Monday, February 12, 2007

Real Estate Price Compression

There has been a lot of talk around the bubbleshere about the concept of 'price compression' which is the tendency of prices of real estate in the suburbs to compress up to the price level in urban areas. There are a few good analysis pieces on this phenomenon that I have read. The best of these articles is from iTulip.

I have now put together a cursory analysis on this topic by comparing the median detached benchmark prices in the Greater Vancouver area (urban) with the median detached benchmark prices in the Fraser Valley (suburban) from January 2005 to present.

What this limited data tells me is that the price compression phenomenon does occur and has occured substantially in the Greater Vancouver and Fraser Valley real estate markets over the past two years. The data is not perfect but I would expect that a higher volume of data would tell a similar story to what we seem to observe anecdotally. That is, potential home purchasers are rational in that the seek value for dollar spent on a home purchase and what $500,000 can buy in Langley is a far cry from what $500,000 can purchase in Van West. People seem to be willing to commute long distances to get more house for their dollar thus driving demand and prices up in the suburbs.

As affordability has worsened in the urban areas people sought out cheaper housing in the suburbs and drove up prices in the suburbs more than prices were driven up in the urban areas. In early 2005 you could hypothetically have traded your GV benchmark detached home for 1.6 simlar Fraser Valley properties. Now, in 2007, you would only get 1.4 FV detached properties in the same exchange.


Apparently price compression is not a purely geographical affair but also a housing type compression. This leads me to believe that as detached prices move out of affordability for people they choose the next best option and move down the housing food chain to attached dwellings or apartments. This chart demonstrates that change in the Greater Vancouver area over the past 6 years. Apartments have gained proportionally more in price versus detached housing types.

I think this is pretty profound stuff here. What are your thoughts?


dingus said...

It's almost like the inverse of marginal utility, isn't it. As you break past the compression stratum, you actually get much more value for your additional dollar.

I remember a few years ago strolling around the mansions of that bit of point grey between 4th and the beach. At the time a nice Kits character home was, say, a million. The homes we were looking at were around 2 million. Much bigger lots, bigger swankier places, premier neighbourhood, right off the beach etc. If you could swing it, the value was there. Of course, people who rely primarily on employment income couldn't swing it, so the prices were really a function of a limited pool of demand.

At some point marginal utility kicks in -- not sure the 10 million dollar places were 5 times as good as the 2 million dollar places.

(If only I had a million more dollars!)

Freako said...

Brilliant work. I have thought about crunching similar numbers, who needs to when you got Mohican? Since you are on a roll, how about SFH versus apartment? I consider compression as tangible "proof" of overexuberance

Price compression will necessarily occur. A working slog in East Vancouver may have no qualms about living on KD and sticking 62% of pre-tax income into an SFH. However, a Westside senior partner in a lawfirm will think twice about sinking $620K of his hard earned million into housing. Soon enoug, the relative valuation between housing breaks down. Which is obviously a market anamoly, because relative pricing exists for a reason, namely tangible quality differences.

Freako said...

You might get more telling ratios if you look at specific sub markets, such as Vanwest versus Vaneast. Within FV and GV aggregate there are a lot of similar areas which mask some of the compression. Still, you clearly found a relationship. Again, for apples to apples, SFH versus townhome versus apartment for the same area would be interesting.

Dignan said...

As well a detatched vs. attached graph would be quite telling as well. Attached prices have been moving closer and closer to detached because it's the only step up people moving from condos can afford now.

mohican said...

I ran the numbers for FV Detached versus FV Apartments and FV Attached and I did not find any evidence of compression from 2005 to 2007. That is as far back as I have data.

This would lead me to believe compression is a purely geographical affair or that I need more data.

I feel like Johnny Number 5 here - MORE INPUT!

mohican said...

Okay, I got more data and my first judgement was wrong. The compression phenomenon is also a housing type price compression. At least that is what the Greater Vancouver data tells me.

Freako said...

