Psychology of a Bubble

I stumbled upon this excellent post on the Irvine Housing Blog.

I suggest reading through when you have a few moments to review some of the important markers of a bubble market, how people rationalize purchasing in a bubble, and how it always ends.

Here is a great quote and some useful visuals:

The efficient markets theory does explain the behavior of asset prices in a typical market, but when price change begins to feedback on itself, behavioral finance is the only theory that explains this phenomenon. There is often a precipitating factor causing the break with the normal pattern and releasing the tether from fundamental valuations. During the Great Housing Bubble, the primary precipitating factor was the lowering of interest rates. The precipitating factor simply acts as a catalyst to get prices moving. Once a directional bias is in place, then price-to-price feedback can take over. The perception of fundamental valuation is based solely on the expectation of future price increases, and the asset is always perceived to be undervalued. There are often brave and foolhardy attempts to justify these valuations and provide a rationalization for irrational behavior. Many witnessing the event assume the “smart money” must know something, and there is a widespread belief prices could not rise so much without a good reason. Herd mentality takes over.

Federal government set to restrict mortgages

Federal government set to restrict mortgages

We will soon see what the changes will be.

From CBC:

Sources say the measures will discourage reckless real estate speculation, such as borrowing heavily for an investment property that is not the investor's primary residence. Flaherty is also set to deter households from taking on more mortgage debt than they can afford to repay when interest rates rise, as they are expected to do later this year.

The finance minister is also expected to discourage people from raising cash by refinancing their homes with larger mortgages — again because they may not be able to make the payments at higher interest rates.

The Canadian Press reports that Flaherty will implement a debt affordability or income test that applicants must pass to qualify for mortgages insured by the Canada Mortgage and Housing Corp.

Read more: http://www.cbc.ca/money/story/2010/02/15/flaherty-mortgage-rules.html#ixzz0ffwmWG2F

UPDATE:

National Post article outlining the changes: http://www.nationalpost.com/news/story.html?id=2570414

Yes Virginia, There is a Housing Bubble

Condo lineups return

Yes Virginia, There is a Housing Bubble

Total madness. People lining up to buy a small box in the sky on a busy street next to a polluted waterway. Awesome!! Sign me up!

Reminder - the interest only payments on $500,000 are $1350 / month at today's 3.25% or nearly $2,200 / month at 5.25%.

From thesaurus.com:

Main Entry: fool
Part of Speech: noun
Definition: stupid or ridiculous person
Synonyms: ass, birdbrain, blockhead*, bonehead*, boob*, bore, buffoon, clod*, clown, cretin*, dimwit*, dolt*, dope*, dumb ox, dunce, dunderhead, easy mark*, fair game, fathead, goose*, halfwit, idiot, ignoramus, illiterate, imbecile, innocent, jerk*, lamebrain*, lightweight*, loon, moron, nerd*, nincompoop*, ninny, nitwit, numskull*, oaf, sap*, schlemiel*, silly, simpleton, stooge*, sucker, turkey, twerp, twit, victim
Antonyms: brain

In the vein of thinking about people for who may be the greater of the above synonyms (greater fool), let's discuss this article from the Globe and Mail which highlights a reputable survey from Bing Thom Architects (press release) that has been done regarding the Vancouver housing market. This survey dispels some of the myths surrounding the Vancouver condo market.

Foreign Owners - nope
Vacant condos - no, not really
Investors - yup, yup, yup - 50 to 60%+ of condos are owned by investors

The question is, why do these investors continue to hold onto a low yielding investment like a downtown condo?

The answer is that they believe that the price will rise in the future. In other words, they hope to find a greater fool in the future whom they are able to sell to.

No, there isn't anyone else to blame except local speculators, ahem, investors, who have bid up prices and snapped up developer units at an unprecedented pace over the past few years.

Here is a snippet from the press release:


In addition to an estimate on empty condos, the study found that:
• Condo ownership is a relatively new form of housing for Vancouver. Over 88 percent of condo units in Downtown Vancouver have been built since 1990.
• Less than 40 percent of downtown condos have more than one bedroom.
• The majority of condos are not occupied by the property owner.
• The majority of non-owner occupied condos are owned by BC residents, with a scattering of foreign owners, predominately from the western US states such as California, Washington, and Arizona.
• Owner-occupied units are typically worth $30,000 to $40,000 more than nonowner occupied units, and the more bedrooms the unit has, the more likely it is to be owner occupied.
• A family with one child in the City of Vancouver earning the median income of $75,000 a year would have great difficulty in finding and paying for a condo bigger than one bedroom, even if condo prices were to fall 25 percent below 2008 assessment levels.

That last one is a doozy and despite better career prospects that is why I don't live in Vancouver with my wife and two children.

Gentrification

I have written about different premiums placed on housing that can lead to prices higher than the current net rents they generate would justify. The two I have discussed are the "ownership premium" that was argued to be fallacious and the "densification premium" that was argued to be reasonable. I will discuss the gentrification premium, an anticipation of increasing a property's future productivity by anticipation of an improvement in its neighbourhood's quality.

