We financial planners preach the merits, virtues and practical common sense of “planning for that eventual day of retirement”. But it is still truly amazing how many people choose not to adhere to these basic tenants, or, worse, do not take the time to meet with an accredited financial planner to set a path to prosperity.
A recent poll by Ipsos Reid shows some staggering results. The key concerns for Canadians over the age of 50 are:
- Inflation and taxes the biggest worries.
- Inflation and taxes are among the top concerns for retirees, with 35% worried that inflation will negatively impact their retirement income, compared to 43% of pre-retirees.
- Sixty-two per cent of retirees worry about taxes on their income, with 66% believing the percentage of their income required for taxes will rise in the next 10 years. Retirees say they are currently living on 56% of their pre-retirement income, indicating that spending drops significantly in retirement.
- 22% of respondents entered retirement with a mortgage on their primary residence.
- The majority of retirees (70%) feel it is still important to be able to save part of their income, yet 28% have acquired new credit products since they retired.
- “It's not uncommon to be concerned about maintaining a sustainable level of income in retirement, but costs you never counted on may also arise,” adds Davies. “For example, our poll found that almost one-in-five retirees spend over $1,000 annually on prescription drugs. Working with a qualified advisor can help you prepare for taxes, inflation and unexpected costs that may impact your retirement goals.”
Saverio Manzo
saveriomanzo.com
Many Canadians enter retirement with debt: poll
Four-in-ten Canadians over the age of 50, who have assets of at least $100,000, retired with some form of debt, according to a new poll released by Royal Bank of Canada (TSX:RY).
The first annual Retirement Myths and Realities poll, which examines Canadians' expectations and experiences in retirement, also found that 22% of respondents entered retirement with a mortgage on their primary residence.
The majority of retirees (70%) feel it is still important to be able to save part of their income, yet 28% have acquired new credit products since they retired.
“More and more, Canadians are carrying debt into retirement, which is not necessarily a bad thing,” says Lee Anne Davies, head, retirement strategies, RBC.
“Having access to credit in retirement can be beneficial to managing income and cash flow and provide additional flexibility. To help make your retirement dreams a reality, our advice is to start early and prepare a comprehensive financial action plan that will keep you focused on paying down debt and saving, as well as establishing a budget for both your pre- and post-retirement years.”
The poll was conducted by Ipsos Reid from March 10-19, 2010. For this survey, a national sample of 2,143 adults aged 50 and over with household assets of at least $100,000 from Ipsos' Canadian online panel was interviewed online.
By IE Staff
Saverio Manzo
saveriomanzo.com
Tuesday, April 27, 2010
Tuesday, April 20, 2010
Mortgages: To lock-in or not?
With all the hype around mortgage rates increasing, as opposed to writing directly about this I found a great piece from Ed Rempel. He really covers the “to lock-in or not” debate very well.
Avoid the 5-Year Fixed Mortgage Trap
Should I go short or long; fixed or variable with my mortgage?
“I wish I had an answer to that, because I’m tired of answering that question.” – Yogi Berra
Number 3 on our list of things on which Canadians waste the most money is 5-year fixed mortgages.
They are marketed as being safe and a good protection against a sharp rise in interest rates. The reality, though, is that they are nearly always a huge waste money, they limit your flexibility and result in losing your negotiating power for 5 long years.
That is why we call it the “5-Year Fixed Mortgage Trap”.
I am not a mortgage broker, but have researched mortgages and always have strong opinions. The most common questions about mortgages are “short vs. long” and “variable vs. fixed”. Which is better? Canadians often debate this, but studies consistently show that short beats long and variable beats long term fixed.
If it is so obvious, then why doesn’t everyone see it? Longer term mortgages are marketed heavily by banks and mortgage brokers that make far more money on them then short term mortgages. Also, most people are bad at math and may get a general feeling of security from a fixed rate, but they do not do the math on how much this protection costs or the odds that they will lose money.
“Unfortunately, most of the existing folklore and advice is rarely subjected to formal statistical analysis and does not address the probability that a given strategy will be successful.” (Moshe Milevsky) The main reasons commonly used for taking 5-year fixed mortgages turn out to essentially be myths:
3 Mortgage myths about 5-year fixed mortgages:
1. They are safer
A study by Moshe Milevsky, finance professor at York University, from 1950-2000 showed that the average Canadian wastes $22,000 after tax (based on a $100,000 mortgage for 15 years) in their life because they got sucked into 5-year fixed mortgages rather than variable.
If your mortgage started at $300,000, then you can expect to waste $66,000. They also took on average 38 months longer to pay off their mortgage. The chance of losing money over 5 years was 89%. A study by Peter Draper (mortgage broker) comparing 5-year vs. 1-year mortgages from 1975-2005 showed that the 1-year mortgage saved money 100% of the time! How can an 89-100% chance of losing thousands of dollars be safer?
2. Rates may go very high like in the 1980s
I was an accountant for a mortgage company in 1982 when mortgage rates peaked at 22.75%. My first mortgage was a 5-year fixed in 1980 at 13.75%. I thought that I had lucked out, since rates jumped to 22.75% and were back to 13.75% by 1985 when it came due. What I didn’t realize was that, even then, I would have saved money by going variable! Based on Peter Draper’s study, I would have lost money for 2 years and saved money for 3 years. So, even with a huge leap of 9% in mortgage rates in the first 2 years of my mortgage, I still lost money with a 5-year fixed rate!
Also, the odds of a huge rate rise are extremely low. We can’t calculate them, since it has only ever happened in the early 1980s, but the odds must be extremely low. Demographers, like Harry Dent, claim it related to Baby Boomers entering the housing market for the first time, which is a phenomenon we don’t expect to be repeated in the next few decades.
3. Your mortgage payments will stay the same
Most variable mortgages also keep your mortgage payment the same during the term. Many people believe that their mortgage payment will fluctuate with a variable mortgage, but this is also a myth.
Top 4 reasons to stick to short or variable mortgages:
1. Save thousands
On average, you should save 22% of the starting amount of your mortgage and pay it off 38 months earlier. (Moshe Milevsky) In the Toronto area, an average mortgage is $2-300,000, which would be savings of $44-66,000 after tax. That is essentially one full year’s earnings, so the average person works one extra full year just to pay the money wasted by taking 5-year fixed mortgages!
2. Low risk
With variable mortgages, the chance of saving money is 89-100%. Yes, the variable is the low risk!
3. Flexibility
Many things can happen in your life in 5 years that may make it advantageous to refinance. You may want to move, roll in other debt to get the lower rate, make extra payments with no limit or change some terms. Our experience with our clients is that most do some sort of refinancing every couple of years, so being locked in for 5 years is a long time.
4. Negotiating power
The mortgage market is very competitive, so every time your mortgage comes due, you have lots of negotiating power. You can change any term you want, get a free appraisal, negotiate a lower rate, or get an unsecured credit line or other banking service. During the term, you have hardly any power. Remember that when you sign a 5-year mortgage, you sign away your negotiating power for 5 years!
The main reason that 5-year fixed mortgages lose money vs. 1-year is that, in a normal market, they start about 2.5% higher. If you pay 2.5% more in year 1, you need the average for years 2-5 to be more than 3% higher than today’s rate. To be ahead, rates would have to jump by more than 3% and stay there for the next 4 years – a very unlikely scenario.
Conclusions:
1. Stick to 1-year fixed or variable mortgages. Usually, you should take whichever is lower, but only take variable at a good discount, such as prime -.8-.9%.
2. Avoid 5-year fixed. Sometimes, they are tempting, but always assume they will end up costing much more, plus you will have lost your flexibility and negotiating power for 5 years. Remember that even when rates leaped 9% in 2 years from 1980-82, short term rates still saved money.
3. Never take a mortgage term longer than you expect to stay in your current home.
We have been referring people to mortgage providers since the mid-90s and most today have rates below 2%. Most of our clients still have the prime -.85% rate that we had for years before this recent crisis or have our recent 1-year rate of 1.99%.
Today, we are recommending 1-year fixed, not variable. The best variable rates are prime -.4-.6%, but rates are normalizing quickly. We expect that the prime -.85% (or lower) rates will be back soon. We expect that anyone taking a variable today will regret having locked in before the larger discount is available.
Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.
Saverio Manzo
www.saveriomanzo.com
Avoid the 5-Year Fixed Mortgage Trap
Should I go short or long; fixed or variable with my mortgage?
