Juggling Dynamite

The housing unaffordability crisis is not just about current interest rates, which are historically average (4.71% 5-year fixed in Canada and 6.57% 30-year fixed in America).

Homebuilders are already offering buy-down rates in the 3 percent range in the US and Canada. Still, new home sales have contracted year over year, while the inventory of new US single-family homes for sale has risen to the highest level since October 2007 (shown below since 1965, courtesy of Charlie Bilello).

The primary issue is that home prices have risen twice as much as the median household income over the past decade (shown below, since 2015).

The US median-priced home for sale, $435k (NAR), is now 5.5x the current median household income ($79k), making it the most unaffordable US market in history.

In Canada, the math is worse: the average home sale price nationally in July ($693k CREA, down 18% since February 2022) was 8.2x the median household income of $84k (before tax), 9.5x the median after tax income of $73k.

In addition, pandemic-inflated prices are now meeting tariff-inspired increases on top of record debt levels across the economy. There’s only so much cash flow to go around.  Aging out boomers and reversing immigration flows are other macro factors significantly impacting housing markets.

The discussion below offers some further insight into these factors.

Ivy Zelman is the Executive Vice President and Co-Founder of Zelman & Associates, one of the most respected research firms advising investors and corporate executives on the real estate market over the past 30 years. In an increasing number of metros, especially where homebuilders are active, Ivy sees conditions starting to favour buyers. Here is a direct video link.

If we had a dime for all the times people say silly things, like “You’ll never lose money in real estate” or “high-end properties always hold their value.” Not true, never has been.

The current real estate correction cycle is well-earned after years of easy money speculation and uneconomically high prices. Three years into the downturn, many people are still in denial. But the mean reversion process is happening, and it packs a big financial hit for owners, lenders, the broader economy and jobs.  See, Cottage purchased for $1.9M sells at a 45% loss in Ontario:

An Ontario cottage purchased for $1.9 million in 2022 just sold for a huge loss.

As housing prices decline across Canada, homes continue to sell for much less than homeowners paid just a few years ago.

In Brampton, a home recently sold for a $469,000 loss, and a Mississauga home sold for a $700,000 loss in July.

In a tough market, recreational properties are not a priority for many buyers. A recent report found steep price declines in recreational markets across the province on a year-by-year basis, with areas like Niagara-on-the-Lake, Peterborough County, Northwestern Ontario, Orillia, and Grand Bend being hit the hardest.

Margin debt (people borrowing against their security portfolios) has now topped $1 trillion for the first time in history, +25% over the past year alone. Other, lesser, margin-abuse peaks occurred before major bear markets/recessions (grey bars below) since 1995, courtesy of Rosenberg Research.

Among professionals, dry powder is also in short supply. Trend-chasing portfolio manglers managers are all in with portfolio cash ratios at a record low of just 1.4%.

The tech-heavy NASDAQ 100 index is today priced at 105% of the US economy (GDP) for the first time ever (shown below since 1990).It is not just the Nasdaq index that’s grossly inflated.

Shopify is back to being the largest weight in Canada’s TSX composite. Three tech stocks–Nvidia, Microsoft and Apple–make up a record 20% of the S&P 500 market capitalization, and the top ten most expensive account for 40%, versus the prior mania record of 27% at the 2000 cycle top.

The historically informative Shiller price-to-earnings ratio for the S&P 500 at 38.8x is a range only seen briefly in the stock market euphoria of 2000 and late 2021 (below since 1975 courtesy of www.multpl.com).

Within the S&P 500, the technology sector’s price-to-sales ratio hit an all-time high of 10x (black line below since 1990), compared with 7.8x at the 2000 tech bubble top and a median ex-tech ratio of 3x (gold line below).  Paying 10x sales for a singular company has long been recognized as crazy, for a whole index? Financially suicidal.

The Wilshire 5000 Total Market Index (Wilshire 5000) is a broad U.S. stock market index designed to measure the performance of nearly the entire investable U.S. equity market. It is currently trading at an all-time high of 212% of US GDP, compared with 172% in February 2021, 137% in March 2000 and a long-term average of 155%. Warren Buffett has famously said that a market-to-GDP valuation over 140% is dangerous.

At the same time, junk debt (with a credit quality less than investment grade) is priced so high as to have the lowest yield spread over similar dated Treasuries since 2021 and 2007.

Market cycles are a full circle, and current valuation levels suggest return-free risk from here. It’s a fantasy to think that the valuation-insensitive capital that’s in today will get out intact.

All’s well that ends well. We can either look foolish by shielding capital and minimizing exposure to irrational exuberance or holding on as prices mean-revert lower once more.  The former can feel hard for a while, the latter tends to leave lasting financial, emotional and psychological harm. Consciously or not, we each pick our poison.