Gentrification is where a neighbourhood is generally seeing a rise in its "quality", however that is defined. From a strict point of view, gentrification is where a neighbourhood's real income rises. But it could well be a neighbourhood appears to be getting wealthier when the actual monetary wealth of its inhabitants is not, even though the "quality" of the inhabitants is indeed increasing. (Wealth can be measured in different ways!) To handle these two scenarios, and for reasons to be apparent, I will be looking at rents, not incomes, as a method of measuring gentrification.

A quick note on taxonomy. A neighbourhood that is "gentrifying" or "undergoing gentrification" is a measurement of its trend towards increased quality. A neighbourhood that is "gentrified" is a measurement of its current quality after the gentrification process. A gentrifying neighbourhood will become gentrified while a gentrified neighbourhood may or may not be gentrifying further.

Gentrifying eventually means a neighbourhood will be more desirable. This can be due to many factors including proximity to shopping, good schools, good quality building, status, etc. Gentrification can even be self-reinforcing, where a neighbourhood receives a good reputation and becomes even more desirable. Many will pay a premium of their incomes to live in a gentrified neighbourhood so rents as well as prices would tend to be higher. Incomes will tend to be higher as well as only those with higher incomes can afford the rents and prices but this is not absolutely true. It can also be that the neighbourhood contains some willing to spend more of their incomes on housing. Thus we have two dynamics: greater desirability generally means people are willing to pay more of their incomes to live there, and greater desirability attracts those with higher incomes. The ultimate arbiter of desirability comes down to rents charged -- whether someone is willing to pay more or has ample income with which to do so is not directly relevant, though it has significant implications about a neighbourhood's ability to make gentrification "stick".

The rents and prices of ungentrified and gentrified neigbourhoods should still line up so as to give an investor a decent return. The investor doesn't really care so much for whether a neighbourhood is gentrified. (He may care to some degree though. Perhaps a gentrified neighbourhood generally attracts a more responsible tenant meaning he can generally afford lower yields but that is likely a secondary concern and not the subject I am trying to address.)

If a neighbourhood is expected to gentrify in the future, prices can carry a premium beyond that suggested by current rents. Imagine a condo in a neighbourhood that is "the next thing". It is a quirky Bohemian neighbourhood and has lots of amenities and vibrant culture. There is an argument that over time the neighbourhood will start attracting more affluent residents or just "ordinary" residents willing to pay a premium to live there. But not yet. There are still warts around drug dealing and crime but the general consensus, vis a vis other neighbourhoods, is this neighbourhood has a bright future. If we can reasonably expect that rents will outpace inflation in the future, this condo can be sold at a premium compared to what its current rent justifies.

The gentrification premium is in many ways speculative but is based on one's reasonable expectation of future inflation-adjusted rent increases. It is not absolutely certain a neighbourhood will gentrify. It may start looking better but perhaps rents don't increase like we anticipated. Perhaps the drug problem persists or other neighbourhoods are offering competition keeping the rents down. The gentrification premium here was not justified because rents did not increase as expected and we are left with unfounded speculation.

Notice the gentrification premium is about anticipation of rent increases. A neighbourhood that is gentrified but not expected to gentrify more would not have a gentrification premium.

An important point is that gentrification can apply to a city as a whole or to its individual neighbourhoods. It is generally true that Vancouver commands a premium to live compared to other Canadian cities but only as it relates to incomes (the ability to pay) and income-to-rent ratios (the willingness to pay). In other words people are willing to pay a larger portion of their salaries towards accommodation in Vancouver than in other regions of the country and/or, possibly, only the more affluent can afford to live there. These two factors can be due to many reasons including cultural ties, climate, ambience, high paying jobs, whatever. If we think that the city's FUTURE desirability will increase and people are willing to pay MORE of their incomes towards accommodations than is currently the case, and/or that incomes are generally set to rise above inflation, Vancouver can carry an aggregate gentrification premium. The data I have seen make this thesis sketchy. Incomes and rents have tracked each other quite closely over the past 25 years and real incomes and rents are at best flat.

If an individual neighbourhood gentrifies and a city's overall rent and income trend is flat, as seems the case in Vancouver, it has important implications for the gentrification premium. Stated bluntly, the sum of all gentrification premiums must sum to zero. For every neighbourhood that is truly gentrifying, to balance the books, there must be another neighbourhood experiencing the opposite, at least in terms of rents. Keep that in mind when touring a sample of neighbourhoods.

Now it could be Vancouver is collectively becoming higher quality without income and rent increases. I applaud such efforts to increase quality, akin to a war effort in a way, and this could well lead to higher rents and incomes. However high quality is based upon producing real value such as vibrant neighbourhoods, workmanship, effective facilities and services, low crime, and sustainable and productive employment; not a quick paint job and a two week vanity party. There is, though, a justifiable premium should residents collectively make the city into something greater than it is today, as measured by income and rents sometime in the future.

Also note that gentrification and densification can go hand-in hand. Densification is generally about increasing land productivity by increasing the number of dwellings where gentrification is increasing land productivity by improving its quality. Often both occur at the same time but not necessarily.

The takeaway from the subject of gentrification is that for a property to have a gentrification premium, one must reasonably expect rents for the same property to increase more than inflation, by way of improved desirability, income growth, or both. The anticipation of the city's future greatness is what has led many to justify paying a speculative premium for Vancouver property and this premium is certainly priced in, in spades. At some point -- and who knows when -- the promise of greatness needs to be delivered.

