Friday, February 29, 2008

Why Condo Projects Going into Receivership will have a negative impact on the local real estate market.

In light of news this past week that 3 more condominium projects in the Vancouver area are being forced into receivership, I figured I'd pen my thoughts on why it will have a profoundly negative impact on the Vancouver real estate market. Here is the news story.

First, some debunking, as some people are claiming that because these projects aren't being completed it will put positive price pressure on existing inventory. This is a ridiculous statement for a couple reasons:
1 - the construction workers who were working on those projects are now working on other projects that will complete quicker;
2 - the Sophia, H&H, etc projects will be completed by the receiver at some point;
3 - the number of units we are discussing here is miniscule compared to the total number of households and available housing inventory in Greater Vancouver; and
4 - perhaps only 10% - 20% of the total number of units in question here was destined to be purchased by an actual owner-occupier so there is not a pent up demand for these housing units except for the pent up demand of the speculator to buy a new BMW. See quotes below.

Now lets talk about the main reasons these receivership proceedings will cause such a negative effect. There are two main reasons:
1 - speculators are going to get cold feet as they realize that risk is part of trying to make money in real estate - the days of putting your name down on any pre-sale and selling the assignment or completed condo at a highly inflated price are coming to a close. I figure that this may begin a 'rush for the exits' type of scenario where speculators begin clamouring over each other to get out of the market. This will flood supply at a time when demand is dropping. Econ 101 anyone?
2 - Psychology - this has a huge effect that is immeasurable but as it becomes apparent that the original pre-sale buyers at these projects will have lost their stake in the Vancouver real estate game many will question the wisdom of playing the game at all.

Here is some choice quotes from CBC News:

"When asked about buyers left scrambling to find a home because of construction delays, Eden said he believed most buyers were actually real estate speculators who would not need the homes to live in, and who know pre-sale agreements are always a risk.

The executive director of the Condominium Home Owner's Association, Tony Gioventu, agrees that buying pre-sale condos is a game of speculation.

But he says there are people who buy them who aren't in it for the investment and don't realize the risk.

"Normally, only between five to 30 per cent of pre-sale buyers plan to live in the condo once it's built, estimated Gioventu, "but those who aren't in it for the investment need to protect themselves."

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16 comments:

Mathematical said...

Nice post, I agree with it 100%. Amazing how many poeple actually believe this a good thing. Less condos = less supply = higher prices.

jesse said...

Good post. Buyers will start behaving rationally as the perceived risk is now obviously non-zero. Greater risk discounts will be the norm from now on. To think that buyers might finally be rational!

I remember talking to presale buyers in the past few years and they always acknowledged the project going into receivership was a risk but none of them thought it was any more probable than a massive earthquake. Oops.

Sam said...

Following on from my comments in the last thread, if buyers are becoming rational, should the appearance of risk not make them think that the market has the potential for higher returns? That is, before if the market was viewed as "safe", then it should be like bonds and have modest returns. If it starts to get a nastier speculative/risky edge to it, then it should attract investors.

I am of course being a bit facetious (since people have viewed the RE market as simultaneously offering the safety of bonds but the growth of small-cap tech stocks), but isn't there a grain of truth here?

Paul said...

The level of confidence in our current market is amazing.

A depression in US real estate
A likely US recession
A possible Canadian recession
Real Estate globally taking a beating
A credit crunch
Our banks losing billions
Price/ Rent ratios that are horrible
Rampant speculation locally
etc........

We can go on and on.

Confidence appears almost unshakeable thus far… completely irrational. Perhaps this combined with economic factors will take the wind from the sails of our local real estate market.

Once we have small price drops then the rush to exit will accelerate. The condo collapse could be unprecedented.

But who knows when, or to what extent.

Strataman said...

PaulB "Confidence appears almost unshakeable thus far… completely irrational" Irrational is the word! There is ONE crack in this confidence, and I think only a couple more months will MAKE it appear in sales. That crack is high end condo rentals > $1400/month. They are going begging offering rent breaks, throwing in fully furnished for little or nothing more then unfurnished suites.Re entering the same suite EVERY DAY for weeks on Craiglist. Thats anything but a "hot" landlords market.

patriotz said...

