Real Estate Chronicle

Real Estate Chronicle

# posted by Luigi Frascati @ Thursday, December 18, 2008 21 comments

Wednesday, December 03, 2008

And The Real Estate Board Says ...

A lesson in Marshallian economics.

_____________________________________

The most recent bulletin released by the Real Estate Board of Greater Vancouver (REBGV) has stirred up a lot of apprehension in the Lower Mainland on the part of Sellers and Realtors alike. Sellers are clearly concerned by what they perceive as a drop in value of possibly their most treasured asset. Realtors, on the other hand, are fearful of the decline in sales with the corresponding decline in commission earnings. Following is the full, integral text of the REBGV Release, with highlighted in red the parts that seem to be causing a great deal of anxiety and widespread concern just about everywhere.

FOR IMMEDIATE RELEASE:

Slow home sales create window of opportunity

VANCOUVER, B.C. – December 2, 2008 – November reductions in home sales and prices have helped improve affordability in Greater Vancouver. However, November also saw a corresponding decrease in the number of new homes coming onto the market.

In its most recent statistics release, the Real Estate Board of Greater Vancouver (REBGV) reports that residential property sales in Greater Vancouver declined 69.7 per cent in November 2008 to 874 from the 2,883 sales recorded in November 2007.

Residential benchmark prices, as calculated by the MLSLink Housing Price Index®, declined 12.8 per cent between May and November 2008, amounting to an 8.3 per cent year-to-date price reduction for detached, attached and apartment properties in Greater Vancouver between November 2007 and 2008. In May 2008, the overall residential benchmark price was $568,411, compared to $495,704 in November 2008.

“Times of turmoil, from which we always emerge, offer excellent opportunities to buy quality real estate,” says REBGV president, Dave Watt.“For those whose personal finances allow them to get involved, there are opportunities in today’s housing market that have not been seen in many years.

“The local real estate market is not immune to the current economic challenges globally; however, Canada’s disciplined lending structure has kept the mortgage landscape steady in these uncertain times.”

New listings for detached, attached and apartment properties declined 10.8 per cent to 3,012 in November 2008 compared to November 2007, when 3,377 new units were listed. Active listings in November declined 4.7 per cent to 18,348 from the 19,257 active listings in Greater Vancouver in October 2008.

Sales of detached properties in November 2008 declined 69.8 per cent to 322 from the 1,067 units sold during the same period in 2007. The benchmark price for detached properties declined 8.6 per cent from November 2007 to $666,525. Since May 2008, the benchmark price for a detached property in Greater Vancouver has declined 13.6 per cent.

Sales of apartment properties declined 67.9 per cent last month to 410 compared to 1,276 sales in November 2007. The benchmark price of an apartment property declined 8.6 per cent from November 2007 to $342,315. Since May 2008, the benchmark price for an apartment property in Greater Vancouver has declined 12.2 per cent.

Attached property sales in November 2008 decreased 73.7 per cent to 142, compared with the 540 sales in November 2007. The benchmark price of an attached unit declined 6.4 per cent between November 2007 and 2008 to $426,287. Since May 2008, the benchmark price for an attached property in Greater Vancouver has declined 11 per cent.

In light of the foregoing figures, which are all but rosy, it would seem to be somewhat anachronistic for REBGV President Dave Watt to talk about "excellent opportunities to buy quality real estate", many of which opportunities have "not been seen in years". Afterall the bulletin speaks of a fall in residential sales to the tune of almost 70 percent for this past November compared to a year ago, as well as of a 13 percent decline of the benchmark price from May to November. And yet if there is one person who would wholeheartedly agree with what would appear to be at first glance Mr. Watt's somewhat optimistic stance, this person would be none other than Alfred Marshall, one of the founding fathers of modern-day Economics.

Prof. Marshall (1842 – 1924) was the first to attempt to explain price behavior within the context of the equilibrium between supply and demand in competitive markets. More specifically, as it relates to inefficient markets, the Marshallian Curve describes how prices vary as a result of a balance between product availability at each price (supply), and the desires of those with purchasing power at each price (demand). A market is defined as "inefficient" when prices of traded assets do not reflect all information about those assets. As such, prices are subject to variations depending upon information that is unknowable at the time the price is set - just like real estate.

Price elasticity of demand is measured as the percentage change in the level of demand that occurs in response to a percentage change in price. In general, a fall in the price of a good is expected to increase demand for that good. More specifically, price elasticity is said to be high when a small increase in price causes demand to fall substantially. An increase in price arises also in the situation wherein the general value of the commodities in an instant segment market falls. Thus, entering a market at a price level that is not in line with market value for similar goods causes demand for that particular good to drop, if its price level is even only slightly higher than the general market value. Lesser demand, of course, causes a fall in price for that particular good which, in turn, has the proximate effect of increasing demand, all of which, therefore substantiates Dave Watt's statement as it relates to the opportunities available in the present market.

Alfred Marshall, during his tenure at the University of Bristol in England, opined furthermore on the concept that consumers attempt to equate prices to their marginal utility, defined as the measure of happiness or satisfaction gained by consuming goods and services or, in the case of real estate, capital assets. Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain consumer behavior in terms of rational attempts to alter prices. Hence, as the pool of buyers dwindles, sellers must apply leverage on the perceived value of the interest in land they are offering , that is alter their utility so as to motivate buyers to purchase. Which, in turn, helps to consolidate the market. And this, of course, explains how real estate, among other markets, always rebounds from times of turmoil, as Dave Watt announces.

Thank you for the lesson in Capitalism, Mr. Watt.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Wednesday, December 03, 2008 6 comments

Monday, November 24, 2008

The Great Canadian Recession

And, if indeed it does happen, how it will affect you.

_______________________________

November 24, 2008 may have been a glorious day in the stock markets following the rescue of Citigroup Inc. with the U.S. Government purchase of $20 billion in preferred shares and the announcement of its subsequent back up to $306 billion worth of the giant bank's assets, in return for a further $7 billion stake. But the financial news coming from our home front, British Columbia and Canada, are far less encouraging.

For one thing early in the morning Prime Minister Harper stated that Canada could soon be in a recession later this year (not much time left) or early in 2009, adding that "Indeed, the economic growth is just about zero, perhaps a little bit less". The Prime Minister, who was attending the Asia-Pacific Economic Cooperation summit in Lima, Peru, attributed Canada's present woes to the deteriorating economic conditions in the western world and "especially in the United States".

This was followed by the announcement that the Royal Bank Of Canada (RBC) will likely be forced to take a CAD1.6-billion hit as market losses mount and loans start to go sour. The largest bank in the country cited "extreme volatility in the American financial markets" as executives said they would write down CAD1-billion in investments and set aside CAD620-million to cover credit losses.

