Tuesday, January 22, 2008

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.

61 comments:

mohican said...

Please link to this post and tell your family and friends about our current situation. It is my hope that someone reading here will avoid making the biggest financial mistake of their life by buying an overpriced asset that is doomed to fall in price with a high leverage loan offered by a bank who has no interest in you making a smart financial decision.

aetakeo said...

Thank you! That's a great one stop resource for newbies.

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

Whoops... What I meant to say was, is the benchmark condo for $377K likely a one bedroom? Does the "benchmark" control or adjust for number of rooms or square footage or other extras (parking, storage, pool, strata fees?)

jesse said...

Thanks for the graphs. A great post to refer friends and relatives to that clearly presents a bearish outlook for Lower Mainland real estate.

jeff said...

Excellent, clear and to the point post! Thank You so much for taking so much of your own time to share this info.

I do have 2 questions. I don't really understand the Vancouver CMA Population chart.
1) What does CMA stand for?
2) I don't understand the yellow "growth" line. Growth of what?

Thanks.

mohican said...

Here is a link explaining the House Price Index.

CMA stands for Census Metropolitan Area.

Growth is referring to population growth in 1000s of persons in the Vancouver CMA.

Siobhan said...

Next question to answer.

Why are speculators keeping their condominiums vacant?

I have heard that recently completed and sold out complexes have some 30 percent of the suites
vacant!

Why are the speculators not renting them?
Is there a tax implication?
Are they keeping them vacant, so that they can do a quick sell?

freako said...

Very nicely laid out case.

What really irks me is that none of the usual suspects ever address these points. Instead we hear the usual rah rah about the Olympics and world class city, or some spiel about strong economy etc etc.

As I pointed out in the other post, there is not a single local high profile (MSM) RE bear.

This is truly nuts.

M- said...

Great post, Mohican!

To add to the downside risks, I would add the following factors:
-Olympic construction employment slows this year, ends next year.
-Worldwide economic concerns.

Jason said...

Freako,
I have noticed in my short career that having a strong opinion that can be perceived as negative, can be detrimental to one's career trajectory. Where I work, at the end of a meeting we have a 'plus/delta' to discuss what went well and what we can do better in the future. It reminds of some Jack Handey Deep Thought, where there are no 'wrong' answers just 'different impressions'.

Can't we all just get along?

Drachen said...

Thanks for the inflation adjusted graph, I've been looking for one of those since VHB went out of business.

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Joel said...

great post!

I would add too that I have actually never heard anyone mention that in the event of any economic slowdown, the net migrants coming here could understandably slow down. Today's mediocre pop growth is just taken for granted.

Clarke said...

Thanks Mohican. Great graph work.

"Please link to this post and tell your family and friends about our current situation."

Uh, yeah, been there, done that. Pretty much everyone I have told not to buy and to wait, has bought anyway. Many of these people now suspect that in my off hours, I wear an aluminum foil hat to keep out the martian mind control rays.....

Arguments based upon prices vs. incomes, prices vs. rents or rents vs. mortgages just do not have the same traction as the ususal inane justifications: RE always goes up, everyone including rich foreigners want to live here, we are running out of land, the Olympics, the economy is strong......

I had the same thing happen during the dot com thing. After all, we were in a new paradigm, where boring things like revenue, earnings and a viable business model were not relevant compared to the boundless growth of the internet based economy.....

To continue repeating myself ad nauseum, the people I have these discussions with are MBAs, CFPs, certified accountants, high level business managers......

fish10 said...

http://fishre.blogspot.com/2008/01/excellent-post_23.html

freako said...

I have noticed in my short career that having a strong opinion that can be perceived as negative, can be detrimental to one's career trajectory.

Well that is exactly what it is. Not necessarily the negative opinion per se, but the ultimate payoffs. Several powerful entities stand to gain from high RE prices, and their "lobbyists" spin to that effect. But what powerful entity stands to gain from lower RE prices? None that I can think of. Rather, the benefits of lower prices are dispersed among many individuals. Too dispersed to form a lobby group, so no voice to counter the professional spin. A knowledgable and educated person speaking out publicaly against the bubble would be doing so on principle, not for personal gain. So far few have stepped up to the plate, none locally that I can think of. The U.S. has Shiller, Roach, and a handful of widely followed bloggers.

aetakeo said...