“I wish I had an answer to that, because I’m tired of answering that question.” – Yogi Berra
Number 3 on our list of things on which Canadians waste the most money is 5-year fixed mortgages.
They are marketed as being safe and a good protection against a sharp rise in interest rates. The reality, though, is that they are nearly always a huge waste money, they limit your flexibility and result in losing your negotiating power for 5 long years.
That is why we call it the “5-Year Fixed Mortgage Trap”.
I am not a mortgage broker, but have researched mortgages and always have strong opinions. The most common questions about mortgages are “short vs. long” and “variable vs. fixed”. Which is better? Canadians often debate this, but studies consistently show that short beats long and variable beats long term fixed.
If it is so obvious, then why doesn’t everyone see it? Longer term mortgages are marketed heavily by banks and mortgage brokers that make far more money on them then short term mortgages. Also, most people are bad at math and may get a general feeling of security from a fixed rate, but they do not do the math on how much this protection costs or the odds that they will lose money.
“Unfortunately, most of the existing folklore and advice is rarely subjected to formal statistical analysis and does not address the probability that a given strategy will be successful.” (Moshe Milevsky) The main reasons commonly used for taking 5-year fixed mortgages turn out to essentially be myths:
3 Mortgage myths about 5-year fixed mortgages:
1. They are safer
A study by Moshe Milevsky, finance professor at York University, from 1950-2000 showed that the average Canadian wastes $22,000 after tax (based on a $100,000 mortgage for 15 years) in their life because they got sucked into 5-year fixed mortgages rather than variable.
If your mortgage started at $300,000, then you can expect to waste $66,000. They also took on average 38 months longer to pay off their mortgage. The chance of losing money over 5 years was 89%. A study by Peter Draper (mortgage broker) comparing 5-year vs. 1-year mortgages from 1975-2005 showed that the 1-year mortgage saved money 100% of the time! How can an 89-100% chance of losing thousands of dollars be safer?
2. Rates may go very high like in the 1980s
I was an accountant for a mortgage company in 1982 when mortgage rates peaked at 22.75%. My first mortgage was a 5-year fixed in 1980 at 13.75%. I thought that I had lucked out, since rates jumped to 22.75% and were back to 13.75% by 1985 when it came due. What I didn’t realize was that, even then, I would have saved money by going variable! Based on Peter Draper’s study, I would have lost money for 2 years and saved money for 3 years. So, even with a huge leap of 9% in mortgage rates in the first 2 years of my mortgage, I still lost money with a 5-year fixed rate!
Also, the odds of a huge rate rise are extremely low. We can’t calculate them, since it has only ever happened in the early 1980s, but the odds must be extremely low. Demographers, like Harry Dent, claim it related to Baby Boomers entering the housing market for the first time, which is a phenomenon we don’t expect to be repeated in the next few decades.
3. Your mortgage payments will stay the same
Most variable mortgages also keep your mortgage payment the same during the term. Many people believe that their mortgage payment will fluctuate with a variable mortgage, but this is also a myth.
Top 4 reasons to stick to short or variable mortgages:
1. Save thousands
On average, you should save 22% of the starting amount of your mortgage and pay it off 38 months earlier. (Moshe Milevsky) In the Toronto area, an average mortgage is $2-300,000, which would be savings of $44-66,000 after tax. That is essentially one full year’s earnings, so the average person works one extra full year just to pay the money wasted by taking 5-year fixed mortgages!
2. Low risk
With variable mortgages, the chance of saving money is 89-100%. Yes, the variable is the low risk!
3. Flexibility
Many things can happen in your life in 5 years that may make it advantageous to refinance. You may want to move, roll in other debt to get the lower rate, make extra payments with no limit or change some terms. Our experience with our clients is that most do some sort of refinancing every couple of years, so being locked in for 5 years is a long time.
4. Negotiating power
The mortgage market is very competitive, so every time your mortgage comes due, you have lots of negotiating power. You can change any term you want, get a free appraisal, negotiate a lower rate, or get an unsecured credit line or other banking service. During the term, you have hardly any power. Remember that when you sign a 5-year mortgage, you sign away your negotiating power for 5 years!
The main reason that 5-year fixed mortgages lose money vs. 1-year is that, in a normal market, they start about 2.5% higher. If you pay 2.5% more in year 1, you need the average for years 2-5 to be more than 3% higher than today’s rate. To be ahead, rates would have to jump by more than 3% and stay there for the next 4 years – a very unlikely scenario.
Conclusions:
1. Stick to 1-year fixed or variable mortgages. Usually, you should take whichever is lower, but only take variable at a good discount, such as prime -.8-.9%.
2. Avoid 5-year fixed. Sometimes, they are tempting, but always assume they will end up costing much more, plus you will have lost your flexibility and negotiating power for 5 years. Remember that even when rates leaped 9% in 2 years from 1980-82, short term rates still saved money.
3. Never take a mortgage term longer than you expect to stay in your current home.
We have been referring people to mortgage providers since the mid-90s and most today have rates below 2%. Most of our clients still have the prime -.85% rate that we had for years before this recent crisis or have our recent 1-year rate of 1.99%.
Today, we are recommending 1-year fixed, not variable. The best variable rates are prime -.4-.6%, but rates are normalizing quickly. We expect that the prime -.85% (or lower) rates will be back soon. We expect that anyone taking a variable today will regret having locked in before the larger discount is available.
Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.
Saverio Manzo
www.saveriomanzo.com
Tuesday, April 13, 2010
Home Ownership: A Good or Bad Investment?
Why home-buying is a great investment
I have little to add, this is a good piece for anyone who owns a home or is pondering a purchase or sale. Full credit goes to John Kelleher and Joe Castaldo
John Kelleher responds to Joe Castaldo's story "Why buying a house is a bad investment."
I refer to your cover article “Why buying a house is a bad investment” by Joe Castaldo in your March 15, 2010 issue (see below for full article).
This article is not a serious discussion of the topic that it purports to cover. It misses the most critical issues involved in understanding whether a home is a good or bad investment and confuses the topic with some misleading charts and facts.
Let me try to illustrate the errors in the article by referring to a summary chart the author shows on top of page 28 [not shown online] — a chart that compares housing returns in various cities to stock market returns. The chart and the article contain the following errors:
1. Exogenous benefits of an “owner lived in” housing investment. When an owner buys a home and lives in it, the owner receives what economists call “exogenous benefits” — meaning that (in addition to being an investment that you can buy and sell for a profit) a home is something that one can live in. You can’t live in a stock or a bond, so this “exogenous benefit” makes a home that you purchase to live in quite different. Simply put, the owner doesn’t have to pay rent to live somewhere else. This benefit is very large, yet is not quantified in the returns when one buys and sells a home. So comparing housing returns to stock returns without considering this issue is misleading and wrong. For example – let’s say I lived in a home for five years and sold the house exactly for what I bought it for — so I didn’t lose any money but I didn’t make any either. It would not be correct to compare the 0% return that is seemingly earned in that case with an 18% return on stocks and say that the house was a bad investment. The owner of the house had a roof over their head for five years! That benefit could easily be worth hundreds of thousands of dollars but isn’t reflected in the numbers because the owner is effectively “paying rent” to himself. This error is a serious one and should have stopped the article’s publication on its own.
2. Principal residence tax exemption. Amazingly, the article fails to mention the principal residence tax exemption on housing in Canada. Gains on housing are tax free, while the gains on investments are taxed! This is another huge miss that should have been caught and another reason why the chart and the article are wrong. By comparing pre-tax returns on stocks to what are effectively post-tax returns on housing, the article makes a critical error. So when an investor has a gain of $100 on a principal residence they keep $100. When an investor has a gain of $100 on stocks the homeowner keeps only about $77. (assuming cap gains tax of about 23%). This is another error that should have stopped this article’s publication.
3. Comparing investments with totally different risk profiles. One of the most basic principles in finance is that one should never compare returns on investments that have different risk profiles. Investing in stocks is generally more risky than investing in real estate — so you can’t make a chart like the one on page 28 and conclude (as most of your readers surely did) that housing is a bad investment because the returns appear lower than the returns for stocks. The author should have compared each asset to its own risk benchmarks (risk-adjusted returns). This is another huge miss that leads to a misleading conclusion.
4. Fees, commissions, and capital expenditures. Fees, ongoing capital expenditures, and commissions for a housing purchase are large and materially impact the attractiveness of a house as an investment. The friction associated with other investments is generally a lot lower. The author’s chart makes the comparison before all of these expenses which again makes the comparison silly. It is true that he chooses to mention this issue in the body of the article, but makes no attempt at quantifying this issue or estimating how it impacts returns. This would not have been hard and would have made for a more substantive contribution.
