House prices in Greater Vancouver are overpriced and consequently the rental yield on properties is very low. The chart above (click to enlarge) shows the long term detached house price adjusted for inflation, the inflation adjusted rents for a 3 bedroom apartment and the price to rent ratio for the benchmark detached family home (I used a multiplier of 2 on the 3 bedroom apartment rent to represent the benchmark detached rent).
The price to rent ratio is at all time highs by a long shot with monthly rent representing 1/300th of the purchase price of a home. In some cases the ratio is much worse.
Any analysis of price vs rent would be ignorant if it did not account of the cost of capital, which is represented here by the five year mortgage rate. Mortgage rates were extremely high in the early 1980s and prices were also very high so the mortgage payment to rent ratio was extreme. It peaked in the third quarter of 1981 at 3.5 times equivalent rent to purchase the same property. In the current cycle we peaked at 2 times rent for equivalent properties. Clearly affordability was worse for a brief time in late 1980 through early 1982 compared to today.
The risk today is of course the prices themselves but the risk of mortgage rates rising is an additional risk that mortgage renewers must keep in mind. Would they be able to absorb an unexpected drop in house prices of 20% combined with a rate increase of 2-3%? Variable rate mortgage holders are in for just such a surprise over the next couple years. Fixed rate mortgage holders may dodge the bullet on the rate increase but the price decreases may leave them feeling a little trapped, especially if the payee loses his or her job.
This is a great post. I think it does put the ratios in a better historical perspective. Here, though, what does it take for the payment-to-rent ratio to come back in line with the long term average? Before it was lower mortgage rates that eased the burden. Now it is going to be falling prices that must do the heavy lifting.
ReplyDeleteYes, we need the benchmark detached home price to come down to $400,000 in order for mortgage payments to be equal to rents again. This basically means a 40% price correction is the minimum correction required to bring home price back into line with fundamentals.
ReplyDeleteIf interest rates rise and lending standards tighten further the correction in prices could be more severe than that. -50% should be on the table for discussion.
That's a great analysis, Mohican!
ReplyDeleteMohican,
ReplyDeleteShiller (off the record at the time) suggested Vancouver housing prices could decline by as much as 60%. The late great John Templeton suggested 90%.
50% is more than reasonable.
One thing that will check the rent ratios you discuss will be a rise, due to mass inflation, of rents, even before housing prices bottom.
Am I reading these graphs correctly? It's *never* been cheaper to own than to rent?
ReplyDeletemontery - yes you are reading the charts correctly but that has mostly to do with the multiplier I chose to use. I used a multiplier of 2 on the 3bdr apartment rent to estimate the rent on a benchmark detached. This would mean that the rent on the benchmark detached today would be approximately $2600 per month. I think this is fairly close to reality - basement suite plus upper suite. Some situations are worse and others are better.
ReplyDeleteThere were brief times during the seventies and eighties in which rental equivalence occurred. Keep in mind that the mortgage payment includes principal paydown but it does not include taxes or maintenance.
Before the inflation of the 70's it was the norm for buying to be cheaper than renting, indeed in the 30's it was WAY cheaper. This changed when people started buying above rent equivalence as a hedge against inflation, and the bubble era began.
ReplyDeleteOne thing that will check the rent ratios you discuss will be a rise, due to mass inflation, of rents
Not without corresponding wage inflation, and if you're expecting wage inflation during a severe recession, dream on. The 80's bust saw CPI inflation that was still fairly high but nominal rents were flat for just this reason. We also are getting a big supply glut of condos which will put further downward pressure on rents.
Oh one more thing - high inflation inevitably brings higher interest rates which puts further downward pressure on prices.
"that has mostly to do with the multiplier I chose to use. I used a multiplier of 2 on the 3bdr apartment rent to estimate the rent on a benchmark detached."
ReplyDeleteThe numbers are about right. The yields on detached properties are lower because future densification will produce higher cash flows in the future. Do the calculations for condos and it has indeed been cheaper to own than rent, and not as long ago as acid wash.
"high inflation inevitably brings higher interest rates which puts further downward pressure on prices."