Thanks for the link, Mohican. I did find that they add features into the benchmark, but didn't find (& maybe I'm not looking in the right places) what those features are for a condo in Greater Vancouver.

And, (okay, I'm cynical), but can we trust MLS to not change that "basket" up? You know, if a bunch of closet-sized condos come online, suddenly the benchmark is 200 sq ft. less but still $100K more?

patriotz said...

And also Krugman and Thornberg. The latter interestingly left the UCLA Anderson Forecast (business school) to start his own firm after he starting issuing bearish forecasts for RE. Did he jump or was he pushed?

Quite frankly I think university business schools have sold out so much that there's no reason to expect them to act as anything other than cheerleaders. You'd might as well complete the process and just let business run them, and not keep spending taxpayers' money on this shilling.

Radley77 said...

Good blog Mohican. It is interesting to see someone else go through almost the same analysis.

By the way, Calgary market is showing signs of cracking, with sales down for January by 30% YoY and January inventory one of the highest in a long time. Sales to new listings ratio is sitting around 30% (worst in many years) and the absorption rate is at 5 months.

Calgary Real Estate Market Blog

patriotz said...

Canadian home market safe as houses: CREA

“The results in 2007 show the strength and the affordability of the Canadian residential market,” said CREA president Ann Bosley.

“The statistics again show just how different the housing markets are in Canada and the United States. Canadian realtors know that Canadian mortgage lenders correctly see that home prices will continue rising.”


The press release was accompanied by a photo of Ms. Bosley riding her pink pony.

Radley77 said...

I think our media in Canada is much poorer at uncovering information about the asset bubble than our American counterparts. Where exactly are our Shiller's and Rubenstein's?

I will be interested in seeing how incoming BoC governor Mark Carney deals with the housing asset bubble.

History has been unkind.

patriotz said...

BoC has no mandate to deal with asset prices per se, which I agree with. It's the business of the capital markets to set correct prices for assets. If people feel like paying ridiculous prices for assets with their own money, the market will deal with them.

However the BoC does have a mandate to ensure the stability of the banking system, and that means preventing the banking system from exposing itself to loans against overpriced assets. I'm not sure whether the BoC itself or some branch of the government is responsible, or ought to be responsible, for such things.

But the real Godzilla is CMHC, which is blithely guaranteeing 100% financing at absurd prices. And who is responsible for this - well the buck stops with Stephen Harper himself. CMHC is not politically independent like the BoC but a policy vehicle for the government. And the CMHC board is stuffed with RE industry honchos who have a vested interest in keeping the juice flowing.

wizardofozziejurock said...

Great work Mohican! With all the blame going around in the U.S. now and outright ridicule of the "experts" who denied a housing bubble, you'd think that the REIC bulls in Vancouver would start trying to cover their asses.

And our politicians are just as complicit as their US counterparts in allowing it to go unchecked.

freako said...

This from Patriotz link:

Canadian realtors know that Canadian mortgage lenders correctly see that home prices will continue rising

What the heck does that mean?


And, (okay, I'm cynical), but can we trust MLS to not change that "basket" up?

I think they would have little to gain and much to lose by monkeying with the statistics. As for your question regarding Sommerville, similar answer. I think he would have little to gain professionally call it as he sees it, and lots to lose.

Quite frankly I think university business schools have sold out so much that there's no reason to expect them to act as anything other than cheerleaders.

Yes, our business schools have been notoriously neutral/mum on the subject. Professors in many other areas tend to outspoken, and even activists, but apparently noboby with credentials is wiling to call a spade a spade.

But the real Godzilla is CMHC, which is blithely guaranteeing 100% financing at absurd prices.

Yes, this is the real culprit. And not only do they insure with abandon, their paid mouthpieces make the same vague booserish statements that industry stooges do. Nothing remotely critical, or remotely acknowledging risks to the downside. And I bet my last dollar that their risk models DO NOT propertly take into account a market wide price correction. In other words, they are treating foreclosure risk as an indpendent factor (such as housefires) instead of systemic (earthquate). Anybody want to venture a guess as to how many billions CMHC would be out if Vancouver CMA prices dropped 40%?

Patiently Waiting said...

"Anybody want to venture a guess as to how many billions CMHC would be out if Vancouver CMA prices dropped 40%?"