In addition to the errors above, the article uses poor examples to make points. These examples actually support the opposite view to what the author suggests! The author might have realized this if he had taken five minutes to run the math. Take the article’s assertion that leverage allows a buyer to make a $50,000 profit given a 20% down payment on a $500,000 house where the asset’s value appreciates to $550,000 in two years. Since mortgages don’t come free, this point is wrong, and materially so. Let’s do some work for a moment. If I assume just a 4% mortgage on the $400,000 of debt in your reporter’s example, the hypothetical profit drops from $50,000 to about $20,000 (yes, you have to pay about $30,000 in interest in those first two years). Now if I add in commissions, land transfer taxes, property taxes and so on the profit actually turns in to a loss. This is why it generally doesn’t make sense to buy a house for only two years. I respectfully suggest that these examples need more thinking and more homework.
Overall, the misses and errors in this article are really disappointing.
When a person buys a house to live in, it is actually an incredibly complex financial transaction. It is akin to a leveraged buyout of a company where the new owner lives in the corporate offices (thereby avoiding the need to rent elsewhere) and where the gains on the sale of the company can be enjoyed tax free. Many variables impact the true return on this decision and the only way to understand that return is to model it. Doing so requires some careful work and some basic training on financial principles.
Regards,
John Kelleher
Why buying a house is a bad investment
Interest rate hikes are looming, and talk of bubbles abounds — so what's with the real estate buying frenzy?
By Joe Castaldo, a staff writer for Canadian Business.
More than two centuries ago, the economist Adam Smith produced his landmark tome, An Inquiry into the Nature and Causes of the Wealth of Nations, in which he wrote, "a dwelling-house, as such, contributes nothing to the revenue of its inhabitant." The father of modern economics placed housing in the same category as clothing and furniture — useful consumer goods that do not generate wealth. For the homeowner, a house is a "part of his expense, and not of his revenue." Were Smith alive to make such a statement today, he would no doubt be regarded as a heretic.
These days, home ownership is widely heralded as the ultimate financial achievement and one of the surest forms of wealth creation available. Homeowners aren't throwing away money on rent, the common thinking goes, but instead putting it toward an asset that can only appreciate in value. Indeed, home prices have more or less climbed steadily for decades. For these reasons, at least two generations have grown up with the same abiding principles when it comes to real estate: save for a down payment, buy a house, and work hard to pay off the mortgage. And you better get in soon, because God's not making any more land.
Nowhere is that mentality more prevalent than in the current market, where housing has soared to record highs after a brief — but gut-wrenching — drop just over a year ago. Existing home sales fell 40%, and prices 12% from their peaks in late 2007 during the turmoil of the recession. But the average home price in January roared back to $328,537, according to the Canadian Real Estate Association, a jump of nearly 20% from the year before. Ultra-low interest rates are providing an unprecedented opportunity for young Canadians to buy their first homes. At the same time, there is a shortage of houses on the market, fuelling intense competition and bidding wars. "Some people don't even balk at paying thirty, forty, fifty thousand dollars over asking now," says Evan Sage, a real estate agent in Toronto. Many factors motivate people to buy property, but one nearly universal reason is for the economic benefits. "Every single decade, prices have gone up," says Sage. "The one consistent thing is real estate."
But a hard look at real estate returns shows that Adam Smith probably had the right idea after all. Viewed purely as an investment, an owner-occupied home has more than a few undesirable traits. In January, during a panel discussion at the annual meeting of the American Economist Association, Karen Pence, head of the Federal Reserve's household and real estate finance division, pointed out a few of the drawbacks buyers tend to overlook. For instance, a house can't be divided up and sold, like a stock portfolio, and it is highly correlated to the job market. Also, a house is undiversified; instead, its future is tied to a single neighbourhood.
Moshe Milevsky, an associate professor of finance at the Schulich School of Business in Toronto, has a similar take. "This blind devotion to investing in a house as being a very, very good idea might not make sense when all is said and done," says Milevsky, who held off purchasing a home for his own family for some time. He believed it was not a smart way to allocate money. In fact, it flies in the face of what decades of portfolio allocation theory have shown. "It's like a stock portfolio that consists of one stock," he says. "If I could buy a house where the bedroom is in Toronto, the kitchen is in Vancouver, and another bedroom is in South America, then that's a diversified house."
But the dream of home ownership is so deeply ingrained, and the belief that real estate is the ticket to wealth so strong, that Canadians are increasingly willing to put their economic well-being on the line for the sake of four walls and a roof. This fact is reflected in the growing levels of debt. The average household in Canada now owes $96,100, according to a study released in February by the Vanier Institute of the Family, an increase of 5.7% over the past year. The same report found that mortgage debt is at a record high.
The euphoria around home ownership crowds out some of the unpleasant truths about real estate: mainly, that long-term returns are often modest at best. Some studies have found that stock indexes actually outperform housing. More worrying is that real estate prices can and do fall — and they can take a long time to recover. Canada has not been immune to severe price corrections in the past, and we could be on the verge of another one now. With interest rates set to rise and curb affordability, and with economists speculating about a bubble, staking one's entire financial future on a home is not necessarily a wise bet. In fact, a house just might be one of the most overrated investments around.
The final months of 2008 were a difficult time for Vancouver real estate agent Peter Raab. His clients simply weren't interested in buying houses, and the market was tumbling. Raab prepared for the worst, cancelling his vacation and cutting expenses. His practice slowed down so much that he didn't get a paycheque for five months. "Everyone was trying to put on a brave face. It weeded a few people out of the industry," he says. But Raab didn't have to wait long for a recovery. His business started to pick up again in March of last year, as it did for agents across the country.
A number of circumstances brought buyers back. Canadians recognized the economy was not headed for disaster, and rock-bottom interest rates were too enticing to ignore. Buyers who had been waiting for the economy to smooth out before buying have started looking again, and others who may have waited until later in the year to purchase are acting now to avoid rate increases. The effect has been compounded in Ontario and B.C., where the introduction of a harmonized sales tax in July will increase the costs around buying and selling homes. Factor in a lack of housing supply and too many buyers, and it would appear prices have shot up alarmingly in a short amount of time, sparking plenty of debate over whether homes are overvalued now, and how they'll adjust in the future.
"There's a unique confluence of factors that has driven house valuations up this sharply," says Derek Holt, vice-president of economics at Scotia Capital. "They're all temporary, and that's a house price bubble that could be pricked as we go off into the next year." The rate of growth in home prices for the past 10 years has in fact been out of line with prior decades, pointing to lofty valuations today, according to Holt. Prominent Canadians such as money manager Stephen Jarislowsky and former Bank of Canada governor David Dodge have also sounded the alarm recently on today's unusually rich home prices.
Although both federal Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney have said they do not believe Canada is in the midst of a housing bubble, they are clearly watching closely. Carney warned about rising levels of debt late last year, as the household debt-to-income ratio reached a record high of 145%. Flaherty took steps to cool the market in mid-February by changing some of the rules around government-backed insured mortgages, most notably with the provision that all borrowers now must meet standards for a five-year fixed rate mortgage, even when opting for a lower rate and a shorter term.
The change was to ensure Canadians don't take on more mortgage debt than they can handle, but impending increases to interest rates still pose a danger to recent homebuyers who took advantage of the cheap credit available over the past year. Even a one percentage point change in a mortgage rate can increase the monthly payment by hundreds of dollars, and it's unclear how homebuyers will cope down the road. A study by CIBC in December said less than 4% of Canadian households would be vulnerable to rate increases, whereas the Bank of Canada estimated the number was considerably higher, at 5.9%. But so strained do Canadians feel that a survey from the Canadian Payroll Association in September found nearly 60% of the respondents said they would have trouble making ends meet if their paycheque was delayed by even one week. This group included many first-time buyers.
Canadians are clearly more than willing to take major financial risks to buy a home. What's ironic is that real estate price gains can be somewhat of an illusion when inflation is taken into account. "People get fooled by nominal numbers," Milevsky says. Long-term returns in real terms are less than spectacular. Harvard economics professor Edward Glaeser looked at the returns in more than 300 metropolitan areas in the U.S. between 1970 and 2000 (before the unsustainable credit-fuelled boom) and found prices increased on average only 1.7% annually. Yale School of Management professor Roger Ibbotson and a colleague examined returns between 1978 and 2004, a period including part of the U.S. housing bubble, and found residential real estate provided an annualized return of 8.6%. The S&P 500 significantly topped that with a 13.4% return.