The problem of discussing "risk" here is that we are really talking about two different things.

Risk in investment means uncertainty of return. But the long run return of any investment depends only on future earnings and purchase price. RE earnings, i.e. rents, are very predictable. So RE is no more risky an investment now that it was in 2001. It's not more risky, it's just a much worse investment.

An adjustment of RE prices to fundamentals is not a risk, it is a certainty.

When a market becomes purely speculative, as RE is now, it just becomes a greater fool game where players make gains only at the expense of other players. The "risk" that players take on is that there will not be a greater fool to pay him off. But it's a certainly that the market will run out of such fools. That's not an investment risk for the asset, that's a gambling risk for the players.

And the awareness of this risk is what brings on the rush to the exits.

johnnyrent said...

As Paul stated, confidence in this RE market is unshakable. I think this substantiates Shiller's comment that we were the bubbliest market in NA. We are certainly the last wound-up hold-out on the continent.

A year or two ago I had thought we were in for a modest correction. I'm now persuaded that the condo market particularly is going to get absolutely clobbered.

patriotz said...

Well I think public sentiment has well and truly capitulated south of the border. Would you believe:

Celebrity real estate losers

Coton said...

I can tell you one thing ... the $1 million plus homes in Victoria (which many are only 3,000 sq. ft. and some under -many are waterfront tear downs) are not selling. Waterfront is not selling. We know this ain't LA and certainly not Beverly Hills.

Take a look at the MLS. You will be amazed at the inventory.

It was suppose to start at the bottom but I actually think it is starting at the top. The figures from February should be interesting.

Coton said...

This is in Victoria - not Vancouver. Are the high-end or rather million dollar homes in Vancouver still selling????

(what does a million $$$$ in Vancouver get you??? - not much I understand)

macho slob said...

Sales for upscale homes in V seem to be slowing.

Perhaps these folks are a little wiser than the first time buyer crowd plunging into lower scale digs.

tulip-Mania2 said...

As the economy slows, inflation is picking up.

STAGFLATION

Tick, Tock, Tick, Tock

jesse said...

"As the economy slows, inflation is picking up."

It's possible to have inflation and deflation happen at the same time, as long as you use different definitions of the terms.

tulip-Mania2 said...

Jesse: inflation and deflation at the same time is nothing new.

GDP and CPI are aggregates,( crude aggregates.)

What we have now is an inflated GDP measure, and understated CPI.

It may take a while yet, but at some point the eroded purchasing power of most individuals will become too obvious to ignore, and that is when an insidious consumer recession has already set in.

patriotz said...

Tulip, you are talking about mismeasurement of economic statistics. That's not "inflation", athough we can use "inflated" to mean "overstated". Inflation means an increase in some parameter, not a mistake in measuring it.

Getting back to inflation, for example in the 70's we saw CPI inflation, but asset deflation (stocks and bonds). Also RE inflation, because we had wage inflation.

Vancouver in 1981-84 saw huge RE deflation accompanied by moderate CPI inflation. At the same time we had bond price inflation, because interest rates were going down.

In the long run monetary inflation is required to sustain all types of price inflation.

Not only is it not necessary for all nominal prices to move in the same direction, it's logical for some of them to move in opposite directions. For example, CPI inflation without wage inflation will get you RE deflation, because RE affordability goes down.

People use "inflation" without a prefix to refer to different things, but that's just a notational convenience, not a matter of one person being right and the other wrong.

Deliverator said...

Patrioz,

As long as one uses a consistent definition of broader inflation, it will be always possible to determine when monetary policy has gone wrong. IMHO, that is growth in the broad money supply when compared to the (real) GDP.

Take a look at the last few years. Broad money supplies as well as asset prices of stocks, real estate and commodities have been soaring, while CPIs have remained relatively stagnant, allowing governments to tell us that inflation was tame. Now the chicken is coming home to roost as the unchecked growth in the money supply is no longer being soaked up in inflated real estate and stock prices, resulting in a rise in consumer prices, or what has come to mean 'inflation' to the general public.