The Argument Against Value Analysis in Vancouver

Much has been made by me and other long-time commenters on this blog about what housing prices would be in the absence of a bubble, the market's so-called fundamental value. Yet Vancouver's housing market has rarely (not never) been at a "fundamental" valuation in the past generation. Does value investing have a place in Vancouver real estate if prices rarely agree with the theory? I will outline the case for why not and offer some commentary.

Here I have attempted to paraphrase many of this blog's comments into this post. The information is not new, only presented. I do hope that readers, if they have time, read some of the comments here and in the archives for more insights into the fascinating subject of real estate in Vancouver, the "most bubbly city in the world".

The simple way of determining fundamental value is to look at an asset's current and expected future cash flows, discount them at your cost of capital, and sum them up. mohican uses a simple formula that I crudely derived here. There are other simpler and more complex methods of course and there is always disagreement over assumptions. With Vancouver specifically the last time properties were valued at what I consider to be fundamental valuation was around 2000 and before that in the mid '80s. Others will say 2000 was never at fundamental valuation, a local minimum that never quite reached the trigger point for them to consider it a good value investment.

The question is, if fundamental valuations have not been present since, say, the mid '80s, do they still have merit? The argument for why fundamental analysis is flawed for Vancouver real estate goes as follows. Real estate consists of cash flows from rents and capital appreciation. The Vancouver market has had many boom-bust cycles in its past. Even if an investor buys when prices are above fundamental value (not necessarily at the peak, mind), a subsequent boom cycle will allow the investor to exit with a decent overall return. Booms and busts are inherent to Vancouver's psyche. Given enough time, typically 7-10 years, you will always be able to cash out positive, the caveat being of course you avoid buying near or at the peak. Fundamental valuation is therefore rarely, if ever, achieved because investors anticipate future bubbles to compensate for poor rental yields.

In a nutshell, that is the argument. And before commenters rip it apart I will say that many people over the past generation have made decent real (or paper…) returns in this fashion. Most I have had discussions with do not engage in "pure" speculation (i.e. flipping) but actually rely mostly on rents for their return; "mostly" because for the return to really make sense they require some form of capital appreciation above inflation. The speculative component (i.e. prices above fundamentals) is apparently omnipresent within a typical investor's time frame.

The Vancouver price graph is indeed "biased" above fundamental value. So the argument goes, as I can make it out, you may have to wait a long long time for true fundamental valuations to return. If this is true, that Vancouver has a propensity for speculation, prices may never retreat to fundamentals in one's lifetime. In fact this is effectively the argument I hear on local blogs and amongst my acquaintances and family. Really they are saying that Vancouver is full of greater fools who will inevitably compensate us for poor cash flows or that their still fruitless but eternal hope of real income growth will manifest itself. And maybe they are right.

Of course speculation is a zero sum game and many we know have done well in the past generation in their real estate investments, "others" not so much. Here though I lob a few words of caution into the hubris.

First the assumption that Vancouver will experience another boom-bust cycle in most investors' time horizons is just that -- an assumption. There are precedents in other cities, most notably Tokyo, where prices have fallen for twenty years and counting. The market there had the ability to absorb a significant amount of investors with speculative components to their business cases and not lead to a subsequent boom; in other words a lot of speculators got burned waiting for the recovery that was not. Indeed the Japanese property market remained rational longer than speculators could remain solvent. Not to say this will not happen in Vancouver, but convincing yourself it won't is a high stakes assumption nonetheless.

Second is that oversupply this time around may all but guarantee a return to fundamentals. There are just not enough people for the number of units being built and, worse, we have seen Vancouver's population "spread out" from past decades. That is, the ratio of occupied bedrooms to the total number of bedrooms has been decreasing for the past decade due to what I believe to be both a demographic shift, and historically low and lasting unemployment (due in significant part to the construction boom as it happens). What is to stop this trend from reversing when average wages are falling? If you think mohican's graph of CMHC units under construction is scary, wait until under-productive dwellings are brought back to more full productivity as people tighten their belts.

Third the past generation has seen a perpetual reduction in mortgage rates and mortgage qualification thresholds from their highs in the early '80s. This in turn has improved affordability for existing owners and pushed up prices for future ones who can still miraculously tap credit lines. That trend is unlikely to continue much further. If mortgage rates increase, it will be decidedly bad for affordability. If mortgage approvals are stricter, fewer can qualify to buy at all. And prices will suffer.

It comes down to one thing, that Vancouver real estate has had a lengthy CV of booms and busts with a distinct bias above what would be justified by fundamentals. As an investor, you may well be relying on Vancouver's house price volatility to ensure your overall returns are satisfactory. Food for thought, though, that THIS time, it may indeed be different, though not in a good way for your future savings. On the flipside, for families looking to buy a personal residence only at fundamental value, there is some chance you could be waiting a long time, though perhaps not.

The Ownership Premium

No analysis blog would be complete without a paradox and I believe there is none more relevant now than the so-called "ownership premium" that owner-occupiers place on property values. I would like to offer an alternate view of the so-called "ownership premium" that has been discussed on this blog and others in the past years.