Hmmm, I could only begin to guess. But what I do know is there would be a political firestorm in Ottawa. Possibly the end of the CHMC as we know it.

Patiently Waiting said...

This post is the best thing I've seen since VHB. I have a couple of young co-workers who are considering buying (I've convinced one to wait, and I doubt the other will get it together to follow through) and I'll send them this link.

I'd love to hear what people here have to say about reverse mortgages. That "wouldn't it be nice" commercial gives me the creeps. I guess - like with other questionable mortgage products - they might be useful for certain people in certain situations. But as a general rule, are they a good thing? How will/can the lender react to a sudden decline in housing values?

Radley77 said...

For awhile now I have heard that "Canadian banks did not take the same risks as American banks." If this was true, then Canadian banks like CIBC would have done better risk analysis of their subprime ABCP.

Another scary example, is the crown corporation Alberta Treasury Bank which recently asked for a $800 million loan from Alberta Finance to cover their exposure.

ATB ABCP Q&A

Why has the media not been talking about this story? Doesn't the 6.9% writedown seem a bit optimistic? And shouldn't the Albertan public be concerned about who and the reasons why they are lending this money?

patriotz said...

And shouldn't the Albertan public be concerned about who and the reasons why they are lending this money?

ATB has a long history of dubious lending, such as to the Ghermezians (West Edmonton Mall) and Peter Pocklington (forever hated in Alberta for selling Gretzky). Nothing ever happens to clean it up.

That's the sort of thing you get in a one-party system bankrolled by oil. Our very own oligarchs.

Mathematical said...

Good Post Mohincan. I will forward the link to my friends and family. I'm am IT Tech and found this site by doing searches. Glad to see I'm not alone with my opinions. I'm not asking for the sky to fall but affordability for a nice place. I make $60,000 per year and have $25,000 down for a payment. Right now it's a sellers market and I have to wait for a buyers market.

I'm 30 and thinking about moving back home with my parents so I can save for a bigger down payment. It might suck but sometimes you have to follow your wallet and not your heart. Believe it or not most of my friends don’t think there will be a drop and if there is it will only be 10%.

Funny how if you talk to a person in RE or a person who owns multiple properties that there might be a correction they won't even listen to you. They will tell you you're dead wrong right to your face. They won't even listen to your side. It’s maybe because they’re in disbelief or denial. I hope to prove them all wrong one day.

J.Son said...

I do remember Ozzie Jurock being interviewed, saying he wouldn't buy anything in the lower mainland because it's overpriced. It was on Youtube. That's a pretty bearish comment from a RE "expert".

Drachen said...

Mathematical:

If you're good at math here you go.

3 main ways to determine where values should be if the market were behaving rationally.

1) P/E ratio or rent-price ratio (P/E is more accurate)

2) Median income/price.

3) Historical refrence. (as shown by Case Shiller and other economists RE prices adjusted for quality do NOT appreciate over time. If they did nobody could buy them.) Prices over time will curve with inflation only. A long term graph that is inflation adjusted looks like a flat line with a few bumps for the bubbles along the way (and 1 major trough between the great depression and the end of WW2).

My math shows that all 3 methods are within about 10% of eachother and all call for a 60% or greater cut in current prices.

For further reading see the motley fool or pick up Shiller's book 'Irrational Exuberance'.

freako said...

(as shown by Case Shiller and other economists RE prices adjusted for quality do NOT appreciate over time.

I agree with the first two, but not this one. I think Shiller's infamous chart is suspect. If we include population growth and density increases RE can indeed appreciate in real terms and still be affordable.

Jason said...

One MSM talking head that has at attempted to address the stupidity of Vancouver RE prices is Chris Olsen. This evening, during a commentary on the recent RBC affordability, he stated that incomes will have to increase or prices will have to moderate to get affordability back in line in Vancouver.

This is not the first time he has given his more sober outlook either, as many of you may remember one of VHB's last post entitled 'Olsen on 'our' side'. That report was on price declines in the Fraser valley.

I'm just practicing being positive to increase the chances of achieving my lofty career goals.

Wu'kong said...

Very well done -- excellent clarity.

A little suggestion: if you have access to the numbers, next time consider using household income instead of single income and that would allow you to also throw in household debt load or maybe savings rate.

If you're going to depress people might as well go whole hog.

patriotz said...

