Vancouver CMA Price to Rent Ratio

A popular ratio used to measure relative housing valuations is the "price to rent ratio" that takes a benchmark price and divides by the annual or monthly rent. This forms a type of price-earnings ratio of housing from an investment perspective. There are some significant caveats with this measure, not least the data sources used. This post will outline the various sources of data and what I believe to be the best measure of a pure price-rent ratio as well as some of the factors and limitations that are inherent in the measure.

Prices

Prices are measured in various ways, from simple average or median prices (average can be found on realtylink.org website, the median can be found in various places, for example the Demographia survey). Royal LePage has data going back to the 1970s to the municipality level and attempt to adjust for sales mix. Other measures include the Teranet HPI that, like the US-focused Case-Shiller house price index, uses sales pairs to attempt to adjust for quality differences in the data. A more recent measure starting to be adopted across the country is the MLS-HPI that uses a form of hedonic adjustments to perform a quality adjustment on sales. Although not using the same methodology as the Teranet model, the MLS-HPI has broadly tracked the Teranet HPI.

The MLS-HPI, Royal Lepage, and average data are broken down by housing type, broadly single detached, townhome, and condo. Teranet provides only aggregated data publicly but does track data based on housing types.

Rents

Rents are more difficult to measure, mostly because the sources of the data are not collated anywhere save through CPI measures ("rented accommodation" and "owner equivalent rent") and some other surveys that have been performed over the years. Metro Vancouver and CMHC have attempted to measure rents through broad-reaching surveys and other datasets with some success. CMHC surveys rents from a pool of purpose-built rental units and has a dataset extending back to 1992. CPI data extend back further than this.

Comparing prices and rents

Price-rent ratio, at its core, is a measure of how favourable an investment housing is at current valuations. A higher price-rent ratio generally indicates a less favourable investment and a lower price-rent ratio indicates a more favourable investment. To understand what price-rent ratio is actually indicating involves more in-depth analysis than what is possible in a blog post. Nonetheless several broad factors can and do influence price-rent ratios being higher and lower. These factors include:

• Quality and age. A property that has a more stable income stream or requires less maintenance will generally have a higher price-rent ratio. For example a new condominium requiring little maintenance outlays and attracting high-quality dependable tenants will be a safer investment that requires less discounting. As a building ages it can become "dated" (resulting in less favourable rental terms for the landlord) or incur additional maintenance that will require cash outlays from the owner. As a unit ages its price-rent ratio will tend to fall.
• Financing. Both short-term financing (ie 5 years or less) and longer-term financing (say a 30 year mortgage) can influence price-rent ratio. Investors will pay higher prices if the financing costs are lower (like a bond), though the caveat is that, in Canada, financing needs to be periodically renewed and that investing in property has a fixed land component that never depreciates. This means that while financing costs can decrease due to lower interest rates, if rates go higher at any point in the future (not just over the course of the loan) this benefit is lost.
• Density. A low density property in an area undergoing rezoning or other density changes will factor in both current and future land use into its price. This means that, say, a 60 year old bungalow in a desirable higher-density area will have a high price-rent ratio. Over time, as the area continues to increase in density, the land becomes more valuable and the price-rent ratio will tend to increase over time. This means that many properties will carry a "ludicrous" price-rent ratio but that does not necessarily mean they are overvalued.
• Rents and income. An area can be undergoing gentrification or population growth that put pressures on rents or imputed rents. This means, ultimately, that the market expects rents to increase faster than inflation and this will push up future earnings from the property. This will lead to a higher price-rent ratio.
• Consumer surplus. If the marginal buyer is not solely focused on cash flows but on ownership this can cause prices to rise above what what an investor may be willing to pay. If owner-occupiers place an intangible net benefit on home ownership they will pay a premium relative to renting. This forces down yields for landlords, although they benefit from the capital appreciation.

There are other factors, such as raw speculation, that affect price-rent ratios. It is not immediately true that all factors that can plausibly affect price-rent ratios are unsustainable. From a net-present-value perspective there are many factors that are "value based" -- meaning future earnings from operations are reasonably expected to support a competitive inflation and risk-adjusted return -- and some that are "speculative" -- meaning future earnings are supported more by the future sales price and less by income. (My use of "value" and "speculative" should not connote good and bad, but should acknowledge how one makes one's money.)

Determining which measures to use

Determining which measures to use for the price-rent ratio involves correcting for sales mix but also correcting for other factors that can determine which factors are supported by incomes and those that are supported only by speculative activities. It can be difficult to separate certain premiums based on density increases from depreciation, finance, or rent-inflation-related factors.

Luckily, to help with this, we have a measure of quality adjustment in the form of the Teranet and MLS-HPIs that reduce the effect of depreciation and quality in our measure. In terms of density increases, this can be partly ameliorated by focusing on already-dense properties such as apartments that are unlikely to undergo significant density-increasing redevelopment in the foreseeable future. This leaves us with the residuals of rental inflation, financing, and of course the catch-all of speculation.

In terms of which rents to use, to compare a same investment over time, given we have a quality-adjusted measure of apartment prices, the best measure is to use a quality-adjusted measure of apartment rents. Here we are in luck because the CMHC rental survey measures purpose-built apartment rents over time. Since purpose-built apartment stock is generally not being replenished in any significant way (though that may change in the coming years), the rents measured on these units are de facto quality-adjusted.

