Monday, July 02, 2007

CMHC Starts and Completions

In real estate, like all other industries, it's all about supply and demand. Demand for products can be created through marketing or because of a need (food, clothing, shelter). What makes someone spend their resources on an item is a basic question of whether its available and if the price is suitable for their situation. Obviously, we live in a real world with limited resources and we must make individual choices about the items we need (food) and the items we want (concert tickets). We tend to base those choices on the perceived benefit that an item will give us and the cost of that item - is it reasonable given the benefit I expect to receive.

On the supply side, a manufacturer of an item will typically make as many items as he can get away with selling at a profitable price. As prices rise, assuming his costs are the same, his motivation is to manufacter even more items to sell them at even higher profits. If he perceives demand to be strong and that there are willing buyers at ever higher prices, then he will continue manufacturing the item in ever increasing quantities and prices. This usually results in all current demand being used up and then the manufacturer must focus on creating demand for his product through creative marketing and by affecting the conditions in which his item can be used. Sometimes this results in a paradigm shift in social perception or some totally new use for a product never imagined before (think computers before and after the advent of the internet). Sometimes it ends badly for the manufacturer as he creates too many items than can possibly be sold with any level of demand and he is motivated to either sit on a large quantity of items or sell them at whatever price he can get.

Throughout history, there have been many situations where manufacturers make too many items, perceiving demand to be higher than is actually is, and there ends up being a glut on the market. This glut is fantastic for potential buyers, many of whom were priced out of the market for the item as prices rose faster than they could save for the item. The glut is horrible for those who bought the item at a much higher price. They are often left bitter and resentful of the new buyers buying the item at a much lower price.





So, the question for today is, will there be a housing supply glut in the Vancouver area in the next couple years? If I were a housing manufacturer in Vancouver, I would be eager to sell as many of my items as possible at today's prices given the profit involved. Why not manufacture more if the demand seems to be there?

23 comments:

HADENOUGH said...
This comment has been removed by the author.
HADENOUGH said...

In Victoria there is clearly over-building. Apparently now there is enough construction to keep builders employed for the next 7 years (if it continues).

There is a real "Build and they will come" attitude here. It is of course geared towards Albertans who apparently ALL want to live in Victoria.

aetakeo said...

Do not, hadenough. They all want to buy teensy tiny rooms in Yaletown. ;)

rentah said...

I believe that the builders are no better than timing that market than any other participants, and that 95% of them inevitably get caught high and dry at the end of any bull run.
This was borne out for me by a conversation I had with an independent developer involved in buying knock-downs and building SFHs on the westside.
I asked him if he'd 'taken profits' on the run up, and his reply was "You can't do that".
He was using the proceeds of his 'flips' for (1) living expenses, and (2) capital to roll into the next deal.
This, despite admitting to having been stung badly in past downswings.
So I think we're guaranteed a glut of product once this turns down.

freako said...

"Throughout history, there have been many situations where manufacturers make too many items, perceiving demand to be higher than is actually is, and there ends up being a glut on the market. "

I'd say more common than not due to the CYOA fear of political accountability in hiearchies of corporations.

As an example:

The market is hot, and manufacturers increase capacity. All except one, whose CEO suspects overproduction.

Outcome #1:
The CEO was right, and makes good mint and his stock rises. The other CEOs explain to the board that the demand just evaporated, and nobody could have known. They are given a scolding, and stay in their jobs.

Outcome #2:
The cautious CEO was wrong and demand remains strong. What was he thinking? Everybody else was producing full out. His ass gets sh*tcanned..

Look at the payoffs. Absolutely no incentive to anticipate the end of the good run.

freako said...

"I believe that the builders are no better than timing that market than any other participants, and that 95% of them inevitably get caught high and dry at the end of any bull run."

I don't know what goes on inside the builder CEO's brains, but based on the comments (must be taken with a grain of salt), and more importantly their actions, I agree with Rentah. Just look at the land options they are walking away from.

I think the builder CEO's are homegrown testosterone filled alpha males. Think builder who goes to executive business school rather than an MBA who gets into the building business. Surely they hire forecasters with multiple degrees, but not sure how much sway they hold.

For some reason, the builders miss what so many on this blog know: That

1. If you build at record levels when population growth is mediocre, prices are on borrowed time.

2.Not all demand is equal. Speculative demand is different from physical demand and can be very fickle.

3. Just as we can have "pent up" demand, we can have "pent up" supply.

4. Forecasting based on pure extrapolation is like weather. Accurate next month, and probably the month thereafter, but meaningless a year out.

rentah said...

freako, your CEO outcome #1 and #2 is exactly the same scenario that causes players in other industries to also follow the pack, most notably managers in the mutual fund industry.
So much risk to career if making contrarian calls; every reason to follow the other lemmings wherever they're headed.
Thus, the industry selects for 'lemmingness'.

Dave said...

Well, obviously this market has gone on a lot longer than most here expected. So those builders who continued to build have done better than those who got out early. At least so far.

Since it's impossible to predict the top of the market it makes a kind of sense to take advantage of the irrationality for as long as it runs.

Who knows, maybe this bubble has a couple of years left in it. I hope not, but I wouldn't assume it's done yet.

cat said...

Both hadenough and aetakeo are wrong about where the the Albertans want to live... Everybody "knows" they want to live in the Okanagagn!! the building around here in Penticton is absolutely spell binding!!much less Kelowna or Vernon ..WTF!?? I just hope this stupid bubble bursts before the Water use (only so much drinking water ..WE're in a Dessert for goodness sake!!)and Garbage dump issues come to a head..Picker shaks should not cost $350 000

patriotz said...

