Sakabatou

A lot of people have been telling me that the chances of a melt down in the Canadian housing market is remote. The whole ridiculous loan scandal in the US never happened in Canada. However, Canada has been going through it's own housing bubble and I think it's important that people don't get too complacent.

On a mailing list I subscribe to one of the people said that their house assessment in Victoria BC came in $100,000 lower than it was last year. But housing prices in Victoria have barely shifted in the last 2 years. What's up?

Here's a graph of the MLS housing sales prices for single detached houses in Victoria BC. The price is in Canadian Dollars (Yes, houses are really going for over $500,000 on average... )

As you can see, for 2 years it's pretty much been solid as a rock. So, what's the panic? Why is anyone worried? Surely if it's been so steady for 2 whole years, it's not going to come tumbling down for no reason, right?

Now take a look at a graph of the ratio of houses sold to houses on the market (expressed as a percent).

So in May 2007, 50% of the houses on the market sold. In November 2008, 10% of the houses on the market sold. Ouch!

But wait! If demand has dropped off so steadily, why hasn't the price gone down? I saw this in the crash of the housing market in London England in 1992. The reason is that people simply can't afford to sell their house for less than they paid for it. Because the *average* house price is half a million dollars, normal people can't afford a big down payment.

So even if they scraped together 10% of the asking price (unlikely given that most Canadians do not have $50,000 in savings), they can only afford to lose up to $50,000 on the sale of the house before they actually have to *pay out of their own pockets* to sell the house!

But what about the money they spent on their mortgage? Surely they've paid off some of the house (the principle). Unfortunately, no. The brilliant way that mortgages work is that you pay off the interest of the loan before you pay off the principle. So for the first 5 years you are barely paying anything off on the house.

So, given the lack of demand and the lack of decrease in house prices, we can infer that the price has already hit rock bottom. People can't afford to sell unless they can hold on to their house and make payments for the next 5 or 10 years.

Unfortunately, there's a kicker to all this. What if you lose your job? Now, you don't have enough money to cover the mortgage *and* you can't afford to sell your house. What do you do?

You declare bankruptcy and the bank takes your house/car/whatever. Luckily, it's not *so* bad. You get to start again with no assets and no credit rating. You don't live in a debter's prison like in Dicken's time... But what about the housing market.

Now, unlike you, the bank *can* afford to sell the house at a loss. And in fact, they don't want to hold on to this house, so they will sell it at whatever the market will bear. That's when the price falls like a shot. And if the poor economic conditions that led to you losing your job continue, then others lose their jobs. Leading to more bankruptcies. Leading to more house fire sales by the bank. Leading to more disruption in the economy.

Look for house prices to drop radically in Victoria in the next year or so. They should fall at least 20%. But it may very well be more. And *that's* why this person has had the assessment of his house slashed by $100,000 (about 20%) after owning it for only one year.