If we include population growth and density increases RE can indeed appreciate in real terms and still be affordable.

That's because as a city becomes bigger, there is a larger cohort of affluent buyers for the more desirable properties. So a particular neighbourhood such as Dunbar can go from middle class to upper middle class to just wealthy. But growth by itself cannot result in the median property in the metro becoming more expensive - it just moves the median property out to a less desirable location or reduces the amount of land it sits on.

What makes rising real RE prices affordable at the median is rising real household incomes. Those have been rising for two reasons - rising real wages (up to 1980 or so), and rising labour participation (mostly women working). That's the reason real house prices rose so much from the 1930's to the start of the current bubble. But there's little prospect of the first recovering, and the second is going to reverse (boomer retirements).

freako said...

So a particular neighbourhood such as Dunbar can go from middle class to upper middle class to just wealthy.

Yes, and the return on housing should be based on apples to apples, no? An SFH in a densifying neighbourhood can handily outstrip inflation.

patriotz said...

The trend in price of an existing property and the median real price are two different things, because an existing property can move toward the high end or the low end as a metro grows. That depends on whether the core is becoming more or less attractive. The former has been true for Vancouver. For an extreme example of the latter, look at Detroit.

Obviously a place like Van West Side or the North Shore has natural qualities which are going to be a locational advantage in the long run, but one really can't guarantee whether Burnaby, for example, is going to keep becoming more desirable just because it's central.

Particularly since Vancouver is losing its CBD in any meaningful sense.

The median cannot grow faster than real incomes, which is Drachen's point:

"A long term graph that is inflation adjusted looks like a flat line with a few bumps for the bubbles along the way (and 1 major trough between the great depression and the end of WW2)."

freako said...

The former has been true for Vancouver. For an extreme example of the latter, look at Detroit.


True enough, but still the original statement was that " RE prices adjusted for quality do NOT appreciate over time".

As we agree, if we measure APPLES TO APPLES (which is a central Shiller theme), RE can outpace inflation in any city whose population and (and corresponding economy) grows. I do think it is a bit ironic that Shiller preaches apples to apples price comparisons (correctly so) but apparently fails to do so for his famous chart.

Yes, the presumption is absolutely that Vancouver has grown and will continue growing. Furthermore, I think it is true for most near burbs. Eventually it will be true for the far burbs. It is not true for many interior towns.

I also think that it holds true for the vast majority of metro areas. I agree that it is not true for Detroit, and that is for specific reason. Their golden hen, the auto industry is sick, and population and economic growth is down. You might be able to think of a few more, especially those exposed to major industries. What will happen to Calgary if oil prices cave? Same as happened last time oil prices caved.

jesse said...

"An SFH in a densifying neighbourhood can handily outstrip inflation"

Vancouver SFHs have outstripped inflation in the past 30 years. How much longer can they outstrip inflation? Densification is already partly priced in. What drives real growth past this? Income stratification can exacerbate relative growth rates for example.

freako said...

Densification is already partly priced in. What drives real growth past this?

Good question. But by the same logic, why do stocks go up? Earnings increases are already anticipated.

Answer to both: Risk discount.

Two-armed said...

Thanks for keeping the spirit of VHB alive! You've earned my small donation. I've left enough money in my pocket to get some popcorn while watching the slooooow motion train wreck. The suspense, like the bubble, is palpable.

jesse said...

"Answer to both: Risk discount."

Or a speculative bubble. Over, say, 100 years a real gain of 1.5% (Van West) compared to 0% (Richmond) is over a 4 times multiple in price appreciation. That has to be sustained to some degree by incomes.

I could imagine a condo tower in Marpole overlooking an identical condo in Richmond, for example; a large multiple difference (even 2x) means the Marpole one is a wee bit pricier and this doesn't make sense to me.

I think m-'s post from a year ago deserved mention on this post. A lot of similar points were made in the comments.

freako said...

Or a speculative bubble. Over, say, 100 years a real gain of 1.5% (Van West) compared to 0% (Richmond) is over a 4 times multiple in price appreciation.

Obviously mispricings will lead to abnormal growth in the short term.

But that is not what I meant. ANY risky asset would beat inflation even when fairly by valued - BY DEFINITION. If it is fairly valued it has to do better than risk free return. Riskfree is generally slightly higher than inflation.

patriotz said...