Naw, you guys are all wrong! They want to live in the Kootenays. Especially Kimberley, where a "ski condo" will cost you twice the price of a SFH (I kid you not).

Yes I know location matters, but Kimberley is just a small town. Everything's close to the ski hill.

HADENOUGH said...

I would like to know how many out-of-towners are actually buying BC property. Are they really keeping prices up?

Swirlyman said...

What with the new promotion of "mixed mortgages", perhaps we should start referring to "MFH" (multiple family home) instead of SFH...

cat said...

The out of town myth seems to be everywhere.. on 'housing panic' they talk about out of country buyers inflating Englands prices.. So when one of these out of town/country buyers stop buying it will trickle down to ALL our small towns.. Don't ya think??

Paly said...

This discussion is a simple one. When people see profits being made in an area, there is an incentive to invest and try to achieve the economic rents.
This can be seen in the RE market over and over again. The number of RE agents in the GVA has increased substantially in the last 6 years (according to Chipman's blog). I believe the number of registered agents has nearly tripled. This means the more competition and fewer profits per agent (on average).
People are getting into the market because they perceive debt as cheap. When the current market is returning double digit returns, and the carrying cost is in single digits, it is a no brainer. You put 25% equity up, carry the cost for one year and sell at a profit. However, as more people see this, they also get into the market because they do not question the rationale or investigate the potential for loss.
Add to this the increasing ability to attain debt cheaper and longer along with favourable terms, and it allows more people into the market. 0% down, 30 or 35 year mortgages, with insurance from CMHC! How can I lose?
Anyone who studies economics knows that the future is uncertain. If you ask an expert for their prediction, they have a 1 in 10 chance of being correct. If you study human behaviour, you realize that people repeat the same mistakes over and over. By studying this, you're prediction accuracy is about 30% correct. That is, people, as a group, are dumb and will repeat the same errors again and again. Look at the 30 years of history of Vancouver RE. Do you notice that there are cycles where prices accelerate quickly for a period and then suddenly drop when all the profits are made??

mohican said...

good comments here. regarding population numbers, have a look at the June 7th post for some BC and Vancouver population statistics.

WoodenHorse said...

hadenough:
http://tinyurl.com/s239p

"Based on data compiled by Landcor, a B.C. real estate research firm, Albertans accounted for just 2.4 per cent of the $48.5-billion worth of residential real estate sold in B.C. last year, and just 2.6 per cent of the total number of units sold."

Last year is 2005 in the above

HADENOUGH said...

Thanks woodenhorse!

That is not much! Certainly not enough to keep prices up the way my RE agent thinks.

This is his reason for high prices in Victoria.

WoodenHorse said...

not a problem.

wrt "not enough to keep prices up the way my RE agent thinks" note the line in the artile I quote.

Albertans accounted for just 2.4 per cent of the $48.5-billion worth of residential real estate sold in B.C. last year, and just 2.6 per cent of the total number of units sold.

So the Albertans account for a higher percetage of the units sold than they account for the percentage of dollars. That indicates to me that they aren't buying the most expensive places.

freako said...

"Naw, you guys are all wrong! They want to live in the Kootenays. Especially Kimberley, where a "ski condo" will cost you twice the price of a SFH (I kid you not).

Yes I know location matters, but Kimberley is just a small town. Everything's close to the ski hill.
"

Honestly, I think I'd take the condo over the SFH. From what I recall, the old mining abodes that masquerade as SFH are not all that.

Second, off in the sticks, most of the value sits in the building, not the land. A newerish and luxurous (granite countertops yada yada) may have more structural value than a beat up SFH.

Finally, I wouldn't doubt that rents would be in similar proportion, which would suggest that the relative prices are fair.

Of course, I wouldn't buy either at this point in time.

freako said...

"Anyone who studies economics knows that the future is uncertain. "

True enough, but in your well reasoned argument, you should also add that there has been little change in fundamentals (rents), and thus it is just a pyramid game based on empty price extrapolation. In that sense, the future is certain: This game will end, and not in a good way.

freako said...

"So the Albertans account for a higher percetage of the units sold than they account for the percentage of dollars. That indicates to me that they aren't buying the most expensive places. "

Well, to me it indicates that they are buying outside of the Lower Mainland. It could well be that they they are buying the most expensive places in the non-Vancouver market.

WoodenHorse said...

Freako: good point, you've got me there.

Alpha_Bear said...

An acquaintance of mine is currently renting an older house on Kalamalka Lake, near Vernon. The Albertan owners recently purchased the property, and are renting it out until they retire in a few years, at which time they plan to tear down the existing house and build their dream house.

Properties in the area sell for around $1.5 million to $2.5 million. My acquaintance's rent is $1300 per month, and he's been living there (so far) for 2 or 3 years. This must be some kind of record for a price/rent multiple. Did I mention that it's lakefront?

There are anecdotal reports of Albertans buying many properties in the North Okanagan, in fact I sold my house to an Albertan couple last year. My observation is that many of the homes purchased by Albertans are second homes or recreational properties, which are purchased as "investments" and which are frequently rented out.

Currently, the story here is that the Okanagan has been "discovered", and that everybody wants to move here. I've heard the same story several times in the more than 40 years that I've lived here, and I've seen the market crash spectacularly several times. I expect this time to be different only in the magnitude of the "correction". I expect to see the worst real estate crash ever.

When the market changes, these second homes will probably be the first to be put on the market.