How much would you pay for this house?

The house is a duplex. I only took a picture of half of it because that’s all you get… the half you see in the picture.

The specs are two bathrooms and four bedrooms (although three of the bedrooms barely fit a queen-sized bed and the closets are only as wide as a normal door).

You get a partially finished basement, too.

I thought, generously, this place would be worth $200,000. But it was listed for C$1.25 million (about $940,000 U.S. dollars). That’s almost five times more than I’d pay for it.

That’s how hot the Toronto real estate market is.

Look, you might not care about what happens in Canada. But when its real estate bubble bursts, American investors will feel the impact, too.

You might think that’s crazy… How can our small northern neighbor’s economy impact us? The U.S. economy is so much bigger than Canada’s.

But that’s exactly what happened during the 2008 financial crisis.

The first cracks appeared in the housing market across the Atlantic. British bank Northern Rock nearly crashed under a pile of toxic subprime mortgages. The ripple effects were felt all the way on Wall Street.

It’s very possible for a similar contagion to start in Canada and spread here.

Right now, I’m in Toronto to pull back the curtain on the biggest display of smoke and mirrors in the Western Hemisphere.

Everyone in Canada—both locals and foreigners—is blindfolded to this crisis. I’m here to show you what’s going on.

What Canadians Are Saying

I attended six open houses to get a feel for what is going on in Toronto.

And what I saw didn’t look good.

First, let’s start with the failure that is the 15% tax on real estate purchased by foreigners.

The Ontario provincial government levied the tax after housing prices in Toronto increased more than 30% from March 2016 to March 2017.

The government thought the tax would scare away foreign buyers and slow down the rise in prices. But that hasn’t happened.

I didn’t see many prospective buyers at the open houses I attended. But the ones I did see were foreign (mainly Chinese and Iranians).

The government also capped the amount landlords can increase rent at 2.5% per year.  But that also hasn’t slowed down the market.

One agent told me, “Sales didn’t slow down until the near collapse of Home Capital Group.”

I wrote about that subprime mortgage lender back on May 9. The company only avoided bankruptcy because of a $2 billion emergency loan.

That’s what really caused demand to slow.

While in Toronto, I saw on the Canadian Broadcasting Corporation (CBC) channel that home sales declined over 20% from the previous month.

And this decline happened in the face of a rising supply. It seems some locals saw the near collapse of Home Capital Group as a warning sign. They want to get top dollar for their property.

Every agent I talked to acknowledged the fact that the number of houses on the market is increasing.

Worst-Case Scenario

Slowing demand in the face of increasing supply almost guarantees lower prices. It’s the worst-case scenario for future prices.

But no one in Toronto is worried.

The real estate agents told me the new supply just matches what they saw last year. And that didn’t cause prices to decline… In fact, they went up over 30%.

Even an impartial investment banker I talked to wasn’t worried.

He said, “In no other city the size of Toronto can you get a single-family home so close to downtown. And that demand will continue coming in because it’s the only safe place for some foreigners to buy real estate.”

The exorbitant house prices didn’t even worry him.

He went on, “The debt-to-income numbers don’t matter. Buyers are either foreign or they’re getting help from mom and dad. Income doesn’t matter.”

Astounding…

Regards,

Nick Rokke, CFA
Analyst, The Palm Beach Daily

P.S. If you want to see how this story ends, watch the 2015 film The Big Short. The movie tells the story of how a few investors made a lot of money shorting real estate. All while the rest of America struggled during the financial collapse. Remember, the 2008 crisis started in a foreign country and spread here. It could happen that way again.

MAILBAG

From Rick B.: Can you comment on the new company that allows people to buy bitcoin from their IRAs? It’s called BitcoinIRA.com. I’m told it’s the only company in the United States that offers cryptocurrencies via your IRA.

Nick’s Reply: My colleague Greg Wilson wrote about Bitcoin IRA right here.

From Greg J.: I recently read an essay entitled “Why Bitcoin Can’t Serve as a Currency.” Any thoughts?

Nick’s Reply: Hi, Greg. We’ve heard this kind of skepticism before (in fact, 129 times and counting). Both my colleagues Teeka Tiwari (“They Killed Bitcoin 129 Times; Each Time, It Came Back Even Stronger”) and Greg Wilson (“Why You Should Ignore the Media and Buy Bitcoin”) have addressed these concerns in full.

From Tony A.: I’ve been a member for a few years now and love your work. I did have one question based on the article on U.S. steel (“These U.S. Steel Companies Are Forging a Comeback”): How did you guys miss that recommendation?

When the government put the steel tariffs in place, someone should have picked up on the positive impact that would have for U.S. steel companies. Seems like too much focus on bitcoin has caused a loss of diversity. My two cents… Keep up the good work, though.