So we have our chosen price and rent measures. Using the Greater Vancouver apartment MLS-HPI, dividing by the CMHC one bedroom apartment rent and normalizing (to 2005), we get the price-rent ratio that I often reference on this blog:

This measure shows the impact of rising rents on the ratio since its peak in 2008, and how elevated the ratio is compared to its value through the 1990s. This measure will be affected by the following broad factors:

• Market expectations of future rent appreciation
• Market expectations of future mortgage rates
• Speculation and other non-cash-flow-supporting returns

The measure broadly corrects for:

• Expected density increases
• Quality and age

The price-rent ratio graph above is by no means a definitive measure of valuation. It is a measure with imprecise factors and should be used as part of a larger suite of measures to form an argument for the sustainability of current housing valuations.

As to what is a "reasonable" price-rent ratio, well, that is the question, isn't it?

The Vancouver Condo Price-Rent Ratio

A method of measuring relative valuation is to look at price-rent ratios, a "price-earnings" ratio for real estate. Vancouver does not have a market rent index, however CMHC does provide rental survey data that I have quickly validated to be close to prevailing rents. The price is garnered from the Greater Vancouver MLS-HPI (note the MLS-HPI before 2005 uses a different base so I "stitched" the two indexes as best I could). The results are normalized for Jan 2005 below:

The red line has been slowly falling from 2008 onwards, most recently the drops have been from an equal combination of rising rents and falling prices. The historical bound for price-rent ratio before 2000 has been between about 70 and 90. As an estimate, say the price-rent ratio is to revert to this historical bound in five years. What average annualized price change is required to do this?

Rents have averaged about 2.5% annual gain since the 1990s. Under this scenario, five years of -2.5% nominal price changes will put the price-rent ratio within historical bounds. To get to the middle of this range would require a more hearty -5% annualized nominal price change. If rental growth slows due to slow income growth or oversupply, price drops would need to intensify.

Affordability and Rents in Vancouver

City of Vancouver mayor Gregor Robertson's affordability task force put their report on the table today, the full report is here (PDF). One thing I thought I might highlight is the state of rentals in the Greater Vancouver region, using two measures.

The first measure is taking the ratio of CPI-reported "rented accommodation" to median regional household income and normalizing:

The second measure is taking the same income but using CMHC surveyed rents

The discrepancy between the two measures is marked, certainly something I would investigate further if I had the time.

Despite the discrepancy, both graphs indicate that, in terms of median incomes, rents in Greater Vancouver have not drifted significantly over the past 20 years. That does not necessarily mean there is no regional affordability problem for certain income tiers or regions (such as the City of Vancouver proper) but on balance I don't see much evidence to support Vancouver being significantly less affordable in terms of baseline shelter costs compared to the past two decades, though last year's CMHC data indicate affordability measures are near the top end of the band, mostly due to income stagnation but also in part due to increasing real rents.

Something to keep in mind when considering the recommendations of an "affordability task force".

Price to Rent Ratios for Vancouver

I have been loath to publish price-rent ratios for Vancouver, even though I think it's one of the primary methods by which prices are set in the long run. I went over the issues with price-rent ratios here. For a backgrounder on why this is important, read Calculated Risk's posts (like this one) and refer to the Federal Reserve Bank of San Francisco's letter from 2004 on the subject.

When looking at an area like Vancouver with increasing density one must be careful using detached dwellings when formulating price-rent ratios as the earnings are forecast to increase greater than rental inflation into the future and would carry a higher price-rent ratio. The best gauge we have for a time-insensitive price-rent ratio is by using apartment rents and prices, that is, properties that have undergone most of their density increases.

Below is Greater Vancouver's apartment price-rent ratio, measured by using the MLS-HPI for apartments and the CMHC-surveyed one bedroom apartment rents, then normalizing them to a point in time.

As of December 2011 the price-rent ratio was 100% above the nadir in 2000 and 66% above the upper level of the price-rent band going back to at least 1991 (and likely longer).

As moderate stress test we can assume that the price-rent ratio will revert to at least within its historical band of 100-120 (on the graph above) in 5 years. For different rental inflation numbers the annual nominal price drops, from December 2011, required are:

• -8.5% per annum (cumulative -35.8%) for rental growth of 1% per annum
• -7.6% per annum (cumulative -32.6%) for rental growth of 2% per annum
• -6.7% per annum (cumulative -29.2%) for rental growth of 3% per annum

For reversion to the middle of the 100-120 historical band:

• -10.1% per annum (cumulative -41.2%) for rental growth of 1% per annum
• -9.2% per annum (cumulative -38.2%) for rental growth of 2% per annum
• -8.3% per annum (cumulative -35.1%) for rental growth of 3% per annum

For reversion to the bottom of the 100-120 band:

• -11.8% per annum (cumulative -46.5%) for rental growth of 1% per annum
• -10.9% per annum (cumulative -43.8%) for rental growth of 2% per annum
• -10.0% per annum (cumulative -41.0%) for rental growth of 3% per annum

The US's experience found that most price drops occurred within several years followed by a more prolonged (and still ongoing) period of flat prices and at-inflation rental growth to fully revert price-rent ratios back to their norms.

If one believes the sanctity of price-rent ratios, those are a lot of scary negative numbers.

