Mark Carney Speaks to Michael Enright

CBC's Sunday Edition's Michael Enright had a 15 minute conversation with Bank of Canada Governor Mark Carney. You can listen to the entire interview here (hour 2, about 10 minutes in).

The most cutting point he made is transcribed below, at about 26:00 on hour 2 (emphasis mine):

Michael Enright: You expressed concern publicly for a long time I think from the moment you took the job about household debt in Canada. I think it was running somewhere around $40,000... and you're concerned about that. Interest rates are very low at the moment. Is there a correlation between the lower the interest rate [and] the more likely it is for people to take on more debt?

Mark Carney: Well this is the concern. Interest rates in Canada are low, abnormally low, exceptionally low...

ME: Are they emergency rates do you think?

MC: Well we had them at emergency levels from April of last year, in April of 2009 after the crisis...

ME: Right.

MC: The Lehman crisis. We got them down to 25 basis points and we further increased our balance sheet beyond that. But we moved them up from emergency levels because the Canadian economy is back at the level we were before the crash, we recovered all the jobs we lost during the crash, and things have moved quite positively for Canada. But they're still at exceptionally low levels. And the risk is that Canadians, some Canadians, take on debt on the assumption that interest rates will always be this way.

ME: Or they're here now, they look pretty good and they'll probably stay that way for a while.

MC: Excatly. And particularly when one thinks about mortgage debt, thirty year mortgage debt, that is not a sensible assumption. And our concern is that people will get themselves into positions which will make it very difficult to service their debt.

ME: But you can't say, wait a minute folks, I wouldn't go and buy a summer cottage because something might happen in the next 6 or 8 months. I mean, that would send Bay Street spinning, wouldn't it?

MC. No. We're taking a longer term perspective on it and we're providing as much transparency as we can about the future path of monetary policy, as much as appropriate. The one thing we can say with high degree of certainty is that over a thirty year mortgage interest rates are not going to be at the same level as they are now, they're going to be higher, and that Canadians, individuals, should be comfortable that they can service their debt at higher interest rates, and the banks that lend to them should also be comfortable about that.

That's central banker speak for "Wake the f&%$ up, Canada."

And, for macro nerds, on "currency wars" and exchange rate management:

ME: The huge worry going into the G20 and we read about it all the time... is the possibility of a currency war. First of all what is a "currency war" and if one breaks out is Canada protected?

MC: Well it's not a term that we use but the concern is that there will be a series of countries will engage in what is effectively competitive devaluation. They will hold down the value of their currency relative to others and that the number of these countries and the weight of these countries will be such that unsustainable adjustment will be pushed on other countries...

ME: To do the same...

MC: Yes. And other countries whose currencies float such as Canada. So in the extreme earlier this fall you had roughly 40% of the currencies by trade weight -- with the US dollar -- so in relative importance four of those 10, or 2 out of 5 of the currencies that trade with the US in importance managing their currencies to some extent.

ME: Gaming the system I guess... Is that what it is? It's like a trade war only you're using currency instead of goods.

MC: Yeah, you're using currency instead of tarriffs, and the issue is, the fundamental issue, is that doesn't work in the long term. You can cause damage to the global system in the short term, but it doesn't work in the long term because ultimately, those adjustments to currencies will come through relative inflation differentials, if nothing else. And if you'll allow me a second, the issue right now is that, let's take between China and the United States, and if China's currency doesn't move, the other way for China's real currency to move, in other words the real value of Chinese goods to increase relative to US goods, which is the same thing in effect, is there to be higher inflation in China than in the US. And what we've seen in the last few months, which we've been saying at the Bank [of Canada] for years, is that Chinese inflation's accelerating and US inflation is decelerating. And so you're getting a more difficult adjustment than you would have if currencies were allowed to adjust.

ME: If the worst-case scenario gets into play, is Canada going to get caught in the crossfire? What protections do we have?

MC: Well we have a number of protections. I think the short answer is no, I mean we're not naive in this situation. We have a number of tools: in the extreme we can intervene in currency markets if extreme movements in our dollar seriously threaten economic outcomes in Canada and those are decisions taken by the Minister of Finance and the [BoC] Governor. They are extreme... but we have tools there. We, very importantly, and I think it's important to understand, our level of currency is very relevant for the Bank of Canada's mandate, obviously. It affects the outlook for inflation in Canada, and if it were to threaten our ability to achieve our inflation target, which is what we're accountable...

ME: the 2%...

MC: The 2%. That's what we're accountable to parliament and Canadians for, we would adjust policy. And we have flexibility in policy here in Canada and we would not hesitate to use it if it were appropriate.

City of Vancouver Permit Update for 2010

I have been producing some graphs starting in early 2009 showing the trend of permits in the City of Vancouver (here and here). Here is an update to December, 2010.