Housing in Canada hasn't behaved much differently. In 2004, Milevsky examined the compounded annual returns on residential real estate in a dozen Canadian cities over the past 25 years. Toronto provided the best return at 5.75%. But the TSX provided an 8.64% return over the same period. The S&P 500 index did even better during that period, at 13.85%. The drawback, of course, was that stock indexes were far more volatile than real estate, although in some markets, the difference was not so pronounced. Real estate in Vancouver, for example, provided only a 3.68% compounded annual return with nearly the same level of volatility as the S&P 500.
Homeowners can easily argue that while the returns are modest, at least they are building wealth rather than paying rent to a landlord. Leverage can also make a huge difference on returns for homeowners if they choose to sell. In crude terms, assume a 20% down payment on a $500,000 house that is sold a few years later for $550,000. After paying back the mortgage, the seller is left with a $50,000 profit, or a return of 50% on the initial down payment. As far as investments go, that is an eye-popping return. But leverage is damaging when prices fall. A homeowner can end up with outstanding mortgage payments worth more than the house.
There are also a slew of egregious fees associated with real estate that affect returns. There are home inspection and appraisal fees, which can total hundreds of dollars each, not to mention land registration fees, legal fees and perhaps title insurance to purchase. Real estate agents take a commission, too — expect to pay at least 2.5% of the purchase price of the home. Regular maintenance has to be done for the home to maintain its value, and that can quickly add up. Canadian personal finance authors Eric Tyson and Tony Martin say a home usually needs to appreciate about 15% in order for the buyer to recoup all of the transaction and maintenance costs.
A society of renters is also more mobile. Andrew Oswald, an economics professor at the University of Warwick in England, found that high unemployment goes hand-in-hand with high rates of home ownership. In Britain, unemployment doubled since 1950 as the share of the population that rented dropped from 60% to less than 10%. Oswald found similar relationships in other countries, such as Finland and Spain. The Netherlands and Switzerland, by contrast, had lower unemployment and a lower rate of home ownership. Oswald theorized that, while homeowners are often stuck with their property through tough labour markets, renters can more easily relocate to find work, which lessens structural unemployment. His theory has been criticized for placing too much emphasis on a causal link between home ownership and unemployment, but it does echo Fed economist Pence's concern about the correlation between home prices and the job market. Prices fall when the labour market tanks. Everyone needs financial security during those uncertain times, but for homeowners, their greatest asset won't necessarily deliver.
In December of last year, CIBC economist Benjamin Tal estimated home prices in Canada to be about 7% overvalued, which he deemed to be a "modest overshooting" that did not necessarily portend a dramatic price correction. Economists at TD Bank Financial Group put the overvaluation at 12%, adding it could rise to 15% this year as buying activity rages on. David Rosenberg, the chief economist and strategist now at Gluskin Sheff + Associates who called a U.S. housing bubble back in 2004, has a more pessimistic take. He says home prices in Canada are between 15% and 35% overvalued, and could plummet as far as 20% from current levels. "That isn't cataclysmic, but believe me, that would hurt a lot of people," he says. A drop that steep would wipe out virtually all of the gains made in the past year and could leave some Canadians who bought at the top of the market with negative equity in their homes.
Housing has undergone painful corrections in the past. The current crop of homebuyers is likely too young to remember the housing bubble that burst in 1981, and the slow recovery that followed. According to data from the Centre for Urban Economics and Real Estate at the Sauder School of Business in B.C., the average real home price in Vancouver took more than 10 years to get back to its peak, before dipping again in the mid-1990s. Calgary fared even worse. Home prices didn't return to 1981 levels until the first quarter of 2006. Toronto homebuyers experienced a similar pain when a speculator-driven bubble burst around 1989. In real terms, prices didn't recover until 2007.
A wait that long can be brutal for those who bought at the top of the market. It can also thwart retirement plans for those expecting to sell their homes and use the profits to downsize and fund their golden years, particularly if they've neglected to save by other means, such as with an RRSP. Canadians have a significant portion of their wealth tied up in real estate — roughly 48%, according to the Vanier Institute of the Family, the highest level in two decades. The fact that real estate markets do fall highlights the need for Canadians to prepare for wild swings in the economy. That message is perhaps more important than ever as the buying rush continues, and the market looks increasingly pricey. "If you're going out buying a home today, understand that you're not following the doctrine of buy low and sell high," Rosenberg says. "You're doing the exact opposite."
The problem for policy-makers — and buyers trying to figure out the best time to enter the market — is that the existence of a bubble is impossible to know for certain until it pops. Gregory Klump, chief economist for the Canadian Real Estate Association, argues we are not yet in bubble territory. "I would describe this as a micro-cycle where demand is outstripping supply," he says. Housing starts are rising, which will help to satisfy demand. Higher prices are also bringing the sellers back to the market who disappeared in 2008 when sales activity dropped, all of which will lead to a more balanced market later in the year. There are signs of optimism elsewhere, such as in the Canadian house-price forwards market operated by Teranet and the National Bank Financial Group. The market allows investors to essentially place bets on where prices are headed, and the index reflects their collective sentiment. As of January, the index showed investors expect a bump of up to 9% in residential real estate by 2014. (Those investors have been wrong before, of course; last year, the index showed a potential nosedive of more than 20%, the exact opposite of what transpired.)
Not everyone is so sanguine about the market. "We're not in a classic bubble yet, but some of the pre-conditions are certainly in place," says Douglas Porter, deputy chief economist at BMO Capital Markets. One of his concerns is that the central bank is not going to raise interest rates any time soon. Carney pledged to keep rates steady until at least mid-year, and that could mean several more months of frenzied buying. The longer home prices continue to rise out of sync with the rest of the economy, the more worrying the situation becomes. Prices have already skyrocketed while incomes have barely moved, and the home-price-to-income ratio in Canada is at its highest level since the early 1990s.
Scotia Capital economist Holt sees a few possible outcomes as the temporary factors supporting the housing market start to wane. One is a "soft landing," where activity cools gradually. The other is a rapid decline. Holt says the speed at which the market recovered since last year lessens the odds of a soft landing. "We've had four or five drivers of the housing market leading toward strong house price gains in a very short period of time, and I think they all come off simultaneously," he says. "That points to just as quick a descent." The new federal mortgage changes will cause the housing market to "turbo-charge" over the next while, according to TD Securities' chief economics and currency strategist Eric Lascelles, as buyers rush to get in ahead of the implementation date in late April. Once that day passes, the new rules become just another factor that, in Holt's view, will contribute to lower prices and sales activity in the months ahead.
Ultimately, all of the uncertainty and concern around residential real estate is likely not going to deter many people from purchasing a home. A house is much more than an investment, after all. It is firstly a place to live. Even Milevsky, the finance professor at Schulich, caved and bought a house after resisting for a while. "We have a large family, and they wanted somewhere to call their own," he says. If prices fall, a home still provides a roof over one's head, unlike a stock portfolio. The danger comes when people link the idea of a house as a home with the idea of a house as an investment, particularly if they stretch their finances with the expectation of getting rich in a few short years. "There can be long periods of time where the real appreciation of housing is negative," Milevsky says. "All of that means is caution is warranted."
Saverio Manzo
www.saveriomanzo.com
I have little to add, this is a good piece for anyone who owns a home or is pondering a purchase or sale. Full credit goes to John Kelleher and Joe Castaldo
John Kelleher responds to Joe Castaldo's story "Why buying a house is a bad investment."
I refer to your cover article “Why buying a house is a bad investment” by Joe Castaldo in your March 15, 2010 issue (see below for full article).
This article is not a serious discussion of the topic that it purports to cover. It misses the most critical issues involved in understanding whether a home is a good or bad investment and confuses the topic with some misleading charts and facts.
