Saturday, March 17, 2007

House Prices Always Rise (over the long term)

As a follow-up to Mohican's post from March 10, here are some files I've been working on recently.

I've tracked 3 sample properties-- a Vancouver westside bungalow (what I'd like to move up to), a Vancouver westside townhouse (what I currently own, bought during the lull in 2004), and a Richmond bungalow (my father-in-law lives in one). My interest in developing these charts was to discover how prices rise over time-- it seemed expensive when I bought my place, but not outrageous. Prices have, of course, risen since then.


First chart: a westside bungalow over 30 years. The mean curve rises at roughly 1.5x the rate of inflation. Note the thin dashed line-- that shows the property price as though it was rising at the mortgage rate. Prices have, over 30 years, never sustainably rised at the mortgage rate. Note that this house left the mean in 2003.



Second chart: a westside townhouse over 20-some years. The mean curve also rises at roughly 1.5x the rate of inflation. This property left the mean shortly after the Vancouver bungalow.




Third chart: a Richmond bungalow over 30 years. Interestingly, prices only rise at the rate of inflation here. Perhaps the lower "mean" line is due to the "desirability" of the westside? This property didn't leave the mean until 2005!




Fourth Chart: all three properties, all together. 5-year mortgage rates and inflation rates are also overlaid onto the chart. (I couldn't figure out how to get Excel to have a second scale for the percentages, so I had to wildly scale them up).



Observations:
-Westside properties tracked up at 1.5x inflation.
-Richmond property tracked up at 1.0x inflation.
-Long-term, prices tend to rise at *less* than mortgage rates, making housing a poor speculative investment.
-During booms, housing is probably a great speculative investment!
-Neither the Richmond bungalow nor the westside townhouse benefitted much from the Hong Kong migration-- perhaps those investors were looking for land with a better investment value?

With all three sample properties, it'll take 15 years for any of the means to catch up to current property values! (unless selling prices drop or inflation goes up)

I'm willing to bet that the three sample properties have a 20-33% (nominal) drop in store over the next five years. However, until housing starts fall off a cliff (which will happen maybe a year after prices go flat-- perhaps early 2008?), and until much of the Olympic contruction is finished (~2009), I don't think we'll see significant drops.

Right now, our local economy is artificially-supported by government spending projects (Olympics) and speculator-sponsored condo development. Once the Olympic construction is done, the government will have finished building an amazing amount of infrastructure, and they (the government and us taxpayers) won't be keen on more deficit-spending to build more infrastructure-- hwy 99, Olympic venues, Athlete's Village, the new Convention Centre, RAV, Green Line (Coquitlam light rail, I think), Port Mann's twin, the Golden Ears bridge (I can't remember its name-- the one that goes from Maple Ridge to Port Kells)...

All those projects ending at the same time. How many construction-related workers moved to Vancouver for those projects? How many of them bought houses or condos? How many bought a handful of presale condos because prices always go up? How many of them will sell their places once the government freezes new infrastructure development after the Olympics?

Note: these charts use Royal LePage pricing data up to Sept 2006, and inflation/mortgage rate data from Sauder. Where data was not available, it was interpolated or omitted.

33 comments:

mk-kids said...

This is an excellent post! A nice change to the drivel I was reading on Chipman's & Pope's blogs (not their posts but the comments... jeesh) Thanks Mohican, I love the graphs. It is interesting to see the variation from the mean, the dramatic upsurge in 2003 prices for VW. I agree that at least a 30% correction is in order.

mohican said...

I gotta give credit to our new contributor for this extensive analysis. I wish I could claim credit for it!

mohican said...

Reversion to the mean is a powerful concept when looking at asset prices and I think M- has done a great job at illustrating why we are due for the correction we have been looking for.

Jesse said...

Thank-you m- and mohican for this drill. 3 comments:

For true "investment" comparison you should include rental yield and carrying costs, not just cap gains.

If Van West prices continue to rise at 1.5X inflation, is this sustainable? What would have to happen to incomes?

I want to clarify the language a bit. When you say "a westside bungalow" do you mean you tracked a single bungalow over this period or is this an average? It makes a difference when comparing these results to something like the Shiller graph

Freako said...

Nice work. BTW, I also got stumped when I couldn't figure out how to graph multiple overlapping variables.

