Sunday, February 21, 2016

A History of the Home Mortgage Part #2 - The Early to Mid 1900’s

In the prior edition of this history on the home mortgage series, we discussed the heavy handed nature of lenders in medieval times and the advancement of mortgage laws to protect borrower’s equity. Throughout history and leading up to the early 1900’s, the mortgage markets were very different then what we know today.  Home mortgage loans were provided by life insurance companies, trust companies, or in many cases, smaller individual lenders or mortgage companies. 

For those of us who have seen the movie “Its A Wonderful Life”, we can fondly remember the scene where they discuss how money deposited at the bank is not actually sitting in the bank’s vaults but has been used to make loans and is now sitting in peoples’ homes.  But, in the US and Canada before the creation of the central banks and government sponsored housing loan insurance organizations, banks were not significant players in the mortgage markets.  The reason for this was simple, if a bank could have a surprise wave of customer withdrawals in a short amount of time and needed to call on loans to gather cash for covering the depositors’ requests, mortgages against real estate could not be collected fast enough to meet liquidity demands.  For insurance companies and mortgage companies, daily access to cash was not as big of a concern because none of their customers would come and demand their money back on a given day of the week. 

The creation of the central bank, the guarantee on deposits later provided by governments following the great depression, and the creation of home loan insurance organizations were the three big changes the banks needed to finally get into mortgage lending. 

1. Central banks allowed the individual banks to co-operate together more easily to manage each of their own liquidity needs. In effect, if one bank needed cash on a given day of the week to meet depositors’ withdrawal requests, it could borrow the money overnight from another bank. This took pressure off the bank and allowed for less liquid loans to be made. 

2. A government guarantee on deposits reduced the probability and magnitude of a potential bank run. This also made it more comfortable for a bank to lend on longer term mortgage loans.  

3. And most important of the three for housing, with the creation of home loan insurance organizations the banks could mitigate loan loss risk if borrowers defaulted or the value of homes went down below outstanding mortgage balances.

From the 1940’s onwards, the banks began to dominate the mortgage markets and ultimately became the leading lenders.  Additional local chartered lenders began operating much the same way, called Credit Unions in Canada or Savings and Loan Co-operatives in the US. These smaller regional players filled geographical gaps or provided loans to borrowers where the larger banks could not.

Part 1 of this series started by describing how individual direct lenders were the only source of mortgage loans prior to the 19th century, followed by outlining how mortgage companies expanded late in the 1800s. This second part to the series covers the portion of history when the banks became active with the invention of central banks and housing loan insurance organizations. 

Part 3 of this series will cover the next big evolution in housing finance which occurred with the introduction of mortgage securitization and mortgage banking. Starting in the 1970’s, the wide spread adoption of national mortgage agencies like the Government National Mortgage Association - GNMA (Ginnie Mae), the Federal National Mortgage Association - FNMA (Fanny Mae), and the Federal Home Loan Mortgage Corporation - FHLMC (Freddie Mac) helped mortgage banking to become a new home financing force.

The following chart shows a progression of housing finance systems starting with simple direct individual lenders, evolving through corporate intermediaries like mortgage companies, followed by the entrance of the banks, and finally to the creation of mortgage banking and the securitization model. 

What is interesting to see, now looking back on these stages of the mortgage market evolution, is the increase in homeownership with each successive development. 

By 1930 home ownership reached 47.8%. Before dropping to 43.6% after the great depression the homeownership rate then rose up to just over 60% by 1970 as a result of the banks becoming the leading lenders.

In the 3rd part of this series we will look at how much the addition of securitization increased home ownership, personal debt levels, and the quality of housing.

*Mortgage Markets World Wide - Blackwell Publishing
*Housing Finance Systems A Comparative Study - Croom Helm Ltd Publishing
*Mortgage Banking in the United States, 1870–1940 Research Institute for Housing America.

*The Historical Origins of America’s Mortgage Laws, Research Institute for Housing America.