Let me try to illustrate the errors in the article by referring to a summary chart the author shows on top of page 28 [not shown online] — a chart that compares housing returns in various cities to stock market returns. The chart and the article contain the following errors:
1. Exogenous benefits of an “owner lived in” housing investment. When an owner buys a home and lives in it, the owner receives what economists call “exogenous benefits” — meaning that (in addition to being an investment that you can buy and sell for a profit) a home is something that one can live in. You can’t live in a stock or a bond, so this “exogenous benefit” makes a home that you purchase to live in quite different. Simply put, the owner doesn’t have to pay rent to live somewhere else. This benefit is very large, yet is not quantified in the returns when one buys and sells a home. So comparing housing returns to stock returns without considering this issue is misleading and wrong. For example – let’s say I lived in a home for five years and sold the house exactly for what I bought it for — so I didn’t lose any money but I didn’t make any either. It would not be correct to compare the 0% return that is seemingly earned in that case with an 18% return on stocks and say that the house was a bad investment. The owner of the house had a roof over their head for five years! That benefit could easily be worth hundreds of thousands of dollars but isn’t reflected in the numbers because the owner is effectively “paying rent” to himself. This error is a serious one and should have stopped the article’s publication on its own.
2. Principal residence tax exemption. Amazingly, the article fails to mention the principal residence tax exemption on housing in Canada. Gains on housing are tax free, while the gains on investments are taxed! This is another huge miss that should have been caught and another reason why the chart and the article are wrong. By comparing pre-tax returns on stocks to what are effectively post-tax returns on housing, the article makes a critical error. So when an investor has a gain of $100 on a principal residence they keep $100. When an investor has a gain of $100 on stocks the homeowner keeps only about $77. (assuming cap gains tax of about 23%). This is another error that should have stopped this article’s publication.
3. Comparing investments with totally different risk profiles. One of the most basic principles in finance is that one should never compare returns on investments that have different risk profiles. Investing in stocks is generally more risky than investing in real estate — so you can’t make a chart like the one on page 28 and conclude (as most of your readers surely did) that housing is a bad investment because the returns appear lower than the returns for stocks. The author should have compared each asset to its own risk benchmarks (risk-adjusted returns). This is another huge miss that leads to a misleading conclusion.
4. Fees, commissions, and capital expenditures. Fees, ongoing capital expenditures, and commissions for a housing purchase are large and materially impact the attractiveness of a house as an investment. The friction associated with other investments is generally a lot lower. The author’s chart makes the comparison before all of these expenses which again makes the comparison silly. It is true that he chooses to mention this issue in the body of the article, but makes no attempt at quantifying this issue or estimating how it impacts returns. This would not have been hard and would have made for a more substantive contribution.
In addition to the errors above, the article uses poor examples to make points. These examples actually support the opposite view to what the author suggests! The author might have realized this if he had taken five minutes to run the math. Take the article’s assertion that leverage allows a buyer to make a $50,000 profit given a 20% down payment on a $500,000 house where the asset’s value appreciates to $550,000 in two years. Since mortgages don’t come free, this point is wrong, and materially so. Let’s do some work for a moment. If I assume just a 4% mortgage on the $400,000 of debt in your reporter’s example, the hypothetical profit drops from $50,000 to about $20,000 (yes, you have to pay about $30,000 in interest in those first two years). Now if I add in commissions, land transfer taxes, property taxes and so on the profit actually turns in to a loss. This is why it generally doesn’t make sense to buy a house for only two years. I respectfully suggest that these examples need more thinking and more homework.
Overall, the misses and errors in this article are really disappointing.
When a person buys a house to live in, it is actually an incredibly complex financial transaction. It is akin to a leveraged buyout of a company where the new owner lives in the corporate offices (thereby avoiding the need to rent elsewhere) and where the gains on the sale of the company can be enjoyed tax free. Many variables impact the true return on this decision and the only way to understand that return is to model it. Doing so requires some careful work and some basic training on financial principles.
Regards,
John Kelleher
Why buying a house is a bad investment
Interest rate hikes are looming, and talk of bubbles abounds — so what's with the real estate buying frenzy?
By Joe Castaldo, a staff writer for Canadian Business.
More than two centuries ago, the economist Adam Smith produced his landmark tome, An Inquiry into the Nature and Causes of the Wealth of Nations, in which he wrote, "a dwelling-house, as such, contributes nothing to the revenue of its inhabitant." The father of modern economics placed housing in the same category as clothing and furniture — useful consumer goods that do not generate wealth. For the homeowner, a house is a "part of his expense, and not of his revenue." Were Smith alive to make such a statement today, he would no doubt be regarded as a heretic.
These days, home ownership is widely heralded as the ultimate financial achievement and one of the surest forms of wealth creation available. Homeowners aren't throwing away money on rent, the common thinking goes, but instead putting it toward an asset that can only appreciate in value. Indeed, home prices have more or less climbed steadily for decades. For these reasons, at least two generations have grown up with the same abiding principles when it comes to real estate: save for a down payment, buy a house, and work hard to pay off the mortgage. And you better get in soon, because God's not making any more land.
Nowhere is that mentality more prevalent than in the current market, where housing has soared to record highs after a brief — but gut-wrenching — drop just over a year ago. Existing home sales fell 40%, and prices 12% from their peaks in late 2007 during the turmoil of the recession. But the average home price in January roared back to $328,537, according to the Canadian Real Estate Association, a jump of nearly 20% from the year before. Ultra-low interest rates are providing an unprecedented opportunity for young Canadians to buy their first homes. At the same time, there is a shortage of houses on the market, fuelling intense competition and bidding wars. "Some people don't even balk at paying thirty, forty, fifty thousand dollars over asking now," says Evan Sage, a real estate agent in Toronto. Many factors motivate people to buy property, but one nearly universal reason is for the economic benefits. "Every single decade, prices have gone up," says Sage. "The one consistent thing is real estate."
But a hard look at real estate returns shows that Adam Smith probably had the right idea after all. Viewed purely as an investment, an owner-occupied home has more than a few undesirable traits. In January, during a panel discussion at the annual meeting of the American Economist Association, Karen Pence, head of the Federal Reserve's household and real estate finance division, pointed out a few of the drawbacks buyers tend to overlook. For instance, a house can't be divided up and sold, like a stock portfolio, and it is highly correlated to the job market. Also, a house is undiversified; instead, its future is tied to a single neighbourhood.
Moshe Milevsky, an associate professor of finance at the Schulich School of Business in Toronto, has a similar take. "This blind devotion to investing in a house as being a very, very good idea might not make sense when all is said and done," says Milevsky, who held off purchasing a home for his own family for some time. He believed it was not a smart way to allocate money. In fact, it flies in the face of what decades of portfolio allocation theory have shown. "It's like a stock portfolio that consists of one stock," he says. "If I could buy a house where the bedroom is in Toronto, the kitchen is in Vancouver, and another bedroom is in South America, then that's a diversified house."
But the dream of home ownership is so deeply ingrained, and the belief that real estate is the ticket to wealth so strong, that Canadians are increasingly willing to put their economic well-being on the line for the sake of four walls and a roof. This fact is reflected in the growing levels of debt. The average household in Canada now owes $96,100, according to a study released in February by the Vanier Institute of the Family, an increase of 5.7% over the past year. The same report found that mortgage debt is at a record high.
The euphoria around home ownership crowds out some of the unpleasant truths about real estate: mainly, that long-term returns are often modest at best. Some studies have found that stock indexes actually outperform housing. More worrying is that real estate prices can and do fall — and they can take a long time to recover. Canada has not been immune to severe price corrections in the past, and we could be on the verge of another one now. With interest rates set to rise and curb affordability, and with economists speculating about a bubble, staking one's entire financial future on a home is not necessarily a wise bet. In fact, a house just might be one of the most overrated investments around.
The final months of 2008 were a difficult time for Vancouver real estate agent Peter Raab. His clients simply weren't interested in buying houses, and the market was tumbling. Raab prepared for the worst, cancelling his vacation and cutting expenses. His practice slowed down so much that he didn't get a paycheque for five months. "Everyone was trying to put on a brave face. It weeded a few people out of the industry," he says. But Raab didn't have to wait long for a recovery. His business started to pick up again in March of last year, as it did for agents across the country.
A number of circumstances brought buyers back. Canadians recognized the economy was not headed for disaster, and rock-bottom interest rates were too enticing to ignore. Buyers who had been waiting for the economy to smooth out before buying have started looking again, and others who may have waited until later in the year to purchase are acting now to avoid rate increases. The effect has been compounded in Ontario and B.C., where the introduction of a harmonized sales tax in July will increase the costs around buying and selling homes. Factor in a lack of housing supply and too many buyers, and it would appear prices have shot up alarmingly in a short amount of time, sparking plenty of debate over whether homes are overvalued now, and how they'll adjust in the future.