Vancouver CMA Rent Analysis

An important part of the housing market is the rental stock, most closely surveyed by CMHC from a universe of just over 100,000 units from buildings containing 3 or more units (CANSIM table 027-0040, using rental survey data taken every October). This dataset is interesting to track because its pool has been relatively unperturbed by new dwellings: most of the rental stock tracked by CMHC is of older vintage. This provides a way of tracking same-unit rental growth over time, something that individual investors would be most concerned about and provides a method to directly compare same-unit price trends to their yields, at least on a relative basis, something that can become muddied with the change of vintage of a survey's data sources. I have pulled the data to look at how rents have changed in Vancouver CMA for this "baseline" rental pool and have normalized them based on 2002 CPI-adjusted prices.

We can see that real rents have been appreciating between 0.75% and 1.25% per year. Note that from between 2006 and 2010 population growth was on the high end of historical ranges and this is correlated with tightness in the rental market.

Looking at the rent to median income ratio:

Median incomes have fluctuated more than rents, causing the ratios to be more variable. After 2008 it can be immediately seen that as a percentage of income rents are now more dear.

An interesting graph is tracking dwelling spreads -- the percentage change between a dwelling type and the dwelling type with one additional bedroom:

What this graph shows is a "curve" for the spread between different dwelling types, in some ways akin to a bond yield curve. A diminishing spread would indicate compression between dwelling types.

There had been some thought that real rents have not been increasing. These data indicate that real rents are increasing at a rate around 1% per year, with more marked changes happening recently from 2006 through 2009. In terms of incomes there is additional fluctuation due to labour market changes, however it appears that rents are over longer time periods tracking incomes closely, though 2011 has produced tighter conditions.

Changes in population growth appear to be having an effect on rental rates. It is unclear recent tightness in the rental market is a permanent change -- for example, rents are increasing because the city is comparably more desirable for a given income -- or if we should expect relative weakness in rental growth going forward. The most recent rental survey from April 2012 indicates no strong signs of weakness.

Vancouver Rental Market Update April 2012

An important component of the housing market is the available rental stock. If inadequate housing is being built we should expect low vacancy rates and increasing rents. CMHC released its survey on monthly rents and vacancy rates for BC.

The CMHC report attempts to break down rents and vacancies based on region and on dwelling type, namely apartments, townhouses, detached dwellings, etc. based on number of bedrooms. Larger dwellings typically have higher vacancy rates than smaller ones and professionally-managed dwellings typically have lower vacancy rates than "amateur" dwellings.

Here are the numbers for "private apartments" (I'll update this as I fish out more data):

Vacancy rate

April 2010 2.2%

April 2011 2.8%
April 2012 2.6%

Availability rate (The availability rate measures the number of rental units which are vacant or for which the tenant has given or received notice to move and a new tenant has not yet signed a lease compared to the universe of rental units.)

April 2010 3.1%

April 2011 3.7%
April 2012 3.7%

Rents (CAD)

April 2010 978

April 2011 989
April 2012 1013

Change in rent

Apr-09-Apr-10 2.3%

Apr-10-Apr-11 1.6%
Apr-11-Apr-12 2.9%

Consider these readings as the "core" rental market. CMHC has in the past attempted to measure non-core rentals, such as houses, basement suites, and privately-held condo units rented out directly by owners or through smaller property management companies.

Vancouver usually has lower vacancy rates than outlying areas. When looking at cap rates for apartments, an area with lower vacancy rates will carry a lower cap rate. Rents were generally strong over the past year though vacancy rates have not statistically decreased. Increases in rent have generally kept up with wage growth. The allowable rent increase in BC for 2011 was 2.3%; this year it's 4.3%. It is plausible that last year saw the rental market demanding changes exceeding the allowable rent increase. How can the 2.9% increase seen last year exceed the rental limit? There are two major reasons: first, the survey includes some rent increases starting early in 2012 which can be at the 4.3% rate, and second, when a unit has tenant turnover, landlords have prerogative to increase rents to whatever they see fit.

Overall this is a solid report for rental growth, something in my view necessary to bring property valuations back down to earth.

Rent or Buy, or Rent and Buy

Another rent vs buy comparison made the CBC website again.

The premise behind the standard buy vs rent calculation, as this one, is comparing two scenarios: buying now and holding for (say) 25 years, or renting now and renting for the same 25 years. Chop off the monthly outlay difference between the two (and putting aside the strangeness of any situation where buying a condo is more expensive than renting, but that's another post altogether!), invest the difference at a "conservative" 5%, extrapolate past appreciation (condos have been appreciating at 5% p.a.), assume current mortgage rates remain for the duration of the loan, and do a comparison. No problem.

The problem, notwithstanding the brazenness of some of the above assumptions, is that there is an embedded out-of-the-money option built into the renter scenario not considered in any of these calculations. That is, a renter need not rent for 25 years; instead he may rent for 5 years and, should prices drop, has the option of buying at lower prices. While lower prices are not an absolute certainty, the option still has value, especially if one calculates a high probability of price drops. (Of course these days landlords are in effect paying renters to hold this option, a bit bizarre when thought of in those terms.)

Vancouver Rental Market Update April 2011

An important component of the housing market is the available rental stock. If inadequate housing is being built we should expect low vacancy rates and increasing rents. CMHC released its survey (press release here) on monthly rents and vacancy rates for various parts of the country. Overall vacancy rates have declined in Canada, but Vancouver and BC? Mmmm... not so much.

Rental market conditions eased across British Columbia housing markets in April 2011, in contrast to most other rental markets in western Canada. The supply of rental units increased as people moved from apartments in purpose built rental buildings to other forms of housing, including homeownership, secondary rental units such as investor-owned condominiums or secondary suites. Favourable mortgage interest rates combined with an ample supply of homes listed for sale for home buyers to choose from and a more stable economic outlook, drew some renter households towards ownership during the first quarter of 2011. The effects of this forward buying are reflected in higher vacancy rates in the province’s more expensive urban housing markets.