Residential dwelling permits graphed since 2007:


Permits parsed for 1-2 dwelling units only (i.e. SFHs):Multi-unit building permits:

All permits' value, residential and commercial:


Analysis:

1. There was a significant, though not full, rebound in multi-unit permits in late 2009 and into 2010. This is commensurate with the rebound in construction employment coming out of the recession.
2. The detached market is extremely hot right now. This is evident through significant price appreciation of detached-zoned lots in the City, notably (but not exclusive to) the west side.
3. Detached permits have been falling significantly since mid-2010. Seasonality in permit applications cannot be discounted; I would not be surprised to see detached permit applications rebound going into the first half of 2011. A builder friend of mine claims the City's permit office has a backlog it's working through.
4. The building recession in late 2008 through mid-2009 is now bookended.
5. The data presented here show what a severe housing recession looks like and hint at how dependent the City is on sustained permit revenue to fund its operations.
6. The permit data are coincidental with faltering sales, however the permit data are released with about a month's delay; sales are available with virtually no delay thanks to paulb over at vancouvercondo.info. It's worth remembering that with housing markets, prices are a lagging indicator.
7. Laneway housing continued its upward trend. Builders and the permit department are likely becoming more familiar with the process and relevant codes (and likely fine-tuning it as they go). I would expect to see a continued increase in laneway housing permits, barring any major pullbacks in the availability of credit.

Greater Vancouver Sales Data Update

I've compiled a graph of sales in the REBGV (Real Estate Board of Greater Vancouver) over the past 12 years.

2010 was a below-average year for sales but not significantly so. As with 2009 there was a surge in Q4 sales that helped muster some respectability to the sales levels. 2011 starts anew; as a friend from Australia recently commented, the markets in Canada and Australia are drifting into uncharted waters.

Happy New Year

Competition Bureau and MLS

As you have probably heard, the Canadian Real Estate Association (CREA) approved changes to the rules governing the use of its Multiple Listing Service and the ability to pay for a la carte services such as a flat fee "listing only" service (akin to For-Sale-By-Owner FSBO). Others have commented on the changes. CBC's The Current ran a piece on November 3rd talking to a Calgarian owner, Bernadette Lonnegan who has tried to sell her property since May, first through an FSBO service, then through a Realtor on MLS offering a "listing only" service.

Ms. Lonnegan, however, has had little luck in selling her property. Her ability to list on MLS produced more traffic but, as it turns out, it also produced a lot of "undesirable" traffic in the form of (likely) scam artists, and, perhaps, anaemic traffic from buying agents at established firms. The overhead in selling a large capital asset, for her, even given she had free time to handle the listing, has turned out to be significant. Herein lies one of the many issues with FSBO in general.

Certainly Realtors have been given a hard time on local real estate blogs, from being called "realtards," shills, used-car salesmen (ouch...), to the more poignant criticisms of the real estate sales industry in general surrounding: the commission structure, obfuscation of previous sales data (which is public through land title offices), conflict of interest when acting as a buyer agent, etc. In the case of poor Bernadette, it turns out selling an expensive capital asset has proven to be difficult. She goes as far to state she thought going FSBO was not worth her time and effort and, doing it again, would have used a Realtor.

The CREA's move to allow access to MLS to FSBO certainly provides a need to a segment of potential home sellers. It should not be underestimated, however, how difficult the sales process for a multi-hundred-thousand dollar capital asset can be. For those who regularly sell in such an environment or simply have confidence they know the sales process, FSBO is a viable choice. But for the overwhelming majority of homeowners this is unlikely the case. Even with FSBO, there is still a chance a buyer agent will want a commission regardless.

What The Current's interview showed me is that, while opening MLS to FSBOs is welcome in principle, it is unlikely to have a significant effect on the marketplace. That the overwhelming majority of Realtors voted to accept these changes is an indication of this.

The next likely step in overhauling MLS will come in the form of opening up the previous sales data to the public, as has been done in the US for several years now. Companies like Google or Redfin, with their various technological innovations, are effectively kept out of the marketplace. Certainly another method of "opening" up the previous sales data could come in the form of changes to the land title offices' distribution of bulk sales data to large companies for a fee. In sum, depending upon what data are provided, it could produce more revenue for them than would the piecemeal requests they receive today.

A big question, as with FSBO, is will access to previous sales data help make the market more efficient? As much as I would like to think so, experience in the US showed that even with unfettered access to sales and mortgage data, many areas of the country saw significant price run-ups regardless. As a value investor looking to buy property, I would not care too much (though not at all) about previous sales data. The price paid is based upon value -- net operating income and development potential -- not what other people are currently paying. As a seller I would care quite a bit about previous sales data, though in theory even if going through a listing-only service, such a service should be able to provide sales data for little extra charge. Nonetheless, in principle, having previous sales data would be a welcome change towards a more open marketplace.

Intrade Bets on Vancouver Housing

The poster Austin over at Realestatetalks has taken the initiative to set up an Intrade bet on the Teranet Vancouver HPI. Here are the two contracts:

https://www.intrade.com/jsp/intrade/common/c_cd.jsp?conDetailID=734327&z=1282235580558

This market is based on the monthly Teranet National Bank National Composite House Price Index for Vancouver (from the map on the main page click on the Vancouver pin to see the latest Vancouver index value).

The contract will settle (expire) at 100 ($10.00) if the monthly Index for Vancouver is 121 or less before the end of 2013.

The contract will settle (expire) at 0 ($0.00) if the monthly Index for Vancouver is not 121 or less before the end of 2013.

The index for each month, up to and including December 2013, will be reviewed when published. If the monthly index is 121 or less the contract will be expired at 100. If not the contract will be expired at 0 once the index for December 2013 is published.

And another:

https://www.intrade.com/jsp/intrade/common/c_cd.jsp?conDetailID=734326

This market is based on the monthly Teranet National Bank National Composite House Price Index for Vancouver (from the map on the main page click on the Vancouver pin to see the latest Vancouver index value).