"There's a unique confluence of factors that has driven house valuations up this sharply," says Derek Holt, vice-president of economics at Scotia Capital. "They're all temporary, and that's a house price bubble that could be pricked as we go off into the next year." The rate of growth in home prices for the past 10 years has in fact been out of line with prior decades, pointing to lofty valuations today, according to Holt. Prominent Canadians such as money manager Stephen Jarislowsky and former Bank of Canada governor David Dodge have also sounded the alarm recently on today's unusually rich home prices.
Although both federal Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney have said they do not believe Canada is in the midst of a housing bubble, they are clearly watching closely. Carney warned about rising levels of debt late last year, as the household debt-to-income ratio reached a record high of 145%. Flaherty took steps to cool the market in mid-February by changing some of the rules around government-backed insured mortgages, most notably with the provision that all borrowers now must meet standards for a five-year fixed rate mortgage, even when opting for a lower rate and a shorter term.
The change was to ensure Canadians don't take on more mortgage debt than they can handle, but impending increases to interest rates still pose a danger to recent homebuyers who took advantage of the cheap credit available over the past year. Even a one percentage point change in a mortgage rate can increase the monthly payment by hundreds of dollars, and it's unclear how homebuyers will cope down the road. A study by CIBC in December said less than 4% of Canadian households would be vulnerable to rate increases, whereas the Bank of Canada estimated the number was considerably higher, at 5.9%. But so strained do Canadians feel that a survey from the Canadian Payroll Association in September found nearly 60% of the respondents said they would have trouble making ends meet if their paycheque was delayed by even one week. This group included many first-time buyers.
Canadians are clearly more than willing to take major financial risks to buy a home. What's ironic is that real estate price gains can be somewhat of an illusion when inflation is taken into account. "People get fooled by nominal numbers," Milevsky says. Long-term returns in real terms are less than spectacular. Harvard economics professor Edward Glaeser looked at the returns in more than 300 metropolitan areas in the U.S. between 1970 and 2000 (before the unsustainable credit-fuelled boom) and found prices increased on average only 1.7% annually. Yale School of Management professor Roger Ibbotson and a colleague examined returns between 1978 and 2004, a period including part of the U.S. housing bubble, and found residential real estate provided an annualized return of 8.6%. The S&P 500 significantly topped that with a 13.4% return.
Housing in Canada hasn't behaved much differently. In 2004, Milevsky examined the compounded annual returns on residential real estate in a dozen Canadian cities over the past 25 years. Toronto provided the best return at 5.75%. But the TSX provided an 8.64% return over the same period. The S&P 500 index did even better during that period, at 13.85%. The drawback, of course, was that stock indexes were far more volatile than real estate, although in some markets, the difference was not so pronounced. Real estate in Vancouver, for example, provided only a 3.68% compounded annual return with nearly the same level of volatility as the S&P 500.
Homeowners can easily argue that while the returns are modest, at least they are building wealth rather than paying rent to a landlord. Leverage can also make a huge difference on returns for homeowners if they choose to sell. In crude terms, assume a 20% down payment on a $500,000 house that is sold a few years later for $550,000. After paying back the mortgage, the seller is left with a $50,000 profit, or a return of 50% on the initial down payment. As far as investments go, that is an eye-popping return. But leverage is damaging when prices fall. A homeowner can end up with outstanding mortgage payments worth more than the house.
There are also a slew of egregious fees associated with real estate that affect returns. There are home inspection and appraisal fees, which can total hundreds of dollars each, not to mention land registration fees, legal fees and perhaps title insurance to purchase. Real estate agents take a commission, too — expect to pay at least 2.5% of the purchase price of the home. Regular maintenance has to be done for the home to maintain its value, and that can quickly add up. Canadian personal finance authors Eric Tyson and Tony Martin say a home usually needs to appreciate about 15% in order for the buyer to recoup all of the transaction and maintenance costs.
A society of renters is also more mobile. Andrew Oswald, an economics professor at the University of Warwick in England, found that high unemployment goes hand-in-hand with high rates of home ownership. In Britain, unemployment doubled since 1950 as the share of the population that rented dropped from 60% to less than 10%. Oswald found similar relationships in other countries, such as Finland and Spain. The Netherlands and Switzerland, by contrast, had lower unemployment and a lower rate of home ownership. Oswald theorized that, while homeowners are often stuck with their property through tough labour markets, renters can more easily relocate to find work, which lessens structural unemployment. His theory has been criticized for placing too much emphasis on a causal link between home ownership and unemployment, but it does echo Fed economist Pence's concern about the correlation between home prices and the job market. Prices fall when the labour market tanks. Everyone needs financial security during those uncertain times, but for homeowners, their greatest asset won't necessarily deliver.
In December of last year, CIBC economist Benjamin Tal estimated home prices in Canada to be about 7% overvalued, which he deemed to be a "modest overshooting" that did not necessarily portend a dramatic price correction. Economists at TD Bank Financial Group put the overvaluation at 12%, adding it could rise to 15% this year as buying activity rages on. David Rosenberg, the chief economist and strategist now at Gluskin Sheff + Associates who called a U.S. housing bubble back in 2004, has a more pessimistic take. He says home prices in Canada are between 15% and 35% overvalued, and could plummet as far as 20% from current levels. "That isn't cataclysmic, but believe me, that would hurt a lot of people," he says. A drop that steep would wipe out virtually all of the gains made in the past year and could leave some Canadians who bought at the top of the market with negative equity in their homes.
Housing has undergone painful corrections in the past. The current crop of homebuyers is likely too young to remember the housing bubble that burst in 1981, and the slow recovery that followed. According to data from the Centre for Urban Economics and Real Estate at the Sauder School of Business in B.C., the average real home price in Vancouver took more than 10 years to get back to its peak, before dipping again in the mid-1990s. Calgary fared even worse. Home prices didn't return to 1981 levels until the first quarter of 2006. Toronto homebuyers experienced a similar pain when a speculator-driven bubble burst around 1989. In real terms, prices didn't recover until 2007.
A wait that long can be brutal for those who bought at the top of the market. It can also thwart retirement plans for those expecting to sell their homes and use the profits to downsize and fund their golden years, particularly if they've neglected to save by other means, such as with an RRSP. Canadians have a significant portion of their wealth tied up in real estate — roughly 48%, according to the Vanier Institute of the Family, the highest level in two decades. The fact that real estate markets do fall highlights the need for Canadians to prepare for wild swings in the economy. That message is perhaps more important than ever as the buying rush continues, and the market looks increasingly pricey. "If you're going out buying a home today, understand that you're not following the doctrine of buy low and sell high," Rosenberg says. "You're doing the exact opposite."
The problem for policy-makers — and buyers trying to figure out the best time to enter the market — is that the existence of a bubble is impossible to know for certain until it pops. Gregory Klump, chief economist for the Canadian Real Estate Association, argues we are not yet in bubble territory. "I would describe this as a micro-cycle where demand is outstripping supply," he says. Housing starts are rising, which will help to satisfy demand. Higher prices are also bringing the sellers back to the market who disappeared in 2008 when sales activity dropped, all of which will lead to a more balanced market later in the year. There are signs of optimism elsewhere, such as in the Canadian house-price forwards market operated by Teranet and the National Bank Financial Group. The market allows investors to essentially place bets on where prices are headed, and the index reflects their collective sentiment. As of January, the index showed investors expect a bump of up to 9% in residential real estate by 2014. (Those investors have been wrong before, of course; last year, the index showed a potential nosedive of more than 20%, the exact opposite of what transpired.)
Not everyone is so sanguine about the market. "We're not in a classic bubble yet, but some of the pre-conditions are certainly in place," says Douglas Porter, deputy chief economist at BMO Capital Markets. One of his concerns is that the central bank is not going to raise interest rates any time soon. Carney pledged to keep rates steady until at least mid-year, and that could mean several more months of frenzied buying. The longer home prices continue to rise out of sync with the rest of the economy, the more worrying the situation becomes. Prices have already skyrocketed while incomes have barely moved, and the home-price-to-income ratio in Canada is at its highest level since the early 1990s.
Scotia Capital economist Holt sees a few possible outcomes as the temporary factors supporting the housing market start to wane. One is a "soft landing," where activity cools gradually. The other is a rapid decline. Holt says the speed at which the market recovered since last year lessens the odds of a soft landing. "We've had four or five drivers of the housing market leading toward strong house price gains in a very short period of time, and I think they all come off simultaneously," he says. "That points to just as quick a descent." The new federal mortgage changes will cause the housing market to "turbo-charge" over the next while, according to TD Securities' chief economics and currency strategist Eric Lascelles, as buyers rush to get in ahead of the implementation date in late April. Once that day passes, the new rules become just another factor that, in Holt's view, will contribute to lower prices and sales activity in the months ahead.
