The shocking truth about the value of your home

New evidence shows that Canadian prices could go down, and stay down, for a decade

The shocking truth about the value of your home

There are still people out there who don’t believe Canada is about to be hit by a devastating housing crisis, but Riaz Kassam isn’t one of them. For him, the crisis has already arrived.

Last July, he made an $80,000 pre-sale payment on a $1.5-million penthouse condominium in Vancouver’s tony H&H Yaletown building, just a few blocks away from where he lives. Kassam, a 42-year-old computer analyst, who’s married with no kids, expected to move in by the end of 2008. But when he put his current apartment on the market, he didn’t get a single offer. He thought maybe he had priced it a little high, so he knocked a bit off. Still, no offers. He lowered it again, and again, until eventually he was offering his apartment for a full $120,000 less than his initial asking price. That’s when he realized he was in trouble. “We reached the point where we couldn’t drop the price any more,” he says, “or we wouldn’t have enough for the down payment on the new property.”

He was caught between a rock and a hard place. Nobody would buy his condo, and therefore he didn’t have enough money for the down payment on the condo he’d already agreed to buy. “We told them that we can’t complete, we can’t sell our place, and we’d just have to forfeit our $80,000.”

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Painful enough, but it was only the beginning. Kassam discovered that even if he had sold his old apartment, his bank “wouldn’t even consider” giving him a $1.5-million mortgage for his new place. Prices in Vancouver had been plummeting, and in just a few months, the assessed value of his new place had fallen to roughly $1.2 million—and his bank wouldn’t issue a mortgage for more than the property was worth. Meanwhile, the condo developer was finding that it couldn’t sell its units either, at least not for anything close to the $1.5 million Kassam had agreed to pay. So it held a “blow-out sale,” offering units for as much as 40 per cent off the original listed price. Kassam’s unit wasn’t one of them, but the sale made it clear that his penthouse was worth even less than $1.2 million. Shortly after Christmas, the developer told him he was liable for the difference. He had signed a pre-sale agreement saying he would buy that condo for $1.5 million, they reminded him, and they reserved the right to pursue him for the drop in that condo’s value. Which means they’re probably not just going to keep his $80,000 deposit. They’re probably going to come after him for more than $300,000.

Kassam thought he’d be settled into his gorgeous new penthouse by now, but instead he’s still at his old place, facing a long and expensive court battle with the Bowra Group, owner of the H&H Yaletown. He’s planning to strike first, with a lawsuit alleging that the developer didn’t deliver his unit on time, but he’s not sure he’s going to win. If he doesn’t, “our nightmare begins,” he says. “It’s going to be devastating if we have a judgment against us.”

Kassam is just one of thousands of people getting buried in the rubble of Vancouver’s collapsing prices; a dream market has turned into a nightmare, faster than anyone thought possible. For over a decade, the real estate industry has pumped out glowing reports, detailing the latest surges in prices and transactions, and predicting nothing but blue skies ahead. The heady combination of a strong economy, urban renewal and low interest rates triggered a stampede into houses and condos. Now the boom is shifting into reverse, and economists are warily backing away from their sunny predictions, and grappling with a question no one has posed for 20 years: how bad is it going to get? It’s becoming increasingly likely that the answer to that question will be “even worse than you imagined.”

The H&H Yaletown has now sent out several warning letters to buyers in retreat. Another developer, the Onni Group, is actively suing at least 20 purchasers of its Aria 2 development in Port Moody for backing out of their pre-sale agreements. Real estate developer Amacon is suing seven purchasers of its Morgan Heights development in Surrey for the same. Condo fire sales are raging—the Onni group has been taking out full-page ads in the local papers trumpeting “Vancouver’s largest real estate liquidation event”—and John White, a Vancouver lawyer representing several retreating buyers, says he now gets about “two or three calls a day” from people who have issues with their contracts.

“No one even came close to realizing the impact of this crisis,” Kassam says. Back when he signed the pre-sale agreement, he was following the news, and “they said the real estate market was slowing down, but they were only predicting maybe a one or two per cent drop in property values—nothing to this extent.” But Kassam has learned that you shouldn’t always believe what you read in the papers and what the economists say on TV. Especially now, because despite the carnage in Vancouver, many economists and real estate groups are still predicting that we’ll have just a little stumble—maybe a drop of three to eight per cent in prices—and then the market will roar back to life by the end of the year. But new data on the plunging housing market suggests that those relatively upbeat assessments are wrong, and Canada could see a 20 per cent drop in average house prices between now and late 2011. If sophisticated investors are correct, it might be close to a decade before we once again see prices as high as they were last summer.