The contract will settle (expire) at 100 ($10.00) if the monthly Index for Vancouver is 143 or less before the end of 2010.

The contract will settle (expire) at 0 ($0.00) if the monthly Index for Vancouver is not 143 or less before the end of 2010.

The index for each month, up to and including December 2010, will be reviewed when published. If the monthly index is 143 or less the contract will be expired at 100. If not the contract will be expired at 0 once the index for December 2010 is published.

These bets can behave weird if volumes are low. However if Vancouver residents and outsiders are in a betting mood, this trade could really take off. Place your bets (if you dare!) and good luck. I'll do a bit of analysis of the potential directions and values of the Teranet HPI, in the next 4 months and the next 2 years, in some upcoming posts.

Teranet's report from May 2010 Vancouver index = 155.23.

A value of 143 on December 2010 would equate to an average 1.17% monthly drop for the remainder of the year or a 7.9% drop from May 2010.

A value of 121 on December 2013 would equate to an average 0.58% monthly drop or a 22.1% drop from May 2010.

The June 2010 report will be out in about a week's time.

The Chinese Property Bubble

It seems, according to news sources, mainland Chinese buyers are sweeping in to grab property around the world. But nor are other areas around the world oblivious to this recent development:

1) Hong Kong: Hong Kong housing bubble! Mainland buyers blamed

2) Australia: Chinese whispers: they're driving up housing prices

3) Vancouver: Mainland Chinese buyers driving up luxury home prices

4) Los Angles: China’s new rich set trend buying luxury homes in California with cash

5)Korea: Rich Chinese buy villa in S. Korea resort to spend weekend

6)U.S.: China property buyers go global as yuan rises

7) Singapore: Chinese developers eye S'pore property

8) Japan: Japan luring Chinese property shoppers


Hat tip to unicas on Realestatetalks

Low Rental Yields

If you think Vancouver has low yields, check out other figures from parts of Asia, courtesy Global Property Guide:

Taiwan: Price Yields 2.84%
Hong Kong: Price Yields 3%
China: Price Yields 3%
India: Price Yields 3-4%

Those are some mighty poor cash returns, if I might say so. Certainly GPG holds back no punches calling bubbles in all the above countries and territories. Remember these are yields before expenses. In Taiwan, it is likely newly-minted landlords are making a 0% cap rate.

But before we pass off these countries as simply being in a giant asset price bubble fueled by low interest rates, it's worth asking why their yields are so much lower than in North America's. Certainly avid speculation and a lack of perceived viable investment alternatives may play a role. There is one fundamental statistic, however, that can justify lower yields: high rental and income growth rates. While inflation is high in these countries, incomes are continually outpacing inflation by a healthy margin as they play catch-up to the developed world. (Albeit Hong Kong is pretty darn first world!) This in turn increases the present value of future cash flows and justifies a lower present-day yield. This is a similar concept why single family dwellings in areas experiencing density increases have low yields: their future cash flows due to re-development will outpace expected rental growth of the current structure.

Rents in Hong Kong increased over 6% last year; in addition, it is estimated 90% of mortgage loans are variable rate, with the variable rate currently around 2% or so. But it is worth noting rental yields have been low for a long time, what Global Property Guide analysts attribute to the wealthy using property as a method of diversification. Though if rents are increasing at a healthy pace, there may be more to it than diversification. In addition, while the "wealthy" certainly have the luxury of throwing a few % of their net worths into real estate, the majority are blithely going along for the ride with a significant and relatively undiversified portion of their net worths.

It helps to look at these Asian countries' property markets since a large number of buyers and sellers in the Vancouver area originate from these countries. It gives us some perspective of the attitudes and comparables these buyers are using when determining the value of North American (and specifically Vancouver) real estate. That said, I have some concern that the economics that, in part, can reasonably justify lower rental yields in certain countries are being improperly applied to North America, where wage growth is limited close to inflation.

How Real Estate Investors Invest Part 2

In the previous post in this series I outlined the basic inputs and calculations used by certain investors when determining the investment value of a particular property. In this installment we go through a simple example for a purpose-built rental building. A massive thanks to Rachelle over at Landlord Rescue for allowing me to publish a simple spreadsheet containing the calculations of an actual property in the Toronto area. (Toronto was used instead of Vancouver to avoid investors in Vancouver real estate from soiling themselves.)

link to spreadsheet (Note there is a bug with google spreadsheets; Click refresh if you get an annoying popup window and avoid dragging your mouse over the "anyone with the link" link. Should be fixed soon I hope.)

This is an actual real-life building in the GTA. We have the following inputs:

Purchase Price = $528,800
Closing Costs = $1,000
Deferred Maintenance (Renovations) = $0

Revenue
Rent = 5 units totaling $3725/month

Expenses
Taxes = $4759/yr
Insurance + Utilities* = $4974/yr
Property management** = 8% of revenue
Building maintenance = 10% of revenue
Vacancy allowance = 5% of revenue
TOTAL = $1668/month

* Rent includes utilities
** Property management fees can be a few % higher in Vancouver

Calculations
NOI = Revenue-Expenses = $2057
Cap rate = NOI/Purchase Price = 4.7%
GRM = Purchase Price/Revenue = 11.82 (price/monthly rent = 142)

Financing
Here the investor is putting 30% down and assuming a 5% mortgage interest rate. With these numbers the mortgage payments just cover the NOI and is cash flow neutral, which is the goal of this particular investor.