Other factors affecting demand for rental accommodation include immigration and youth employment levels. Immigration continues to support rental housing demand, as recent immigrants tend to rent first before becoming homeowners. However, recent data show that the level of immigration to British Columbia dipped in the fourth quarter of 2010, pointing to moderating rental housing demand. During the first four months of 2011, British Columbia youth unemployment levels rose compared to levels recorded during the first four months of 2010. Lower levels of youth employment likely reduced household formation among young adults (under 24 years of age) who are predominantly renters, reducing demand for rental accommodation.

The vacancy rate edged higher in the Vancouver CMA but remained relatively unchanged in the Victoria and Abbotsford CMAs. The movement of renters to homeownership continued during the later part of 2010 and into 2011, freeing up rental accommodation. As well, purpose-built rental apartments in these urban centres face increased competition from the secondary rental market, including secondary suites rented out by homeowners and investor-owned condominiums available for rent.

The CMHC report attempts to break down rents and vacancies based on region and on dwelling type, namely apartments, townhouses, detached dwellings, etc. based on number of bedrooms. Larger dwellings typically have higher vacancy rates than smaller ones and professionally-managed dwellings typically have lower vacancy rates than "amateur" dwellings.

Here are the numbers for "private apartments" (I'll update this as I fish out more data):

Vacancy rate

April 2010 2.2%

April 2011 2.8%

Availability rate (The availability rate measures the number of rental units which are vacant or for which the tenant has given or received notice to move and a new tenant has not yet signed a lease compared to the universe of rental units.)

April 2010 3.1%

April 2011 3.7%

Rents (CAD)

April 2010 978

April 2011 989

Change in rent

Apr-09-Apr-10 2.3%

Apr-10-Apr-11 1.6%

Consider these readings as the "core" rental market. CMHC has in the past attempted to measure non-core rentals, such as houses, basement suites, and privately-held condo units rented out directly by owners or through smaller property management companies. It appears this half's survey did not include those data. While the "non-core" data are interesting, it's difficult to ascertain whether they bring much statistically significant insight into setting housing policy. I expect if the "core" rental market is strong, so too should the "non-core" readings and, akin to core CPI, the core rental market can be used on balance to measure the health of the overall rental market.

The first item to note is that Vancouver usually has lower vacancy rates than outlying areas. When looking at cap rates for apartments, we should understand that an area with lower vacancy rates will carry a lower cap rate. Second CMHC notes (surmises?) that the home ownership rate increased in Vancouver through 2010 and the first months of 2011, meaning the "core" market faces a reduced tenant pool. Third it noted that there is decreased immigration into Vancouver than in past quarters.

I think one additional point is that, as I noted on vancouvercondo.info back in March, the outflow of temporary workers due to a federal government policy shift is starting to have direct effects on the rental market:

for Q1 2011 and potentially beyond there will be that many more dwellings looking for inhabitants, and perhaps this indicates a push by the government to get permanent residents, who are in sum suffering from elevated unemployment levels, back to work.

Backing up anecdotes I have been hearing online, the experiences of friends looking for accommodation in the Vancouver area, perusals of Craigslist, and my knowledge of landlords attempting to fill vacancies, this report should not come as a surprise.

This was a weak report for the property rental industry of Vancouver and BC as a whole. Note this trend is opposite to that seen nationally and is distinctly opposite to the direction rents are taking in the US.

Buy vs Rent Pet Peeve

News out of the US is showing prices are falling again but, on a positive inflationary note, rents look poised to rise, meaning the price-rent ratio is looking rather average. The combination of these two factors has caused the blogosphere to dust of the old rent-vs-buy calculators and show that, wonder of wonders, buying might not be such a bad financial move after all, in certain conditions, though there are still some doubters.

According to Ben Rabidoux's analysis of the data, Canada is still a ways off on this front. (Courtesy theeconomicanalyst)

There are a bunch of calculators out there, one of the more famous ones is the New York Times calculator that includes opportunity costs and other fees often glossed over by conventional buy-vs-rent calculators I've seen around. The calculator is well done, showing the number of years until owning will exceed renting from a strict financial perspective. In New York, of course, only around 55% of residents own, so there is some indication the consumer surplus (or ownership premium) is close to zero. As an investor at heart, with no ownership premium to speak of, I would recommend a more numbers-focused approach I outlined here that looks at real estate as an investment without financing costs (i.e. looking at the business case) first, then worrying about the financing later. But anyways.

I'm all for calculators -- I use one bought 20 years ago to do my day job -- but in the case of using one to calculate buy-vs-rent, one of the major pet peeves of mine is ignoring the "low probability high severity" risks in the calculations. Owning an expensive, complex and unique capital asset carries risks that are difficult to quantify on a spreadsheet. I put these low probability high severity risks into two categories: expense risk, and revenue risk.

Expense Risk

Since, for most, investing in property concentrates one's capital into a handful of assets, there is risk of some large un-hedged event occurring. For example water damage, plumbing, or other structural flaws may not be covered under insurance and many tens of thousands of dollars may need to be spent to correct them. These events will be rare but do happen from time to time.