The "ownership premium", sometimes called the "control premium", is a premium that a potential buyer will pay for the right of owning (and "controlling") a property compared to renting. Here is an example thought process of how the premium concept works, from a buyer's perspective:

jesse is renting a condominium for $1200 per month but is on a month-to-month lease. With a wife and young child, jesse does not want the uncertainty of renting month-to-month and his wife wants to customize the suite, something not always possible when renting. jesse looks at the condo for sale next door. If he were to buy it at market rate, the total costs of doing so far exceed that of continuing to rent. After factoring in all expected costs and trade-offs, jesse decides he is willing and able to pay a monetary premium to buy. But – and here's the thing – he doesn't have to.

The alternate view of the ownership premium looks not at individual circumstances but at the overall market comprised of owner-occupiers and investors competing over the same product. Here, for simplicity, we can look at condominiums that have a healthy mix of both owner-occupiers and investors. If owner-occupiers will pay a market premium to own, the investor must compete by also paying the same premium. This has the effect of reducing the investor's yield and instead must rely on capital gains to compensate for the poor yield.

In speculative bubbles, low rental yields go virtually unnoticed because everybody is "making money" on capital appreciation. Investors can compete head-to-head with owner-occupiers because rental yield is dwarfed by capital appreciation. The "ownership premium" train of thought becomes justified, even amongst many investors who justify it as a premium for scarcity and control of how the property is used. During bubbles, the premium continually increases.

However, when a bubble deflates, total return is not about capital appreciation but net income from rents. At this point the investor will require higher rents or lower prices to make the investment worthwhile. Housing markets around the world are starting to revert to where cash flows make sense again and this means lower prices. Rising rents are next to impossible when there is an oversupply of dwellings and wages are flat to falling with rising unemployment. The ownership premium, for investors, is once again meaningless.

This does not mean that the ownership premium for owner-occupiers is a fallacy. It exists and is real. In addition, for many others, the mobility and lower responsibility offered by renting means their personal premiums are negative. The point is that it doesn't matter. When a significant portion of a market is focused on monetary returns ex intangible benefits – i.e. investors –they will eventually and invariably set the price. It also doesn't mean anyone is necessarily wrong for paying a premium but ones doing so should not use it to justify high prices and instead realize they made an investment with a lower monetary return.

Edit: the "ownership premium", as described here, is in its essence describing one's personal preference to own or rent a property -- the "intangibles" of ownership. It is not to do with more tangible premiums related to speculation of future price gains or expected increased utility by densification. The point is the intangibles of ownership do not in themselves justify higher prices.

Hoorah for 2008 and Predictions for 2009

2008 in Review

2008 was the year that the entire world woke up to the fact that houses don't go up in value forever and the entire mess of a year that 2008 was can be summarized in that fact.  Stock, bond, and commodity markets all reacted to the spectre of a long and protracted recession with no quick turnaround in sight.  It is truly amazing to see how consumption and borrowing against the value of a home had an impact at inflating the US and Canadian economies.

Locally, house prices fell dramatically starting in May and benchmark prices are now down nearly 14% in the REBGV area and just over 9% in the FVREB area.  The pundits are still calling for a spring turnaround and many real estate agents will likely be disappointed with their incomes during 2009.  They had better learn how to get sellers to drop the price fast or no paycheques will be forthcoming in 2009.  I fully expect that many real estate agents and mortgage brokers will try to find other work during 2009.

Prediction Time

I was 2 for 3 on my predictions for 2008 but I missed a big one as I didn't see how bad the stock, bond, and commodity markets would turn out.  

Predictions make fools of us all unless we are lucky enough to guess correctly.  Sometimes an educated guess is better than nothing however and it is kind of fun to toss around what we think is coming during the next year.

Here are my thoughts:

1) Real estate prices in the Metro Vancouver area will fall by 20% or more during 2009 from current levels.  The fall in prices will be worst for apartments and will be best for moderately priced suburban detached homes.

2) BC will enter recession sometime in 2009.  Canada and the US will continue in their recessions throughout most, if not all of 2009.

3) The Vancouver construction industry will be decimated during 2009 with many more projects hitting the completion phase and the need for labour dries up.  See historical employement statistics here.  The Metro Vancouver area will probably see a loss of 50,000+ jobs in 2009 from the construction, retail, finance, and real estate professions.

It's a Random Walk

From Investopedia:

Random walk theory gained popularity in 1973 when Burton Malkiel wrote "A Random Walk Down Wall Street", a book that is now regarded as an investment classic. Random walk is a stock market theory that states that the past movement or direction of the price of a stock or overall market cannot be used to predict its future movement. Originally examined by Maurice Kendall in 1953, the theory states that stock price fluctuations are independent of each other and have the same probability distribution, but that over a period of time, prices maintain an upward trend.

In short, random walk says that stocks take a random and unpredictable path. The chance of a stock's future price going up is the same as it going down. A follower of random walk believes it is impossible to outperform the market without assuming additional risk. In his book, Malkiel preaches that both technical analysis and fundamental analysis are largely a waste of time and are still unproven in outperforming the markets.

Malkiel constantly states that a long-term buy-and-hold strategy is the best and that individuals should not attempt to time the markets. Attempts based on technical, fundamental, or any other analysis are futile. He backs this up with statistics showing that most mutual funds fail to beat benchmark averages like the S&P 500.