Monday, October 12, 2015

A History of the Home Mortgage - Part #1 - Medieval Times to the Early 1900’s

The use of debt to facilitate the purchase of goods and services has occurred for more than 5000 years.  What most people think of when the hear the word “mortgage”, is a more recent form of property title secured loan used to fund the purchase of a home.  The amount of money required to buy a home today is very different than before there was such a thing as building codes, high quality housing design, municipal services, and home insurance. It would take many’s decades worth of saving disposable income to afford the purchase of a home outright. Now, we think of the market for mortgages and the willingness of lenders to provide financing for property ownership as constant and pervasive, but it hasn’t always been this way.  

Up until early in the 1900’s there was not a consistent and continuously available market for mortgages. The mortgages that happened to be available were short term in nature, often requiring all of the principal amount to be paid at the end of one year, along with a equivalent interest rate above 20% to 30% per annum.  We wanted to find out about the origin of mortgages and understand the evolution of mortgage law up to and beyond the turn of the 20th century, as well as understand the biggest shifts in the mortgage market during the last 100 years. We will also look at how the mortgage markets went from being spotty, unregulated, and uncertain, to become one of the most sophisticated and largest financial markets in the world. Although the ability for the majority of people in North America to obtain a mortgage has improved, there is still much room to grow and expand mortgage finance. New mortgage options have the ability to accelerate economic development and open up home ownership as a universal choice. Read on to find out more.

In medieval England, up until the 16th century all “mortgage’ contracts actually provided the lender control of title (rather than the borrower). Charging interest was considered “usurious” (sinful) and therefore illegal up to that point in time.  Instead, the “lender” would charge rent and participate in profits generated from the land by virtue of holding title. When the required payments were made to satisfy the mortgage contract, control of title would pass free and clear to the borrower.  This form or mortgage tended to result in many more cases of the borrower losing the property, with the lender forcing the borrower off and permanently keeping ownership along with all profits from that day forward.

Prior to the introduction of the “equity of redemption” law in the 17th century, borrowers had few rights and would easily lose their entire economic interest in a property. They needed to not only satisfy the repayment of the terms under the mortgage agreement but were also required to produce written proof confirming the same. They needed this additional documentation to defend themselves in court if a lender tried to argue they had failed to satisfy the agreement while intending to take full ownership for themselves without having to pay the borrower any more for it.

With the advance of the “equity of redemption” right, borrowers could then regain their property by making the required outstanding payment of principal and interest within a period of time after the repayment date stipulated on the mortgage contract.  In addition, if the full amount wasn’t paid on time, the lender was required to keep a strict accounting of the rents or profits received and once enough had been collected to cover the deficit the property had to be transferred back to the borrower. The right of redemption period could be as long as 20 years, or the lender could apply to the court for a final end to this period which became known as “foreclosure”. By way of comparison, over the last 100 years, the right of redemption for most States in the US has dropped down to 3 or 4 months or less.  In Canada, there is a 6 month right of redemption period which applies unless the lender proves there is no equity in the property and their principal balance is at risk.

Through out the 1800’s the lending markets for mortgages were not nationally organized.  Mortgage contracts and the ownership of land largely revolved around farming and food production as well as urban housing development. 

Prior to the creation of Central Banks in the US and Canada during 1913 and 1935 respectively, mortgage markets were largely funded by life insurance companies, regional trusts, mortgage companies, as well as individual lenders. And especially prior to the 1900’s in the US, as national banks were prohibited entirely from lending in the farm mortgage market

In the late 1890’s, mortgage banks could fund their lending activities by issuing debentures against pools of mortgages.  There was a crises that ensued following several years of drought when a wave of farm mortgage defaults began. Evidence was later found showing mortgage companies had placed lower quality loans behind the debentures that had been sold to investors. It seems history clearly repeated itself when during 2008 the great recession started based on loans that were provided to people who could not have afforded the payments and were a key part of the sub-prime mortgage securitization industry. 