Discussion
Here we see the investor requires 30% down and 5% mortgage rate to make this property cash flow neutral. Also note the investor does not consider capital appreciation when determining the investment's value; it's all about the cash flow at what they consider to be a sustainable financing rate.

We can see right away the impact of lower mortgage rates on these investors' criteria for a cash flow positive property. They have no earnings, at least initially, save debt repayments. In time, the investor assumes, the rents will increase with inflation and start producing positive cash flow.

After some years there will be some added expenses as the building starts aging. This is partly, but not completely, accounted for in the 10% gross rent maintenance allowance. Significant overhauls may be necessary from time to time and this is accounted for through depreciation allowances, usually a few % of the purchase price on a geometric schedule. Though the spreadsheet does not explicitly cover this, one can expect in time some of the free cash flow to be diverted to capital replacement.

Also for consideration is the 5% assumed mortgage rate. Certainly in today's climate mortgage rates could easily stay at or below this level for some time. I have no doubt some investors are using even lower rates (even variable rates!) when calculating their monthly cash flow. Food for thought, though, that rates this low are borderline deflationary. It is unclear if the projected rental increases will be as large as anticipated if rates remain low.

With this in mind, there is a box at the bottom of the spreadsheet for calculating purchase price for a given cap rate. That is (at least in theory), an investment with revenues that generally track inflation should not vary their present value when inflation changes, therefore the cap rate will stay constant. What cap rate would be considered acceptable? Well the "acceptable" number used by this investor is 8% for that particular property, putting an acceptable purchase price in the area of $308,600. Food for thought.

So there you have it. A real-life example of a cursory analysis of a potential real estate investment. Certainly there is a ton more to consider when evaluating a particular property's investment viability but, following this investor's philosophy for what it's worth, having these numbers work on a particular property (at whatever values one considers acceptable) should warrant some additional investigation. Otherwise, it's probably best to spend one's efforts elsewhere.

Metro Vancouver Rental and Ownership Data

A great summary of the ownership, rental, and affordability state of the union for Metro Vancouver can be found over at metrovancouver.org.

• Key Facts
• Housing Diversity

In the latter link there is a presentation entitled Metro Vancouver Housing Data Book (PDF) that contains some wonderful demographic and affordability data that make authors of a housing analysis blog drool. A few key points made in this presentation:

• The median owner income of $69,318 is equal to approximately 125% of the median household income for the region.
• Based on the median income of $69,318, an “affordable housing cost” is equal to $1,733 per month using the standard that housing should not cost more than 30% of a household's gross annual income.
• In 2006, there were 817,230 households in Metro Vancouver; 531,725 (65%) were owners and 285,045 (35%) were renters.
• 21% (59,275) of renter households had annual incomes above $45,000. This fits the general definition of moderate and above income (above 80% of the regional median income). Of these households, 11% (31,220) had incomes between $70,000-$100,000, and 7% (19,975) had incomes above $100,000.
• Region wide, 39% (314,780) of all households had an annual income of $70,000 or above, of which 84% (262,035) were home owners and 16% (51,195) were renters. 20% (106,030) of owner households had annual incomes between $70,000-$100,000, and 29% (156,000) had incomes above $100,000.
• Of the 285,045 renter households in 2006, approximately 37% were accommodated in the 104,952 purpose-built apartment rental units counted by CMHC. The remaining rental stock is predominately non-market rentals, private condominium rentals, and rented single detached and other ground-oriented units
  
• The Statistics Canada Censuses shows that between 1991 and 2006 the total number of households increased from 609,380 to 817,035. For this period, as a percentage of the total housing inventory, apartment households increased from 34% (208,225) to 40% (321,970), while single detached households declined from 50% (302,120) to 35% (288,320).
• Data reported from CMHC shows that for Metro Vancouver for the period from 1999 to 2008 (10 years), average apartment rents increased from $725 to $937, an increase of 31% or 2.7% per year.
• During this same 10 year period for Metro Vancouver, according to the BC Stats Consumer Price Index, general prices increased by 20% or 1.8% per year on average.
• During this same 10 year period for British Columbia, according to BC Stats, average wages increased by 24% or 2.2% per year on average.
• Overall for the period, the average wage increase was greater than the general price increase, but lower than the average apartment rent increase.
  
• Metro Vancouver estimates that there are 69,200 - 75,500 secondary suites in the region. This represents approximately 22% to 24% of the total rental households (318,000) in 2009. [jesse: note the secondary suite accounting is all over the map. It is in many ways the proverbial "dark matter" of the city's housing market.]
  
• The average rent for a one bedroom secondary suite was $730, 20% ($189) less than the average rent in a conventional apartment building. The average rent for a two bedroom secondary suite was $862, 26% ($307) less than the average rent in a conventional apartment building.

There are much more data in the presentation. Well worth a read if you're trying to wrap your head around Metro Vancouver's housing market.

How Real Estate Investors Invest

This blog often deals with subjects that border on the abstract when it comes to the nuts and bolts of real estate investing. I recently viewed a spreadsheet used by a full-time real estate investor, one also used by many of this investor's acquaintances in the same line of work. This post is devoted to me explaining what factors they are using in their spreadsheet to calculate returns.

I will be focusing on a spreadsheet for the so-called "buy and hold" strategy -- buy, rent out, and hold indefinitely. We do not assume the property will be sold any time soon but, of course, capital appreciation comes in to calculating total return. So lets get into it.

(Note, I do not have permission to share this spreadsheet directly, however I will summarise how its calculations are performed as well as what inputs are used.)

Purchase Price

The first input into the spreadsheet is purchase price. We add into this closing costs and taxes, as well as any renovations that need to be performed before occupancy:

Total Price = Purchase Price + Closing Costs + Renovations

Revenue (Rent)

The major source of revenue for a property is rent. Here we use the anticipated annual rent from the property. There may be additional income sources, including: parking, vending, storage, interest income (e.g. on capital reserve), laundry, et cetera.

Operating Expenses

Operating expenses are the ongoing costs of maintaining the property. These would include property taxes, insurance, vacancy loss, advertising, repairs, management, strata fees, etc.

A big operating expense that is often overlooked by much of the analysis I see online is the so-called "capital cost allowance" which is effectively building up a reserve for capital replacement. This is, in the extreme, building up a reserve for building replacement but also includes large or small renovations that inevitably occur as the building ages.

Calculations

After determining our purchase price and costs, revenues, and operating expenses, we can calculate a few common values used by investors to determine their return. These are listed below:

Net Operating Income (NOI) = Revenue - Operating Expenses
Cap Rate = NOI/(Purchase Price) *
Gross Rent Multiiple (GRM) = (Purchase Price)/Revenue

* Note one can substitute Purchase Price with Total Price.

None of these calculations take into account financing. They are straight calculations on the investment's operations. They are also based on current, not future, operations; rent or operating expense increases are not calculated. GRM is analogous to the "price to rent ratio" that local commenters like to refer to. (A price to monthly rent ratio R would be equal to GRM*12.)

Debt Service and Financing

Financing is simply where the money to purchase the property comes from. It is either from the investor directly or through borrowing from a lending institution. Total debt servicing is an expense. Debt servicing costs are highly dependent on the interest rate. For longer term calculations, this interest rate may need to be modified to account for higher or lower rolled over financing costs.

Closing costs is the amount of cash required to complete the purchase, equal to Total Cost - Debt. A typical amount for closing costs would be, say, 25% of Total Cost, though other ratios are of course possible.

Capital Appreciation

Like most property, there will be some capital appreciation, usually expressed as an expected average percentage gain year-over-year.

Calculations after Financing and Appreciation

In a nutshell, a total return is comprised of: cash generation, debt repayment, and appreciation. After 1 year:

Cash on Cash Return (COC) = NOI/(Closing Costs)
Equity = (Purchase Price)*(1+Appreciation) + Cash - Debt
Return on Equity (ROE) = NOI/(Equity)
Total Return on Investment = Equity/Closing Costs - 1

NOI is annualised.

Stuff Not Done

As mentioned, there are things that are not calculated. Rental and expense increases, as well as debt repayment schedules are not calculated. There is a good reasons for this, in this particular case. The philosophy is that if the return after the first year is not positive, it generates no income for the investor. This is not sustainable without a large pool of cash to finance the shortfall -- these particular investors want to produce income.

Summary

Above are some of the formulas used by full-time residential property investors to calculate an investment's return. You can plug any property you see for sale on the market into these formulas into and come up with some typical figures, then play around with the financing costs and appreciation (both these have high sensitivity when it comes to calculating return). I'll go through a simple example next time.

These investors own property locally and are actively looking to invest in property in the current market. If you want to know who is looking to buy, it helps to understand what calculations and analysis they perform to determine a property's value and under what conditions they would buy.

School Closures in Vancouver

The Vancouver School Board has announced (PDF) closures of 11 schools.

As you may be aware, trustees faced difficult financial decisions this spring, and last evening approved a budget that includes approximately $16 million in spending reductions and eliminates 137 positions. We also received a report earlier this month from a government appointed special advisor recommending we consider school closures to reduce our costs.

It is in this context that district management prepared a list of schools that trustees might consider for possible closure. The schools on the pre-notification list were selected because of a number of factors, including low enrolment, under utilization and the availability of space at neighbouring schools.

Without delving into the politics of the matter there has been a general trend towards lower public school enrollment in the past number of years. This is not to say that the school-age population is necessarily dropping -- parents may be opting for private or home schooling instead. Statistics do indicate a dropping school-age population in Vancouver but, interestingly, the number of family-sized dwellings in the city has not commensurately dropped.

Looking at recent birth rates, it is likely these school closures may be a bit premature. But beyond even that, a look at the city's available housing stock shows a strange dichotomy between dwellings designed for families with school-age children and the actual residents of these dwellings. At some point it would seem reasonable the utility of these dwelling should match the residents' needs by way of demographic shift back towards more children or re-development away from the usual family-oriented architecture.

What Normal Looks Like

What is "normal" for Vancouver real estate? A very quick gauge is to look at a month at the peak of the annual real estate buffalo jump -- June -- and normalise it for population. This gives us sales per capita.

Note June 2010 is an estimate after 3/4 of the month's sales have been recorded. A fair estimate of sales in a "balanced" June market (where "balanced" refers to sales volume) will be about 1.5 sales per 1000 residents. Things will really get interesting if we see the 1.2 sales per kiloresident at the lower bounds of the data series, a level with historical precedent and far worse than even 2008 when prices began to fall precipitously.