While many still follow the preaching of Malkiel, others believe that the investing landscape is very different than it was when Malkiel wrote his book nearly 30 years ago. Today, everyone has easy and fast access to relevant news and stock quotes. Investing is no longer a game for the privileged. Random walk has never been a popular concept with those on Wall Street, probably because it condemns the concepts on which it is based such as analysis and stock picking.

It's hard to say how much truth there is to this theory; there is evidence that supports both sides of the debate. Our suggestion is to pick up a copy of Malkiel's book and draw your own conclusions.

300th Post and I'm at Housing Bubble Ground Zero

Happy 300 posts and nearly 300,000 visitors!

I sat back today and assessed how my personal housing situation has changed in the past few years. My wife and I bought a condo in 2004 for a reasonable price that made our mortgage payments plus strata and property taxes less than the cost of renting. We were happy with our purchase and paid down our mortgage quickly, starting with a 15 year amortization and making double payments until we sold the unit last August for nearly double what we paid.

Needless to say we were happy with the profits and would have gladly purchased a reasonable townhouse to accomodate our growing family but no such suitable unit was found after a fairly extensive search.

We are now renting a larger condo in a brand new smaller building and we enjoy our location close to work and amenities. Our cost of renting this unit is half the cost of purchasing on a monthly basis and we are socking away our savings for an even larger down payment once we find a suitable home at a reasonable price. This extra monthly savings combined with the earnings from our extracted home equity is very substantial by any account and make these renters quite satisfied with our lowly renting status!

Now I find myself at Vancouver Housing Bubble Ground Zero

The building we live in has 32 units and currently 20 of these units are listed on the MLS website. Yes, that is right, no typo - 2/3rds of the units in our building, including the one we rent are for sale at this very moment. My landlord was hoping for quick profits by flipping this condo and realizing no quick sale he franticly sought a renter to help cover his costs while trying to sell the unit. His asking rent was ridiculous but was easily bid down by 25% with some fairly convincing arguments and some stiff competition.

The parking garage is empty and we have watched the poor realtors hold open houses all spring long with no traffic and no bids. Reluctantly the sellers lower their prices by $2000 and $4000 at a time but still no takers. Nobody realizes the game is over yet and there are a declining supply of greater fools to buy mediocre houses at inflated prices.

I am happy with my spectator status. It is going to get real interesting so grab some popcorn and a cold pop!

REBGV Area Officially in Bear Mode

Well it is mid May and the real estate market is supposed to be sizzling with sales and what is that sound I hear at your local open house. . . . .




. . . . . . .




- - - crickets chirping - - - -




. . . . . . .




In the formerly red hot Vancouver housing market, the inventory of homes for sale is piling up like empty pizza boxes at a teenage boy's birthday party. The rich immigrants and Albertans are not buying them all, locals can't afford them and the wannabe sellers are having to reduce their prices.

It only took a few months longer than the outlying FVREB area but the inventory of resale homes officially hit 26 weeks or 6 months of inventory this past week (as per Paul B's numbers) and that officially puts the Vancouver housing market into bear mode. Look for further price declines and listen for the cry of the wailing speculator - which sounds a lot like crickets chirping at an open house except louder.



The supply-demand relationships at work here should make price declines a virtual certainty through the summer, fall, and winter of 2008 based on seasonal real estate inventory patterns.

Of course if the seasonal pattern doesn't hold this year we could see a different result.

Guesstimates

The local real estate boards will be out with the monthly numbers tomorrow and I am guessing we will have price declines across the board. The inventory level is reaching super-bearish levels in the outer areas and bearish levels closer in. These levels of inventory are so high that it is unavoidable to have price decreases as sellers compete for buyers.

What are your guesses at the numbers?

Mohican thinks:
REBGV - down -1.5% MOM
FVREB - down - 2.0% MOM

Oh - - - if only I could short Vancouver real estate.

Wanderings

I'm going away to wander the countryside for a week or so with my wife and baby mohican. Baby mohican seems to be growing up quite fast - where do the days go?

Enjoy these pictures that I took while on a walk in my neighbourhood. All of these pictures were taken within 4 city blocks of each other and here I thought there was no more land left. Boy was I ever wrong!

Sorry about the quality but it was taken in low light with my camera phone.

There was another large vacant lot that was being cleared for 153 condominiums with the sales centre just getting setup. There was another 100+ lots being prepared with no for sale signs.

Shortage of Wheat

I am long DBA at the time of this post. I am also using the Fidelity Special Situations Fund as an agricultural inflation play.

From CBC News:

Soaring wheat prices have Canadian bakeries struggling, farmers rejoicing and customers digging deeper at the till to pay for their bread and pasta purchases.

The price of flour has been climbing steadily over the last year. The price of flour has doubled in the past two months as weather problems, including two years of droughts in Australia, have depleted wheat stocks to lows not seen since the 1970s. Also contributing to the shortage is the flux of grain farmers switching to other crops, such as canola or corn, that produce biofuels.

"It's a very, very tight situation," said Canadian Wheat Board analyst Bruce Burnett. "World production has been under consumption in the last couple of years, so we have been drawing stocks down … and we've finally hit levels that have made the market very, very concerned about supplies and rightly so."

Burnett said the prices are likely to remain high for at least another 18 months, as it could take up to three years of strong harvests to rebuild the worldwide stocks.

