; Why Canadian real estate is not in a bubble
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Why Canadian real estate is not in a bubble

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									                            The Pundits (like Garth Turner) Say:

       Canadian Real Estate Is A Bubble About To Burst!
                                        Cliff Küle Says:

                         “Perhaps, But Perhaps Not”
                                    (It’s Deflating Already)

                                         By Cliff Küle

In ancient China, there lived a poor, but wise, farmer. One day the farmer’s only horse broke
out of the corral and ran away. The farmer’s neighbors, all hearing the bad news, came to the
farmer’s house to console him. The neighbors all said, “Oh, what a misfortune.” The farmer
replied, “Perhaps, but perhaps not.”

About a week later, the horse returned, bringing with it a whole herd of wild horses, which the
farmer and his son quickly corralled. The neighbors, hearing of the corralling of the horses,
came to congratulate the farmer on his good fortune. As they looked at the corral filled with
horses, the neighbors said, “Oh, what a blessing!” The farmer replied, “Perhaps, but perhaps

A couple of weeks later, the farmer’s son severely broke his leg when he was thrown from a
horse he was trying to break. The neighbors all hearing the news, came to console the farmer
and son. The neighbors said, “Oh, what misfortune.” The farmer replied, “Perhaps, but
perhaps not.”

At that time in China, a war broke out between two rival warlords. An army came to the
village and conscripted all the young men to fight in the war. The farmer’s son, with his
broken leg, was left behind, unfit for military service. The other young men of the village died
in that war.

                               - NEVER BE TOO CERTAIN -

The price of Canadian real estate has held up remarkably well since the crash that demolished
real estate values in the U.S. & around the world. Some basic, ordinary homes in Toronto and
Vancouver are selling for over $1,000,000.

It seems easy to claim that prices will crash in places where they did not crash. Try ‘googling’
the words Canadian real estate bubble and you will see more than 4.5 million results. If that
doesn’t seem outrageous, consider it relative to Canada’s small populationi. Consider that
Canada’s Housing Bubble is a surprisingly active websiteii. Think about CBC headlines like: “Be
Very Afraid of the Canadian Housing Bubble”. Think about the Globe & Mail (Canada’s major
newspaper) headlines like: “Real Estate Swoon Deepens”.
Garth Turner (Canadian author of investment books, former member of Parliament, former
Business Editor of TV & newspaper) has been pounding the table on his blogsite, The Greater
Fooliii. He says things like “There’s a 100% chance interest rates will be going up .. to deflate
demand & values and create that melt that I keep telling you will be ..”iv. He also says that six
years into the U.S. real estate implosion, “it just gets worse. The lie of a nation is that Canada
escaped. We won’t.”v

It seems like the whole world is saying: ‘Canadian Real Estate is in a Bubble That Will Burst’.
We say: ‘Perhaps, but perhaps not.’ We also say that a general consensus is generally wrong, and
‘conventional wisdom’ is an oxymoron. Our point is that there may be forces at work that aren’t
being seen.

                       Canadians Might Not Be Seeing ‘The Big Picture’

The real driving force might not be in Canada. It may be global forces that are driving Canadian
real estate prices. Global economic forces are massive relative to Canada’s small population.
Global perceptions work on Canada in a highly leveraged manner. The Canadian economy is
1/10th the size of the U.S. When the world alters the percent which it chooses to invest in
Canada (especially as compared to the U.S.), it has far more ‘torque’. If the world normally
invests 1/10th as much in Canada as it does in the U.S., then raises it to 1/5th , the impact on
Canada is a doubling, not a 10% increase. The leverage is explained by an old expression. It has
been said that when some Canadian investment becomes the ‘darling’ of U.S. investors, “it is
like trying to get Niagara Falls to flow through a garden hose”.

 We will focus here on the Canadian residential real estate, though much will also apply to
commercial & farmland real estate.