Central1: The sheen is clearly off the housing market

You heard them. Read their report here (PDF). A few excerpts:

The sheen is clearly off the housing market, with this week’s release of the MLS® data. As expected, residential home sales in British Columbia continued to trend lower in May. Sales fell for the seventh consecutive month, dipping 6.5% from April on a seasonally adjusted basis. Since reaching a market peak in October, annualized sales have fallen 30% to 75,500. The markets that led last year’s rise in activity, namely the Lower Mainland and Victoria, are now leading the downtrend.

On the supply side, B.C. recorded an unseasonal decline in the flow of new listings in May -- the first April to May decline since 2002. We expect to see a pattern similar to early 2008 emerge, where potential sellers hold back on listing their homes in response to higher inventory levels and price declines. However, month-end inventory levels will likely rise over the next few months as the new listings remain elevated and sales continue to trend lower.

Note Credit 1 refers to seasonally adjusted (SA) sales. This blog typically refers to non-seasonally-adjusted (NSA) sales as do the real estate boards; both methods have their trade-offs: SA is good for comparing months long trends but NSA is more closely tied to the front-line effects of supply and demand. The seasonal adjusted data seem to indicate a persistent malaise of sales reminiscent of 2008 (though not as extreme). This was relatively obvious, given listings growth since the start of the year. Interestingly they claim an "unseasonal decline" in new listings for BC in May. Certainly in Vancouver and Victoria this did not seem to be true, however it looks like inventory is now not growing as fast, not because of a lack of new listings but because of a lack of sales and a large number of expiries. Remember that a recorded expiry, sale, or (usually) listing does not change the available housing stock.

We now segue into Central1 on rentals:

Results from Canada Mortgage and Housing Corporation’s semi-annual survey of the purpose-built rental market suggest that rental demand softened over the past year as higher unemployment, particularly among young workers, and a weaker economy slowed the rate of household formation. In addition, existing renters may have found alternative housing in the competing investor owned condominium rental stock or were induced into the ownership market by lower mortgage rates.

Among British Columbia’s larger urban areas (populations of 10,000+), 21 of 27 markets reported higher townhome and apartment vacancy rates in April 2010 from a year earlier. The aggregate figure for all urban areas rose from 2.5% in April 2009 to 3.2% this year. Among B.C.’s largest markets, the largest relative increase occurred in the Victoria and Abbotsford Census Metropolitan Areas, while the Chilliwack Census Area was the only major market to report a drop in the vacancy rate. Additional slack in the rental market also impacted the rate of growth in market rents, which rose at a much slower pace in 2010. Average rents of properties in B.C. common to both the 2009 and 2010 survey samples rose by 2.2% this April, compared to 3.4% a year earlier.

A relatively bearish report on both the capital and income portions of the BC housing market.

Tom Bradley on Real Estate

It is rare a mainstream media commentator has cut through the plethora of myths surrounding real estate investing AND writes something I agree with. Until Tom Bradley wrote this piece in the Globe and Mail.

We’re starting to see stories about a softening real estate market in Canada. Listings are up, sales are down, and even the always bullish industry executives are predicting lower prices in the coming year.

It reminded me of a quote I saw recently: “Real estate is the drunk driver on the economic highway.” This statement, attributed to Tom Barrack, the CEO of real estate investor Colony Capital, speaks to the fact that residential real estate can be volatile. Yet that same volatility highlights why it can be fertile ground for a disciplined, patient investor. There are a number of reasons for this.

First off, it’s cyclical in the best way – the cycles are generally long while memories are always short. The most recent trend, up or down, is assumed to be sustainable. For an investor willing to take a longer view, this is a good thing.

Second, real estate is a topic that produces lots of “armchair” experts. Despite a lack of rigorous analysis, views are strongly held and overconfidence is rampant. Again, this is good for someone who is less entrenched and has a broader perspective.

No argument, really. The first point is borne by the extensive analysis on this blog, where we have shown price movements are highly correlated to relative, not absolute, pricing. I certainly cannot argue the second point, being one of said "experts" myself.

Despite these attractive investment features, there are reasons why I don’t invest in real estate beyond my personal needs.

Hm. Now that really got my interest. He explains:

For one, I have a day job, and this type of investing is time intensive. It also doesn’t help that transaction costs are extremely high (commissions, legal fees and taxes), and there are significant carrying costs.
...
Because leverage is involved, real estate prices are sensitive to changes in interest rates. Purchases are often financed up to 90 per cent with debt, so mortgage payments are a key factor in determining prices.

For almost 30 years, we’ve been in a bull market for interest rates and with every tick down, property values have gone up. Given that we are somewhere near the end of the rate declines, investors have to recognize that a huge tail wind is swinging around.

So for one he doesn't have the time, or at least recognizes that real estate investment, even when many management duties are outsourced, still has a large time and cost component for the investor. In Mr. Bradley's case, his hourly chargeout rate is likely way higher than many investors.

The second point is more interesting. He's saying that recent valuations have been inflated by riding a decades-long secular trend of decreasing interest rates. Further gains due to this interest rate arbitrage are unlikely and could well reverse over the course of another few decades.

House owners deploy a strategy that is at the core of hedge fund investing – buy long-term assets with short-term financing. The strategy dials up the investment’s return potential, both on the upside and downside.