I can't stress how important this point is. The BEST scenario for prices is continued low inflation expectations and this still means a 40% haircut. If mortgage rates increase (due to rising inflation expectations, increased risk attributed to housing, or just higher origination/servicing costs as lenders become more cautious), it further cuts prices, as mohican said. Higher mortgage rates need not come from rising long term bonds but from a lasting increase in the spread. The US Federal Reserve Bank is currently trying to combat the spread issue.
great points patriotz and jesse
ReplyDeleteI now see -40% as a 'best case scenario' for the very reasons you mention.
Approximately how much do you think a 2 bedroom condo in downtown/kits/kerrisdale will cost in a year or two? What about detached homes in kits/kerrisdale or even Richmond? Do you think we'll see this crash soon or will it take some time?
ReplyDeleteThanks and great blog
trading edge,
ReplyDelete50% less than today's prices or 60% from peak.
Wow...... and to think I was close to buying a house last summer. How quickly do you all expect this absolute collapse to occur?
ReplyDeleteHow fast?
ReplyDeleteCould be 18 months, but most of the damage will happen after all those re-listings hit the market in the spring along with thousands of new completions, just when the recession will spook the last few remaing buyers out of the market.
Anyway, no need to worry about missing the bottom, as the market will languish for years.
Thanks.
ReplyDeleteI'm not too concerned about catching the bottom, but I have the money to buy a place right now but obviously will not do so int he face of a potential 50% decline. At the time time, however, I'd rather buy a place than continue renting for years and year.
Looks like things are getting ugly:
ReplyDelete"Vancouver Condo Info is now closed.
That's right, I'm pulling a VHB and closing the blog down in the middle of the night.
The REBGV has expressed concerns about some of the content on this site"
Think that's going to make one bit of difference to this meltdown, you jackasses? You can kill the messenger, but you can't kill the message.
"The REBGV has expressed concerns about some of the content on this site."
ReplyDeleteAny idea what kind of concerns? The only thing I can think of is use of their data. Otherwise I can't believe they would be able to harass people over simple negative content.
This comment has been removed by the author.
ReplyDeleteBut really what can REGBV do? Someone should remind them that in theory we have freedom of speech in this country. Maybe someone like Mohican can post what made them uncomfortable on his site. That will teach them.
ReplyDeleteOh there's no mystery what made the REBGV uncomfortable. As Jesus said, "You shall know the truth, and the truth shall make you free". They were afraid of the pubic finding out the truth, that's all. It has never worked before and it won't work this time.
ReplyDeleteAs to what specific threat was made to the Pope, he is probably precluded from talking about it by the terms of their "agreement".
I found out through this: http://forum.freemarkets.ca/topic.php?id=201. Although they did not provide any explanation or conspiracy theories either.
ReplyDeleteI still don't get how they could get him to close down the blog. The only thing I can figure is pure bribery. In that case pope if you are reading this I hope you stuck it too them. I wouldn't be cheap and I hope you were not.
ReplyDeleteI told my girlfriend my bribery theory. She thinks I should start a blog. lol
ReplyDeleteThis could be lucrative.
Swatting at flies with a sledgehammer. Thanks to the Pope and other local bloggers for all the hard and often thankless work. Many a reader is indebted to your work (no pun intended).
ReplyDeleteMore like fighting a hydra with a sword, if you get the point. And Dave Watt is no Hercules.
ReplyDeleteI'm not too concerned about catching the bottom, but I have the money to buy a place right now but obviously will not do so int he face of a potential 50% decline. At the time time, however, I'd rather buy a place than continue renting for years and year.
ReplyDeleteI really don't understand what this renting stigma is about. What's so bad about renting when all the numbers point to it being a better choice? Am I really missing out on all the fun of maintenance and taxes?
You are right M-. This is really a great analysis Mohican!
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Great blog most of the damage will happen after all those re-listings hit the market in the spring along with thousands of new completions, just when the recession will spook the last few remaing buyers out of the market.Thanks for sharing........
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The charts are cool, but don't include labels for the years.
ReplyDelete