Then La Presse Canadienne reported that the "Prairies see biggest-ever consumer confidence decline in November". In a very concise statement, La Presse declared that "Resource-rich Western Canada, once thought to be the most recession-proof component of the national economy, is beginning to experience the same economic malaise that has gripped the rest of the country". La Presse Canadienne quoted a survey published by the Conference Board Of Canada wherein consumer confidence in the Prairies has dropped 7.4 percentage points between October and November - the region's biggest decline on record. The Conference Board attributes the drop to energy exports to the United States, which will see "an expected 12 percent decline in 2009".

And, finally, there was Colin Hansen, Finance Minister of British Columbia who in a terse bulletin announced that the Province "will lose more than $3 billion in revenues over the next three years because of the cascading effects of the American financial crisis", adding that the CAD 1.77 budget surplus this year will have to be scaled down to 'only' CAD950-million.

Heck, it sure seems that Canadians like Americans only when they are rich! So much for all those who thought that Canada was somehow 'immune' to the crisis affecting pretty much the rest of the world.

Canadians, just like their American counterparts, are unaccustomed to recessions, particularly when they involve shopping less. During the past quarter-century Canada has suffered only two official downturns, in 1990-91 and 2001. Both were short and shallow. What's more, in 2001 consumer spending barely skipped a beat; a decade earlier it fell, but only briefly. Since then, the Canadian wallet has not snapped shut. But all this may be about to change.

Evidence is mounting that the economy has slipped into recession - and this time consumer weakness is to the fore. For instance, the Real Estate Board of Greater Vancouver reports that "Residential property sales in Greater Vancouver declined 55 percent in October 2008 to 1,364 from the 3,028 sales recorded in October 2007" and that prices are down 8.8 percent since May, 2008, or about 17 percent annualized (if you wondered why I have taken up writing again in this blog, this is it). Likewise, the British Columbia Real Estate Association estimates a conspicuous drop in the number of licensed realtors in the Province in 2009 (I will stay on).

The once doughty Canadian consumer is being pummeled mainly by two things: the perceived forthcoming housing bust and a weakening labor market, especially in the East where unemployment has been steadily rising as the private sector has lost jobs for four months straight. And seeing that consumer spending accounts for 70 percent of demand, that hurts, especially when coupled with the near collapse of the once mighty construction industry.

There are two big questions about this downturn, both for Canada and the world: how long and how deep? On the second count, there is room for guarded optimism: although American recessions have usually sent the world economy into a funk, this time around the slowdown need not be so severe, especially for the emerging world. The economic test instead may come from the length of this downturn: an America that stays sluggish for several years could cause all sorts of problems.

Contrary to the popular and widespread belief that the origin of this crisis is due to housing and the real estate bubble, the present situation is a direct consequence of the biggest asset bubble in history: the stock market. Financial markets have already suffered arguably their biggest shock in eighty years, dragging down even real estate. There is a reason as to why Congress is poised to throw billions and billions of dollars at financial institutions of all sorts and at the Big Three, all important players in the Dow Jones, and not at the real estate and construction industries. In fact, the Dow began its decline a full three years before real estate, a modern day 'Fall Of The Gods'.

A prolonged sluggish America will be a problem hard to tackle for President-elect Obama. With the budget deficit rising, big domestic reforms such as expanding health-care coverage will become more difficult. And with a fragile economy, the Democrats may have to rethink their plan to roll back George Bush's tax cuts, while the momentum to re-regulate the financial markets and punish the oil industry, credit-card firms or indeed any other malefactors of great wealth will grow.

So where will all this leave you, the British Columbia consumer? Let me appeal to that old and somewhat clichéd saying:"Cash is king". It is a saying not without some wisdom. For when a recession strikes then asset prices fall - shares, real estate, just about everything you can buy - and the person with cash in hand can take advantage. So if you are pondering how to invest your millions, perhaps the best option right now is simply to open a deposit account with a triple A-rated bank.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Monday, November 24, 2008 1 comments

Friday, October 19, 2007

The Triumph Of Unreason

Examining why you are not always rational when purchasing real estate

__________________________________________

Neoclassical Economics is built on the assumption that humans are rational beings who have a clear idea of their best interests and, moreover, strive to extract maximum benefit -or "utility" as economists are fond of saying – from any situation. Seeing from this viewpoint, price helps people decide which combination of work, spending and saving suits them best. In real estate, however, things are not quite this simple.

Theory of price asserts that the market price reflects interaction between two opposing considerations. On the one side are demand considerations, while on the other side there are supply considerations. In real estate, however, there is another factor – value - which is frequently confused with price, because market value is calculated as the quantity of some good multiplied by its nominal price. Clearly this should not be so, in that value represents by definition how much a product or service is worth to someone relative to other things. But then, of course, the worth of something is in function of consumer's perception. Thus the old saying that real estate is only a matter of emotion.

Neoclassical Economics assumes that the process of decision-making is rational in that, as mentioned at the beginning of this article, humans are viewed as rational beings intent at maximizing utility. But this too is only partly true when it comes to real estate. And there is now growing evidence that decision-making draws heavily on emotion, even when reason is clearly involved. In other words, scientific evidence is being presented that humans are not only irrational in real estate – they are irrational, period. This is the triumpf of unreason.

The role of emotions in making decisions makes perfect sense. It is wired in our brain, as our ancestors had to weigh frequently the pros and cons of, say, obtaining food, whom to mate with and confronting or fleeing threats. The neural mechanism evolved in such a manner so as to maximize utility at minimum cost of energy. Since emotions is the mechanism by and through which animals are prodded towards such maximization, evolutionary and economic theory predicts the same application in humans. But the question today is: does this mechanism work when we have to respond to the stimuli of urban modenity?

It appears that it does not.

Researchers have discovered that different parts of the brain are involved at different stages in the decision-making process. The "nucleus accumbens" for instance, the collection of neurons within the forebrain, is the most active part and its level of activity correlates with the desirability of a certain product. It processes rewarding stimuli such as food, recreational drugs and monetary gains, as well as the anticipation of those rewards.

Price, however, increases activity in different parts of the brain. Excessively high prices increase activity in the "insular cortex", a region of the brain linked with expectations of pain, monetary loss and the viewing of upsetting pictures. This is also the part of the brain that lights up when consumers decide not to purchase an item. Price information activates also the "prefrontal cortex", that is the anterior part of the frontal lobes. This region is involved in rational calculations as well as in the balancing of the expected and actual outcomes of monetary decisions. Particularly, the reaction of the prefrontal cortex seem to correlate with both desirabilty of a product and its price, rather than to price alone. This evokes in turn a higher sense of a good bargain, and it precedes the decision to buy.

All the foregoing seems to contraddict orthodox economic theory. Rather than weighing the present good against future alternatives, people seem to balance the immediate pleasure of the prospective possession of a product vis-à-vis the immediate pain of paying for it. Which makes perfect sense in a cash purchase, as the future utility of what is being given up is embedded in the price that is being paid for it. But when it comes to real estate, where payments are practically always deferred by way of mortgaging, the balance between the pros and cons of purchasing appears to be modulated in favor of the pros. This is so because of the abstract nature of mortgage deferred payments.