Revenue Risk

Yes, people do get sick, die, lose their jobs, or get divorced. "It" will happen to other people until it doesn't, but we know statistically "it" will. Some of these events can be hedged against through insurance while others cannot. (Ask your spouse about buying divorce insurance if you like sleeping on the couch.) These risks are of course not unique to home owners and they can be mitigated by moving in case the expenses are too onerous. Owners face the challenge of not only moving but also selling, and this could be during a bout of market weakness; that is, the additional risk for owners is not being able to "ride out the dip" if prices fall.

Liquidity Risk

There are also risks with future "liquidity events". Housing market recessions are often accompanied by illiquid marketplaces where houses take significantly longer to sell than in normal times. If the above risks occur and cash is needed, or the house needs to be sold due to relocation or other life events, it may not be possible without selling at a steep discount. 

What can be done

Many of these items, as mentioned, can be hedged through insurance or, in the case of larger operations, diversification of holdings (which is what insurance companies do... normally). Diversification is not practical for a homeowner so he or she must absorb some of these difficult-to-hedge risks. Governments realise this to a degree, which is why they attempt to make housing more affordable for owner-occupiers through various (and often catastrophic) schemes like preferential mortgage rates, tax treatments, et cetera.

So after considering the factors in even the best buy-vs-rent calculators, there are risks that they do not account for. The nature of the risks means they are not meted out evenly and are difficult to quantify; how does one put a number on the probability of prolonged illness? The nature of low probability risks and their inability to be easily quantified means they are often simply ignored, even if they're real and potentially severe. That's a big mistake, in my opinion.

The ignoring of low probability risks is akin to a "reverse lottery". Since few will experience the fallout due to these risks, it will appear that the majority of people will have come out ahead by owning, which is true, but not necessarily in aggregate. If we sum all experiences, including the many "winners" and the few "losers", the buy-vs-rent gap narrows and may even turn negative.

The best method of mitigating low-probability high-severity risks is to demand a discount in home ownership over renting and diversify your investments. This may mean buying less primary residence and more other assets. The online calculators can only provide part of the information required to make a proper financial buy-vs-rent decision and should be used with caution.

Raising Rents

A post from Rachelle over at LandlordRescue.ca (not the imitator LandlordRescuse.com) opines on raising rents:

"As a landlord you must never be complacent about increasing your rents. Unfortunately I see this a lot. There are several misconceptions about having lower rents that are just plain wrong, in my opinion.

People will stay longer – They might but is it really worth $200 per month to you? For a long time?

It’ll rent faster – It might, but is it worth $200 per month to you?

I’ll get better tenants – If you think that less education, less income and more dysfunction makes for better tenants, good luck!

You owe it to yourself to rent 100% of your space at the highest price possible."

It does raise an interesting point about renting out units, namely are all tenants created equal? Imagine a scenario where you have two identical suites, one tenanted to a high-quality tenant who pays rent on time and requires close to no "management". The other is tenanted to a marginal-quality tenant who misses payments, causes undue wear-and-tear to the property, and is overly-demanding about repairs. Should tenant #1 be charged the same rent as tenant #2?

The answer, surprisingly, isn't so obvious. If we put on our quant hat and compare the two suites as we would, say, a bond, it should be immediately obvious that suite #1 should have a lower yield than suite #2 because the risks are different. That is, an investor will accept a lower yield on an asset with lower risk.

Yet this is often not the case, on the surface, with professionally-managed properties (well, properties in normally-functioning markets anyways...). Rent increases are pretty much de facto regardless of the tenant. If a good-quality tenant doesn't like it, he leaves and the property manager sifts through the drawer full of applications and picks the best tenant possible. In Vancouver, professionally-managed properties have extremely low vacancy rates, in the order of 2-3% and have been as low as 0.8% (which is basically choc-a-bloc).

Yet... for "amateur" landlords (landlords who act as both the investor and manager on a small number of properties) it is indeed the case that better-quality tenants will generally receive a discount compared to market rates. Put yourself in such a landlord's shoes -- you accept a tenant who smells reasonable and has a pleasant demeanor at market rate. Over time your shrewd choice pays off and he fixes his own appliances and pays the rent on time. After a year's tenure you now have a choice: raise his rent at inflation and risk him moving, or offer him a discount. It turns out many landlords will offer this tenant a discount by not raising rents, at least for a time, as an incentive for him to extend his tenure: they are effectively accepting lower yield for lower risk.

The question is, why would a professional manager refuse to "pass on" the lower-risk savings to a high-quality tenant? There are a few possible reasons for this. First the manager is often paid as a percentage of the gross rent so there is an incentive to raise rents. In addition it may look to a numbers-focused investor like a manager "isn't doing his job" if he doesn't raise rents every month. Second the manager receives a fixed rate for performing services but has limited ability to expand his properties under management quickly; if a tenant is high-quality he gets more free time but he doesn't want free time like an amateur landlord may want -- he wants more money.

Now in not-so-functional markets the professional landlord equation changes, namely when there just aren't enough "high quality" tenants from which to assemble a manageable tenant mix. In this situation there is a cap on how much time a property manager can spend on lower-quality tenants and this must be traded-off against the incentives to raise rents. We then hear of discounts from professionally-managed properties, in the form of lower starting rents or lower rent rises, and slightly increased vacancy rates on the older rental apartments where landlords would rather hold units vacant than take the risk of a substandard tenant.

In the long-run the differences in incentives between various rental property management techniques is an indication of to where higher-quality tenants will migrate; over time we should expect that an increasing pool of "amateur" landlords will accept more and more of the share of high-quality tenants who know rents will likely be lower with amateurs than with the pro shops. If you're a "high quality" tenant, you may start finding deeper and deeper discounts, especially if properties for sale stop flying off the shelves and owners decide to hunker down and rent them out instead.