In the US, beginning with a nationwide trend moving to single family home ownership starting early in the 1900’s and following the Great Depression, the banks finally began to enter the mortgage market with concerted effort. It took the governments of both the US and Canada to create housing loan insurance programs to allow the banks to get comfortable carrying long term fixed rate mortgage debt on their balance sheets. With the advent of these new mortgage insurance plans the banks volume of home loans grew to become the majority of the market within two decades. It took both a great war and a depression to put these wheels in motion but both Canada and the US decided that home ownership and the construction of housing was an important part of the economy. This improved activity in the mortgage markets helped fulfil the popular dream of owning a home in North America.

Coming soon in the next part of this series, we will look at how the markets evolved from the early 1900’s around the time the banks entered the scene, to what happened leading up the credit crisis of 2008.

Mortgage Banking in the United States, 1870–1940 Research Institute for Housing America.

The Historical Origins of America’s Mortgage Laws, Research Institute for Housing America.

Sunday, September 20, 2015

Leading vs. Lagging - Staying Ahead of the Pack in Real Estate

The stock market has its P/E ratios but what are the best indicators worth watching for real estate to know when a change in strategy is needed?
As real estate is a slower moving and less liquid asset class amongst stocks or bonds, it is important to see change approaching while it is still off in the distance.  The two largest drivers of real estate value movement for an urban market are the population and per-capita income changes within that region.  The problem with waiting for data on these two indicators is in some cases they can lag the market by 6 to 18 months.  The census data collected by the government on population figures which may be one of the more reliable sources can be well over a year behind the date it is needed. 
Given the lag in these indicators we must find ways of inferring up-coming shifts in market trends before those stats are released.  Three important leading data-points to understand and pay attention to are: Housing Starts, Sales to Listings Ratio, and Local Unemployment. 
Housing starts is a less frequently talked about indicator but is posted every month. Housing "starts" are tracked as the number of new building permits taken out by builders in each  municipality and can be treated as part of the housing supply.  Along with the number of active MLS listings which would include some of these new homes being built, the combination of these two represent the homes that buyers can choose from.  Some builders do not list all of their condos or houses on the MLS and prefer to sell them through direct advertising so it is important to watch both numbers.  
The Sales to MLS Listings Ratio could be viewed as a better and more timely indicator than population change although it is a mixture of a number of different factors including interest rates and effect of changes in the economy.  The sales to listing ratio in some of the Greater Vancouver sub-markets during the summer of 2015 was between 60-80%.  Anything over 30% is considered to be a sellers market, and in some cases there were more sales than the number of listings on MLS, showing a market where literally everything was selling. This stat is available monthly within weeks of month end making it a great leading indicator.
The last signal is unemployment.  The home buying power within an urban market is based on how much mortgage a buyer can afford to make payments on.  The level of unemployment is released every two weeks making it a great leading indicator. Taken in account along with recent changes in the prime interest rate and we can see how much change has occurred in the home buying power of the existing population within a city.  Right now Vancouver is seeing the lowest unemployment rate in recent history at 5.8% and with the lowest prime rate in the last five years at 2.7%, the fundamentals seem to be positively supporting home prices.
With strong GDP growth forecasted in BC for the rest of the 2015 calendar year, along with a relatively low level of MLS listings, extremely positive employment trends, and continued inward immigration, it is reasonable to expect the home price index will out-perform inflation (CPI).  
In future posts we will come back to these leading indicators and watch how changing real estate trends can be predicted.  If you have any more of your own favourite leading indicators feel free to share them in the comments below. Our collective goal should be to avoid the kind of exuberance which pushes markets beyond their fundamentals all the while ensuring we have the insight to make timely intelligent decisions about our real estate portfolios.

Monday, September 7, 2015

Home Price Increase Covered by Family Income Growth

Searching for the source of the increase in the prices of residential real estate in Canada, we looked to the growth in home buying power that comes from increases in family income. We found that family income growth covers virtually all of the growth in home value in most major markets - find out how below.

Looking at the average after tax income for Canadians* and specifically tracking the middle 60% of the country, we have come up with a growth in buying power benchmark of 75.4% from 2005 to 2015.  This number was calculated using an inflation adjusted change in family income with the change in prime rate factored in. To arrive at the buying power number we used a mortgage affordability calculator like the one on TD's website ( Taking the prime rate as a relative borrowing cost bench mark in December of 2004 a 4.25%, and the current prime rate of 2.7%, we found that buying power growth very closely tracked the home price index (surprise surprise).

Toronto and Calgary are above the national home price index** for the 10 year period so it would make sense they are above the national buying power increase bench mark (Calgary has a much higher average family income than most other markets).  Vancouver is nearly equal with the buying power benchmark and most other urban real estate markets are below.  

It is amazing how much media coverage and how many sensational stories on the potential demise of the market ignore this primary benchmark for home affordability economics. If the buying power bench mark drops due to family income decreasing and the prime rate increasing they would would expect to see home prices go down. Otherwise, as inflation drives up family incomes the home price index will continue to appreciate right along with them.

*Source: ESDC calculations based on Statistics Canada. Table 202-0703 - Market, total and after-tax income, by economic family type and after-tax income quintiles, 2011 constant dollars, annual, CANSIM (database). These numbers were modified back to non-inflation adjusted with CPI to match the non-inflation adjusted home price index. Found by website link

$757 Billion Home Market In Vancouver

To put $8.48 Billion into perspective, if we take 533,500 as the number of private "ground" dwellings in Vancouver from the 2011 Stats Canada Census, and multiply that by the average home price of $1.42 Million, we get a total market of $757,570,000,000 or $757 Billion. This number is for only Vancouver excluding the rest of the Fraser Valley and would not include condos or apartments.
Additional buying power of $8.48 Billion amounts to another 1.12% of the total market. Of course the number of $8.48 Billion is only taking into account the Provincial Nominee program immigrants and doesn't include the other 24,500 people immigrating to BC. Coming up next we will look at the change in the average income level of Vancouver and Toronto residents to see what impact they may have on these markets.

$8.48 Billion Into The Vancouver Housing Market

Where have the residential real estate equity gains been made in Canada recently?

Over the last three years the ranking goes*: 

1. Toronto (+21.94%) 
2. Calgary (+17.88%) 
3. Vancouver (+13.92%) 

But recently the numbers tell a different story.

Vancouver is leading over the last 6 months and is beginning to close the gap with Toronto and Calgary. With the price of oil dropping, the Calgary home price index has effectively been flat over the last 12 month period. During the last 6 months, the home price index ranking is as follows*: 

Vancouver (+9.17%)
Toronto (+7.54%) 
Calgary (-0.62%) 

What is giving Vancouver the financial fuel to support these home price trends? 

As of July 2nd, 2015 the Province of BC announced the “Provincial Nominee Program” was accepting applications again after taking a 90-day pause**. The focus is now on “high-impact workers and entrepreneurs”, described to align better with BC’s labour market and development priorities. 

Vancouver has seen positive population growth similar to Toronto, with strong inward flows of “economic immigrants”, of which approximately 2/3 are coming from Asia, 1/5 from Europe and Africa, and the rest from the Americas***. 

The total population change in BC from 2013 to 2014 was +31,519****. BC received 21,452 “economic class” immigrants which made up approximately 2/3 of the total. Seven thousand (7024) of these came from the “Provincial Nominee Program" alone in 2014. The vast majority - 86.1%*** of those coming to BC are choosing to live in the Lower Mainland, which continues to provide positive market support there. 

Lets try a simplistic calculation by making the assumption that all of the Provincial Nominee Program (PNP) applicants bought a home at the Vancouver average price of $1.2 million (based on the Greater Vancouver average in June 2014). If this was the case, then the total amount of home purchasing power flowing from the PNP would be $8,428,800,000 or $8.43 Billion. 

This wave of new money flowing into the region will continue to apply pressure to an already premium priced housing market. For as long as the PNP is in effect and the immigration into BC carries this economic class into Greater Vancouver, the home price index will be supported by it. With the recent announcement that the average home price in Greater Vancouver is now up to $1.42 million as of June 2015, the trend seems to be continuing. 

* - Data from The Canadian Real Estate Association Home Price Index 

** - Announcement details for the Provincial Nominee Program 

*** - Data from Welcome BC Immigration stats 

**** - Population growth stats from