Research continues, of course, and nothing is definitive as of yet. But if in fact it turns out to be proven that buying on mortgages, just like buying on credit, eases the pain of purchasing, then real estate purchase financing will have to join the list of things such as fatty and sugary foods that subvert human instincts in ways that seem pleasurable in the present tense, but which in fact can have a long and malign aftertaste.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Friday, October 19, 2007 2 comments

Wednesday, August 01, 2007

Financial Insecurity And The Rise Of Real Estate

The effects of the recent real capital appreciation on income.

_______________________________

There is a segment of analysts, in Real Estate Economics, that worries about consumers financial insecurity. More specifically they contend that the average middle class has seen few effective gains from the recent boom in real estate, since as profits have soared inequality has widened. Because of this, the standards of living of most people are more precarious than they used to be, because incomes have become more volatile. They argue that the defining economic shift of recent times has been the increasing instability facing households in North America. While income inequality – the gap between the highest and lowest earners – has risen sharply due in large part to the appreciation of real capital assets, income fluctuations have increased even more dramatically.

Examining stack after stack of economic data, they conclude that the average North-American household has a 17 percent chance of seeing its real and effective income drop by more than half from one year to the next, and that the painful consequence of this all is to be seen in the higher personal bankruptcy rates as well as in the rising number of home foreclosures. In sum, they conclude that income volatility is undesirable and excessive.

Rising income instability, however, is not necessarily a bad thing. A dynamic, mobile society is one in which people's income varies a lot. Milton Friedman pointed out that living standards should be affected only by permanent changes in their income, as short-term fluctuations are smoothed out by borrowing and saving. The fact that real capital assets have appreciated so dramatically and that, in turn, household saving rates have plunged does not necessarily suggest that consumers are now terrified by the spectre of more variable incomes. In fact, the opposite is more likely to be true. The increased sophistication of credit markets and, particularly, the ability to extract equity from housing has made temporary income instability easier to cope with.

There is little doubt that household incomes are more variable than they were a generation ago, but this argument is nuanced. It is not clear, for example, that rising bankruptcy rates have much to do with income instability. In fact, economic mainstream theory suggests that most people's consumption varies as permanent income changes, but barely responds to temporary shocks. Only poor people, who are less able to borrow, are affected by temporary changes in income.

In this respect, therefore, the recent appreciation of real estate works as a safety net for most consumers as against specifically what some analysts seem to be worrying so much about – financial insecurity.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Wednesday, August 01, 2007 2 comments

Tuesday, July 24, 2007

Real Estate And The Degree Of Happiness

Real Estate can make us rich. Don't ask it to make us happy as well.

_______________________________

Having practically doubled in value during the past six years and going, real estate is over half way towards notching up its best decade ever. Market capitalism, the engine that moves real estate, seems to be doing its job well. But is it? Once upon a time that job was generally agreed to be to make people better off. Nowadays, this is not so clear. A number of real estate consumers backed, somehow, by an increasing number of analysts think that real estate ought to be doing something else: making people happy.

The view that real estate should be about more than just money has been widely held in Europe for decades. And now the idea of "wellness" behind real capital assets has sprouted in North America too, catering especially to the prosperous baby-boomers. Much of this draws on the upstart science of happiness, which mixes psychology with economics. Its adherents cite copious survey data, which typically shows some unsurprising results: the rich report being happier than the poor. However, a paradox emerges that requires an explanation: affluent countries, taken as a whole, have not gotten much happier as real estate has appreciated and as people have grown richer.

The science of happiness offers two explanations for the paradox. Capitalism, it notes, is adept at turning luxuries into necessities, thus bringing to the masses what the elites have always enjoyed. But the flip side is that people come to take for granted things they once coveted from afar. Homes they never thought they could possess become essentials they cannot do without. In a way, consumers are stuck on a treadmill: as they achieve a higher standard of living, they become inured to its pleasures.

Add to all this the fact that many of the things people most prize – such as an exclusive home address – are luxuries by necessity. An exclusive mansion, for instance, ceases to be so if it is provided to everyone. These "positional goods", as they are called (a reference to the hierarchical 'position' within society), are in fixed supply: you can enjoy them only if others do not. The amount of money and effort required to grab them depends on how much your rivals are putting in.

All this somehow casts a doubt on the long-held dogmas of Economics. The science of Economics, especially as it applies to Capitalism, assumes that people know their own interests and are best left to mind their own business. How much they work and what they buy is their own affair. But the new science of happiness is much less willing to defer to people's choices. In 1930 John Maynard Keynes imagined that richer societies would become more leisured, where people would have more time to enjoy the finer things in life. Yet most people still work hard to afford things they think will make them happy. They also aspire to a higher place in society and purchase status goods such as expensive homes, and in so doing they work even harder and have less leisurely time at their disposal.

On the other hand, if economic growth through consumerism does not make people happy, stagnation will hardly do the trick. Ossified societies guard positional goods even more jealously. A flourishing economy creates opportunity, which in turn spurs happiness to a certain degree. It is hard to say that most people were unhappy during the heydays of the real estate boom.

To find the real estate market or, for that matter, the entire capitalistic system at fault because they do not deliver joy as well as growth is to place too heavy a burden on them. For many to do well is not enough: they want to do better than their peers, and this competition sets anxiety very deep.

Real estate can make people well off and the consequence of it is that one can choose to be as unhappy as he wishes. To ask anymore of it would be asking too much.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Tuesday, July 24, 2007 4 comments

Friday, June 22, 2007

Real Estate And Personal Wealth

How the appreciation of real capital assets has redistributed household wealth.

__________________________________________

Much of Adam Smith's classic treatise on "The Wealth Of Nations" is not really about wealth at all, but about income. The two concepts are different: income is the flow of money a nation or household receives in a given lapse of time, say a year. Wealth, conversely, is the stock of capital assets the nation or household have accumulated over their lifetime, minus debts. The difference matters, but how much is hard to say.

On the one hand the distribution of income has been debated over and over but, on the other hand, the distribution of wealth has been largely ignored. This is so because whereas it is relatively simple to measure global income inequality, to measure wealth is an entirely different story. This is all the more true in this time and age, when the richest 10 percent of adults in the world own 85 percent of global household wealth, while the bottom half collectively owns barely 1 percent.

Even more strikingly, with the appreciation of real property assets particularly in Western nations, the average person in the top 10 percent of wealthy adults owns nearly 3,000 times the wealth of the average person in the bottom 10 percent.

In everyday conversation the term ‘wealth’ often signifies little more than ‘money income’. But the economic interpretation of wealth is much broader and encompasses the value of all household resources, both human and non-human, including the ownership of real capital. Although real capital is only one part of all personal resources, it is widely believed to have a disproportionate impact on household well-being and economic success, and more broadly on economic development and growth.

The World Institute For Development Economics Research (WIDER) in Helsinki has now attempted to measure personal wealth, which includes real estate, financial assets, consumer durables and even livestock. Specifically, estimates of wealth levels are based on household balance sheets and wealth survey data, which are available for 38 countries. These include many of the rich OECD countries, that is those nations members of the Organization For Economic Cooperation And Development, as well as the three most populous developing countries, China, India and Indonesia; so the data cover 56 percent of the world’s population and 80 percent of all household wealth.