A bout a year ago, Simon Côté, managing director of property derivatives at National Bank, had a bright idea. He noticed that the market let investors bet their money on oil futures, bond futures, even canola futures, but there wasn’t a way to bet on the future prices of Canadian houses. So he decided to launch a whole new market, one that, among other things, would allow investors who think they know where the housing market is going to put money on it. If they thought house prices would go up by five per cent in a year, while others thought prices would go down, they could buy a contract saying so, and if they were right, they could rake in huge profits. The market would also be useful for investors who wanted to hedge against falling house prices. By buying contracts that paid out if house prices declined, they could help to recoup any money they lost in the housing market.

In conjunction with the forward market (like a futures market, but with contracts sold over the counter), National Bank also launched the Teranet-National Bank House Price Index, which tells us where house prices are at right now. The index uses data from Teranet, a respected but little-known company that manages the land registry database for the government of Ontario. Because every house sale in the province must be entered in the database by law, and Teranet has agreements with other provinces to access their data, Côté says the company’s numbers are much more “robust” than the house price data economists currently use. Because much of that current data comes from the real estate industry itself, the Teranet data can boast of coming from a more unbiased source as well.

When the Teranet market started up in December, it immediately predicted a shocking drop of 20 per cent, followed by an excruciatingly slow recovery that might not see prices return to last year’s high for seven years, or longer. It’s still young and thinly traded, but the Teranet market outlook is startlingly different from what most economists see. Last week, for instance, the Canadian Real Estate Association (CREA) predicted a drop of just eight per cent in 2009, followed by a speedy recovery that would see prices starting to edge up again in 2010. Most banks and investment firms (with the exception of Merrill Lynch Canada, which predicted a more significant drop followed by a slow recovery) fell into line with similar predictions of drops between eight and 12 per cent.

Just six months ago, the Canada Mortgage and Housing Corporation (CMHC), the government agency that insures billions of dollars worth of Canadian mortgages, predicted that we would actually see an increase in house prices of almost three per cent in 2009. It has since backtracked dramatically, issuing a new forecast three months later predicting an increase of just 0.1 per cent. Another revision was scheduled for last week, but the agency cancelled the release at the last minute, saying that the data needed more analysis than expected. They set a new date for the release, but they missed that date too. “Conditions in the housing markets really have been changing,” CMHC’s chief economist Bob Dugan says. “So we’ve been doing a series of revisions to our forecasts.” He says their latest figures now show that housing prices will go down in 2009. But that doesn’t mean he sees any real cause for concern, despite January’s largest-ever single-month job loss figures and our faltering GDP. “When I look at the economy as a whole,” he says, “I don’t really see the smoking gun.” He’s been scanning the numbers and just can’t see “the big scary indicators that say things are going south really terribly.” So he also predicts just a little dip followed by a quick recovery. “We think that house price growth is going to catch again during the year,” he says. “So year over year, you’ll see a decrease when you compare 2009 to 2008, but we think that during the year, prices will start to increase again.”

The sunniest forecast of all comes from Royal LePage, a national real estate company. In a recent release entitled “Correction, not crash for Canadian real estate market in 2009,” Royal says there will be a minor slip of three per cent, then “consumer confidence is anticipated to recover, prompting real estate activity to pick up once again in the latter half of 2009.” Phil Soper, the CEO of Royal LePage, says when you look at both prices and the volume of houses being sold each month, the market has already been declining since the end of 2007, so we’re due for a recovery soon. “We’ll hit bottom in about mid-year,” he says. “We believe that things will flatten out in the third quarter, and the recovery will begin for housing towards the end of the year.” He rejects the idea that the industry burnishes its predictions. “I can say absolutely that it does no one in the real estate industry any good to forecast home prices higher than the reality.”

So who’s right? The economists predicting a brief setback, or the futures market investors who see years of decline? Robert Shiller is an economics professor at Yale University and an internationally acclaimed expert on housing markets. He is one of the creators of the S&P/Case Shiller Home Price Index in the U.S.—one of the world’s most closely watched measures of real estate values. He says it looks like we’re in for the long decline. “I’d go with the futures market,” he says. “That’s called putting your money where your mouth is.”

Shiller says that when the U.S. market peaked in 2006, he saw the exact same situation we’re now seeing in Canada. Like us, the U.S. had just launched a futures market, and it was telling a drastically different story from the one the economists were pushing. “At first our market specialist thought the market would go up, but he immediately lost a lot of money,” says Shiller, “because the people trading on the market kept predicting declines. And ever since then, they have continued to predict declines.” Meanwhile, the economists were still talking of increases, or at worst, a minor correction. “The National Association of Realtors had economists that were boosting the market all the time, and doing everything they could to get people in,” says Shiller. “Their chief economist, David Lereah, even wrote this dreadful book called Are You Missing the Real Estate Boom? He wrote that in 2005, just before the peak.”