Ultimately, all of the uncertainty and concern around residential real estate is likely not going to deter many people from purchasing a home. A house is much more than an investment, after all. It is firstly a place to live. Even Milevsky, the finance professor at Schulich, caved and bought a house after resisting for a while. "We have a large family, and they wanted somewhere to call their own," he says. If prices fall, a home still provides a roof over one's head, unlike a stock portfolio. The danger comes when people link the idea of a house as a home with the idea of a house as an investment, particularly if they stretch their finances with the expectation of getting rich in a few short years. "There can be long periods of time where the real appreciation of housing is negative," Milevsky says. "All of that means is caution is warranted."
Saverio Manzo
www.saveriomanzo.com
Friday, April 9, 2010
More on Gold, Silver and Base Metals
In the not to distant future I will write about the reversals of some historical correlated assets: Gold vs. the US Dollar vs. the Canadian Dollar, etc. All are performing in non-traditional ways and I'll explore why this is the case. But for today, lets see what some of the guru's are saying about PGMs:
BMO forecasts gold, silver, and PGMs to do ‘very well' next few years
BMO Capital Markets Global Commodity Strategist Bark Melek, forecasts gold and other precious metals are "projected to do very well over the next several years."
"The key drivers for the precious metals group are the U.S. dollar, the competitive currency devaluation concerns, an eventual move toward a higher inflation environment, and improvements in jewelry and industrial demand as the world pulls out of recession," Melek suggested. "The end to producer de-hedging, central bank net buying after a very long pause, and concerns that excessive U.S. and European government debt may lead to future monetization are additional key drivers for the outlook."
He also suggested there will be "considerable upward price pressure well into 2011 due to lackluster mine site production, sharply higher power costs in South Africa and a relatively high currency in producing countries."
In his analysis, Melek noted that copper has jumped 165% from its low during the bad days of late 2008 and early 2009. Lead and nickel are up 150%, zinc has jumped 125% while iron ore is up 120%. Gold has jumped about 65%, platinum 100%, silver 105% and palladium just over 190%.
George Soros Bets on Gold - Soros Fund Increases Stake in Gold ETF
Legendary hedge fund manager George Soros is double downing his bet on gold, even though he considers the market to be a bubble.
Back in late January, at the World Economic Forum, Soros called gold "the ultimate asset bubble."
He failed to mention, however, that his hedge fund had recently more than doubled its position in the yellow metal.
“We remain positive on gold’s medium- to longer-term outlook. The fundamental
factors that have underpinned the nine-year bull market for gold remain fully intact
in our view, including:
• central banks are likely to continue to be net buyers of gold as emerging
economies look to diversify their reserve holdings,
• investment demand for gold (at the institutional and retail level) should remain
strong as individuals look to diversify their positions,
• questions remain about the long term viability of the U.S. dollar as the world’s
reserve currency,
• continued improvement in the U.S. economic situation could lead to
accelerated inflation fears,
• gold mine supply remains challenged over the longer term, and:
• a recovering economy is likely to lead to increased demand for labour and
materials further challenging the cost base to produce an ounce of gold”
INDUSTRIAL COMMODITIES TO PERFORM VERY WELL
BMO Research expects industrial commodities "to perform very well into 2011, with most prices above the 2009 levels.
Copper, iron ore and met coal are BMO's top industrial commodity picks, based on strong demand in China coming from fixed asset and export growth. Melek suggested demand for copper and other metals and bulks (iron ore, metallurgical coal) will move higher) "due to increased global industrial (U.S., Europe and Japan) production activity and firm capital spending."
The future's hot for lithium - and getting hotter
Lithium is not just a flavor of the year. It is in high demand for hybrid and electric vehicles, laptops, cell phones and will remain even more so as technology is perfected and consumer demand increases globally.
Saverio Manzo
BMO forecasts gold, silver, and PGMs to do ‘very well' next few years
BMO Capital Markets Global Commodity Strategist Bark Melek, forecasts gold and other precious metals are "projected to do very well over the next several years."
"The key drivers for the precious metals group are the U.S. dollar, the competitive currency devaluation concerns, an eventual move toward a higher inflation environment, and improvements in jewelry and industrial demand as the world pulls out of recession," Melek suggested. "The end to producer de-hedging, central bank net buying after a very long pause, and concerns that excessive U.S. and European government debt may lead to future monetization are additional key drivers for the outlook."
He also suggested there will be "considerable upward price pressure well into 2011 due to lackluster mine site production, sharply higher power costs in South Africa and a relatively high currency in producing countries."
In his analysis, Melek noted that copper has jumped 165% from its low during the bad days of late 2008 and early 2009. Lead and nickel are up 150%, zinc has jumped 125% while iron ore is up 120%. Gold has jumped about 65%, platinum 100%, silver 105% and palladium just over 190%.
George Soros Bets on Gold - Soros Fund Increases Stake in Gold ETF
Legendary hedge fund manager George Soros is double downing his bet on gold, even though he considers the market to be a bubble.
Back in late January, at the World Economic Forum, Soros called gold "the ultimate asset bubble."
He failed to mention, however, that his hedge fund had recently more than doubled its position in the yellow metal.
“We remain positive on gold’s medium- to longer-term outlook. The fundamental
factors that have underpinned the nine-year bull market for gold remain fully intact
in our view, including:
• central banks are likely to continue to be net buyers of gold as emerging
economies look to diversify their reserve holdings,
• investment demand for gold (at the institutional and retail level) should remain
strong as individuals look to diversify their positions,
• questions remain about the long term viability of the U.S. dollar as the world’s
reserve currency,
• continued improvement in the U.S. economic situation could lead to
accelerated inflation fears,
• gold mine supply remains challenged over the longer term, and:
• a recovering economy is likely to lead to increased demand for labour and
materials further challenging the cost base to produce an ounce of gold”
INDUSTRIAL COMMODITIES TO PERFORM VERY WELL
BMO Research expects industrial commodities "to perform very well into 2011, with most prices above the 2009 levels.
Copper, iron ore and met coal are BMO's top industrial commodity picks, based on strong demand in China coming from fixed asset and export growth. Melek suggested demand for copper and other metals and bulks (iron ore, metallurgical coal) will move higher) "due to increased global industrial (U.S., Europe and Japan) production activity and firm capital spending."
The future's hot for lithium - and getting hotter
Lithium is not just a flavor of the year. It is in high demand for hybrid and electric vehicles, laptops, cell phones and will remain even more so as technology is perfected and consumer demand increases globally.
Saverio Manzo
Thursday, April 1, 2010
Our Economy: Will the Growth Continue?
Like with any good "capitalist society", its takes a good blend of multiple conditions working hand-in-hand, harmoniously, so as to give us the opportunity to proposer, and to see and have our standard of living increase over time, for ourselves and for our children.
After a horrendous 2008 and beginning to 2009, the past few quarters in Canada are proving to lay the continued foundation for our society to prosper. Will this continue or is it a result 'all that government spending'?
Economy off to a roaring start in 2010, GDP records highest gain in three years
From Julian Beltrame, The Canadian Press, March 31, 2010
OTTAWA - The Canadian economy bolted out of the gate with its strongest performance in three years in January, with robust activity cited in factories, at construction sites, in mines and the oil patch.
The 0.6 per cent advance in the country's gross domestic product will have significant impact on everything from jobs, to interest rates and even government deficits if its a sign of things to come, economists say.
The dollar, which was up all day, closed up 0.35 cents at 98.44 cents U.S.
It was especially good news for Canada's battered manufacturing sector, which gained 1.9 per cent on the month. This week, both Honda and General Motors announced plans to hire more workers.
"The main message is that the economy has been a lot stronger than even the biggest optimists could have hoped for," said Douglas Porter, deputy chief economist with BMO Capital Markets.
"The economy has risen at better than a five per cent pace the past six months now...that's the best six months since the very height of the tech boom in early 2000," Porter said.
Porter says it likely means Bank of Canada governor Mark Carney will almost certainly raise interest rates in July and could move even sooner. And when he does, it may be a half-point hike that would push mortgage rates higher.
There are also implications for Ottawa's estimated $49-billion deficit this fiscal year, which was based on a 2.6 per cent growth rate. It now could be bettered by a full point, which would mean government revenues will rise and costs, for such things as unemployment benefits, will fall.