Bakers rising prices

The pricing crunch is affecting bakeries, and their customers, across the country. In Winnipeg, KUB Bakery said its prices need to go up to help cover the rising costs. "We're not going to gouge anyone, we're going to take what we need to stay afloat. Bread is going to have to go up, any product with wheat in it will go up, that's a certainty," Ross Einfeld, the bakery's manager, told CBC News. "I'm sure all bakeries across the board have the same problem. Their flour price has doubled, their ingredient price has doubled. So you're going to see prices increase."

Calabria Bakery, in Scarborough, Ont., is also finding rising flour prices a challenge.
The bakery's Sam Cuzzolino said they use roughly 15 tonnes of flour a month for bread and pizza dough and "as far as the bread side goes, if we're breaking even I'd be amazed at this point." He said if the profits in the 50-year-old business continue to decline, he'll have to consider stopping baking bread altogether.

Mount Pearl, N.L., bakery manager Tom Bennett said bakeries can only swallow flour increases for so long. "It's such a labour intensive thing and really, when you see the cost going up …to pass it on to the customer, it's a very big increase for them to swallow," he said, adding that his customers would be upset if he raised his prices from $1.75 to $2.50 a loaf to help cover the costs.

The rising costs are also shrinking the bottom line at Coleman's grocery store in Mount Pearl, Newfoundland. "From what we were paying a year ago to what we're paying now, it's actually phenomenal," said Tom Bennett, bakery manager. "You wouldn't really think all these different things going on would affect the price of flour here in Mount Pearl, but it has."
Soaring prices have farmers 'optimistic' While bakeries are struggling, the high prices are encouraging for farmers.

Doug Chorney, a wheat farmer near Winnipeg and a member of farmers' group Keystone Agricultural Producers, says he and his colleagues are "very optimistic." "These are the best prices for wheat we've seen in many farming careers, perhaps ever. Everyone is optimistic this is going to be a good year, providing we can produce the crop that hasn't grown yet," he said.
Chorney, who said he has already decided to plant more wheat this year, also said the expected profits may help keep some farmers in the industry. It "may encourage some young farmers to stay on the land and take up farming as a career," he said

And another story:

A massive shortage of wheat on the global market is setting the stage for what some market analysts say could be a "once-in-a-career" windfall.

The stage is being set for record-high prices for Prairie farmers, said Mike Jubinville, a market analyst with ProFarmer Canada, a Winnipeg-based company that helps farmers decide when is the best time to market their commodity.

Wheat supplies in the U.S. are expected to fall to 60-year lows by the end of May, the global inventory of grains continues to decrease as aggressive demand for high quality, high protein wheat is soaring, particularly in Asia, Jubinville told CBC News on Friday.

"In nominal terms, we're looking at prices that have never been achieved before on these various commodities, and obviously that's created a great deal of enthusiasm in the farm community," he said.

The last major rally on wheat was in 1996, Jubinville said, when it sold for $7.50 a bushel. Wheat is currently being traded at $19 a bushel, and the market value of canola has more than doubled. The profit potential for farmers is improving to levels that haven't been seen in decades, he said.

"This is, in my mind, one of those once-in-a-career years, that profits this year can make up for a fair number of bad years," he said.

"It seems like you almost can't go wrong growing any individual crop, and we're just trying to find the ones that have the potential to will make us the most money."

2008 will be the "year of the farmer," he predicted, a dramatic change from recent years, when farmers, plagued by early frost, delayed seeding and drought, seemed to lose money no matter what they grew.

Correction Scenarios

Some discussion took place on the previous post about how a correction may play out in our local real estate market. Will it be fast? Will it be slow and steady? Will it look like previous busts? How will unemployment or a recession factor in? What about the olympics or other psychological factors?

Here is a pictoral illustration to give some food for thought - click to enlarge.


If we accept the premise that housing in Vancouver is overvalued based on fundamental analysis of the assets and the earnings or imputed earnings that these assets can earn, then we must evaluate how this overvaluation will be corrected.

Will earnings / rents grow to meet current prices? This would require a near doubling of local rents. I think most people would agree that this would devastate the local economy as the labour pool would dry up rapidly and many businesses would shut down due to the expense of operating here.

Will prices undergo a minor correction while rents increase modestly and interest rates are lowered? This is possible although trouble in the internation mortgage and credit markets would indicate that lenders may be unwilling to lend money to purchase real estate.

Will prices correct very quickly thus restoring a fundamental valuation to local real estate assets? This is also possible and perhaps even the most likely outcome given several possible events.

Here is the way I see things:

As the US enters recession it is likely to effect many industries here in Vancouver. This, combined with a wrapping up of several mega projects (Canada Line, Highways Improvements, Convention Centre, Condo Developments) during the next 12 - 18 months will drive unemployment up rapidly.

This unemployment will cause two things:
1) Developers will fast-track current housing projects as labour becomes available and
2) Unemployed or underemployed workers will leave and / or put up their homes for sale as they are unable to make the payments.

A wildcard in all of this is the amount of 'speculator owned' housing inventory out there. It is impossible to quantify at this moment but, if anecdotes are to be proved correct, this accounts for perhaps tens of thousands of underutilized or unutilized housing stock that could be put onto the market very quickly.

What do you think?

Olsen on Our Side?