The researchers at WIDER found that wealth levels vary widely across nations. Among the richest countries, mean wealth measured in US Dollars was $144,000 per person in the USA and $181,000 in Japan. Lower down among countries with wealth data are India, with per capita assets of $1,100, and Indonesia with $1,400 per capita. Even within the group of high-income OECD nations the range includes $37,000 for New Zealand, $50,000 for Denmark and $127,000 for the UK.

The regional pattern of asset holdings shows wealth to be heavily concentrated in North America, Europe, and high-income Asia-Pacific countries which together account for almost 90 percent of all global wealth. Although North America has only 6 percent of the world adult population, it accounts for 34 percent of household assets. Europe and high-income Asia-Pacific countries also own disproportionate amounts of wealth. In contrast, the overall share of wealth owned by people in Africa, China, India, Russia and other lower income countries in Asia is considerably less than their population share, sometimes by a factor of more than ten.

So, how wealthy are you compared to the rest of the world?

If you have more than $2,161 in net worth, defined as the overall value of your capital and financial assets minus debts, you belong to the wealthier half of the human race. If you are lucky enough to own more than $515,000, you belong to the top 1 percent of wealthy mankind, although this is hardly an exclusive club, since it contains 37 million adults just like yourself.

The top ranks are dominated by the Japanese, Americans and Europeans, in that order. China occupies the middle ground. Throughout the globe, wealth is shared much less equitably than income: more than one-half of it is held by just 2 percent of the world's adults. The distribution is equivalent to a world of ten people, in which one had $1,000 and the other nine had $1.00 each.

Furthermore, there are some appalling results as well. Many people in poor countries have next to nothing, but quite a lot of people in affluent countries have even less than that, since their liabilities exceed their assets (negative net worth). Take Sweden, for example: the bottom half of all Swedes have a collective net worth of less than zero. And this is a characteristic of pretty much all Nordic countries, due in large part to their social welfare set-up. Sweden, for example, has a wealth per head of $39,000 – less than South Korea.

Someone ought to tell the Swedes that ownership pays.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Friday, June 22, 2007 5 comments

Tuesday, June 19, 2007

2007: Mid-Year In Review

A retrospective look at 2007 reveals that, contrary to many year-end predictions and a few economic forecasts, Real Estate still rolls, Canada is still in one piece, America has not drowned into the worst recession since the disappearance of the dinosaurs and the Twelfth Imam has not landed from the Moon yet.

____________________________________________________

Things seem to be moving in slow motion this year. We are all still alive and well, when in fact by now we should be all dead and buried - according to some prognostications I was reading all the way back in mid-December 2006, that is.

For the past few years the economies of North America have consistently defied the naysayers. Time and again the Cassandras who predicted trouble – whether a bubble explosion and the consequent crash of housing prices or the collapse in consumer spending followed by the crash of the American Dollar – were proven wrong. This year does not seem to be the exception, at least for now. Particularly the 'bubbleologists' – those individuals who have made the goal of their lives that of exploring the Milky Way with their economic telescopes looking for bubbles ready to collide with our planet – seem to be especially wrong.

To be sure, the housing boom has ended dragging down the pace of overall economic growth. But the housing 'correction' – as analysts are now beginning to call it – did not have calamitous consequences. In particular, we have not seen a recession in 2007 since – as I did anticipate at the end of 2006 – rather than slashing interest rates to stave off a slump, Central Banks both in the United States and Canada have focused more on inflation. Especially in the United States, after twenty-four months of steady interest-rate rises that have ultimately caught up with American serial borrowers, spending is now set to be a lot softer, which is a good thing overall. And the household saving rate, which in the last quarter of 2006 dipped to a negative 0.5 percent, has finally begun to inch up.

Even the so anticipated flood of defaults on mortgages and the consequent rise in loan delinquencies has failed to put a dent in the economy. Most household balance sheets are strong enough to withstand a drop in house prices. With consumer spending lower but not stagnant, overall economic growth this year is forecasted to be a little less than 2 percent for the United States and a little more than 2 percent in Canada – below its potential but not exactly a slump.

So, where does the foregoing scenario leave us and what can we reasonably expect the future to bring in the forthcoming months?

There is no question that 2007 is going to be a sluggish year, and a sluggish year is exactly what we need both to stem external imbalances and keep inflation under control. Allowing the economy to get an even footing through a slowdown of capital appreciation and at the same time allowing real wages to catch up is exactly the tonic needed for a healthy foundation. In general lines spending fuels consumption, which in turn erodes a limited quantity of resources. This is the concept behind inflation in an economy founded on scarcity of goods, which is typical of all capitalistic economies. As a direct and proximate result, therefore, controlling inflation is the key.

Core inflation, which excludes the volatile categories of food and fuel, is well above the 2 percent that Central Banks here in North America deem comfortable. Central Banks, therefore, will need to be extremely vigilant throughout the remainder of the year because the economy's natural 'speed limit' – defined as the rate of GDP growth that can be sustained without fuelling inflation – has slowed down. The two drivers that determine how fast an economy can safely grow – the number of employed workers and their overall productivity – are both flagging.

Unusually rapid productivity growth has been the source of economic strength in Real Estate over the past few years. But in 2006, as the stocks of unsold houses soared, builders cut back sharply after a multi-year construction binge. The pace of residential building fell by a fifth, enough to drag overall output down by one full percentage point. This year, conversely, the slump in construction has eased up already as builders have worked off a good portion of their excessive inventories. Adjusting to the shift in growth may not be easy for everyone, but absolutely necessary in order to avoid a recession.

And on the bright side of things, with growth strong in the rest of the world slower spending in North America can reduce the mammoth trade deficit without a serious dent in the overall global growth.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Tuesday, June 19, 2007 1 comments

Monday, June 11, 2007

The Incredibly Shrinking Dollar

... and how it affects real estate consumers in North America.

______________________________

An exchange rate is the price at which the world demand for one currency equals the world supply of another currency. Foreign exchange rates are of particular concern to governments because changes in foreign exchange rates affect the value of products and financial instruments. As a result, unexpected or large changes can affect the health of nations' markets and financial systems. Variations in exchange rates also impact international investment flows, as well as export and import prices. These factors, in turn, can influence inflation and economic growth.

Interest-rate differentials between countries are one of the main factors that influence exchange rates. Money tends to flow into investments in countries with relatively high real (that is, inflation-adjusted) interest rates, increasing the demand for the currencies of these countries and thereby their value in the foreign exchange market. Price of oil, trade and the fiscal position and ratings of each country are also equally important.

The Greenback's tumble early on in the year to a 20-year low of $1.32 against the Euro was no surprise to many observers. In fact, now that the Dollar has continued to fall to its present rate of $1.35 for Є1.00, in retrospective the only real surprise was that it had not slipped sooner. And, furthermore, there are good reasons to expect the slide to continue.

