Ubergeek Post Update June 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 famous scatter plot for half-over-half versus 3 month moving average MOI (the red dot is June 2009's datum):



Remarkably the correlation is disturbingly accurate into the downturn. Looking forward we can see how well the model has "predicted" the next month's price movements.



Weak-minded fool that I am, I second-guessed myself and thought the benchmark would come in at $690K, though if I had stuck to the model I would have been closer. I am at a loss to explain the reason for how well this model has done in Vancouver. Other cities where I have tried to run similar analysis show nowhere near as tight a correlation between months of inventory and price changes. Since the causation underlying this model is not well understood the model is interesting but not much more -- it will track until it doesn't.

If you're flabbergasted by the market's recent strength, consider affordability has improved close to 30% in the past year (thanks for pointing this out, fish10). That's a Brobdingnagian shift, even with aggregate incomes coming under severe pressure.

The "Inflation Hedge"

Much talk has ensued in past months, around the time of quantitative easing by central banks, about the concept of real estate being a so-called "inflation hedge". What is meant by this?

The concept of "hedging" is pretty straightforward: take a position in an investment that limits the possible losses when summed with another investment. Generally one gives up some return for doing this but one can prevent against an investment being wiped out. Of course in the context of real estate, there is no hedge per se. What is meant is that real estate returns generally track inflation. Therefore if you have investments that would be hit hard if inflation increased, real estate is purported to generally increase its total return in an inflationary environment and you would at least have something, all said and done.

It helps to remember, when it comes right down to it, why real estate has any value at all. Simply, real estate is a capital asset that generates income from rents. Without that income or potential income (tangible or intangible), real estate would have no inherent value. It so happens that rents generally increase with inflation so the future value of the asset would tend to increase with inflation as well, minus depreciation of course.

The problem with blindly touting real estate as an "inflation hedge" is that the cash flows eventually determine prices. If prices are out of line with cash flows, what fundamentally justifies prices increasing with inflation? Often it is taken on blind faith that real estate prices increase with inflation as a law but prices are dependent upon the cash flows -- prices do not rise in and of themselves without cash flows rising as well. Unless there is speculation.

In a speculative bubble, where yields from cash flows are poor compared to other similar investments, it is not true that prices generally appreciate with inflation. In such an environment the balance of probabilities will have prices trail inflation at least until the underlying income streams are competitive again. You would be better off investing in real return bonds or perhaps some of the countless other investments whose income streams track inflation as well, many of which may well have better risk-adjusted returns than that condo with a 4% cap rate.

Greater Vancouver - Inflation Adjusted House Price Index

As promised a few days back, I've put together a chart which shows quarterly Greater Vancouver benchmarked detached House Prices from 1976 to present. I have also added a simple linear trendline to the chart and the year over year change in real prices.

I really think that we have not seen the end of price decreases yet since this would be the smallest correction on record after the biggest boom on record - that would be unusual.

What do you think?

PS - I'm going away for a bit of a break so jesse and other will hold down the fort for the time being. Warm regards.

Teranet House Price Index for April 2009

JUNE 2009

Downtrend slower in three cities Canadian home prices in April were down 6.7% from a year earlier, according to the Teranet-National Bank National Composite House Price Index™. It was the fifth consecutive 12-month decline. April was also the eighth straight month in which the composite index fell from the month before - the longest run of monthly declines since the beginning of index coverage in February 2000. The composite index is now 8.9% below the peak of last August. Teranet – National Bank National Composite House Price Index™ Contact Us For general enquiries: simon.cote@tres.bnc.ca For licenses covering all index-linked products, please contact: Simon Côté simon.cote@tres.bnc.ca 514 879-5379 Website www.housepriceindex.ca

