Baseball’s legendary Yogi Berra is credited with our headline’s déjà vu quotation. It means: “We’ve seen this before.”
The real estate industry released some great numbers this week. Home sales have increased by 87% over last January’s depressed levels and prices have gone up by 15% to 20%. For homeowners and real estate speculators, this is welcome news. Or is it? Is there more to this story than the collective sigh of relief of two thousand real estate agents? Let’s look more closely.
What’s happened so far?
1. Many investors are fed up with the stock market after the 2008-09 crash when market averages dropped 50% in only nine months. Many fed up investors turned to real estate for something more wholesome, less risky.
2. The stock market crash was followed by a world banking crisis, a crisis in corporate America and the continuation of the US junk mortgage crisis. These crises triggered a massive drop in interest rates, including mortgage rates.
3. These two factors combined to give us the flurry of real estate activity that was reported this week. Volume of sales is up and prices are up.
Has this ever happened before? Remember the late 1980s?
1. After the 1987 stock market crash, many investors became fed up with the stock market. They turned to real estate for something more stable, less risky.
2. The 1987 crash was followed by a US ‘Savings and Loan’ crisis. [In the USA they refer to trust companies as ‘savings and loan’ companies.] And that crisis was followed by a junk bond crisis. Those crises triggered a huge drop in interest rates, including mortgage rates.
3. These two factors caused an increase in both volume of sales and house prices.
4. In late 1988 early 1989, there was an up-tick in interest rates, including mortgage rates. This triggered a rush to buy houses – that rush to buy resulted in an even greater flurry of sales and house price increases.
5. In April 1989 a hush settled over the real estate industry. The top of the cycle was in.
6. House prises dropped and did not start up again until 1996. The world’s biggest real estate company, the Reichmann brothers’ Olympia and York, went broke. Construction was stopped on the monolithic office tower between Bay and Yonge Streets in Toronto [just south of The Bay]: the unfinished building stood there for years. The game was over. It took seven years for the real estate down trend to stabilize.
The Warning Signs.
IF mortgage rates tick up ever so slightly AND this triggers a flood of buying – beware. The real estate market will be in the same condition it was in 1989: a long term top.
Our American cousins are already well into the downward part of their real estate cycle. Both their housing and commercial real estate are in trouble. Remember Pierre Elliott Trudeau’s famous words: “When America sneezes, Canada catches a cold.”
What should a real estate owner do in the face of all this? Here are some thoughts:
1. Homeowners: don’t do anything. Just keep living in the home you love. If you are thinking of selling your small house and buying a big one because you need more space, do it. But if you are thinking of buying a bigger home to increase your overall investment exposure to real estate, put off your decision until things stabilize. And if you are thinking of selling your large house and buying a smaller one, do it sooner rather than later.
2. Investors in houses: those who buy residential real estate and rent it out. Sell your rental properties when mortgage interest ticks up. You could be selling at the top. And, as the house prices drop, you will be in the perfect position to buy future distress sales.
3. Commercial and industrial. How did you feel when the recession was ON in 2008 and 2009? How did you feel when your tenants were laying off employees and subleasing their space? Imagine how real estate investors feel in the auto manufacturing towns of southern Ontario. Or the oil patch in western Canada. Consider selling your marginal properties and reducing the debt on your higher quality properties. Read more about the pickle our American cousins are in. Re-read the story of what happened to the Olympia and York’s $14 billion real estate empire in the early 1990s. This is not a time for complacency. Try to stay positive: if trouble develops, you want to be the strong one when the others are weak. In order to buy at the bottom of the cycle, you have to sell at the top.
In my book, Beyond the Bull, I discuss the correct attitude for stock market investors to take in a long term bear market. This is the same attitude that real estate investors should have now: the attitude of a fighter. It’s like the Kenny Rogers song: “You got to know when to hold, know when to fold ’em. Know when to walk away, know when to run.” There is a strong possibility that real estate investing is coming into a time like 1989 to 1996 - the down part of the cycle. It’s time to fold ‘em and walk away. The down part of the cycle brings opportunity for those in a strong financial position. Having more cash and/or less debt is strength.
Ken Norquay, CMT
Market Street Investment House
Here are the links to Beyond the Bull on the three major Amazon sites: