Vancouver's house-sales fever: Will the price bubble burst?

[aberdeenoil]

Vancouver's house-sales fever
Will the price bubble burst?: If Sydney is anything to go by, soaring prices won't last

Chad Skelton
Vancouver Sun


July 18, 2005


For all those who think Vancouver's housing boom will never end -- that the Olympics, our limited land base, or our growing population will keep house prices rising for a long time to come -- it's worth taking a look at what happened in Sydney, Australia.

If Vancouver had a twin sister, it would probably be Sydney.

Located around a huge natural harbour, Sydney is renowned for its mix of big-city amenities and stunning natural beauty.

It is the country's gateway for new immigrants from Asia, with about 1,000 new people arriving every week, and is a favourite of foreigners looking for a second home.

And, like Vancouver, Sydney is hemmed in by geography.

With the Pacific Ocean to its east, a mountain range to its west, and large national parks on both its north and south, Sydney has a growing population but only a limited amount of land to build on.

All those factors, and a booming Australian economy, helped fuel a huge housing boom in Sydney in the late-1990s and early 2000s, with the average price of a detached house rising to close to $600,000 by late 2003.

Then prices started to fall.

Since the end of 2003, the average house price in Sydney has dropped about 15 per cent, according to figures compiled by the Commonwealth Bank of Australia.

Michael Blythe, chief economist with the Commonwealth Bank, said the drop in house prices, which shows no immediate signs of recovery, took many by surprise.

"The typical experience in Australia is you always get these periods of rapid house price growth and then prices [flatten out] for a number of years," he said. "This time around the fact that prices have actually fallen ... is a little bit different."

And, perhaps most troubling, Sydney's price drop came without either of the two big triggers many here say would be needed to deflate Vancouver's hot housing market: a big spike in interest rates or a weakening economy.

Australia's central bank did raise interest rates in late 2003, but only by a measly half a point -- from 4.75 per cent to 5.25 per cent.

"It didn't take much on the interest rate front to slow the housing market here," Blythe said.

And Australia's economy remained strong right through the drop in house prices, with unemployment remaining at its lowest level in 30 years.

Sydney's housing bubble simply popped.

And some are now pointing to Sydney -- and a wobbly housing market in Britain -- as the first dominoes to fall in a global collapse in house prices.

In a cover story earlier this month, the influential magazine The Economist called the worldwide increase in house prices "the biggest bubble in history," comparing it to the dot-com bubble of the late 1990s.

"It is impossible to predict when prices will turn," the magazine predicted. "Yet turn they will ... Over the next five years, several countries are likely to experience price falls of 20 per cent or more."

The Economist isn't the only influential voice predicting trouble in the housing market.

Yale economist Robert Shiller, whose book Irrational Exuberance successfully predicted the dot-com collapse, released a revised version of his book this spring that predicted a crash in house prices.

And in a recent television interview, Shiller argued "glamour cities" like Vancouver will likely be the hardest hit.

"Vancouver is one of the [most] glamorous cities in the world," he said. "Beautiful place, west coast, ocean view. It can kind of make investors a little bit flighty. They think this is such a wonderful place [that] everyone wants to live here. And they think there is no limit to price. But there is always a limit to price. There is only so much people can afford to pay."

Shiller added that Vancouver is no stranger to booms and busts.

"Vancouver is the most bubbly city in the world, I believe," he said. "They've had very volatile prices in the past. The rest of Canada, I don't get quite such extreme stories."

Indeed, during a two-year period between 1979 and 1981, house prices in Vancouver jumped nearly 120 per cent -- only to be followed by a spectacular crash that wiped out nearly all of those gains.

The city experienced less dramatic jumps -- and drops -- in house prices in the early- and mid-90s.

And yet many of those who follow Vancouver's housing market closely say they don't think we're heading for a crash.

For one thing, they say, the price increases in Vancouver aren't large enough to truly be called a bubble.

Since early 2002, Vancouver has had fairly steady price increases of about 10 per cent a year.

And while those increases are significant -- especially since they come on top of the highest house prices in the country -- they are fairly modest compared to those in other cities around the world.

Sydney, for example, experienced three straight years of roughly 20-per-cent price growth before its market began to drop -- with prices more than doubling over a five-year period.

And many of the hottest markets in the U.S. are currently experiencing annual price increases of 20 per cent or more.

Even within Canada, Vancouver's price increases aren't as dramatic as many think.

Tsur Somerville, an expert on housing markets with the University of B.C.'s Centre for Urban Economics and Real Estate, keeps data on eight major housing markets in Canada.

Over the past three years, he said, prices have risen faster in Vancouver than the Canadian average, behind only Montreal and Toronto.

But Vancouver's housing boom only really got going in 2002 -- lagging the rest of the country by a couple of years.

If you look at prices over the past five years, rather than the past three, prices have actually risen slower in Vancouver than the national average, trailing every major city except Calgary and Halifax.

And many observers say there are sound reasons for house prices to be going up in Vancouver.

"In Vancouver, the housing market is being supported by some pretty strong fundamentals," said Cameron Muir, senior analyst with the Canada Mortgage and Housing Corp.

Those fundamentals include a booming economy, low unemployment, rising wages and more people moving here from other provinces.

And just as important, said Muir, is that all that good economic news came after a lengthy period of stagnant economic growth -- and flat house prices -- in the 1990s.

As a result, when the economy finally began to pick up, there was a lot of pent-up demand for housing that pushed up prices.

In its article predicting a housing market collapse, The Economist argued that the "most compelling evidence" that house prices are overvalued is the growing gap between house prices and rents.

The argument is that the true value of a home as an investment is its value as a rental property -- either by its owners renting it out to someone else, or living in it themselves rent free.

In many countries around the world, this "price/rent ratio" has reached historic highs -- and Vancouver is no exception.

While house prices in Vancouver have risen strongly in recent years, rents have actually fallen slightly.

As a result, the price/rent ratio in Vancouver is now at its highest point in a quarter-century -- higher even than it was at the very top of the early-1980s housing bubble.

Those figures suggest that house prices in Vancouver are dangerously overvalued.

But it's only one way of looking at things.

The other is affordability.

For most people, buying a house isn't primarily an investment, but a place to live in.

And for them, the return on their investment isn't nearly as important as what kind of house they can afford.

Over the past few years, wages in B.C. have risen slightly and, more importantly, interest rates have reached historic lows -- meaning the average Vancouver resident can afford a much more expensive home today than he could a decade ago.

As a result, even though prices are higher now than they've ever been, the average home in Vancouver is actually more affordable now than it was in the mid-1990s, according to a report by RBC Financial Group.

In 1993, for example, an average homeowner in Vancouver had to spend more than 70 per cent of his or her income to carry a typical mortgage on a two-storey house.

Today, that figure is about 60 per cent.

"Even though affordability is bad in Vancouver, it's not as bad as it has been," said Allan Seychuk, the RBC economist who wrote the affordability report. "It's nothing you're not used to."

That could all change, of course, if interest rates jumped several points, as they did in the 1980s.

But Seychuk said the Bank of Canada has a much better hold on inflation now than it did in the 1980s -- making such a dramatic rate hike unlikely.

One of the other telltale signs of a housing bubble, experts say, is speculation -- people buying houses just to flip them, rather than to live in.

"For a bubble there needs to be a lot of speculative activity going on," said Helmut Pastrick, chief economist with the Credit Union Central of B.C.

Investors buying up houses in hopes of a quick buck are also those most likely to flee when the market turns down -- increasing the chances of a crash.

There are strong signs that speculation has reached very high levels in many U.S. markets.

For example, fully a third of new mortgages in the U.S. now are interest-only or "negative amortization" (in which the size of the loan grows over time, rather than shrinks) -- risky gambles that prices will keep going up.

Speculation is on the rise in Vancouver, too, but it is still relatively low.

Just four per cent of homes in Vancouver are resold within six months, according to data collected by Landcor Data Corp.

That compares to 10 per cent during Vancouver's last housing boom, which ended in 1990, and more than 20 per cent during the early-1980s bubble.

All these factors -- a strong economy, low interest rates, and low speculation -- lead most local experts to argue that Vancouver is not in a housing bubble.

But that doesn't mean there isn't cause for concern.

While the market appears stable overall, experts say that doesn't mean there can't be micro-bubbles in certain sectors of the housing market.

For example, anecdotal evidence suggests a fair deal of speculation is going on in the downtown condo market -- speculation that often doesn't show up in the official figures because condos are resold before they're even built.

"Where people are just buying up condos for investment without really evaluating them well -- when they're treating all these things as a good investment independent of the fundamentals of that property in that area, then you get concerned," Somerville said. "While overall we're not worried ... that doesn't mean there isn't behaviour that makes you concerned."

And while few think Vancouver is in store for a spectacular market crash like we saw in the early 1980s, that doesn't mean we aren't due for a milder "correction" in prices.

Underlying economic conditions in Vancouver are strong, Somerville said.

But they aren't strong enough to justify 10-per-cent-a-year price increases forever.

"We have house price inflation that's above what it should be," he said. "You've got [economic] fundamentals to support that -- they just don't support it on a continuing basis."

House prices, like everything else, tend to operate in cycles -- increasing for a while, then dropping off or remaining flat for a while.

The average housing boom lasts about four years and the longest sustained increase in prices in Vancouver's recent history lasted just under five.

We're about three years into the current one.

"I would say some time over the next three years, we are extremely likely to see some kind of correction," Somerville said. "These things typically don't last more than five years. If I look at house prices, they've been rising for about three years. So I expect sometime in the next three years they have to stop."

So what does that mean for those thinking of buying a house?

"It is an issue for the person who says real estate is great and I'm selling all my stocks and buying real estate in the Lower Mainland," said Somerville. "For that person, it's a problem."

But for those who are simply looking for a home to live in for a long time to come, it's less of a concern.

For them, said Somerville, what house prices do over the next 10 or 20 years isn't nearly as important as whether buying a house is right for them -- and if they can afford to make the payments.

"If I'm making the payments and enjoying the house, house prices can fall without a big change in my standard of living," he said.

And Somerville should know.

For family reasons, he's decided to finally quit renting and start looking for a house.

"From an investment perspective, I think I'd be more inclined to rent for a while rather than buy," he said. "[But] like lots of people, my housing decision is not based primarily on investment but is driven by what our family needs happen to be."

And while Somerville is reluctant to make exact predictions about when Vancouver's hot housing market might begin to cool, he can't help himself from making just one.

"You'll know when the market has hit its peak on the day that I buy a house," he said.

cskelton@png.canwest.com

Pulse of the market

Three classic measures in housing economics as they apply to Vancouver:

House values in real terms

In the early 1980s and the mid-'90s, home ownership in Vancouver was nearly as expensive as it is now. But in both earlier examples, the cost in real terms then went on to decline.

Price-rent ratio

Economic theory says a bubble exists when residential rents and housing prices are out of balance. Shown below is Vancouver's price-rent ratio over time.*

*"The fundamental value of a house is the present value of the future housing service flows that it provides to the marginal buyer. In a well-functioning market, the value of the housing service flow should be approximated by the rental value of the house."

-- Federal Reserve Bank of San Francisco

Share of income to pay for the roof overhead

The ownership bite is creeping up yet remains well below historic highs.

For a standard 2-storey home in Vancouver; percentage of household income taken up by ownership costs, annual average.

