The plot

Wait a minute. Are they right?

A constant conspiratorial drumbeat on this blog (and other places people go to whimper and vex) is that The Man is conspiring to keep real estate values high. Stupid high. And for the young, impossibly high.

The kiddos make two broad claims. First, that our non-financial Finance Minister instructed the banks to kid-glove owners who borrowed excessively at ultra-low rates. Thus they’re shielded from defaulting upon renewal at twice or thrice the rate or being forced to sell, helping to bring prices lower. This, the houseless gen claims, is the reason bankers were told to allow 40, 50 or 70-year amortizations on mortgages within bank portfolios.

Second, what Trudeau said. During an interview the PM gave creds to every critic when he stated: “Housing needs to retain its value… It’s a huge part of people’s potential for retirement and future nestegg.” Pow. There it was. From his own lips. It became clear to those who feel locked out of real estate that the government which for years has been promising ‘affordable’ houses, a bonanza of new construction and ‘generational fairness’ never meant a word of it.

Well, the reality is Ottawa did not order the banks to deal favourably with existing borrowers. It was just business, and math. Lenders do not want borrowers to default, nor do they wish to take title to anybody’s real estate. They’re in the money business, not the property one. Every accommodation will be made to try and keep debts serviced, and retain clients at the time their debts come to term.

As for the long amortizations, they were fictional – the time it would take to pay down a debt if current variable-rate payments were maintained. But every mortgage at renewal resets to a standard, traditional amortization and monthly payments jump to reflect current rates. There is no gift. In fact, lots or renewers will owe more because payments did not cover accumulating interest. As for Turdeau’s comment, it was just reality. No government is going to attempt, or take credit for, a real estate bust.

Yabut. There’s more. Proof indeed of a nefarious move to keep the market from imploding. At least a big, important chunk of the overall market – urban condos.

First, understand how this works. Every year in major markets like Toronto, Vancouver, Montreal and Calgary  thousands of fresh units are proposed, pre-sold or under construction. New buildings command more than existing ones. Financing is easy to get and a deposit can hold a unit until it’s actually built two (or three or four) years hence.

But during that time much can change. Like interest rates which affect overall market demand and economic conditions. In Toronto, for example, new-build units hit about $1,500 a foot (they’re back down to the $1,300 range now) while resales were closer to a grand. At least half of all units went to people with no intention of moving in – they planned to sell for a profit upon completion (usually an assignment sale prior to closing) or rent it out as an investment property.

So when the Bank of Canada jacked money costs ten times, with 2% loans turning into 6% mortgages, values dropped. Now finishing construction, a slew of urban condos aren’t worth what people agreed to pay. In general prices have declined by about a fifth – or very close to what the average investor gave as a downpayment. In other words, there are many, many buyers who, upon closing, have zero equity – and require, in essence, 100% financing. Which is not allowed by the bank regulator. But they’re getting it anyway. And that’s the rub.

Broker and media gadfly John Pasalis (who hates me) has been leading the charge on this file. Resale condos have had flat price growth for the last four years, he notes, and combined with still-high interest rates, that’s dragged down new-builds to the point where buyers are in trouble.

At least, they would be in trouble – and have to exit at a loss with condo sale prices falling – if the banks were not bending the rules and bailing them out.

“Normally, when a property declines in value between the time the buyer purchases it and the closing date, banks will only underwrite the mortgage based on what the property is worth (the appraised value), not what the investor paid for it,” he points out. “For example, if an investor paid $800,000 for a unit that declined in value by 20%, banks will only provide a mortgage of up to 80% of the appraised value of the property – which is $640,000. A buyer who planned to make a 20% down payment ($160K) based on the original purchase price would have found that their original down payment covers the decline in the property’s value. They would have to contribute an additional $128,000, which serves as the 20% down payment required based on the lower appraised value.”

But that’s not happening.

Pasalis claims banks are using ‘blanket appraisals’ to establish financing, which assume the newly-built condos are worth what the buyers paid years earlier, despite current conditions.

This means that the condo investor does not need to come up with additional funds on closing when their unit is worth less than what they paid. However, it also means that banks may be issuing mortgages equal to 100% of the current market value of these properties in some cases. This practice introduces significant long-term risks. By not adjusting appraisals to reflect current market conditions, banks may be inflating the true value of their loan portfolios and misrepresenting the loan-to-value ratio on this debt.

This practice also keeps the market inflated. Unit prices are not allowed to drop. Distressed buyers are in fact rescued with additional financing. And the kiddos pay the price. “Young potential home buyers have a right to be furious about these trends. The real estate playing field was already stacked against them, and by protecting investors from the consequences of their bad investment decisions, our government has transferred the costs of these mistakes to younger buyers in the form of condo prices that are higher than they otherwise would have been.”

So the system protects property values, and itself. The free market is not allowed to be free. Regulators blink. Those who bought on spec are shielded from risk. Saving people from themselves to stabilize the market creates a moral hazard. However the banks are protected. The government is spared from explaining why new housing construction is collapsing and its goals unmet.

But it’s no conspiracy. Honest.

About the picture: “This is my uncle’s Bermese Mountain Dog, Noah,” writes Ray. “My uncle got him as a puppy. He was born in September 2014.  He had a good long life but, sadly, he died yesterday.”

To be in touch or send a picture of your beast, email to ‘garth@garth.ca’.