The recent decline was triggered by nasty news about the American economy, paramount among which the fact that the housing markets' troubles are having a wider impact on the economy as a whole than originally anticipated and, second in line, the global imbalances that the American current account deficit has created. The U.S. current account deficit, which is mirrored by current account surpluses in Asia and in many oil-exporting countries, has grown to the point where the United States needs to attract 70 percent of the world's capital flows to finance its interest payments only - clearly an unsustainable situation. There are also mounting concerns that Central Banks in China and to a lesser extent in India, which have been piling up Dollars assiduously for years, may start selling.

Ben Shalom Bernanke, the Chairman of the Federal Reserve System, continues to sound unperturbed suggesting that the American economy will enjoy a soft landing, a statement which would lead to believe that interest rates are not going to undergo drastic cuts. This notion has underpinned the belief that the Dollar will hold up in the medium run, because foreign investors will remain eager to buy American assets and so finance the country's current account deficit. But if house prices continue to fall, the risk of a recession will grow and the enthusiasm of foreign investors for the Greenback will shrink.

Yet, despite all, the attractiveness of the American Dollar is based more on an illusion than anything else.

The main psychological reason for the strength of the Dollar has been the widespread belief that the American economy vastly outperformed the world other rich-country economies in recent years. This belief is now beginning to change among foreign investors, for a variety of reasons. First and foremost the figures do not support the hype. For instance, it is true that America's GDP growth has been faster than Europe's, but that is mostly because America's population has grown more quickly. In fact, in real terms productivity growth over the past decade has been almost the same in the Euro Zone as it has been in America.

So therefore, contrary to the popular perception, the American economy has not significantly outperformed Europe's in recent year. But to achieve this not much better than parity status, the United States has incurred a huge current account deficits, while household savings have plummeted to a record low. Over the same period, the Euro-area economies saw no fiscal stimulus and household savings barely budged.

America's growth has been driven by consumer spending. That spending, supported by dwindling saving and increased borrowing, is clearly unsustainable and the consequent economic and financial imbalances must be inevitably unwind. As that happens, the country could face a prolonged period of slower growth that could spill across the border and affect America's single biggest trading partner as well: Canada.

In light of the foregoing, then, how should American and Canadian real estate consumers react?

Two countervailing factors tend to support the Dollar. First, emerging economies - especially China and India - hold so many Greenbacks that they fear the capital loss that they would incur if they encouraged the Dollar to drop. Second, emerging economies have all the interest to keep the value of their own currencies down to help their exports. As much as China and India have done giant leapfrogs forward in both manufacturing and finance - and in this respect both countries deserve the praise of the international community - neither has been able to fully create a domestic economic section of consumers that can absorb in whole or even in noticeable part what they produce. Besides, many a firm located overseas are American or branches or sub-branches of American multi-national corporations, and their ultimate goal is to produce output cheaply for export into North America.

Seen in this light, that talk of the weakness of the American Dollar is vastly exaggerated. In fact, the Federal Reserve reports that the real trade-weighted exchange rate of the Greenback against a broad basket of currencies is still close to the 30-year average. In other words, the Dollar needs to fall a lot more to make a dent in America's external deficit.

Moreover a falling Dollar does not necessarily spell doom for American consumers. In fact, all of us in North America could well benefit from a gradual slide in the American currency, as the ultimate result would be to shift production back into America's tradable sector, thus cushioning the domestic economy. A weaker Dollar would tend to hurt exporters in Europe and Asia and benefit those in North America as goods made here would become far more competitive abroad, thus spurring capital in-flow into the continent, as well as both foreign and domestic consumption.

Hence, so long as interest rates remain stable, real estate consumers both in Canada and in the United States need not to be overly concerned with the drop in value of the Greenback.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Monday, June 11, 2007 2 comments

Saturday, June 02, 2007

Sticky Deals

Price stickiness in a slower real estate market.

____________________

As markets are decelerating, there is an anxious face-off between sellers and buyers of real capital assets as expectations of big profits fade away just as well.

In economic terms, the slowdown that we are witnessing today in many real estate markets is actually welcome news since allowing the economy to cool off through a reversal of real capital appreciation while at the same time allowing real wages to catch up is exactly the tonic needed to consolidate market wealth achieved thus far, eliminate the 'froth' by reducing speculation and, in ultimate analysis, keep bubbles away.

But then, of course, not all of us are economists - at least not my own clients.

The house party had to end eventually, even if many sellers still refuse to believe it. In fact many sellers remain defiant to the point of delusion, demanding one more drink at the housing bar. ‘Stickiness' is a noun used in Economics to describe a situation in which a variable is resistant to change. Price stickiness, therefore, reflects the fact that asking prices of interests in land remain high and even increase at a time when demand lowers.

Sales of existing homes, both new and resale, are down 7 percent and 6.6 percent nationwide respectively in the United States and Canada in the first quarter of 2007 compared to one year ago. Buyers are taking their time, leery of overpaying and taking on too much debt, and yet particularly in the United States the National Association of Realtors reports that in the first quarter of this year listing prices of single-family detached units not only failed to match the decline in demand, but in fact in eighty-two metropolitan areas they actually increased compared to a year ago.

Experts in market psychology say stubborn sellers suffer of a classic case of denial. When it comes to financial-making behaviour, people would rather gamble and hope that prices come back. They tend to ignore information suggesting that prices are dropping. It is the same mentality that leads blackjack players to double down in a losing streak. This explains sellers' reluctance to cut down prices, and in fact several academic studies also suggest that frustrated sellers take their homes off the market rather than accepting lowball offers. Conversely, when investors see prices rise they get overconfident - much like the hot-hand bias that leads folks to think a basketball player will sink his fourth shot after making the prior three, even though probability says the odds are the same for every shot.

Price stability certainly is the utmost desire of central bankers, in any market. In fact, many a central bank have it, more or less. Consumer-price inflation hovers to 2 percent in America, 2.2 percent in Canada, 1.6 percent in the Euro Zone and 0.6 percent in Japan. One might argue, therefore, that because the overall price level is not changing a lot, nor are individual prices - but this is not necessarily a rule of thumb.

How often prices move is an important question. Shifts in prices are like the traffic lights of an economy, signalling to people to buy more of this and less of that, to spend or to save, or to find new jobs. If the lights change readily, resources can be redirected smoothly. If they get stuck, so does the economy. In particular, if neither prices nor wages shift easily, the cost in output and jobs and, ultimately, the cost of reducing inflation can be high. Sticky prices also mean that an inflationary shock - an increase in oil prices, for instance, like the one that is happening this very moment - can take a long time to work its way through the system.