"Long-term, prices tend to rise at *less* than mortgage rates, making housing a poor speculative investment."

You do need to take rents into account. And that makes all the difference.

I don't think we can gleem useful data from the last 5 years, so graphing a long trendline for three different areas/property types is very enlightening.

From a market efficiency perspective, one would expect the riskiest investment to appreciate the most in the long run. We would also expect SFH to appreciate the most because of the lower density and lower cash flow.

But 50% faster growth rate, that is hard to reconcile over a 30 year time span.

Freako said...

Actually, if we to take into account the rental income and compound it forward for each property type, it could well be that it accounts for a large portion of appreciation differentional. The Richmond property would obviously have much better yield.

bakakuse said...

Awesome graphs and post.

I especially like the reference to infrastructure being way ahead of the city itself. Vancouver wants to be a big city, it just isn't.

Patience is a virtue, but well worthwile in times like these.

manafromheaven said...

Anybody naive enough to think that we will not be affected by the looming devastation in the US reminds me of a recent comment on ROBTV:

One observer wondered why the price of gold was getting hammered along with stocks in response to the Chinese market and the subprime mortgage thing, when (based on fundamentals) it should have done the exact opposite ..
...only to be told that people were selling because they can.

rentah said...

Thanks for the work, M, and the post, mohican.
M, when you get a chance, please address jesse's question re language. Is this an average?

Warren said...

bakakuse said:
I especially like the reference to infrastructure being way ahead of the city itself. Vancouver wants to be a big city, it just isn't.

I'm not sure if I'd go that far. A lot of people who come from other cities can't believe the apparent lack of transportation infrastructure in the GVRD.

That being said, I think that goes a long ways towards making the city great. IE: lack of giant highways running all over, creating wastelands and ghettos around them.

M- said...

Thanks for the comments, everybody.

Jesse: As for rental yield, judging by Sauder data, rental yields have risen at less than the rate of inflation. From what I remember offhand while collecting the Royal LePage data for these charts, for a VW Bungalow, rents started around $700-800 in the '70s, was in the $2,000 range in the late '80s, and up close to $3,000 these last couple of years.

Recently on Canaca.com Renting, I saw two VW houses-- one near Langara, assessed at $650K, renting for $2,150, and one near Shaughnessy assessed at $1.2M, renting for $3,500.

Language clarification: it's a Royal LePage "index" value-- ie, realistic selling prices for a "typical" VW Bungalow. Prices on my charts are not adjusted for inflation, whereas Shillers are.

M- said...

Freako: yes, ultimately for investment purposes, a house should be cashflow-positive as a rental.

If looked at from a speculative angle only, it's a poor investment. For example, my relatives have strongly encouraged me to buy the biggest, most expensive place the bank will lend me money for.

In my case, if I compare my "reasonably-priced" townhouse (which gives me and my wife plenty of space to live in) to a more-expensive, larger townhouse (same number of rooms, but all the rooms are a bit bigger), and the place would cost 1.5x as much money, that would be a poor speculative investment. I would have a little more space, but I'd have to hold twice the mortgage for it, and I'd never recover those extra mortgage payments back out of my larger townhouse when I sell it.

I agree about the difficult-to-interpret data over the last 5 years-- "composite" pricing for Greater Vancouver is definitely not clear to interpret.

Van West has historical reasons for it carrying higher values-- False Creek used to be pollution-central. Fresh air coming off the ocean blows the industrial smoke from the West to the East, leading to pollution in East Van. Wealthier people purchased houses on the west side to live in, and landlords owned rental houses on the east side that they rented to blue-collar workers. That said, back in the '70s, there was a minimal difference between west and east.

My own experience the last few years-- I used to rent a house up near Fraser and 49th (4-bedrooms, rent $1300+utils, assessed at $450K), and the summer weather was always a few degrees hotter than my parents' house in Kitsilano. The residents there also threw a lot more garbage on the ground there.

For what it's worth, my current 2-bed 800-sq.ft. townhouse is assessed at about $360K. Judging from recent sales in my building, it's worth ~$425-445K. Realistically, it would probably rent for $1600/month. On that, it's probably a better rental investment than my old rental place on Fraser St.

Freako said...

"As for rental yield, judging by Sauder data, rental yields have risen at less than the rate of inflation."