Vancouver Housing-Related Statistics

This post is intended to summarise data sources that can be used to analyse the metropolitan Vancouver housing market. Many of these data sources can be used for other housing markets too. Unfortunately there is no one good source of data, however the Sauder School of Business has summarised much of the key historical data.

House Prices

Real Estate Board of Greater Vancouver House Price Index
jesse's REBGV tracking spreadsheet
Fraser Vally Real Estate Board House Price Index
Teranet National Bank House Price Index
Sauder data

Inventory and Sales

REBGV Press Releases
FVREB Press Releases and statistics
AgentWill's statistics (tracks a sub-area of the Vancouver CMA)
jesse's REBGV tracking spreadsheet

Rental

CMHC reports "Rental Market Reports — Major Centres"
Sauder data

Employment

Statscan labour force survey
BC Stats labour and income
Sauder data

Wages

GVRD city median incomes
City of Vancouver income map (2000)
City of Vancouver local area statistics
BC Stats taxfiler income tables
BC Stats labour and income

Population

BC Stats Migration

BC Stats Population Highlights
BC Stats Population Estimates
GVRD key facts
City of Vancouver statistics

Metro Vancouver housing data book

Housing and Construction

CMHC reports "Monthly Housing Statistics"
GVRD data
City of Vancouver statistics (from Census data)

Immigration

Citizenship and Immigration Canada statistics

Interest and Mortgage Rates

Sauder data
Bank of Canada data
Government of Canada 5 year bond quote

Economic Accounts
BC Stats


Economic Reports

BC Stats economic statistics
RBC Housing Trends and Affordability
TD economic reports

General

CMHC statistics
GVRD key facts
GVRD census bulletins
City of Vancouver statistics
Sauder Centre for Urban Economics and Real Estate data
BC Stats
Statistics Canada

Low Rental Yields

If you think Vancouver has low yields, check out other figures from parts of Asia, courtesy Global Property Guide:

Taiwan: Price Yields 2.84%
Hong Kong: Price Yields 3%
China: Price Yields 3%
India: Price Yields 3-4%

Those are some mighty poor cash returns, if I might say so. Certainly GPG holds back no punches calling bubbles in all the above countries and territories. Remember these are yields before expenses. In Taiwan, it is likely newly-minted landlords are making a 0% cap rate.

But before we pass off these countries as simply being in a giant asset price bubble fueled by low interest rates, it's worth asking why their yields are so much lower than in North America's. Certainly avid speculation and a lack of perceived viable investment alternatives may play a role. There is one fundamental statistic, however, that can justify lower yields: high rental and income growth rates. While inflation is high in these countries, incomes are continually outpacing inflation by a healthy margin as they play catch-up to the developed world. (Albeit Hong Kong is pretty darn first world!) This in turn increases the present value of future cash flows and justifies a lower present-day yield. This is a similar concept why single family dwellings in areas experiencing density increases have low yields: their future cash flows due to re-development will outpace expected rental growth of the current structure.

Rents in Hong Kong increased over 6% last year; in addition, it is estimated 90% of mortgage loans are variable rate, with the variable rate currently around 2% or so. But it is worth noting rental yields have been low for a long time, what Global Property Guide analysts attribute to the wealthy using property as a method of diversification. Though if rents are increasing at a healthy pace, there may be more to it than diversification. In addition, while the "wealthy" certainly have the luxury of throwing a few % of their net worths into real estate, the majority are blithely going along for the ride with a significant and relatively undiversified portion of their net worths.

It helps to look at these Asian countries' property markets since a large number of buyers and sellers in the Vancouver area originate from these countries. It gives us some perspective of the attitudes and comparables these buyers are using when determining the value of North American (and specifically Vancouver) real estate. That said, I have some concern that the economics that, in part, can reasonably justify lower rental yields in certain countries are being improperly applied to North America, where wage growth is limited close to inflation.

Central1: The sheen is clearly off the housing market

You heard them. Read their report here (PDF). A few excerpts:

The sheen is clearly off the housing market, with this week’s release of the MLS® data. As expected, residential home sales in British Columbia continued to trend lower in May. Sales fell for the seventh consecutive month, dipping 6.5% from April on a seasonally adjusted basis. Since reaching a market peak in October, annualized sales have fallen 30% to 75,500. The markets that led last year’s rise in activity, namely the Lower Mainland and Victoria, are now leading the downtrend.

On the supply side, B.C. recorded an unseasonal decline in the flow of new listings in May -- the first April to May decline since 2002. We expect to see a pattern similar to early 2008 emerge, where potential sellers hold back on listing their homes in response to higher inventory levels and price declines. However, month-end inventory levels will likely rise over the next few months as the new listings remain elevated and sales continue to trend lower.

Note Credit 1 refers to seasonally adjusted (SA) sales. This blog typically refers to non-seasonally-adjusted (NSA) sales as do the real estate boards; both methods have their trade-offs: SA is good for comparing months long trends but NSA is more closely tied to the front-line effects of supply and demand. The seasonal adjusted data seem to indicate a persistent malaise of sales reminiscent of 2008 (though not as extreme). This was relatively obvious, given listings growth since the start of the year. Interestingly they claim an "unseasonal decline" in new listings for BC in May. Certainly in Vancouver and Victoria this did not seem to be true, however it looks like inventory is now not growing as fast, not because of a lack of new listings but because of a lack of sales and a large number of expiries. Remember that a recorded expiry, sale, or (usually) listing does not change the available housing stock.