"Okay, I got more data and my first judgement was wrong. The compression phenomenon is also a housing type price compression. "

And that is a double whammy, as in normal times (efficient market), one would expect apartments to gain less (depreciation, less risk). Apartments are normally a slow, reasonable safe, plodding of investment. Now it is apparently a vehicle for speculation. That will not end well.

Joel said...


Condomania in the burbs

Now that the condominium craze has changed the Vancouver landscape and used up virtually all available space, condo fever is sweeping the suburbs and it's there we're finding the biggest percentage increases in condo prices.

Condo benchmark price, % change January to January:

New Westminster: +24.8
M. Ridge/P. Meadows: +21.5
Port Coquitlam: +18.8
North Vancouver: +17.6
Richmond: +17.5
Coquitlam: +17.3
Burnaby: +15.5
West Vancouver: +14.7
Vancouver East: +14.3
Vancouver West: +12.7
Port Moody: +10.6
South Delta: +6.7


Interesting, I think VHB noted that SFHs are down 1% yoy in New West.

solipsist said...

Great work mohican. Your graphs speak volumes. I posted on that yesterday, before I had a chance to visit here. I was about 7 hours behind you.

As I have watched condo prices approach the prices of SFH (and in many cases, surpass), it has made me more and more dismissive about the "shortage of buildable land" argument. As I mentioned at a few days ago, it will be 100 years or more before Vancouver becomes a city of high-rises a la Hong Kong. I don't think anybody has any intention of turning Kitsilano, or Marpole, or Renfrew into a new Yaletown anytime soon, so in my mind, future density is a very small part of the price phenomenon at present.

What remains, in my view, is marketing. Specifically, the selling of life style. That's what drove droves of drones down to skid row to buy The "W". I hope that when they top that mess with the W again, they add TF? to it.

Hmm. I just gave myself a photoshop idea...

solipsist said...

Dang - I just did a Randomblabber html. Chinga!

the pope said...

Great post mohican, there's definately compression showing up all over: The benchmark SFH has lost more value over the last five months than condos or townhomes, and condos in more expensive areas have dropped in value since september while those in lower priced areas have seen their prices go up over the same time period. The one that astounded me is Westvan with a benchmark price drop of more than $50k! Thats a decent car.

It would be interesting to see the compression effect graphed over a long term and how they looked in the eighties and nineties.

Freako said...

"It would be interesting to see the compression effect graphed over a long term and how they looked in the eighties and nineties. "

My guess is that compression charts would be a fairly good predictor of future price movements, especially in the extremes. Of course, we could just use affordability, but then people may argue that the market is forward looking with regards to future growth. But when it comes to compression, there is absolutely no valid reason why relative pricing should break down. If the future is rosy (population growth), SFH would have the most to gain, so I would expect "decompression".

scoop said...

A recent post from Aussie poster "riptide" on RET shows what future decompression might look like:

Here in several Aussie markets & the Sydney market in particular we now have a 2 tier market. Essentially the better located wealthier suburbs are experiencing solid price gains whilst the mortgage belt suburbs are suffering large price drops & a record number of bank foreclosures.

rentah said...

Thanks for the data and the charts, mohican, and for all the discussion, folks.

freako said:
If the future is rosy (population growth), SFH would have the most to gain, so I would expect "decompression".

We've discussed how we ultimately expect similar % pullbacks across geography and price strata, when the pullback plays out.
But will the 'shapes' of the pullbacks differ across geography and price strata?
Do we expect "decompression" on the way down?

Pondering said...

I would expect price decompression. As shown on another blog there are many examples of prices of Houses in East Van approaching those in Van West. As the prices drop people who can afford it will be more likely to jump back in at a smaller percentage drop as they will see value in the Van West house long before the East Van one.

Deliverator said...

Freako, Master of All Things Oil, said:

But when it comes to compression, there is absolutely no valid reason why relative pricing should break down.

Could the quality of new apartments have some bearing on this? Most condos built in the '80s and '90s didn't have high-end appliances, granite countertops, sophisticated electronic security, etc. I'm not saying it can account for all of the price compression, but it's something to think about.