Indeed it has. I compounded the Sauder rental data and compared it to inflation for the entire data set. I don't have exact number handy, but real rents dropped 35% over the 35 odd years.

"yes, ultimately for investment purposes, a house should be cashflow-positive as a rental."

Actually, that is not what I meant. I just meant that comparing appreciation to mortgage rates only gives you part of the picture. You need the total return, which includes rental income (net of expenses). Coming at it from a finance perspective, I see no problem with negative cash flow per se. If an area is expected to densify, present cashflow is mostly meaningless, just as present earnings are for an unproven growth stock.

Again, great work, it is nice to see an attempt at apples to apples for such a long time series. Sometimes the finer points get lost in the aggregate numbers, as you point out with regards to "composite pricing"

"Van West has historical reasons for it carrying higher values--"

The historical high valuations would have been awarded early in the game. It is a one time shot in that respect. Unless the market has done a lousy job at looking forward, investments returns should be fairly equal once risk adjusted. I don't think they are too far off.

patriotz said...

Van West has historical reasons for it carrying higher values

There's a more basic reason. Everything west of Cambie and south of 16th was a separate municipality, Point Grey, which was one of Western Canada's original tony suburbs (the other being Oak Bay). It had the first zoning laws in the province.

In tandem with this the CPR held the bulk of the property and master planned it to maximize property values.

Properties in Point Grey also had covenants preventing undesirable people such as Asians from living there.

People on the right like to complain about "social engineering" but in fact it was the right who invented it.

Jesse said...

"The historical high valuations would have been awarded early in the game. It is a one time shot in that respect."

This does not explain the 1.5X versus 1.0X inflation. Increasing income gaps would, however.

A point on the Shiller graph. What makes it pertinent is it compares same property prices and removes new supply that can shift average prices higher. That said, Van West bungalows are mostly old stock, assumedly replaced by 2-storey units over time.

Jesse said...

"our local economy is artificially-supported by government spending projects"

A quick comment: you are seemingly biased towards claiming government projects create "artificial" economic activity. Please be careful with inferences when presenting analytical treatises.

M- said...

Jesse: Interesting, I did not know that the Shiller graph looked at the same properties.

As far as government projects go, I'm actually a government employee. Or at least, I'm close to one, being that my company is a subsidiary of a private government corporation, or something like that.

There's a normal amount of government infrastructure development, and then there's the recent level of infrastructure development.

My parent corporation is currently spending money like there's no tomorrow. The folks I keep in touch with, and the grapeving, would seem to suggest that there is no tomorrow-- right now, government money is easy, so they're replacing our old infrastructure as much as possible.

They weren't able to do this until 2-3 years ago, and they believe the easy government money will dry up after 2010, much as it did after 2001 (for our company).

That said, you're right-- it's grapevine-rumours that certainly are not actual data.

rentah said...

M: I'm willing to bet that the three sample properties have a 20-33% (nominal) drop in store over the next five years. However, until housing starts fall off a cliff (which will happen maybe a year after prices go flat-- perhaps early 2008?), and until much of the Olympic contruction is finished (~2009), I don't think we'll see significant drops.

I believe we'll see 40-50% drop, in anything from 2-7 years.
I don't think it's necessary for Olympic construction to finish before the price drops occur.

Although RE prices aren't exactly like stock prices in discounting the future, there is a component of that to the pricing. People are anticipating future developments: the Olympics, future escalating prices, Asian economic strength, 'running out of land', etc.
So, one could argue that Olympic related development is at least partly (and perhaps even totally) priced into current values.

Further, the direct economic effect of the Olympic construction is less than the effects of the housing ATM (as per our discussion on mohican's blog a week or two back). So flat prices will immediately result in a shrinking of spending that outweighs any direct stimulus from the Olympic activity.

machoslob said...

With this bubble being worse than anything we've seen in the past, I would not expect the selloff to be any less dramatic than in 81, 90, and 95, which saw most of the damage happen within a year, and then stay flat for a much longer time.

Freako said...

"This does not explain the 1.5X versus 1.0X inflation. Increasing income gaps would, however."

Sorry, I thought I explained that earlier.

The yield on the Richmond property would have been higher. If you reinvested the differential for the entire time series and carried it forward, I betcha it would close much of the gap. The risk could be attributed to compensation for risk.