Of the six constituent city indices, three were down from a year earlier: Vancouver (−10.9%), Calgary (−9.8%) and Toronto (−7.6%). Three cities held out against 12-month deflation, though with marked deceleration of their 12-month rises: Montreal (2.4%), Ottawa (0.6%) and Halifax (0.2%). The 12-month price increase in Halifax was the first since January. Calgary prices have been correcting for well over a year now, since August 2007, and are now down 13.3% from the peak of that month. Calgary has shown monthly declines in 17 of the 20 months posted since then, including the 10 consecutive months from last July through April. Vancouver prices have also shown 10 straight monthly declines and are down 11.9% from peak. Toronto prices have declined eight months in a row and are 11.3% below peak. In Ottawa the downtrend is less pronounced: prices have declined in each of the six months since the October peak and are now down a cumulative 4.8%. Halifax and Montreal prices were up from the previous month in both March and April and are now only 1.7% and 1.4% below their respective peaks. Teranet – National Bank House Price Index™ The historical data of the Teranet – National Bank House Price Index™ is available at www.housepriceindex.ca. Metropolitan area Index level April 2009 % change m/m % change y/y From peak Peak Date Calgary 152.01 -0.6 % -9.8 % -13.3% August 2007 Halifax 119.81 1.4 % 0.2 % -1.7% November 2008 Montreal 120.79 0.2 % 2.4 % -1.4% September 2008 Ottawa 112.53 -0.5 % 0.6 % -4.8% October 2008 Toronto 104.01 -0.6 % -7.6 % -11.3% August 2008 Vancouver 132.67 -0.3 % -10.9 % -11.9% June 2008 National Composite 119.19 -0.4 % -6.7 % -8.9% August 2008 The Teranet–National Bank House Price Index™ is estimated by tracking observed or registered home prices over time using data collected from public land registries. All dwellings that have been sold at least twice are considered in the calculation of the index. This is known as the repeat sales method; a complete description of the method is given at www.housepriceindex.ca The Teranet–National Bank House Price Index™ is an independently developed representation of average home price changes in six metropolitan areas: Ottawa, Toronto, Calgary, Vancouver, Montreal and Halifax. The national composite index is the weighted average of the six metropolitan areas. The weights are based on aggregate value of dwellings as retrieved from the 2006 Statistics Canada Census. According to that census1, the aggregate value of occupied dwellings in the metropolitan areas covered by the indices was $1.168 trillion, or 53% of the Canadian aggregate value of $2.207 trillion. All indices have a base value of 100 in June 2005. For example, an index value of 130 means that home prices have increased 30% since June 2005. By: Marc Pinsonneault Senior Economist Economy & Strategy Team National Bank Financial Group Teranet - National Bank House Price Index™ thanks the author for their special collaboration on this report. 1 Value of Dwelling for the Owner-occupied Non-farm, Non-reserve Private Dwellings of Canada.

Inflation and House Prices

Following up on a conversation in the previous post, I thought it would be interesting to look at the correlation between consumer price inflation and house prices. This chart shows YOY BC CPI and the YOY change in Nominal Benchmarked house prices for Greater Vancouver. Click on the chart to make it bigger.



The correlation between the two series is 0.18 - not strong, but positive. I think we need more data than 15 years to prove conclusively that there is a link between inflation and house prices. The fact of the matter is that inflation has been relatively low for a very long period of time and interest rates have fallen dramatically during this low inflation period. We don't really know what much higher inflation will do to real estate values of the short / medium term but we do know that real estate is a very interest rate sensitive asset since most people use borrowed money to buy real estate. If I look back at high inflation periods in the past (the 70s), house prices were a much smaller multiple of personal incomes than they are today and rates were also much higher than they are today which would indicate that affordability is a combination of the interest rate and the price - duh!

If we expect inflation then we should also expect much higher interest rates eventually to bring the inflation down and this would deflate house prices as current house prices with a 10% or 15% mortgage rate would be out of reach for all but the super rich. As we know, the housing market is fundamentally a supply / demand based market and if there is no demand at a given price the price will fall until the price meets someone's ability to pay.