We now segue into Central1 on rentals:

Results from Canada Mortgage and Housing Corporation’s semi-annual survey of the purpose-built rental market suggest that rental demand softened over the past year as higher unemployment, particularly among young workers, and a weaker economy slowed the rate of household formation. In addition, existing renters may have found alternative housing in the competing investor owned condominium rental stock or were induced into the ownership market by lower mortgage rates.

Among British Columbia’s larger urban areas (populations of 10,000+), 21 of 27 markets reported higher townhome and apartment vacancy rates in April 2010 from a year earlier. The aggregate figure for all urban areas rose from 2.5% in April 2009 to 3.2% this year. Among B.C.’s largest markets, the largest relative increase occurred in the Victoria and Abbotsford Census Metropolitan Areas, while the Chilliwack Census Area was the only major market to report a drop in the vacancy rate. Additional slack in the rental market also impacted the rate of growth in market rents, which rose at a much slower pace in 2010. Average rents of properties in B.C. common to both the 2009 and 2010 survey samples rose by 2.2% this April, compared to 3.4% a year earlier.

A relatively bearish report on both the capital and income portions of the BC housing market.

The Dirty Underbelly

I wanted to point people's attention to the blog Landlord Rescue, a fun blog to read on the trials and tribulations of a professional landlord in Ontario.

With BC property sales relatively weak (the pace for June sales is lower than May's; in strong markets it's almost always the opposite) but borrowing rates still relatively low compared to the 15 year average, we are likely to see many investors make a longer term commitment to become part-time landlords. Many if not most will find cash flows to be stable with little hassle. While they may not be making an exceptional return if they bought at recent prices, they won't necessarily have negative monthly carrying costs. It is certain, however, a select few will be stuck with significant problems. On average, revenue from real estate is less than headline rent and expenses more than regular maintenance and taxes, which is why professional landlords typically require some premium to account for this aggregated risk.

If you are thinking of renting out a property, it's worth considering what can and does happen every day to landlords. Perhaps reading Landlord Rescue concentrates too much on the fringe cases but, at least, I hope it gives some idea of what some landlords -- and not just the professionals -- will face in the coming years.

Seafield Update

This is a quick follow-up post to the post I made on the RTO decision (PDF) last year to raise rents at an apartment complex in the West End. A relatively exhaustive series of blog posts is covering the decision. Start here.

In my analysis I was intrigued the RTO decision interpreted the law that it needn't use any evidence forwarded by tenants in making its decision to markedly increase rents above the annual cap. It turns out, according to the Supreme Court of BC, you can't do that. The law was meant as a way of ensuring that extreme cases of low rents could be fairly addressed. Unfortunately, the law has been difficult to interpret and follow. This case highlighted how much variance there is in rents, even between comparable units. Variance in rents is due to dwelling location, amenities, and quality, and quality of tenant; the law does not address the latter factor in any way.

What will this decision mean? Well, for rents that are significantly below market, there is some argument for ensuring the law is kept in some form. The alternative is a situation where the rental cap is removed and there is a continual push on the Legislature to do just that. On a street level it likely won't have much impact at all. This part of the law that allows above-cap rent increases is rarely used because of the significant amount of research and time required to make a valid case.

Removing the rental cap has its own problems, most notably that landlords can use it as a way of eviction. There are provisions for preventing this but are not universally enforced. The other method BC landlords often resort to is moving in to the property for some months -- the law says it must be at least 6 months -- but it is the prerogative of the evicted tenant to confirm this and complain to the RTO. We heard about this situation for a recent Olympic rental.

The biggest myth around rental caps is that it keeps rents below their fair market value. This is patently untrue according to all the data I have seen. The data we do have on rents come from CMHC (see UBC Sauder School of Business graph (PDF)). Average rent is increasing in line with average income, about 1.8% per year, which is less than the rental cap of around 3-4%.

No matter what the laws and protections awarded to both tenants and landlords, we do know that the vast majority of tenants are not subjected to looming eviction or massive rental increases (or even rental increases at the cap for that matter...). When a business relationship -- which the tenant-landlord relationship is in its essence -- goes sour and trust is lost, the boundaries of law, fairness, and morality are tested on both sides. I know of both tenants and landlords who seem to be perpetually in some sort of conflict with the other. I wonder if it's worth the time and cost.

Rental Rates

An article in the local newspaper the Georgia Straight indicates the effects of low interest rates.

The Metro Vancouver Housing Corporation is losing many of its moderate-income tenants to the housing market.

With variable mortgage rates going as low as 2.25 percent, plus incentives being offered by sellers, families are buying homes and moving out of affordable rental properties operated by the public housing body, according to a report by regional housing manager Don Littleford.

Although this may be good news for the real-estate industry, Littleford noted in his report—to be received tomorrow (October 23) by the MVHC board—that this is a matter of “growing concern”.

"Growing concern?" For whom exactly? The public housing that is offered by MVHC is often at a very low vacancy rate. The concern is, apparently, for MVHC's profits, not so much the tenants taking on high amounts of debt, though as a good Samaritan I would be concerned for both MVHC and the tenants. What is interesting, though, is an indication that the affordable rental market is predicting trouble filling its units. To fill the units they need only drop the price by some amount to attract more applicants, which will certainly hurt their profitability to some degree. I have little doubt they are capable of filling their units to near 100% capacity, but the luxury often awarded to these professionally-run outfits is they leeway choosing their tenants at the expense of charging slightly below-market rents. This luxury may be starting to evaporate. That produces a dilemma for the PMs: take a chance and rent to a suspect tenant or leave the unit vacant. If this is the course they take, profitability can drop by more than the implied decrease in profitability due to lower market rents.