"ThiJesse: Interesting, I did not know that the Shiller graph looked at the same properties"

If it does, I'd be very interested in hearing the methodology. I have long been a critic of the Shiller graph as I feel it grossly understates RE appreciation.

Rentah, Machoslob: Yes, this bubble is something else. It is global in nature, and our city got a double dose of speculative fever with the Olympics as well as Yaletown being the showcase city for downtown condos. It is very very pervasive. I don't think a bubble of any kind, from tulips to dotcom has sucked in so many people for so much money. Some of these people went in kicking and screaming (they really needed a home, or just lost their nerve). Others jumped in both feet. The industry (builder/realtors/lenders/CMHC) don't seem to have a clue what they are dealing with. Everybody seems to be operating on old assumptions which work great in normal times. This is not your fathers RE boom. Though it may be your grandfather's if he/she lived during roaring 20's.

Remember that Simpsons where Homer went to the get rich quick seminar and everybody was appeased when they learned that it was a trapezoid and not a pyramid. Feels a little like that. The old RE cliches (that really shouldn't be applied) are being used to defy common sense. Shame, I say, on those who should know better but insist on priming the pump.

mohican said...

RE: Shiller graph methadology

"The monthly S&P/Case-Shiller Home Price Indices use the “repeat sales method” of
index calculation – an approach that is widely recognized as the premier methodology for
indexing housing prices – which uses data on properties that have sold at least twice, in
order to capture the true appreciated value of each specific sales unit."

More details here: http://tinyurl.com/3dnffj

Jesse said...

"Sorry, I thought I explained that earlier."

Sorry: I was talking past you without understanding your point. My point, somewhat different from yours, was to look forward at 1.5X inflation continuing unabated and understand if it is sustainable.

Your method of looking at rental yields is a good one. It is certainly worth someone's time to really understand what you are saying.

Freako said...

"My point, somewhat different from yours, was to look forward at 1.5X inflation continuing unabated and understand if it is sustainable."

Now I got you. How can house prices outpace inflation? First of all, rising real incomes, as you mention. But also densification (or potential to densify). Densification increases the productivity of land (you can collect more rent for a given amount of land). Now, alot of the Westside has not densified, nor does it look like it will be zoned to happen anytime soon, so that throws a monkey wrench into my theory. However, zoning really is meaningless in the long run. Take a look at now and then photos of Vancouver and you will see what I mean. And some West Side corridors ARE getting condos.

Freako said...
This comment has been removed by the author.
Freako said...
This comment has been removed by the author.
Jesse said...

"Densification increases the productivity of land"

This is true. We have talked before about how the densification factor. The concept is that real land value rises at the population growth rate if land supply is fixed, as long as densification can happen. From that point of view I would have thought an area that can densify quickly due to fewer zoning restrictions would have a premium due to time-cost of money.

Freako said...

"The concept is that real land value rises at the population growth rate if land supply is fixed, as long as densification can happen."

If market efficiency holds, the land would rise NOW based on EXPECTED population growth rate, discounted for risk and time value of money. Markets are (or at least ought to be) forward looking, so it is really hard to find direct correlation between population increase and prices. Contained in prices is an implicit assumption about future rents (which is also an assumption about density, which in turn is an assumption about population growth).

Let's just say that there is a lot of growth priced into todays prices. Enough for a negative risk premium, me thinks.

" From that point of view I would have thought an area that can densify quickly due to fewer zoning restrictions would have a premium due to time-cost of money"

One thing I learned in school (which I thought was kinda useful) was the speculative aspect of UNDER utilizing land. Why where there dozens and dozens of Impark lots all over downtown? How could a $500 of daily parking fees compete with several hundred units of housing? Obviously the land is vacant and Impark is just renting it meanwhile. So why is it vacant? The owner is speculating. On what? When you build, you commit that land. If some of those Impark lots had been built 15 years ago with say 15 story buildings, the builder would have been kicking himself, because if he had waited he could have built 40 stories. That difference makes up for the foregone cash flow. In theory at least.

The moral: Don't underestimate the value of under utilized land in a growing metropolitan area.

M- said...

Just a note as far as the densification theory goes-- westside townhouses have also risen at 1.5X inflation-- not just westside bungalows.

So land that has already densified (and is not subject to further densification) was increasing in value at the same 1.5X inflation rate.