1. Canada is viewed as a safe haven in the global financial crisis. In some sense, as the world’s
financial crisis gets worse, Canada’s attraction increases. Much of the world perceives Canada as
more fiscally prudent, with safer banks, a more welcoming attitude and business environment
than other developed nations (including the United States). Whether true or not, perceptions are
important. Money comes into Canada for investments in the commodities sector. Emerging
markets need resources and Canada has them. Money is also coming to Canada for its currency
and government bonds. Investors view the Canadian Dollar as a ‘commodity-based currency’ at
a time when there appears to be a long-term, secular commodities boom (albeit with serious
‘hiccups’). Foreign investors have also put money into Canadian government bonds; perceived
as having less of a debt problem than the U.S.. Demand for Canadian bonds is helping to keep
interest rates low in Canada, which in turn, helps keep home prices buoyed.

2. Immigrants are seeing Canada as more attractive than the United States. While the U.S. was
a welcoming nation generations ago, recent history seems xenophobic. Middle Easterners have
had a hard time even before 9/11. Fences, vigilante border guards & campaigns to remove
Mexican workers have an impact on attitudes around the world.

Pierre Trudeau (“that liberal pinko” according to the Nixon administration) encouraged
immigrants to maintain their distinct communities and culture. The policy was referred to as a
‘Canadian Mosaic’. This was very different than the U.S. ‘Melting Pot’ model. Is it possible that
all these years later, the ‘Canadian Mosaic’ model is paying dividends to Canada; increasing
immigration and investment? While the U.S. seems to believe that foreigners are taking jobs
away from Americans & taking government-provided social services, Canada has done studies
that show immigrants to be a positive force. They tend to accept more labor intensive jobs and
save a higher percent of their earnings than average Canadians. Studies also show that
immigrants, on average, become net contributors to Canada in less than 5 years; not ‘drains’ on
the tax system. Like an investment in a new business, it takes a few years to get established. The
‘Mosaic’ seems to appreciate differences instead of trying to eliminate them. Immigrants may
find it more welcoming.

When immigrants come to Canada, their strong family and community values drive population
rates higher relative to the native-born population. This is positive demographics. In Canada,
many of the immigrants are either well-educated or very wealthy. They are buying homes on
arrival, especially in Toronto and Vancouver. Because these immigrants have no prior credit
history with Canadian banks, many of them pay cash for their homes. This non-credit fueled
buying is not prone to a bursting bubble.

3. In addition to immigrants coming to Canada, there are foreigners buying homes in Canada
for investment, and for a “Plan B” escape. For example, Chinese in Shanghai are buying homes
in Toronto and Vancouver because there have been growing restrictions on buying multiple
properties in China, and also because they are setting up Canada as their back-up “Plan B”
escape (in case things go bad in China). They may simply see Canada as being better place for
raising a family. Some of these foreigners are not even immigrating Canada yet, simply buying
homes for their potential future in Canada.

4. As the financial crisis sweeps the world, many immigrants and wealthy families are coming
to Canada. We have spoken to Americans who foresee the day they will want to escape from
their country’s escalating debt problems and nasty partisan gridlock that makes solutions
impossible. These are well educated, upper middle class Americans that fear emerging draconian
laws targeting businesses and the wealthy. During the American Revolution , Canada had a huge
increase in immigration; the Empire Loyalists from the U.S. colonies. Are the American
purchasers of Canadian properties leaving the new Empire; an ironic twist of history?

5. In some respects, Canadian banks are more powerful than the Canadian government. The
Canadian government started a key home insurance program in 1946 called CMHC.vi Today this
insurance protects the banks on a significant portion of their home mortgage loans held. The
insurance protects the banks in case the homeowner walks away from the home mortgage loan.
The banks benefit greatly from this program – not only do the banks lower their risk, but they
don’t even have to pay for the insurance. The insurance is paid for by the home buyer. So, it is in
the interest of the government to protect home prices. The banks don’t have to convince the
government to do a ‘TARP’ type of bailout - it is built in. Foreclosures lead the banks to go to
the government to claim their insurance payouts. Therefore, the Canadian government will try
every policy within their power to support stable prices.
6. It is difficult to emphasize how bullish today’s low interest rates could be when the
‘overhang’ (excess inventory) is gone. The excess inventory in Canada was never as outrageous
as in the U.S. See some previous posts of ours, from over the years, that discussed some of these
issues .. vii. One post, in particular: viii "The primary difference between the two markets is that
Canada doesn't have the mountain of fraud .. Canada is not perfect: just less bad.”