ANY risky asset would beat inflation even when fairly by valued - BY DEFINITION.

The total return has to beat inflation, not the asset price. That's not an argument for house prices rising faster than inflation.

Indeed, it's not even an argument for house prices keeping up in nominal terms, if your city turns into a ghost town. Such markets have high rental yields for just that reason (e.g. Klondike).

freako said...

Indeed, it's not even an argument for house prices keeping up in nominal terms, if your city turns into a ghost town.

Operative word was "fairly valued". Fairly valued means expected returns and risks are true.

The total return has to beat inflation, not the asset price. That's not an argument for house prices rising faster than inflation.

True enough. All said and done, I would expect central SFH prices to beat inflation, but not central high density.

M- said...

"real gain of 1.5% (Van West) compared to 0% (Richmond)"

As a slight clarification, my 30-year charts that I posted a year ago indicated nominal gains of:
Van West: 1.5 times inflation
Richmond: 1.0 times inflation.

In other words, excluding the latest boom, Richmond showed zero real gain. Van Westside showed real gains of 50% of inflation. Strange to have such a disparity maintained for 30 years? I think so!

...Incidentally, I'll have to dig up those old Excel files and see if I can update them again!

patriotz said...

True enough. All said and done, I would expect central SFH prices to beat inflation

Such properties will have a lower yield today, which is expected to be compensated for by future improvement in fundamentals due to densification/locational advantage. Kind of like a growth stock.

Less well located properties will have smaller price gains but higher yields today. Like a value stock.

But I would expect the same total return overall.

What is truly bizarre is the huge multiples being paid for condos, almost all the value of which is in the building which will eventually become worthless or require major maintenance, which amounts to the same thing.

freako said...

But I would expect the same total return overall.

Yes, once adjusted for risk. SFH contains more speculation about population and densification, so it has more risk, and would therefore earn a higher TOTAL return. This is much like equity returns versus bond returns. Or perhaps a better analogy, common stock RETURNS versus preferred RETURNS.

Some of the confusion in this discussion has been the lack of distinction between price increases and total return. The later would need to have rental income added, and expenses deducted.

Again, the beef I have with Shiller's chart is that bears use it to say imply that RE is a bad investment. I think this is as bad as bull arguing some other non sequitor.

In summary:

1. Shiller's chart measures real prices only, not return.

2. As Patriotz pointed out in his last reply, there is a relationship between cash flow, price increases and total return.

3. Apples to apples, SFH in a growing metro does appreciate in real terms. The yields of these are lower. However, because of higher uncertainty, metro SFH would be expected to have a deserve a risk discount and therefore a higher expected return. I think broad historic data support this, recent Vancouver RE being an exception.

This is all seems nitpicky and arcane, but I think it is worthwhile to pursue because there are many oversimplifications and misconceptions.

What is truly bizarre is the huge multiples being paid for condos, almost all the value of which is in the building which will eventually become worthless or require major maintenance, which amounts to the same thing.

Yes. I cannot say with absolute certainty that an SFH in the near burbs is overvalued because I don't know the future growth rate.

I can say with certainty that a condo is overvalued because rents don't come close to covering expenses of a limited life asset, and densification is NOT an option.

For a condo not to be overvalued, rents would have to increase dramatically. That would require large increases in incomes and/or population growth. But if rents go up, the market adjusts by building more condos. When you own a condo you are a landlord in competition with other landlords. When the going gets good others flood to the game in a freeding frenzy bring yields back down. This related building is of course what causes SFH to get bid up as builders aquire land.

Warren said...

patriotz:What is truly bizarre is the huge multiples being paid for condos, almost all the value of which is in the building which will eventually become worthless or require major maintenance, which amounts to the same thing.

FWIW I purchased a condo in 2001, at that time it was 25% land value, 75% building. As of my last assessment, it was about 60% land, 40% building.

I'm assuming that any drop will come out of the land value.

patriotz said...

Cyclical drops will come out of the land, but the real value of the building will decline in the long term, unless recapitalized. Nothing lasts forever.

the beef I have with Shiller's chart is that bears use it to say imply that RE is a bad investment.

The correct implication of the chart is that housing should only be bought for yield because that accounts for almost all the real total return in the long run. Which of course means it's a terrible investment now.

freako said...

