Living in a Microcosm of the Housing Bubble

Since 2009, I’ve harped about Canada’s housing bubble. I’m not new to the party. Americans have already been to the bottom of this rollercoaster.

The housing bubble is at its most grotesque and obvious in the condo market. In Toronto, developers have been literally throwing up these dog-kennels-in-the-sky, and commanding hundreds of thousands of dollars for units. Some even come with exploding balconies!

There are over 170 condo buildings under construction in Toronto. NYC has less than 100 buildings under construction. That means Toronto, at today’s insane sales rate, has over a five year supply of condominiums. Looks a lot like Miami, to me.

I could harp about the Price:Income ratio which is at an all-time high. The Price:Rent ratio is also record-setting. No market has ever survived such conditions without an eventual devastating price drop. It’s economic fact.

But I’d rather tell you about a microcosm of the housing bubble.

Living in a Dog Kennel in the Sky

I rent a unit in a brand new building. When I moved in, the building hadn’t yet registered. I rent a unit that was being sold for over $250,000. If you include Harmonized Sales Tax, it’d be around $300,000. But the weird thing is that I live in Scarborough, which is kind of Toronto’s industrial wasteland (to use a polite analogy that doesn’t refer to bodily orifices). The building is not downtown, but my work is; the commute takes about 45 minutes on the TTC, each way.

The building is brand new, yet it’s had its share of problems.

The A/C and Heat system in our unit and many others can not, running at full power, keep the unit at room temperature. This problem was “addressed” during the summer. We were instructed to turn off the unit’s breaker and turn off the power box in the unit. Neither resolved our issue.

A leaky roof caused an all-night fire alarm in the summer. I watched as the alarm repairperson opened the smoke detector on the top floor and water poured in. Is the problem limited to only the hallway on the top floor? Sure… There was also a garage flood in the fall, which required the builder to tear up a swath of the parking lot. Plus there’s leaky windows in the unit. Here’s a real picture; a similar mess had been cleaned up just a few days before and it had already returned. I’ve heard complaints from other residents about similar issues.

Oh did I mention the building has glass walls? Glass walls have inert gases inside them, to provide insulation. These gases leak out. Inside a decade, the building’s exterior glass surfaces might not have any meaningful insulation value without expensive and intrusive interventions. Glass-walled condos are what the CBC called “Throwaway Buildings”. Glass-walled condos have “…an average shelf life… of only 15 to 20 years, provoking a massive new problem of how to retrofit them when the glass starts to fog and condensation leaks inside.” Really? It takes 10 to 15 years for condensation to leak in? The windows here could have fooled me.

There are only two elevators for a building of hundreds and hundreds of people. One elevator was shut down for days for repairs. The doors squeal when they open and close.

The living room floor is warped, and no, my level is not wrong nor does my warped mind affect the laws of thermodynamics.

The building’s units have “low” maintenance fees of just $150 or so a month. Some units already have fees of over $200 a month. With issues per above, how long will the fees stay low? Even well-built buildings have a limited life span. Look at the fees for most non-new condos – they exceed $300 a month. Many are $500, $600, even $700. Don’t try to tell me that these are headed south in the long run. With condo fees like those, who needs rent? Just buy yourself a $300,000 noose that costs you a grand a month beyond the mortgage!

I could get into the issues of “moral hazards” and “tragedy of the commons” to discuss why a condo building is inferior to a managed apartment rental building, but let’s leave that for another day.

What does it really cost?

A $300,000 mortgage, at a low variable rate of 2%, costs about $1164 a month (let’s imagine the CMHC fee of $10,000 and the closing costs of $5000 get added into the mortgage to avoid considering the investor’s cost-of-capital). Add in $100 a month for electricity (which includes heat and AC) and you’ve already arrived at what I pay for inclusive rent. Don’t forget the “low” $150 a month condo fee that could *never ever* go up.

Can the flippers flip?

OK, so this hypothetical “investment” would only cost the hypothetical “investor” over $100 a month. He or she will make it back on the sale, right?

Oddly enough, lots of flippers have gotten into the condo bubble. My ‘lil building of tiny 700-square foot “luxury” units is no different.

I moved into the building in 2011. At the time, only a few units were left. A funny thing happened in the second half of 2011.

No units got sold according to the above chart and, if the last few units did, they certainly didn’t get it registered. This is in a brand new building. And then, as soon as the condo building registered in early 2012 (should it take two years for a condo to get registered?) an even funnier thing happened. At least eight units were immediately posted on MLS. (There may be even more for-sale units that aren’t listed on MLS. We’ve seen a “For Sale by Owner” door sign and posters on the building’s bulletin boards).

All of these ads picture empty units, except one – which was clearly professionally staged. Many of these ads boast of “Never Been Lived In” units (a.k.a. we haven’t been able to rent them and now we’re trying to dump them).