7. For the last 40 years, the world’s money has simply been Credit. There is no ‘security’ other
than credit to the government’s authority. Trillions of dollars have been created with the
sovereign debt of nations as the ‘bedrock’ - the safest of safe. Pensions, insurance companies,
and institutional investors of the world have spent decades believing that loans to government are
the safest investments possible. Trillions of dollars are just starting to realize that nations default
on their debt; the security is not safe. The asset behind Treasury Bonds is the government’s
ability to collect more taxes from its citizens - not a safe bet in today’s economy. Real estate
provides a tangible asset; physical security.

8. Low interest rates are bullish for real estate values AND there are forces at work which
could keep interest rates low for many years to come.

Higher interest rates could cost the Canadian government too much .. they would fight it with
any policy possible. A precipitous fall in home values could cause mortgage insurance payouts
to the Canadian banks. Also, if Canadian interest rates go higher, the Canadian dollar gets
stronger. Canadian manufacturers and exporters would get hurt by a stronger currency. They are
a powerful interest group in Canada.

Moreover, note the fact that the central bank of the U.S., the Federal Reserve, has promised
interest rates will stay at essentially 0% (on the short-term rates), and low in general for longer-
term rates, into 2015 and maybe beyond that. Canada has a need to follow the U.S. lead on
interest rates (due to the above-mentioned negative effects on Canada’s exports).

Furthermore, if either the U.S. or Canada were to raise interest rates, the cost of the national debt
would consume more and more of the federal budget (in the U.S., it already consumes about
1/7th of the entire budget at today’s artificially zero interest rates)

And finally, a big objective of the so-called quantitative easing (money printing) programs is to
keep interest rates low. What may not be understood by many people is that an estimated 80% of
the hundreds of trillions in derivatives held globally are in interest rates – there is no way that
central banks can let interest rates go too high nor move higher too fast. The world could
experience a derivatives meltdown that would make the 2008 financial crisis look like a picnic.

Therefore, interest rates could remain low for many years to come, thereby helping to keep home
prices up.

9. Canada’s Central Bank Governor seems to understand Austrian Economics and the possibility
that Keynesian Economics may have reached its endpointix. This seems miles (kilometers) ahead
of the central bankers in most countries
             After considering all of the above, will home prices ever go down?

In fact, prices are going down, not only in the U.S. but also in Canada. In real terms; real
inflation-adjusted terms. Meaning, if you bought a home in Canada a few years ago, even though
‘nominal’ home prices have risen, in real inflation-adjusted terms, or in gold terms, or in
commodity-based terms, home values have gone down. This trend could continue. Another way
of saying this: If you buy a home today for $500,000, you could have bought 350,000 cups of
Tim Horton’s coffee or 175,000 TTC (Toronto Transit Commission) tokens. It is possible that in
10 years time, even though the home value may rise to $1,000,000, that much money might be
able to buy only 100,000 cups of Tim Horton’s coffee or 50,000 TTC tokens. Real terms value
is what really matters. Who cares if you have millions of a currency, if you need billions to live?
Check out the charts below of housing prices in gold terms for both the U.S. and Canada
(Toronto, Vancouver, Calgary).

                          CHART OF U.S. HOUSING IN GOLD TERMS

                         Courtesy of RightWayCharts.com and Bullionvault

                     Courtesy of Canadian Housing Price Charts www.chpc.biz

In other words, the ‘housing bubble’ is deflating some already (even if prices are still going up!)
But very few are seeing it! The depreciation of fiat paper currencies, with no tangible asset
backing, hides deflating bubbles. Depreciating currencies create optical illusions.

If interested, please contact us for references & further evidence to our claims. We are only
saying that perhaps Canadian real estate prices won’t crash, as so many pundits are predicting.
We do believe there is some serious imbalance (that may take years to fix) when a small, but
nice condo in Florida (with great amenities) can be bought for the price of a parking spot in
downtown Toronto (no joke).
Cliff Küle

Cliff Küle's Notes

2012 ©Cliff Küle’s Notes 


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