Shiller says that futures markets are better predictors because while the predictions made by CMHC, for instance, represent the opinions of one or two economists, the predictions made by a futures market represent the combined best guesses of many investors who are so convinced of their forecast, they’re willing to literally bet money on it. As New Yorker writer James Surowiecki detailed in his bestselling book The Wisdom of Crowds, such prediction markets tend to be more accurate than individual predictions, both because they are less biased and because the collective wisdom they draw upon is more powerful than any one economist’s best guess.

Even when you look at the quality of the underlying data itself, the Teranet numbers come out ahead of what the economists are working with. The National Bank’s Côté says he originally didn’t want to produce a housing index at all. If there had been a reliable source for Canadian housing data already, he says he would have likely just used that. But it turned out that the only comprehensive data for resale home prices in Canada came from CREA, the national organization supporting the real estate industry.

Unfortunately, the CREA numbers had problems. “There was a lot of cleaning on their data to be done,” he says. “Their data is actually physically inputted by real estate agents as they sell the houses. And obviously, as a real estate agent, it’s in your best interest to show that prices are not falling too much because that’s how you make your living.” He was also nervous about the fact that CREA depends on the co-operation of real estate boards across the country to gather the data, and some weren’t thrilled about taking part.

So, he went with the Teranet data instead, and then he one-upped CREA, which did not respond to interview requests from Maclean’s, by adopting a more rigorous number-crunching methodology too. Like the Case Shiller index, the Teranet data tracks the resale prices of individual single-family houses in selected metropolitan areas, while CREA uses Canada’s Multiple Listing Service (MLS) to add up all the money spent on houses in a given area, then divides it by the number of houses sold. Côté says the real estate industry’s data can be misleading because cities that have a higher level of sales activity have a disproportionately large influence on the national average. In other words, if there’s more sales activity in Calgary than there is in Ottawa one month, then the higher prices in Calgary will tilt the numbers up, even though there are roughly the same number of homes in each city.

Beyond the quality of the data, Shiller says there’s another, more common-sense reason why you should trust the futures market over what the real estate economists tell you: the Teranet investors aren’t trying to sell you houses, and the real estate agents are. “The predictions from those guys are very biased,” he says. “They know that in a declining market, the volume of sales falls dramatically and real estate agents lose their jobs. So they don’t want to say anything that could be seen as contributing to a falling market. If their economist predicted a decline in the market—and then it happens—that’s deadly. The guy would have to watch out for his life.”

That’s part of the reason why David Lereah, the chief economist for the U.S. National Association of Realtors (NAR), kept pumping out the optimistic outlooks. He has since complained publicly about the pressure he was put under by his bosses at the NAR to toe the line. Now the U.S. is mired in the worst housing crash the country has ever seen, and Lereah has been discredited. He’s left his job at the NAR, lost millions in his own real estate portfolio, and he has been largely ostracized by his former colleagues.

We shouldn’t smugly assume that the same couldn’t happen here. One of Canada’s top economists, who spoke on condition of anonymity, says that he questions a lot of the numbers coming out of the real estate sector in Canada. “There’s clearly a lot of spin,” he says. Even the CMHC, which promotes home ownership and depends on home sales to sell mortgage insurance, has an interest in seeing the market prosper. “There is quite a lot of uncertainty regarding the market in general right now, and there are too few uninterested parties who are giving any sort of reasonable analysis on that outlook.”

That leaves just one question: if the Teranet futures market is right, and house prices are about to embark upon a long, slow decline followed by an anemic recovery, what will that mean for Canada? On the positive side, it will mean thousands of families who can’t currently afford houses may gradually see them fall within reach. But the negative fallout will be painful, long-lasting and will touch us all. It will mean more lawsuits against people like Riaz Kassam, who get trapped by tumbling prices. It will mean a huge drop in the wealth of millions of Canadians, as their biggest investment slowly sinks in value. It will mean consumers clamping down on their spending because they feel poorer, contributing to the general economic decline.

Shiller says it’s the inevitable end to a truly wild ride. “We’ve never before had this all-pervading belief that I can buy a house in any city and prices will just keep going up,” he says. “This cultural change helped to bring on the world’s largest housing bubble, and that outlook has invaded Canada, just as it has other countries.” It’s time to brace yourself, he says, because that bubble has popped. Over the coming years, houses will cease to be speculative investments, and will simply become places to live again. Shiller says it’s a necessary correction, but that doesn’t mean the process will be a pleasant one. “We may be in for a bad recession,” he says, “and we may not see the markets perform well for a long time.”