Source: University of British Columbia (top 2); Statistics Canada, Royal LePage, RBC Financial Group (bottom chart).

Vancouver Sun

© The Vancouver Sun 2005

[honkytonkman]

...good, bring it on....

[Bellagio]

finally, a balanced article.

[SilverMountain]

"For a bubble there needs to be a lot of speculative activity going on," said Helmut Pastrick, chief economist with the Credit Union Central of B.C.
Investors buying up houses in hopes of a quick buck are also those most likely to flee when the market turns down -- increasing the chances of a crash.
...
Speculation is on the rise in Vancouver, too, but it is still relatively low.
Just four per cent of homes in Vancouver are resold within six months, according to data collected by Landcor Data Corp.
That compares to 10 per cent during Vancouver's last housing boom, which ended in 1990, and more than 20 per cent during the early-1980s bubble.
All these factors -- a strong economy, low interest rates, and low speculation -- lead most local experts to argue that Vancouver is not in a housing bubble.

Does anyone know if assignments were included in the speculation statistics? Also were there more or less assignments in the previous Vancouver bubbles?[/quote]

[Bellagio]

"For example, anecdotal evidence suggests a fair deal of speculation is going on in the downtown condo market -- speculation that often doesn't show up in the official figures because condos are resold before they're even built. "

Looks like assignments are not included in their stats, my guess is that they weren't before either, but a guess is useless.

Instead, a question:

Did this same system of 'assignment' always exist?

cheers

[2KTNGO]

"For example, anecdotal evidence suggests a fair deal of speculation is going on in the downtown condo market -- speculation that often doesn't show up in the official figures because condos are resold before they're even built. "

Looks like assignments are not included in their stats, my guess is that they weren't before either, but a guess is useless.

Instead, a question:

Did this same system of 'assignment' always exist?

cheers

I think pre-sales are not included. The pre-sale contract is between builder and investor/buyer (sort of like "letter of intent"), since no transfer tax is paid on these deals, they are probably not recorded as "home sales".

Personally, I don't care for all these "studies". They don't compare relevent data points and thus are worthless.

Speaking of Shiller. Here is another Elaine Garzarelli in the making.

[freako]

Interesting to say the least. They gave good old Cameron Muir a chance to say his piece.

It will be very interesting to see where Sydney goes from here. My speculation about "negative elasticity" driving prices will get a test. Dropping prices should make housing very elastic in a jiffy.

At the moment I have the following observations/comments:

1. Should China stumble, Sydney will get the other shoe.
2. Sydney ran ahead of fundamentals, so it is no surprise that it can drop without a change in fundamentals. All that is needed is the catalys, whatever that may be.
3.

In Vancouver, the housing market is being supported by some pretty strong fundamentals," said Cameron Muir, senior analyst with the Canada Mortgage and Housing Corp.

Those fundamentals include a booming economy, low unemployment, rising wages and more people moving here from other provinces.

Well enough Cameron, but so as not lift ourselves by our bootstraps, we should remove housing and housing related resource activity from economic growth. Going one step further, one could argue we should remove inflated equity consumption resulting from inflated equity from economic calculations.

As a result, even though prices are higher now than they've ever been, the average home in Vancouver is actually more affordable now than it was in the mid-1990s, according to a report by RBC Financial Group.

In 1993, for example, an average homeowner in Vancouver had to spend more than 70 per cent of his or her income to carry a typical mortgage on a two-storey house.

Today, that figure is about 60 per cent.

Well, dude. Comparing affordability at record low rates and double digit rates is a little misleading. Where would you rather run out of gas, at the top of a hill or the bottom. Affordability being severly constrained at record low rates is very much like running out at the bottom of the hill. The 70 percent situation was an anomaly caused by offshore money coupled with high rates. Todays situation is pervasive, and the number of households entering such a sitution very large. And these people are normal working folks strapped to the limit, not Asians fleeing Hong Kong handover. The article should have clarified this, especially since it is used to excuse current affordability. The point is that as rates fell, affordability worsened. Only speculation can cause that.