I think that's a key assessment. It is a monumental mistake to assume that short term financing rates will prevail indefinitely. Even if rates remain low, it is not a savior for prices: low rates in perpetuity imply incomes are stagnant or falling on average.

Read the full article. Understanding his basic tenet -- that real estate is in its essence a capital purchase with decades-long amortization -- is well worth a pause for consideration before investing in real estate in the current climate.

Hat tip to Tom on VCI

The Dirty Underbelly

I wanted to point people's attention to the blog Landlord Rescue, a fun blog to read on the trials and tribulations of a professional landlord in Ontario.

With BC property sales relatively weak (the pace for June sales is lower than May's; in strong markets it's almost always the opposite) but borrowing rates still relatively low compared to the 15 year average, we are likely to see many investors make a longer term commitment to become part-time landlords. Many if not most will find cash flows to be stable with little hassle. While they may not be making an exceptional return if they bought at recent prices, they won't necessarily have negative monthly carrying costs. It is certain, however, a select few will be stuck with significant problems. On average, revenue from real estate is less than headline rent and expenses more than regular maintenance and taxes, which is why professional landlords typically require some premium to account for this aggregated risk.

If you are thinking of renting out a property, it's worth considering what can and does happen every day to landlords. Perhaps reading Landlord Rescue concentrates too much on the fringe cases but, at least, I hope it gives some idea of what some landlords -- and not just the professionals -- will face in the coming years.

Comparing US Prices at peak to Canada Today

It's always refreshing to see new data to analyse but it's equally as refreshing to see existing data analysed in a different way. Over at vancouvercondo.info poster vibe performed some analysis comparing the price-income ratios in Canada today to the US in 2006, around the peak of their prices [jesse: I inserted an updated graph]:

"...there was some discussion about whether Canada is in a real estate bubble. Everyone pretty much agrees about Vancouver, but here are a couple of points that were made about the national scene:

1. It is reasonable to claim that there is not a housing bubble in Canada because only certain areas are over inflated.
2. Vancouver's very high prices skew the national average and cause Canada to look worse than it really is.

One thing I think we can all agree on is that the US did have a housing bubble. Well I put together a spreadsheet that I feel shows that affordability is about as bad across Canada as it was in the US at their peak. It also shows that Vancouver is not skewing our national data any more than the most overpriced cities in the US were skewing their data. In order to measure affordability I used house price to personal income ratios. I compared the 20 cities used in the Case Shiller Housing Index to the 6 cities used in the Teranet Housing Index. The US data is from 2006 while the Canadian data is from 2009.

I think the following graph most clearly illustrates my point:

Vancouver is the only Canadian city with a ratio over 9, while the US had 3: LA, San Fran and San Diego. Toronto is the only Canadian city with a ratio between 5 and 9, the US had 9 in this range. The under 5 range looks bigger for Canada but we have more population covered by our index than they do by theirs. The important thing is that the percentage of each nations population living in cities with elevated ratios is similar.

The distribution and average ratios for both countries are almost identical.

(Highlighting above is mine.)

Almost identical.

These data would be less of a concern if sales volume were low but, based on the volume of sales in the past several years, we know a not-insignificant portion of the population have bought at high prices. In addition we know the make-up of personal debt in Canada has been trending into the "unsustainable" territory, throwing into serious question the argument that future income gains justify high prices, even in part.

Gird yer loins!

House Price Comparisons

Just sayin'...

Over at vancouvercondo.info is a constant stream of listings and sales data from commenters for the Greater Vancouver area. The listings growth is robust, as is the level of sales. We are on track to bust records for April listings and sales in recent memory. What will happen to prices, specifically the benchmark and house price index?

According to mohican's months of inventory to price change correlation analysis, the benchmark price will not start substantially falling until sales slow or active listings continue to increase at breakneck speed. Below is the half-over-half prices changes and 3 month moving average of months of inventory (i.e. active listings at month-end divided by sales from the month) on a time and scatter plot. (I extrapolated expected April MOI on the time plot.) This series provides the best correlation of the data. I've also included the scatter plot on semilog which allows the low MOI data to be better resolved.


Although not immediately obvious from the graphs, assuming the rate of sales does slow, a meaningful price drop from current levels is unlikely to materialize until sometime in the summer. If sales remain robust it is unlikely prices will drop unless active listings significantly increase. It's worth asking who is selling, or trying to sell. That listings are increasing fast may be a harbinger for lower sales going forward.

Given there appears to be an integral component to listings growth, it is unlikely listings growth will slow until sometime in the summer. Hat tip to PaulB for the hourly numbers. This one's for you and the inventory junkies. Subliminal message at 1:05.

Upcoming CMHC rule changes

There has been much ado about the upcoming CMHC changes to requirements for qualifying for mortgage insurance. Some basic math has been done by local bloggers here and here.

For some speculative investors, the upcoming changes will have significant impact as they are required to carry a higher downpayment. In addition homeowners cannot carry higher than about 90% LTV for refinancings and be insured. This does not mean that this part of the market is cut out, only that people borrowing with higher leverage face significantly higher financing costs in the way of non-government-backed loans.