Price stickiness in any market, but especially in a big-ticket market such as Real Estate, is responsible for and reflects some confusion that exists between nominal and real values and gives rise, moreover, to a particular phenomenon known as the ‘Money Illusion'. Money illusion does influence people perceptions of outcomes. Experiments have shown that people generally perceive a 2 percent cut in nominal income as unfair, but see a 2 percent rise in nominal income where there is 4 percent inflation as fair, despite the fact that the two situations are almost rational equivalents. The same happens in Real Estate, where the trend is for asking prices to remain high or even increase when selling prices are dropping.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Saturday, June 02, 2007 2 comments

Thursday, May 03, 2007

Real Estate, Wealth Accumulation And The Rise Of Prosperity

On whether it is wiser to treat real estate capital accumulation as a nest egg or as a credit card, that is to save as opposed to spend.

________________________________

Prosperity, in Capitalism, is the epitome of financial stability, reliability, and security.

It can be more easily thought of as an abundance of items of economic value, or the state of controlling or possessing such items, and encompasses money, real estate and personal property. Particularly as it relates to the field of Real Estate, it can be safely stated that when house prices rise, so does prosperity. This is so because there exists a well-established link between housing wealth and spending, which makes an increase in prosperity - both as a nation as well as at individual levels - in direct function of an increase in spending which, in turn, increases the acquisition of all the aforesaid items upon which prosperity is founded.

When house values increase - especially as dramatically as in recent years - people feel freer to spend from the wealth they have, or the wealth they perceive they have. They may decide to buy a bigger car, to eat out more often, to indulge in electronics or fashionable items, all of which is in most cases financed by their equity. And, strangely enough, people spend their hypothetical riches faster when their houses go up in value than when their stocks do, because they believe that housing gains are more stable.

In response to this greater affluence, the general trend of people is to increase their spending. Conversely, when housing values diminish people cut back spending in a similar way. The general consensus is that a $100 drop in wealth, over time, reduces spending by about $5.00 per year. This suggests, therefore, that weakening housing prices have a mild effect on consumer spending, to the tune of an approximate annualized rate of spending reduction of five percent.

This makes sense, in that economic theory tends to support the fact that rational consumers ought to adjust their long-term spending in response to changes in their wealth, not the ease in which they can tap it. But there is another element equally important to be factored into the determination of the level of prosperity: how well debtors manage their debt. For instance, the Mortgage Bankers Association (MBA) reports that seasonally adjusted index of mortgage application activity, which includes both refinance and purchase loans, increased 3.6 percent to 575.6 for the week ended December 29, 2006. The index stood at 555.8 the previous week, which was its lowest level since early August. Demand for home refinancing loans also strengthened as the MBA's seasonally adjusted index of refinancing applications increased 2.2 percent to 1,640.4. In 2005 the index stood at 1,363.2.

This evidence would suggest that consumers are using more of their home equity to pay off other borrowings such as credit card debts, in light also of the fact that mortgage debt in both the United States and Canada carries considerable tax advantages. This is another indication that, contrary to the forecast of some analysts, consumers manage their debts prudently, not recklessly.

The equilibrium in the issue as to whether consumers ought to treat their housing wealth as a nest egg or as a credit card - that is whether they should save rather than spend - is to be found in the ratio of spending to personal income. Surveys have shown that this ratio has peaked at more than fifty percent in 2005, meaning that people spent more than fifty percent of their disposable income using mortgage-equity withdrawal. This in turn would indicate that a slowing of mortgage-equity withdrawal could drag down spending faster than anticipated. The stakes here are high, because the behaviour of consumers will largely determine whether North-American economies will tumble into a recession or will merely slow down. This is so because in North America housing wealth has a bigger influence on consumption than other financial assets such as stocks and bonds.

Which in turn means, once again, that the level of prosperity is affected by the degree of spending proximately derived from the real capital wealth of consumers.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Thursday, May 03, 2007 4 comments

Wednesday, April 04, 2007

Re-thinking Collateral

New mortgage products on the horizon.

___________________

Did you take a close look at your banker, lately? Did you notice how skinny he or she has become? That is because, following the spike of house prices and the subsequent downturn in Real Estate, the carnivores have had a real hard time finding new flesh to feed upon. Things, however, seem to be changing now. As property values have risen dramatically in recent years and the pool of buyers ready, willing and able to purchase real capital assets has dwindled, lenders are beginning to re-think collateral.

Financial theory postulates that it makes little sense for market participants to borrow a lot to invest on a single assets class. But this is exactly what homeowners, investors and speculators in real estate markets all across North America and Europe had to do as a direct and proximate result of rising property values. High prices in many nations have forced many buyers to take on debts that are substantial multiple of their incomes. This has turned houses for most homeowners not only into their biggest single financial asset, but also into their biggest single financial liability as well.

To obviate this problem, banks in Europe are beginning to offer a new mortgage product, which is sure to reach North American shores very soon. Zurich Cantonal Bank (http://www.zkb.com/) is now offering a type of mortgage that links the value of the loan to that of the property.

This package comes in two versions: the first includes a ‘put-up option', that is a kind of insurance linked to Zurich's house-price index. At a cost of approximately 0.5 percent per year, this option ensures that if regional house prices fall, the size of the loan will decline in tandem. The second version, instead, links the level of the mortgage rate to the house-price index.

This new type of mortgage is designed specifically to shield market participants from the fluctuations of real estate markets, as well as to partly protect the same market participants from the affordability crisis, a problem rampant also in Europe - not only in North America. The primary culprit and cause of the crisis is the ratio between wages and real estate market values. This ratio is entirely skewed to values. Whereas market values in metropolitan areas in North America have appreciated an average of fifteen percent per year for the period from 2000 through 2005 - or a total of seventy-five percent, salaries have increased an average four percent per annum - or twenty percent total. The problem is even worse in Europe. There is, therefore, a fifty-five percent gap, which accounts for the problem buyers on this side of the Atlantic are facing today when it comes to go to the bank and qualifying for a loan. This gap is even larger in Europe.

By putting the principal balance of the loan on a sliding scale linked to the house-price index or by tying rate fluctuations to the oscillations of house values, Zurich hopes to attract a fresh pool of buyers and, at the same time, offer a better refinancing option to existing property owners. The flip side of the coin, of course, is to see how many buyers will actually be willing to pay more for their loans in times of market expansion.

In Britain, on the other hand, Advantage (http://www.adv-elect.co.uk/advantage.asp) - the marketing arm of Morgan Stanley - has unveiled a mortgage product named ‘Flexishare Home Ownership Plan', with the following highlights:

[ ] Gives borrowers greater purchasing power.

[ ] Borrower owns 100% of property.

[ ] Part Residential Ownership Loan, part Conventional Mortgage.

[ ] Advantage shares proportionally in appreciation and depreciation.

[ ] Overpayments and buy back of Advantage's Share allowed.

[ ] Flexible amount of Advantage participation.

[ ] Choice of two stepped fixed rates.

[ ] Portability allowed (not committed to any additional lending).

[ ] Affordability based.

[ ] No Higher Lending Charge.

[ ] Fees may be added over 95% LTV.

[ ] Minimum 5% deposit.

[ ] Available in England, Wales, mainland Scotland and Northern Ireland.