Just four per cent of homes in Vancouver are resold within six months, according to data collected by Landcor Data Corp.

I hardly think that this stat by itself determines the level of speculation, it is fairly arbitrary. Maybe this time speculators are too greedy to let go, and only buy. Flipping is not synonymous with speculation. It is a subset of speculation.

Underlying economic conditions in Vancouver are strong, Somerville said.

"We have house price inflation that's above what it should be," he said. "You've got [economic] fundamentals to support that -- they just don't support it on a continuing basis."

Ok Somerville. But why are rents lagging then? Only one answer in my mind. Increased desire for OWNERSHIP, which is no free lunch as it is increased demand from a static number of individuals, a zero sum game.

When I get around to it (on a crappy wireless connectionat the moment), I will check some of the residential REITS. It just occurred to me that these could be a good proxy for rent levels if their financials are somewhat transparent.

[upbeat]

[quote="aberdeenoil"]And yet many of those who follow Vancouver's housing market closely say they don't think we're heading for a crash.

For one thing, they say, the price increases in Vancouver aren't large enough to truly be called a bubble.

Since early 2002, Vancouver has had fairly steady price increases of about 10 per cent a year.

And while those increases are significant -- especially since they come on top of the highest house prices in the country -- they are fairly modest compared to those in other cities around the world.

Sydney, for example, experienced three straight years of roughly 20-per-cent price growth before its market began to drop -- with prices more than doubling over a five-year period.

And many of the hottest markets in the U.S. are currently experiencing annual price increases of 20 per cent or more.

Even within Canada, Vancouver's price increases aren't as dramatic as many think.

[/quote]

[upbeat]

[quote="aberdeenoil"]
Sydney, for example, experienced three straight years of roughly 20-per-cent price growth before its market began to drop -- with prices more than doubling over a five-year period.

Since the end of 2003, the average house price in Sydney has dropped about 15 per cent, according to figures compiled by the Commonwealth Bank of Australia.[quote/]

I would take that!

[upbeat]

[quote="aberdeenoil"]
But Vancouver's housing boom only really got going in 2002 -- lagging the rest of the country by a couple of years.

If you look at prices over the past five years, rather than the past three, prices have actually risen slower in Vancouver than the national average, trailing every major city except Calgary and Halifax.

And many observers say there are sound reasons for house prices to be going up in Vancouver.

"In Vancouver, the housing market is being supported by some pretty strong fundamentals," said Cameron Muir, senior analyst with the Canada Mortgage and Housing Corp.

Those fundamentals include a booming economy, low unemployment, rising wages and more people moving here from other provinces.

And just as important, said Muir, is that all that good economic news came after a lengthy period of stagnant economic growth -- and flat house prices -- in the 1990s.

As a result, when the economy finally began to pick up, there was a lot of pent-up demand for housing that pushed up prices.

Underlying economic conditions in Vancouver are strong, Somerville said.

But they aren't strong enough to justify 10-per-cent-a-year price increases forever.

House prices, like everything else, tend to operate in cycles -- increasing for a while, then dropping off or remaining flat for a while.

The average housing boom lasts about four years and the longest sustained increase in prices in Vancouver's recent history lasted just under five.

We're about three years into the current one.

"I would say some time over the next three years, we are extremely likely to see some kind of correction," Somerville said. "These things typically don't last more than five years. If I look at house prices, they've been rising for about three years. So I expect sometime in the next three years they have to stop."

[/quote]

No one expects prices to "flatten" or "correct" for another 2-3 years, Yeah! Let's stop the hand wringing and Let's make some money!

[beaux]

When I get around to it (on a crappy wireless connectionat the moment), I will check some of the residential REITS. It just occurred to me that these could be a good proxy for rent levels if their financials are somewhat transparent.