Jesse said...

"...it is really hard to find direct correlation between population increase and prices"

There has been some research on the subject (I think Philly did a study a few years back) but nothing that closes the debate. I can only draw common sense conclusions based upon having more people in a fixed area increasing unit land costs, other things (e.g. incomes) equal.

I think we agree cap rates are low historically and we can leave it at that.

"the builder would have been kicking himself"

The builder would also be close to death! :) How long do you hold on to vacant land before you sell? By your argument it is always better to wait. Maybe that is the right decision if your horizon is long enough. I still think this effect would be priced in to some degree, with a risk factor of course.

Land without eviction and demo costs will be more valuable to a developer.

m-: townhouses are still relatively low density. I don't think there are very many areas locally where maximum densification has already happened with a long price history to draw comparisons. Westend is close tho.

Freako said...

"Just a note as far as the densification theory goes-- westside townhouses have also risen at 1.5X inflation-- not just westside bungalows. "

The reason is that it is not actual densifification that increases land value, but the POTENTIAL to. Zoning is an obstable, but I think the market generally prices in re-zoning potential.

" I can only draw common sense conclusions based upon having more people in a fixed area increasing unit land costs, other things (e.g. incomes) equal."

There most definitely is a strong correlation. The difficulty is that prices move when the EXPECTATION of density increase occurs, not when it actually does. And when the expectation turns out wrong, prices also adjust. In that noise, it is hard to draw the direct connection. Todays prices contain tomorrow's pop growth. The longer the time horizon, the stronger the relationship. As a parallel, the long run real growth in S&P earnings is around 8%. That is also the long run return of the stocks. Not entirely conincidental.

"The builder would also be close to death! :) How long do you hold on to vacant land before you sell? "

But if we extend your logic about immediate utitlization of vancant land, why parking lots and other underutilized land remain exist at all then? Lazy or irrational owners? And when I say builder, it could just as well be land owner. A developer planning for a 40 story building is willing to pay more for the land than a builder putting up a 15 story. The point is that when you commit a structure to a piece of land, the decision is irreversible. Think of raw land as an option.

"By your argument it is always better to wait. "

Not at all. Remember, I said that the land owner is speculating. He is acting on imperfect information. Sometimes it is the right decision, sometimes it isn't. And of course, it feeds back into prices. If fewer land owners hold it vacant, there is more building now, which increases supply which decreases prices now. On the other hand, in the future, there will be less raw land left on which to put higher density, so future prices will be higher. And vice versa of course. Much like the "consume now versus consume later" decision. Very theoretical, of course, but not totally without relevance.

"Land without eviction and demo costs will be more valuable to a developer."

Yes, from the sunk cost perspective. The guy building a 15 story, will be very averse to knocking it down prematurely. But when we are out of raw land, stuff will get knocked down when the opportunity cost goes above its rental income. Obviously, older and lower density will go first.

Freako said...

"Just a note as far as the densification theory goes-- westside townhouses have also risen at 1.5X inflation-- not just westside bungalows. "

Sorry, misread that. Are those townhomes apples to apples? Obviously townhomes sit on prime land for density potential, so perhaps its relative position improved by an equal amount (the potential of going from townhome to high rise condo).

Yield will give us a clue. If the yield is the same as SFH, then that could be the case. If yield is higher, then Westside townhomes had a higher total return than Westside SFH. Why that would be, I don't know. A market quirk? Westside specific price compression?

vineland said...

Interesting that Richmond was slower to have it's price boom, I thought all nice areas around Vancouve went up equally.

Maybe everything westside goes up because of current and future city planning. There is a video clip on CBC which shows Vancouver as the best biking city around. Its future plans are to be a pedestrian and biking city. Transportation to the burbs (except Richmond) is lame.

The difference between East and West Van as home is huge. I went from living all over the westside during University days to owning on the Eastside. It was great, but a completely different feel than the westside. Not everyone wants to go there.

If Vancouver is not going to have a freeway or more sky train built through it, the west side will become extreamly valueable to some. For example: live in the burbs and be cash positive, time negative OR live on the westside and be cash negative, time positive.

Jesse said...

"Westside specific price compression?"

This is a likely reason. Many people need to own on the westside. The schools, neighbours, perceived safety, whatever. Either buy a townhouse or live in (gasp) East Van.