about whether or not buying a duplux is a good thing right now.  If the numbers work, it can make sense, but for this individual it didn't.  You will see why down below.  And Friday's Star Phoenix has 2 quotes I would like to share.

From the Star Phoenix

more than 2,400 apartments were converted into condos in a 10year period, most between 2006-08. At the height of the conversion boom multi-family apartment buildings were trading at a record-breaking average of $101,555 per unit and at rates of return as low as three per cent.
 

Wow!, 3 per cent and after taxes that is less than inflation.  Why would anybody in the right mind buy these units as an investment?

Before we get to that, how do we calculate rate of return?
Capitalization rate (or "cap rate") is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value.

• Gross Operating Income – Expenses = Net Operating Income (NOI)
• Net Operating Income/Purchase Price = Cap rate

Income is easy to figure out, what about expenses?  Mortgage payment, insurance, property taxes, utilities, (most tenants pay utilities) maintenance, property management and vacancy allowance are all included in expenses.  Very few investors use the last 3 in their calculations for expenses, but I would stress they NEED to, if they want to be a successful property investor.

The property I was asked about is a 70's duplex which is listed for close to $500,000.  It needs some work but is rented out for $3000 per month.  Assuming a $100,000 down payment at a 3% mortgage rate over 25 years.
Monthly expenses for this property look like this.
Mortgage payment = $1900
Insurance = $150
Property taxes = $375
Maintenance (8% of gross revenue) = $240
Property Management (10%) = $360
Vacancy (5%) = $180

Monthly income is $3000 while monthly expenses are $3205.  This is a negative cap rate with 20% down payment along with emergency low interest rates.  So why would a person buy a duplex or any unit that has negative cash flow?  For the same reasons people bought properties in the Star Phoenix article I linked to.

"Investors were not buying these apartments for the income they were generating annually, but on the prospect of converting these rentals into condominiums and selling them per unit for a substantial bump in price," said McClocklin. "We are now beginning to replenish the rental units we lost and I suspect that this is just the beginning of the new wave of apartment construction."

To get a healthy cap rate of return of lets say 5% or 6%, rents would need to be raised substantially, but rents are sky high as it is right now, how much more can renters be squeezed.  If anything expenses have more room to grow than rents as interest rates are at all time lows.  If they were to increase, this investor would be in trouble.  So why would anybody buy this duplex?  The only reason is in hopes of capital appreciation, just like the units in the Star Phoenix article.  Smart investors wouldn't touch this one as they do not like throwing money in the toilet.

Winnipeg part 3, housing bubble or what?

Here is part 3 of the Winnipeg housing series.

First, I want to start off with population and employment growth, as they have been lackluster at best over the decade and a half.

Population Change

Or better yet, how does Winnipeg compare to others?

In the last 15 years, Winnipeg has averaged 0.8% population growth per year. Compare that with Saskatoon at 1.35%, Canada at 1.03% and Calgary at 2.81%.

 

Employment, Wage, House Price and Population Growth

Population and employment growth since 1998 are lukewarm at best. And if we look at when house price growth started it's double digit march in 2003, employment growth was almost 0% and population growth was .04%. In 2005 we see that employment growth was negative but house prices still marched at over 12% growth! The housing boom was not result of an employment or population boom at all in the last decade. There are only 2 years where the average weekly wage is above 4%.   Other than that, the average weekly wage per year is less than 3%.

 

Labor Market

Winnipeg is like most other major centers in that real estate related industries are the major job growth engine of local economies over the last half decade. And this does not take into the account the spinoffs such as retail sales where people borrow against their homes to fund their lifestyles.

 

 

Building Permit Values

Other than the last couple of years, the significant majority of the construction boom has been in residential construction. 

 

 

So was Winnipeg undervalued and is it now just properly priced?

I have turned over many rocks.  Inflation, wages, rents, population, employment et al do not explain why house prices have tripled in just over a decade.  But when backed into a corner, there is always an excuse, so many people will use the quote "our house prices were undervalued" to justify skyrocketing house prices.   I have a bit of a problem with that.  Why? What were house prices undervalued to? Incomes? Rents?  Who has said that house prices were undervalued? The Real Estate Association?  Banks? People whose livelihood depends on  credit accumulation and housing? How many other countries ( dozens) had those professions saying the same thing before their housing bubbles popped?  Conflict of interest with those industries maybe? Is there now an affordability problem for many renters and young home buyers now that house prices are not undervalued?  Were home builders losing money on homes they were building before prices skyrocketed?

 

 

So why did house prices skyrocket?  Simple. More and more people started to see homes as an investment first, ( for some, speculative) and a place to live in, second. House prices skyrocketed because people saw homes as the new best investment.  This is a common theme found around the world at various time periods over the last decade.  As I have said before, by looking at the numbers, Winnipeg is a classic example on how human emotion can drive up an asset price because all the fundamentals do not explain why house prices have tripled in just over a decade.  Nothing, other than the increase in debt like I showed in the first post can explain the run up in house prices. 

 

Instead of saying house prices were undervalued, maybe the banks and the real estate association should say that future buyers had more capacity to take on more debt.  Think that will happen?

 

So housing bubble or what?

Winnipeg is ringing some alarm bells, Demographia says that housing in Winnipeg is "moderately unaffordable".  Apartment rents have not increased at anywhere near what house prices have increased.  Most of the price to income and price to rent ratios show that Winnipeg house prices are most likely in the overvalued category.  While all time low emergency interest rates do help monthly affordability, and probably keep Winnipeg from entering the big bubble category, basing the strength of house prices and the housing market on these low interest rates is questionable at best.