Finance Minister Jim Flaherty couldn't resist a shot at Liberal Leader Michael Ignatieff, saying that while Canada is "not out of the woods," the numbers show the government's policies are working.
"We need to stay the course ... and unlike the leader of the Opposition, we're not going to kill jobs by raising taxes," he told the House, a reference to Ignatieff's proposal to delay business tax cuts.
Stronger growth will likely also result in demand for more workers. In another strong economic report issued Wednesday, Statistics Canada said the total hours worked by payroll employees increased 0.3 per cent in January, a precursor to job gains.
A big question remains, however, about what happens with the recovery in the United States, since about three-quarters of Canadian exports head south.
But even there, there was an encouraging signal with the U.S. reporting a strong pick up in factory orders, following an upward revision for the previous month.
"No ifs, ands, buts or excuses," said Scotia Capital economist Derek Holt. "The V (shaped recovery) is even more alive at U.S. factories than previously thought."
Such robust growth coming out of recession is what historically happens as pent up demand, combined with the arithmetic of a smaller baseline, inflates growth numbers. But it wasn't supposed to happen this time because of the continuing uncertainty over the viability of the global financial system and the belief that U.S. consumers were tapped out.
In an interview, Bank of Canada senior deputy governor Paul Jenkins suggested growth may just be getting advanced by extraordinary government stimulus and low interest rates, as well as temporary factors. In other words, the surprisingly strong numbers may not last.
"When you've got that type of stimulus at play, particularly at turning points ... you can get more demand pulling forward," he said.
In January, the Bank of Canada estimated fourth-quarter growth for 2009 would come in at 3.3 per cent, while predicting first-quarter growth for 2010 at a slightly higher 3.5 per cent. The fourth quarter actually turned in a five per cent performance and economists now project the first quarter at between five and six per cent.
In the last five months, the economy has already recouped more than half of its recession losses, with output now up by 2.7 per cent from last May's low.
The rebound has surprised economists, given that the U.S. economy, although it has posted impressive GDP numbers as well, remains in the dumps in the area that impacts Canada most, consumer spending. As well, the U.S. has yet to stop bleeding jobs, while Canada has gained 160,000 since July.
Queens University economics professor Thorsten Koeppl credits the strong performance to the resilience of Canadian households, which have not been hit by a major loss in net worth given that house prices have held. In turn, Canadian consumers appear to be optimistic enough to fuel domestic spending.
But while short-term prospects appear strong, economists also cautioned that, longer-term, things are not quite as rosy.
CIBC analyst Krishen Rangasamy noted manufacturing is getting a one-time bump from the restocking of inventories in the United States. With American stimulus spending receding, a slowdown in the latter half of 2010 in the U.S. would also likely have an impact on Canada.
As well, with each good economic report in Canada, the loonie gains in strength, setting the stage for pain in the export sector later on.
There also remains major weaknesses in the Canadian economy. The output gap is still about two per cent below capacity and employment, while improving, is about 260,000 jobs lower than where it stood in October 2008, and that doesn't account for population growth.
But Porter also offers some reason for optimism. Just as it was not written in stone that the first half of 2010 was going to come in like a lion, there is no guarantee the second half will go out like a lamb, he said.
"I don't think it's a foregone conclusion things will taper off so adversely in the second half of the year," he said. "One has got to be impressed with what is going on in manufacturing, and there's lots of room for manufacturing to grow still."
Saverio Manzo
saveriomanzo.blogspot.com
After a horrendous 2008 and beginning to 2009, the past few quarters in Canada are proving to lay the continued foundation for our society to prosper. Will this continue or is it a result 'all that government spending'?
Economy off to a roaring start in 2010, GDP records highest gain in three years
From Julian Beltrame, The Canadian Press, March 31, 2010
OTTAWA - The Canadian economy bolted out of the gate with its strongest performance in three years in January, with robust activity cited in factories, at construction sites, in mines and the oil patch.
The 0.6 per cent advance in the country's gross domestic product will have significant impact on everything from jobs, to interest rates and even government deficits if its a sign of things to come, economists say.
The dollar, which was up all day, closed up 0.35 cents at 98.44 cents U.S.
It was especially good news for Canada's battered manufacturing sector, which gained 1.9 per cent on the month. This week, both Honda and General Motors announced plans to hire more workers.
"The main message is that the economy has been a lot stronger than even the biggest optimists could have hoped for," said Douglas Porter, deputy chief economist with BMO Capital Markets.
"The economy has risen at better than a five per cent pace the past six months now...that's the best six months since the very height of the tech boom in early 2000," Porter said.
Porter says it likely means Bank of Canada governor Mark Carney will almost certainly raise interest rates in July and could move even sooner. And when he does, it may be a half-point hike that would push mortgage rates higher.
There are also implications for Ottawa's estimated $49-billion deficit this fiscal year, which was based on a 2.6 per cent growth rate. It now could be bettered by a full point, which would mean government revenues will rise and costs, for such things as unemployment benefits, will fall.
Finance Minister Jim Flaherty couldn't resist a shot at Liberal Leader Michael Ignatieff, saying that while Canada is "not out of the woods," the numbers show the government's policies are working.
"We need to stay the course ... and unlike the leader of the Opposition, we're not going to kill jobs by raising taxes," he told the House, a reference to Ignatieff's proposal to delay business tax cuts.
Stronger growth will likely also result in demand for more workers. In another strong economic report issued Wednesday, Statistics Canada said the total hours worked by payroll employees increased 0.3 per cent in January, a precursor to job gains.
A big question remains, however, about what happens with the recovery in the United States, since about three-quarters of Canadian exports head south.
But even there, there was an encouraging signal with the U.S. reporting a strong pick up in factory orders, following an upward revision for the previous month.
"No ifs, ands, buts or excuses," said Scotia Capital economist Derek Holt. "The V (shaped recovery) is even more alive at U.S. factories than previously thought."
Such robust growth coming out of recession is what historically happens as pent up demand, combined with the arithmetic of a smaller baseline, inflates growth numbers. But it wasn't supposed to happen this time because of the continuing uncertainty over the viability of the global financial system and the belief that U.S. consumers were tapped out.
In an interview, Bank of Canada senior deputy governor Paul Jenkins suggested growth may just be getting advanced by extraordinary government stimulus and low interest rates, as well as temporary factors. In other words, the surprisingly strong numbers may not last.
"When you've got that type of stimulus at play, particularly at turning points ... you can get more demand pulling forward," he said.
In January, the Bank of Canada estimated fourth-quarter growth for 2009 would come in at 3.3 per cent, while predicting first-quarter growth for 2010 at a slightly higher 3.5 per cent. The fourth quarter actually turned in a five per cent performance and economists now project the first quarter at between five and six per cent.
In the last five months, the economy has already recouped more than half of its recession losses, with output now up by 2.7 per cent from last May's low.
The rebound has surprised economists, given that the U.S. economy, although it has posted impressive GDP numbers as well, remains in the dumps in the area that impacts Canada most, consumer spending. As well, the U.S. has yet to stop bleeding jobs, while Canada has gained 160,000 since July.
Queens University economics professor Thorsten Koeppl credits the strong performance to the resilience of Canadian households, which have not been hit by a major loss in net worth given that house prices have held. In turn, Canadian consumers appear to be optimistic enough to fuel domestic spending.
But while short-term prospects appear strong, economists also cautioned that, longer-term, things are not quite as rosy.
CIBC analyst Krishen Rangasamy noted manufacturing is getting a one-time bump from the restocking of inventories in the United States. With American stimulus spending receding, a slowdown in the latter half of 2010 in the U.S. would also likely have an impact on Canada.
As well, with each good economic report in Canada, the loonie gains in strength, setting the stage for pain in the export sector later on.
There also remains major weaknesses in the Canadian economy. The output gap is still about two per cent below capacity and employment, while improving, is about 260,000 jobs lower than where it stood in October 2008, and that doesn't account for population growth.
But Porter also offers some reason for optimism. Just as it was not written in stone that the first half of 2010 was going to come in like a lion, there is no guarantee the second half will go out like a lamb, he said.
"I don't think it's a foregone conclusion things will taper off so adversely in the second half of the year," he said. "One has got to be impressed with what is going on in manufacturing, and there's lots of room for manufacturing to grow still."
Saverio Manzo
saveriomanzo.blogspot.com
Subscribe to:
Posts (Atom)