Here is a synopsis of last night's "Olsen on Your Side" segment of the local CTV News. Highlights are mine. Look for another segment every night this week on the CTV News. Watch last night's segment here.

Will Vancouver's red hot real estate market cool?

Updated: Mon Jan. 28 2008 12:55:48 bc.ctv.ca
Real Estate Forecast

This week we're beginning a five part series on real estate and what's putting pressure on owners and buyers alike.

I think there is an assumption that real estate prices always go up. But that's not always the case. In the US, the sub prime mortgage crisis has slashed prices in many desirable communities as a flood of homes come onto the market.

In just the last three months in California, 32,000 ended up in foreclosure 82,000 more have gone into default on their mortgages; an early indicator of possible foreclosure. In Phoenix 56,000 homes are for sale, many of them foreclosures, 10 times as many as three years ago. And that can't help but effect prices. In Fort Myers Florida, foreclosures have climbed 500 percent in one year while house prices have fallen by 30 percent in two years.

I'm not saying that is our future -- but it was only two years ago when there were stories in the US of real estate booming, prices out of reach for many people, and today, if you hadn't bought then you have a lot to choose from.

While we don't have a sub prime risk here, if the US slips into recession that will effect our economy and there are a number of other factors that could come into play.

Like what if our investors start taking their money to the US to cash-in on the bargains there? We talk about that on Wednesday in our series. And what about affordability? With prices where they are now -it's a real issue in Vancouver and other communities. We'll show you how the market is trying to accommodate first time buyers. And how to get the best price you can whether you're getting in or moving up. That's tomorrow.

And later in the week we also have a reality check story on what sacrifices you need to be willing to make to own a home here.

Real Estate: Where now?

Can the lower mainland's red-hot real estate market keep heating up?

Some experts say the increases we've been seeing just aren't sustainable and they've got a warning for speculators.

Catherine Stofer wants to own her own condo in Vancouver. But it's been tough. "I earn a good living, that's the frustrating part. Here it is at the age I'm at if I amortize, I'll be in my grave before I pay it off," she complains.

As prices have been rising, units have been getting smaller, in an effort to keep first time buyers able to buy something.

At 670 square feet the unit Stofer is looking at is considered a larger unit "Some of the dens we've seen basically couldn't accommodate a computer," she notes.

"I'd say we are somewhere near the top of the cycle," predicts UBC real estate professor Tsur Somerville. He says the numbers tell the story. Real estate prices in Greater Vancouver have been rising 15 percent per year on average for the last four years.

Historically, you'd expect six percent annual increases and we are two and half times that.
"The risk you are facing now is that you have a market that is near a peak. You have employment in major construction projects that is going to tail off. You've got
negative news in terms of Canada's trading partner," calculates Somerville.

And since real estate prices have fallen in the US, will local or foreign investors pull their money out of this market to invest down south where our dollar buys more. What would happen if they did?

"If they sell and people notice prices are softening, are they going to race to sell: and is that going to cause a downturn particularly in the condo market? There are a lot of different ways this could play out and because we haven't had a lot of experience in that we really don't know the way this plays out," says Somerville.

Professor Somerville says if you are buying a place to live in long-term timing the market isn't critical. But speculators face a far riskier market today.

"The person who has over extended himself, is the person most at risk," he concludes.

Catherine just wants a place to call home. "Just keep trying, there has got to be something out there," she muses.

In all markets there is a psychological aspect. People believe that what happened last year will happen this year. If people believe prices will keep going up, then prices rise faster than the economy that supports them. But remember, expectations can also change quickly and that will affect the market too.

With a report from CTV British Columbia's Chris Olsen

Vancouver Real Estate Bubble Uberpost

It has been awhile since I've put everything together in a complete picture for us to formulate an informed view on our local real estate market. This is a long post but well worth it.

First some history:

Average home prices have catapulted into the stratosphere recently.


The price of a benchmark condominium in Greater Vancouver has risen 111.5% in the past five years to a disgustingly unaffordable $377,579.

The price of a benchmark townhouse in Greater Vancouver has risen 100.8% in the past five years to a sickeningly unreachable $456,941.

The price of a benchmark single family home in Greater Vancouver has risen 95.5% in the past five years to nauseatingly excessive $730,399.

Even adjusted for inflation we are far above any historical norm.

What this means is that the average family can’t afford to buy a first home or upgrade since the income required to fund this purchase via a mortgage is double or triple what they make.

Now our current house prices wouldn't be a problem if people were earning more money but they aren't. Average incomes have not increased to the extent necessary to afford the average home.

This wouldn't be all that concerning on its own either if rents were rising but the crux of the matter is that the income yield or rent from real estate in the Vancouver area has not increased to the extent necessary to justify today's high prices.

Many observers point to low interest rates to justify current real estate prices but this does not explain our current situation either. If interest rates were low enough to justify current prices then we should see a similarity between mortgage payments and rents but we see a wide disparity between the two at this point in time. In fact we would have to go back to the heyday of 1981 and 18% interest rates for the mortgage payment to rent ratio to be as high as it is today.

Many people see the current building boom and assume we have high population growth which, if it were true, would partially explain the huge run up in prices but it is just not true as population growth has not been high by historic standards.