Under this plan, the value of part the loan rises and falls in line with the house price. In return, Advantage charges a lower interest rate only on the fluctuating part of the loan, and hopes to raise the balance by packaging up such loans and sell them on the capital markets, where they might be a viable alternative to index-linked bonds. Again, though, there is a flip side to this type of scheme: in England, just like in America, homeowners are mainly accustomed to property values going higher and higher in the long run, and may not be willing to give up some of the potential rise in house prices by paying a higher interest rate, in order to insure a downside.

Both the foregoing products have the ultimate goal of allowing real estate purchasers and current homeowners alike to buy or otherwise refinance real capital assets using both equity and debt, and it will be interesting to see how successful and popular they will become. But aside from how welcome they will be in Real Estate, it would certainly appear that your friendly, neighbourhood Tyrannosaurus Rex is getting ready yet for another feast - wherein you are going to be once again the main entrée ...

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Wednesday, April 04, 2007 2 comments

Tuesday, February 20, 2007

Real Estate And The Year Of The Pig

Gung Hay Fat Choy! (Happy New Year)

____________________

The Lunar New Year dates from 2600 BC, when Emperor Huang Ti introduced the first cycle of the Chinese zodiac.

Because of cyclical lunar dating, the first day of the year can fall anywhere between late January and the middle of February. On the Chinese calendar, 2007 is Lunar Year 4704-4705. On the Western calendar, the start of the New Year falls on February 18, 2007 - The Year of the Pig.

The Year of the Pig is of particular importance for North American real estate markets, since the level of interest rates is in direct function of how China's Central Bank will direct the investment of its USD 1 trillion in foreign exchange reserves.

China's foreign exchange reserves are at twice their level of two years ago and amount to more than one-fifth of all global foreign exchange reserves in American Dollars. To put things into perspective, this humungous amount would be enough to buy all the gold sitting in the vaults of all central banks or, put differently, it would be almost enough to buy all residential property in the London Metropolitan Area. This massive hoard of foreign cash reserves is growing exponentially to the tune of some USD 20 billion per month.

China's foreign exchange reserves already far exceed the minimum level required to ensure financial stability. As a rule of thumb, a country needs enough foreign exchange to cover three months of imports. The reserves of the People's Republic are already enough to cover five times as much - 15 months worth of imports. This is the direct and proximate result of the country's large current account surplus, significant foreign investments and big inflows of speculative capital, especially over the past couple of years. In theory, strong flows of foreign capital into China should have pushed up the Yuan to astronomical levels, but Beijing has resisted this by refusing to allow its currency to float freely, thus forcing the Central Bank to buy up the surplus foreign currency.

How this stack of money is invested has big implications for the world economy, not just for China. But no place is more dependent on the decisions that the Central bank will make in the Year of the Pig than North America. This is so because approximately seventy percent of the country's foreign reserves are invested in American Dollars, mainly in US Treasury securities. This has propped up the Dollar and reduced American bond yields by as much as 1.5 percent.

China's Central Bank, however, has now signalled its intention to switch from Treasury bonds to American mortgage-backed securities and corporate bonds in an attempt to earn higher yields. What's even more important, Chinese officials are also debating the need to diversify reserves out of American Dollars in order to reduce the exposure of a big drop in the value of the Greenback, and to invest a larger slice into Euros and the emerging Asian currencies.

Clearly, a big shift out of the Dollar could therefore push up bond yields and hence mortgage rates, thus damaging further the already weakened North-American housing markets. And this is the reason why the Year of the Pig promises to be a pivotal year and of great repercussions here in North America.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Tuesday, February 20, 2007 4 comments

Saturday, February 17, 2007

Real Estate Outlook 2007: The Great American Iced Lemonade!

What do California sunshine, the citrus industry, an excess surplus of ice cubes and Nancy Pelosi all add up to? Find out ...

_______________________________________

Did anyone out there ever coined the phrase ‘The New Era Of American Socialism' yet?

Well alright, that is unfair. After all Real Estate was sliding downwards even before the Democrats took over the House and Senate, and Nancy Pelosi became the Speaker to be. However, it can be safely stated that the recent mid-term elections have not exactly shed a ray of hope on the already faltering housing prices. So now, in light of the entirely new and revolutionary political landscape in Capitol Hill, what are mundane folks like you and I supposed to do?

Sure, the social agenda of the Democratic Party in general, and the personal ‘socialist' agenda of Congresswoman and Speaker of the House Nancy Pelosi (D-Cal.) in particular take somehow the breeze out of the investment world, both as it relates to Real Estate and the Stock Market. But when it comes to Real Estate, however, there are some positive notes worth mentioning.

Housing supply is produced using land, labour, and various inputs such as electricity and building materials. The quantity of new supply is determined by the cost of these inputs, the price of the existing stock of houses, and the technology of production. Essentially, the production of real estate output depends on the accumulation of capital, which requires a constant supply of labour force that can conserve and add value to inputs and capital assets, thus creating a higher value.

The rationale behind this is that labour adds value by satisfying demand through production, since when people work and acquire income they tend to invest it, and the more people that work and acquire income the more people that tend to invest it. Therefore, there is a correlation between capital and employment in real estate or, if you will, between income and labour. An increase in levels of consumption sets forth an increase in prices caused by a corresponding increase in demand, in itself generated by a commensurate increase in the income-employment factor.

It follows, therefore, that growth is derived by the equilibrium of capital and investment with labour and employment. And since, furthermore, production is in direct function of consumer-spending which increases as unemployment falls, it follows that capital accumulation increases as employment rises and capital accumulation decreases as employment falls.

Therefore, seen from this perspective, the Democratic agenda of both increasing minimum wages and put people at work through more direct governmental intervention than the Republicans otherwise would like to see, finds in fact its long-term benefits in Real Estate. It is a statement of fact that, in retrospective, many workers in North America have missed out and are missing out on the rewards of globalization, so trumpeted about by both the present Chairman of the Federal Reserve System, Prof. Bernanke, as well as the former Chairman, ‘Maestro' Alan Greenspan.

Rich countries have democratic governments, so continued support for the globalization process will depend in large part on how prosperous the average worker feels. Yet in the United States real wages have been flat or even falling these past few years while, at the same time, capitalists and large corporations have never had it so good. In America specifically, profits as a share of GDP are at an all-time high of about 15.5 percent, and Corporate America has increased its share of national income from seven percent in 2001 to thirteen percent this year.

In fact the primary culprit and cause of the slowdown in Real Estate is the ratio between wages and real estate market values. This ratio is entirely skewed to values. Whereas market values in metropolitan areas have appreciated an average of fifteen percent per year through 2005 inclusive - or a total of seventy-five percent since 2000 - salaries have increased an average four percent per annum - or twenty percent total. There is, therefore, a fifty-five percent gap, which accounts for the problem buyers are facing today when it comes to go to the bank and qualifying for a loan. In this sense, therefore, a redistribution of income from capital to labour is now due.