Some ads boasted of a “steam room” amenity. If the “investors” or their “professional” two-week-course Realtors had stepped foot inside the building, they’d know the builder abandoned the steam room and put in a library instead.

And every unit is UPGRADED to include free stainless steel appliances and granite countertops?? Wow! It’s like the builder got discounted stainless steel appliances in bulk and offered them as a “special incentive” package to all of the brilliant “investors” who wanted to flip dog-kennels-in-the-sky. I laughed even harder at the ads that didn’t mention the stainless steel appliances – as though the Realtor could pull out this “freebie” as a huge bargaining chip to incentivize a bidding war. If my unit is upgraded, I don’t want to see one that isn’t.

I haven’t heard of any of these units selling yet. Maybe these “investors” will find their greater fool. Given the current market, it’s entirely possible.

At some point, however, somebody either (1) needs to live in the unit, or (2) needs to rent out the unit for positive cash flow. The former would enslave the owner to debt servitude and the latter is impossible at these insane prices.

When Financing Regresses to the Mean

Speaking of renting the unit out for positive cash flow: my analysis has thus far ignored the “regression to the mean” of interest rates. This is to say that interest rates will inevitably go up. Between 1990 and 2010 (not a stellar time for high rates) the average was 6.12%. If – actually, when – rates return to the mean, the monthly mortgage payment becomes about $1900. Suddenly the unit costs $2150 a month. Only $850 a month in loses, with no greater fool to whom one can sell the unit? What a great investment! All of this assumes that there’s no multi-million dollar replacement of glass walls or leaky roofs or general inflation in the maintenance fee, or a run-up in electricity prices.

Don’t expect to make up for the shortfall with tax savings. The interest portion of your mortgage is deductible, but not the principal component. Uh oh.

Just to pre-empt you: no, rents will not increase to reflect this surge in costs. Why? Rents have not increased anywhere near enough to fully incorporate the run-up in Toronto’s housing market and they won’t. There’s no creative financing available for renters, amongst other reasons.

Miami is a Nicer Place to Live than Toronto

The condo market brutally collapsed in Miami. We’re talking price drops of well over 50%. And Miami is actually a nice place to live. You can buy a well-built nice condo in Miami for under $100,000, with low maintenance fees and negligible utilities (down there a kWh doesn’t have the cost of green energy stimuli tacked on to it). There are also fantastic customer service-oriented property managers that cater to snowbirds.

In Miami, rents did not skyrocket to match the over-leveraged housing market’s obscene prices. Prices eventually returned to reality and matched rents.

Another P.S.: in America, you can get a 30-year mortgage. No, not a 30-year amortization. A 30-year interest term. It’s fixed for three decades. The rates aren’t even bad – in the neighbourhood of 4%. In Canada, the maximum you can get is about 10 years and the rates are obscene. See what happens when the taxpayer insures a bank’s investment, regardless of default? It means the banks have zero incentive to prevent defaults. They’ll make their money anyways whether it’s the borrower or the taxpayer footing the bill. There’s no disincentive, so they capitalize on flippers’ greed by giving them high interest, short term mortgages.

Why must Toronto’s condo market defy economic logic in perpetuity? The answer is that it won’t. Canada has nothing but land and an atrocious unemployment rate (particularly when you factor in the realities of underemployment, the trend towards part time work, and decreases in high-wage sectors). The PetroDollar has destroyed our once-great province. This bubble is being driven by low interest rates and speculators’ greed. It will pop when rates go back up, or perhaps sooner (such as when flippers get stuck with unsellable units and realize they can’t rent them for positive cash flow, resulting in panic-dumping. We’ve seen many ‘for-rent’ posters in this building for units in this building. Yes, you read the last sentence correctly and it wasn’t redundant. One ad asked for $1600 plus hydro and another tried to command $1800 a month. Talk about trying to hopelessly cover your sunk costs. Leaving an expensive rental unit empty is definitely throwing good money after bad. In psychology they call it the commitment heuristic. Good luck!).

Despite what the Realtors and flippers want to believe, it’s not different this time.

As I said, at some point, somebody needs to live in the unit, not just re-sell it. It either needs to be leased for positive cash flow (impossible in the given market) or inhabited by the owner. The latter has no interest in living in an overpriced slapdash building that leaks. At least not the ones with common sense. We’ll see how long the Canadian Greater Fools keep destroying their lives.

The only thing different is that, in this bubble, more people bought into the lies and more lives will be ruined. I’m just glad that I can end a lease and walk away.

Bubbles are the result of speculative excess. Speculative excess is driven by greed.

Greed will result in winners and losers. It’s not an expanding pie of profit; bubbles are, at their peak, a fixed sum game. Some make it out with profits; realtors, mortgage brokers, and successful flippers among them. Others are left destitute. I just hope the losers aren’t young families.