The important change for owner-occupiers comes in the form of changing the requirement that qualification be based on, at minimum, meeting the standards for a 5 year fixed rate mortgage instead of a 3 year fixed rate mortgage. Here is where the confusion starts. First, we are unsure if CMHC requires banks qualify customers at their posted or "discounted" rates. A quick perusal of CMHC's website yielded no definitive answer though perhaps a reader can let me know what they do now. (I will save the rant on CMHC's lack of transparency for another day.) I am assuming, for now, that they use some semblance discounted rates, only because some lenders advertise close to fully discounted rates anyways. The change from 3 to 5 year, I assume, would follow the same general policy. (Update: apparently they will use 5 year posted. See mohican's link in the comments.)

Second, a quick look at posted rates shows 3-5 year spreads as high as 2% and as low as 1%. Taking the spread to be 2%, the amount for which a borrower is maximally qualified drops by just over 20%; at a 1% spread this drops to about 10%. If we assume the entire market is comprised of buyers maxing out what they can afford, we would expect the market to drop by 10-20% on this change alone. The market of course is not solely comprised of people leveraging themselves so as to require mortgage insurance and/or people maximising their affordability limits. While we do know many are taking on high levels of debt to become homeowners there is not much publicly available data to show the finances of those who are buying. You can bet the banks have these data. (Related, banks were the ones openly calling for the government to tighten its mortgage insurance qualification rules.)

Third, an interesting point is that spreads between 3 year and 5 year mortgages are extremely high compared to even 2 years ago when the spread was no more than a few hundred basis points. This is a product of the low end of the yield curve clamped near zero by the Bank of Canada.


When the Bank raises rates, as experts are expecting later this year, we expect the 3-5 year spread to narrow. In other words, while the changes to CMHC policy will have some advanced impact on demand, the longer-term impact in and of the policy change itself will be muted by 3 year rates eventually climbing closer to 5 year rates anyways. There is also no rule that says that 5 year rates cannot fall to the current 3 year rate but I don't have a good feeling for how likely this is.

How will the CMHC changes affect the market? A fringe of able investors will be cut out -- most markedly in the buy-to-let investment arena -- and this has real potential to be a catalyst for what this blog believes is an eventual return to lower price-to-rent and price-to-income ratios. Taking a step back, higher debt levels, rising unemployment, government spending cuts, dwelling under-utilisation, and a reliance on relative (not absolute) pricing by marginal buyers all indicate marginal pricing is unsustainable. The CMHC policy changes do not and can not change this blog's thesis one iota.

City of Vancouver Permit Update

I produced some graphs about 10 months ago showing the trend of permits in the City of Vancouver. Here is an update to November, 2009. I do not yet see data from December or January on the City's website.

First all residential dwelling permits graphed since 2007.


Here are the permits parsed for 1-2 dwelling units only (i.e. SFHs):


Note there is an increase in permit value in the later half of 2009. I am unsure why that occurred.


We turn our attention to the proverbial elephant in the room, multi-unit buildings (i.e. condos):


And a quick look at all permits' value, residential and commercial:


Analysis

1. There should be no doubt in anyone's mind that the City of Vancouver has become reliant upon permit revenue to fund its ongoing operations. That the City has announced severe cuts to operations -- layoffs -- should come as no surprise after looking at these data.
2. This is the strongest evidence I have seen that there was a severe building recession through most of 2008 and into early 2009, though we all pretty much knew this to be the case without these data. The total number of permits issued through this recession is significantly below what is required to feed the City's average population growth rate of the last decade.
   
3. Permits for SFHs eked out a rebound in the second half of 2009. I am not surprised by this at all given how low mortgage rates were and continue to be. I would expect a continued higher level of permit applications for SFHs through at least the first half of 2010.
   
4. The proverbial elephant in the room is multi-unit permits. While there was a slight resurgence in permits for condos in the latter half of 2009, it is significantly subdued from those heady days earlier in the decade.
5. The majority of laid off construction workers must look elsewhere for employment in the coming year.
   
6. Laneway housing started to be reported in November 2009. There were a handful of permits issued: 9. I will be interested to see how successful this scheme becomes in the coming year.

Ubergeek Post Update December 2009 - Price Changes and Months of Inventory in GVREB

Here is a quick update on the work mohican and I did in spring 2008 around refining mohican's work tracking price changes and months of inventory. Remember that the best fit was to track half-over-half (i.e. 6 months over 6 months) price changes to a three month moving average of months of inventory (total active listings at the end of the month divided by the sales in that month).

Here is mohican's scatter plot for half-over-half versus 3 month moving average MOI, updated inclusive December 2009 data:



The correlation still exists, and another small step closer to the designation of "law". We can see how well the model has behaved.



Months of inventory was extremely low through the second half of 2009, an odd event in history when unemployment is rising. There was a step-change in affordability due to low mortgage rates, coupled with a lack of tightened requirements for loan qualifications. Are there other plausible reasons for low inventory and high sales? Last year's about-face happened across Canada but unique local factors still play a role.

What will 2010 bring for BC housing? There are several portents.

- There are musings on the wind of tightening mortgage requirements which will have some impact on demand.
- Interest rates are predicted to rise the second half of this year. We'll see. Low interest rates will reduce the chances of a price collapse but will not prevent prices from falling.
- Rental demand looks to remain weak. With the Olympics finishing in 45 days or so we may see some extra rental supply and, perhaps, extra for-sale supply as well.
- Unemployment is unlikely to decrease through 2010. Government budgets, at all three levels, are under stress. The pool of money grows increasingly thin, as one would expect as the world continues to de-leverage, though the process appears to be a drawn-out affair.