Granted, we have had population growth (in 1000s of persons) and all of these people do need to live somewhere. We did go through a period of time in the late 1990s and early 2000s when developers were not building a lot of new homes because there wasn't a lot of profit in it and demand seemed low but that changed quickly as interest rates declined dramatically after the tech bubble crash and 9/11. Subsequently, people went out house shopping in droves causing a shortage of supply in our local market.

We do live in a mostly free market economy and supply demand economic equations really come into play when we are discussing price movement of commodities such as real estate. When development companies are able to make a profit selling a home they will do so and the higher the profit earned they will consequently build even more homes. Logically, this would suggest that we shouldn't have a problem at all with prices because supply and demand should quickly come into balance but this is not so.

The problem is that real estate product takes from 6 to 24 months to produce and the time lag is substantial as people, after all, do need a roof over their head. This lag produces another effect - speculation - savvy speculators perceive shortage in the marketplace and act quickly to take advantage of the obvious price implications of shortage by buying any available units. This competition for housing causes prices to rise very quickly. This also causes a feedback loop and sends a signal to developers indicating that there is even more demand and so they build even more units. This feedback loop causes further effects such as skilled labour shortages and escalating construction costs as other people become aware and want to take advantage of the perceived shortage. People now feel the prices are justified because of these higher costs.

All the while the loop increases until we have exhausted all demand and the feedback loop that made everyone feel we were in a boom ends and it is replaced by a vicious circle of increasing developer inventory, speculators who cannot sell the homes they speculated on, decreasing construction input costs as competition becomes fierce, and increasing unemployment which further exacerbates the problem. We are nearing this exhaustion point as the number of units under construction in the Vancouver Census Metropolitan Area is way higher than justified by our population and many projects have completed or are scheduled to complete in the next 12 - 24 months.

Anecdotes abound of Realtors, mortgage brokers, and wanna-be Donald Trumps picking up 4, 8, or 12 housing units before they are even completed so they can sell at a profit when the building is finished. The problem is that this will cause the vicious circle mentioned above and prices will decrease as all demand is exhausted and the supply burgeons with newly completed inventory and desperate speculators.

The prospects are bleak for Vancouver real estate as there are very few potential buyers out there, population growth is low, average incomes are below urban Canadian averages and we have a housing inventory that is projected to increase dramatically in the next 12 - 24 months. Stay tuned and grab some popcorn since this is going to get real interesting.

Bob Rennie is a (very well) Paid Shill

I heard a panel of financial market analysts on CKNW this morning comprised of Michael Campbell, Michael Levy, Helmut Pastrick and Bob Rennie. I am amazed every time I hear the silver tongued Bob Rennie open up his mouth. I believe that Bob actually believes the crap he says about Vancouver being able to weather the financial storms that are hurtling around the world right now and that our economy is an invincible fortress built upon ever increasing real estate wealth.

At times, during the few minutes I could tolerate, it seemed as if the 3 actual financial industry players were about to say - "What is this guy doing here?" After all Bob Rennie is a marketer, not an economist. He wouldn't know a price/rent ratio if it hit his Rolls Royce on the hood.

Bob, after being lobbed softball questions by host Bill Good, spouted the usual nonsense about the Vancouver Olympics, world class city, blah, blah, blah. Are you nucking futs? Blind? Deaf?

Rant off.

2008 Crystal Ball

Well, my crystal ball is broken but maybe yours isn't. I'm interested in hearing what everyone out there thinks about 2008.

Will the Vancouver area real estate market continue to defy fundamentals and continue on its heavenward ascent?

Will the Canadian and BC economy thrive through a US economic slowdown?

Will the stocks, bonds, cash, gold, real estate, or other commodities be a good investment in 2008? Which one will be the best?

I don't really think anyone can "predict" the future but we can make some educated guesses. Here are mine.

1) 2008 will be the year of turning for the local real estate market. I think we will see year over year declines by summertime - at least in the Fraser Valley.

2) The Canadian and BC economy will slow down dramatically in 2008. Labour shortages will be a thing of the past by the end of the year in BC.

3) I have no idea about the stock market but I think it will be another good year for growth stocks. I like value stocks always but will they go up in value this year? I don't know or care since I am just looking for bargains with good earnings and dividends. I think agricultural commodities will be a good investment among other commodiites. Financial stocks will probably not fair that well but could be good buys this year as they will be continually battered in the news.

Please DO NOT take this as financial advice as I always recommend having a diversified portfoli0 and a proper financial plan.

Statistical Speculation

It is the end of the month and you know what that means for data addicts like me . . . the local real estate boards will release their statistics package outlining inventory, sales, and prices for our local real estate market early next week - probably Tuesday.

So let us speculate, unscientifically of course, on what the data will be.

Last month saw 6 months of inventory in the Fraser Valley Real Estate Board area with no significant price changes. Prices have not risen in the Fraser Valley since the July / August period and seem to be stuck at that level for the time being. We need more inventory and/or lower sales to see further price declines. Will we see that this month?

Last month also saw 4 months of inventory in the Greater Vancouver Real Estate Board area with modest price appreciation. Price growth is still robust in the GVREB area, although some areas are showing weakness, especially in the outlying areas. Inventory and sales are still bullish in the Greater Vancouver area and we need to see inventory grow and sales shrink before any price correction can materialize. When will we see this happen?