Not necessarily Freaky. They generally don't break it out by building so what you're getting is a very macro view. Besides, there are only 3 apartment REITs in Canada- CAP, Boardwalk and Killam. I believe that CAP and Boardwalk trade at or near NAV (haven't check in a while but it's a worthwhile exercise) but Killam, which is on a ridiculous acquisition binge buying up all of the Maritimes pracitcally) trades at a HEAVY premium. It's also really difficult to accurately determine NAV as you'd need an market appraisal for each building to really assess the values. I suspect if CAP and Boardwalk were trading a significant discounts to NAV the analysts would be screaming BUY as they did in 1999 when their traded at about a 20% discount. I'd be interested to hear your thoughts.

FYI here in Toronto where I have first hand knowledge I can attest to the fact that market rents have generally fallen modestly since their peak in about the summer of 2002. The reason is primarily twofold- higher affordability (% rates) and greater supply thru new condo construction. A third factor is the declining immigration numbers into the GTA but I believe the impact of that statistic to be quite negligible.

[freako]

Well, Belle. I wasn't particularly interested in NAV, only relative rents. So I was merely going look at rental revenue on comparative financials. If there are no significant changes in assets this would be a reasonable proxy of relative rents. If there were changes, then I would have to come up with some adjustments to compensate. Hoping not to have to do that.

[freako]

believe that CAP and Boardwalk trade at or near NAV (haven't check in a while but it's a worthwhile exercise) but Killam, which is on a ridiculous acquisition binge buying up all of the Maritimes pracitcally) trades at a HEAVY premium. It's also really difficult to accurately determine NAV as you'd need an market appraisal for each building to really assess the values. I suspect if CAP and Boardwalk were trading a significant discounts to NAV the analysts would be screaming BUY as they did in 1999 when their traded at about a 20% discount. I'd be interested to hear your thoughts.

1. I will investigate Killam, maybe a good short. One question, are management solid hard working types, or pompous jackasses? Rarely go wrong shorting the latter (tend to overstate financials, short term mentality etc.)

2. I am playing with a long term strategy of shorting premium REITS and going long discounted ones. Would likely give positive cashflow as well.

Thanks for the anecdotal GT data.

[beaux]

1. I will investigate Killam, maybe a good short. One question, are management solid hard working types, or pompous jackasses? Rarely go wrong shorting the latter (tend to overstate financials, short term mentality etc.)

I've seen these guys at the apartment conference. They are as modest and unassuming as they come. I greatly admire their KISS strategy (keep it simple stupid) of institutionalizing the multi-res market in the Maritimes. However, when I pulled out their financials I was totally shocked at the premium their units were traded at compared to the underlying value of their suites. The market has a strong perception that they are a super-growth company. I suspect that they will reach a siginficant wall to growth in the near future as resistence from sellers will overwhelm their acquisition binge. Still, humble and seemingly very honest and ambitious management.

BTW- careful shorting REITs- you need to cover the distributions.

[freako]

They are as modest and unassuming as they come. I greatly admire their KISS strategy (keep it simple stupid) of institutionalizing the multi-res market in the Maritimes. However, when I pulled out their financials I was totally shocked at the premium their units were traded at compared to the underlying value of their suites

That makes me think twice. Since shorting has a significant level of risk, I prefer crappy overvalued crap than overvalued gold. Still a possibility though.

BTW- careful shorting REITs- you need to cover the distributions.

Of course, but since the discounted REITs that you are long would likely have a higher distribution, you would have positive cashflow (if long-short balanced).

My logic is basically that REITs behave like fashion. Hot (as in popular) segments get priced above NAV. Since fashions rarely last, I would expect the actual underlying NAVs to reverse. The bonus of course is that if that happened, profit chasing investors also cause a reversal in premium and discount.

It could well be that an actively and successfully managed REIT deserves its premium. Unlike a closed mutual fund, one cannot duplicate the portfolio.