The correct implication of the chart is that housing should only be bought for yield because that accounts for almost all the real total return in the long run.

Again, maybe I am being nitpicky, but to me it is not actual yield but POTENTIAL yield that should be taken into account. Subtle, but significant difference.

A property with high growth potential would be expected to have a low yield, and a property with low growth potential would have a high yield. If we look at currenty yield to myopically, we would not see that these may both be fairly valued.

freako said...

Cyclical drops will come out of the land, but the real value of the building will decline in the long term, unless recapitalized. Nothing lasts forever.

Yes, land is what appreciates (and depreciates). Which makes sense if consider that fact that the cost of building is fairly stable over time in real terms. That the price of structures is fairly stable can be seen by comparing against vacant land in the area.

patriotz said...

It also occurs to me that one reason why the Case-Shiller curve is so flat may be that historically, existing properties in the US have not been appreciating in aggregate (real terms) due to white flight and neighbourhood decline. Before the bubble of course.

jesse said...

"Van Westside showed real gains of 50% of inflation."

Yes. In my example 1.5% real gain is 50% of 3% inflation, coincidence of the 1.5X.

patriotz:
Case-Schiller HPI has been broken down city by city though I don't know how far this breakdown goes back. Yes: migration leaves collateral damage so a country-wide HPI includes abandoned residences and homesteads and the new housing that had to be built elsewhere. I'd look at somewhere like Boston where the economy and migration has been relatively stable over time.

Schiller did a HPI chart with Amsterdam going back 400 years. Real gains were close to flat.

"A property with high growth potential would be expected to have a low yield, and a property with low growth potential would have a high yield."

This makes sense. I would expect neighborhoods in close proximity to have the sub-components of total return (asset appreciation and rents) stay within reasonable proximity as well. My point earlier was that Richmond and Van West land values cannot stay on different growth curves forever -- there is, to a certain degree, a condition of continuity of the sub-components of total return. Between population centres geographically separated there can be long-lasting and possibly permanent differences in rental yields.

Drachen said...

Patriotz

"existing properties in the US have not been appreciating in aggregate (real terms) due to white flight and neighbourhood decline."

The graph goes back over 100 years. Those are relatively new phenomena.

As has been pointed out, if Amsterdam's real estate appreciated at only 1% faster than inflation in those 400 years prices would be 5350% of what they were (in adjusted dollars). It's simply not possible. As I have said and others have said, some properties and some districts may appreciate during times of flux but metros don't because in the long term even a very small appreciation would be unsustainable.

jesse said...

"Van Westside showed real gains of 50% of inflation."

M-: Probably worth re-iterating here again, but bungalows are not being replaced with bungalows; they are replaced by two-story or multiplex. So I think bungalows are a reasonable measure of same-property price changes, not including renovation.

freako said...


As has been pointed out, if Amsterdam's real estate appreciated at only 1% faster than inflation in those 400 years prices would be 5350% of what they were (in adjusted dollars).


1. For a good part of that stretch, inflation was non-existant.

2. It is for the most part densification that allows prices to outpace inflation. In the Amsterdam example, you would need to compare an apples to apples smack downtown piece of land. Also remember that Holland is dense in the European way (lots of low rises), not the DT Vancouver way (high rises). In that sense, the the real winners are those in the PATH of growth.

3. Real incomes have risen. This would also allow for RE to outpace inflation.

The moral of the story is that densification increases the "productivity" of land.

freako said...

So I think bungalows are a reasonable measure of same-property price changes, not including renovation.


If we are trying to predict the total return of RE, we should stick apples to apples.

The easiest way to do that is the follow the piece of land, not the property type. The problem with Shiller's chart it that he compares West End SFH with West Side SFH with East Side SFH with Surrey SFH and so on. If a property becomes too valuable, it is replaced by higher density. To coin a quasi financial term, Shiller's chart may suffer from reverse survivorship bias. Imagine what stock market returns would look like if dropped a company once it became to successful. We would grossly underestimate total returns.

And as discussed earlier, in total return calculations we need to include rents and expenses.

newbie said...

great post mohican. do you have any graphs of how the stock market trends to the real estate market? for folks who have some of their savings in the stock market while waiting for the RE market to correct itself... i would expect the two markets to have similar trends but it would be nice to see some graphs as i can't find any good ones..

3mudds said...
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