The flip side of the Democratic agenda, however, is that it is going to take a long time for government economic intervention to get a foothold in the economy, in order to make workers earn income sufficient enough so that they can go to the bank, get a loan and go shopping for real estate. Thus, it is going to take equally long for demand to jump and prices to increase as well. This is so because demand is in direct function of underlying personal income. An increase in personal income will encourage investment to a higher degree, which, in turn, will spur demand causing a proximate levitation of prices and subsequent economic expansion.

A second but equally important flip side is how foreign investors and debt-holding nations are going to view this sudden shift to the left of the American behemoth, and whether emerging economies such as India and China will continue to finance America's spending habits. Confidence in the U.S. Treasury is out of the question, but how convenient is it going to be for foreigners to continue investing in an America tilted definitely to the left?

Many economists have long been expecting America's widening current account deficit to cause a financial meltdown in the Dollar, and the main reason as to why this has not happened yet is that emerging economies have been happy to finance the deficit. In 2005 India, China, South Korea and Japan (not an emerging economy but a very important debt-holder nonetheless) ran a combined current account surplus of about USD 2 trillions, a large chunk of which was reinvested in American Treasury securities. It is all to be seen, however, whether the Asian Tigers will continue to find the convenience in investing their foreign cash reserves in American securities or if instead they are going to withdraw their support of the American capitalistic system, especially if such system will be perceived increasingly as shifting much too much to the left.

By purchasing Dollar assets the Asian economies and Japan are subsidizing American consumers, encouraging too little saving on our part and too much spending. But should they decide not to buy anymore and in fact to cash in, the American economy is likely to suffer a real hard landing. This is the reason why it is important to monitor and understand how developments in the world economies affect the balance between domestic demand and supply. Exchange rate movements tell something about economic developments that may be having a direct impact on aggregate demand.

By monitoring the fluctuations of the Dollar in the forthcoming months it will be possible, therefore, to anticipate whether the Central Bank will ease or tighten monetary policy by stimulating the economy through lower interest rates or by reducing the stimulus through higher interest rates. And, therefore, it will be possible to predict the impact that anticipated shifts in interest rates will have on demand for domestic real capital assets. Clearly, in the eventuality that demand for U.S. Treasury bonds will abate, the Federal Reserve will have no other choice under the present circumstances but to raise interest rates, so as to continue to attract foreign capitals and thus contributing to a further slowdown in the domestic housing markets.

Should a forced rate increase actually take place in 2007 to maintain the momentum with foreign debt-holders, that would really fly in the face of all those analysts and commentators who have assumed that a vote for the Democrats would contribute to a rate settling.

Certainly we are entering into a period of financial uncertainty, all the more remarked by what promises to be an economic - if not political - stalemate between a conservative White House and a liberal Congress. And should this stalemate translate into higher interest rates, the soft landing that Chairman Bernanke was mentioning only this past July may very well become in 2007 a distant, wishful dream.

Luigi Frascati

Real Estate Chronicle

# posted by Luigi Frascati @ Saturday, February 17, 2007 0 comments

Thursday, February 08, 2007

American (or Canadian) Dream 2007: Keep Those Real Estate Properties Financed!

The untold secret of homeownership.

______________

If you had enough money to pay off your mortgage right now, would you?

Many people would. In fact the American Dream is to own a home - and to own it outright, with no mortgage. Imagine owning your home without having to send a cheque to the bank every month, the feeling one will enjoy when - after thirty long years - the moment finally comes to make one last payment so that the house is paid off, at last. Being so fortunate must evoke a sense of security, gratification and well-being that anyone only can dream of.

But if in fact the American Dream is so wonderful, how come thousand of financially successful people - folks who have more than enough money to pay off their mortgages right now - refuse to do so? Why is it that a small group of Americans and Canadians, who are invariably among the wealthiest five percent of the population, insist on carrying on a mortgage even if they can afford to wipe it out entirely today? Because they are aware of the biggest untold secret of homeownership: a mortgage is primarily a loan against the borrower's income, not primarily against the value of the house. It this was not the case, then naturally anyone with a $30,000 annual income would qualify to purchase a multi-million dollar mansion.

All of which, then, makes the whole difference in the world when it comes to a process known in Economics as the accumulation of wealth. Prosperity in any society and at any given time is the epitome of financial stability, reliability, and security. Specifically in Capitalism, additional capital value (commonly referred to as ‘surplus value') is what drives the accumulation of wealth. Although capital accumulation does not necessarily require production, ultimately the basis for it is value-adding production which makes net additions to the stock of wealth. Capital can accumulate by shifting the ownership of assets from one place to another, but ultimately the total stock of assets must increase. Other things being equal, if surplus value fails to grow sufficiently, the level of debt will increase, ultimately causing a breakdown of the wealth accumulation process.

This is exactly the reason why saving money has never made anyone rich. For some obscure logic people generally tend to equate the concept of saving money with that of making money, yet the two are not synonymous. As people want to save money in interest payments, they will go the extra length to pay off their mortgages. With that issue out of the way after a considerable number of years, they then start focusing on saving for retirement and do their best to save regularly. As a result, they fail to accumulate wealth and cannot figure out why.

The issue is relatively simple, though not necessarily transparent. By prioritizing mortgage repayments, they fail to consider the role that mortgages play in their wealth building process. The battle to reduce interest expenses is won, but the wealth accumulation war is lost. The reason is that every dollar they have returned to the bank is a dollar they have not invested.

Mortgages today cost anywhere between 5.5 percent to 6 percent annually. Over the next thirty years, on an annual basis, will alternative investments earn at least that much? Of course they will. Even government bonds pay nearly that amount, and stocks have been averaging 10 percent a year since 1926. Thus giving money back to the banks to save 6 percent denies people the opportunity to invest that money where it might earn 10 percent. Which means that, rather than actually saving money, those who opt to pay off mortgages factually lose money. And which, furthermore, goes to explain why bi-weekly mortgage payment plans are not a great idea - because they speed up the process of mortgage repayments.

Specifically as it relates to real estate, furthermore, the irony is that people somehow feel they are making a ‘good investment' by paying off their home loans. In fact, all they are doing is burying money under a mattress - they are not investing at all. Consumers, and a great deal of them, strive to pay off their mortgages as quickly as possible so they will be able to borrow later on against their equity to pay, among other things, for their kids' tuition bills. But isn't that refinancing? Talk about bizarre strategy! Consumers struggle to give banks their money back now, so they can borrow it again in the future. Why don't they just invest their cash, so that it earns competitive returns and, at the same time, remains available whenever needed?

Their homes will grow in value over the next thirty years whether they have a mortgage or not. When it comes to selling a home, does any Buyer care about what the Seller's mortgage outstanding balance is? Of course not. And neither does the IRS (Internal Revenue Service) or the CCRA (Canada Customs and Revenue Agency) when it comes to calculating taxable capital gains, losses or recaptures.

The simple truth is that mortgages do not affect home values. But being primarily financial instruments anchored to income, they do affect the wealth maximizing process of investors and market participants by opening up a host of possibilities to invest liquid money derived by consumers' own income elsewhere, for higher rates of return. Which is what the wealth accumulation process is all about.

Luigi Frascati

Real Estate Chronicle