We are hearing reports of weakness in the rental market, likely because of the combination of rising unemployment (causing people to use dwellings more efficiently) and continued dwelling completions exceeding the population growth rate. Low interest rates have allowed the choice of owning to be viable for many more compared to last year -- and a great many obviously prefer to own -- but someone choosing to own instead of rent does not change the overall dwelling supply. The weakness we are witnessing in the rental market is an indication of too much supply for what the population is willing to support. That does not bode well for residential construction starts in the next while, nor are sizable rent increases likely to stick en masse. That sounds awfully deflationary to me.

Hat tip to German Guy.

Raising Rents

An interesting case study of the provincial government’s law allowing landlords to raise rents above rent control to market rates was recently put to use with the residents of a West End apartment unit. You can read the news coverage here and here and, if you are truly interested in what is required under the Residential Tenancy Act's provision for Rental Increases, read the entire decision (pdf).

This is a bit of a long post but if you have interest in this case, you may also be interested in reading on.

In order to apply for a rent increase above the rent control limit, a landlord must show specific and comparable units whose rents are above what would be possible under normal allowed rental increases. The ruling went partially in favour of the landlords, who recently bought the units, and are looking to increase their profits.

Whether you agree or disagree with this provision in the Residential Tenancy Act is one thing. I would like to offer some commentary on how this particular case went and some observations I see ignored by the news coverage, the landlords, and the tenants.

Be Specific

It is immediately obvious the Dispute Resolution Officer (DRO) was required to use specific and comparable rents in deciding the outcome. For the most part the decision provided little in the way of specific rents from comparable units from tenants. The DRO used only a handful of comparable properties in making the final decision, all from the landlord.

In the decision the DRO has stated:

The landlords do not have to prove that the rent is significantly lower than all comparable rental units, but merely have to prove that there is evidence that in the current market, there exist similar rental units which attract a higher rent than what is currently being paid for the subject unit

An interesting interpretation of the Act; it effectively cuts the tenants from having their data used as balancing evidence. Scary perhaps. But if it's any solace most landlords don't resort to such rent increases, and not because they are bad businesspeople.

It is probably fair to say the landlords filtered units for rents that were purposefully higher than those in the units they own. It would be silly of them to present units that do not maximise the rents they can charge. But, yes, they are allowed to do this.

The tenants have learned the hard way that, while they needed to find specific and comparable examples to their units, when it came time to make the decision, it didn't seem to matter. Given all tenants in that neighbourhood have an incentive to keep their rents down, the tenants should have had no problem finding comparable rents that were not cherry-picked to be high. What I am not sure of is what burden of proof tenants are required to show to have their evidence considered and accepted. This is certainly a valuable lesson to be learned by others who may find themselves in a similar situation.

Subprime Tenants

What is often missed by looking at listing rents is that renters, like mortgage applicants, have different credit ratings. I am sure landlords will agree that there are tenants that are duds. If a landlord were to rent to such a tenant, to compensate for the added risk of taking on a deadbeat tenant, he should charge a premium.

Why this is important is that, while the Act looks at comparable rents to make a decision, no weight is given to the quality of the current tenants. It could be these tenants are “golden”; maybe they always pay their rents on time, perhaps even taking on repairs themselves since the rent is so good. The previous owner may have accepted lower rents because the risk was exceptionally low.

With new landlords, these unfortunate tenants have effectively lost their built-up credit and business relationship with the previous landlord. To be fair, the new landlords don’t know these tenants from a hole in the ground so are, perhaps a bit naively, treating them as any generic off the street renter. By raising rents to market rate, they are effectively raising rents to what they would charge a tenant with no “credit” history.

What are the current tenants to do? Perhaps they will accept the rent increase, act in good faith, and try to build up their past good favour again with the new boss. This will manifest itself by below inflation rent increases as the landlords realise the tenants are actually “prime” tenants. This assumes the landlord places value on low maintenance tenants. Not all landlords think this way, in which case I would strongly advise the tenants to find a landlord who does. There is no easy way to win a war with a slum lord, or even a landlord looking to offer a premium service for a premium price.

The problem now for the landlords, unfortunately, is that by taking an adversarial approach, they will most likely be paying more than they would should the rents have been raised at a smaller rate. The tenants who decide to stay will undoubtedly “work to rule”. Perhaps the little repairs and renovations they did to save their previous landlord money are now left to the landlord to handle. Perhaps heats are turned up a little too high.

It is hard to really know the motives of the landlords. It could be they are hardnosed businesspeople who will run this rental complex like a generic high turnover unit. This is their prerogative of course but this comes at a much higher operations cost than would a stable lot of tenants, either through higher turnover or greater wear and tear. To be fair, some landlords charge high rents but offer a high quality service to compensate. Perhaps they paid a high price for the units and the only way to stay cash flow positive is to jack up the rents. I don't know anything specific about the actual owners in this case.

All’s Fair

The third thing to note about this sad affair is that, while the Act’s arbitrator has decided for a marked rent increase, the court of public opinion is much more divided and angry. Rent control and the treatment of seniors (of which some of the tenants happen to be) seem to trigger an emotional response. I am sure the landlords have faced added stress and complications by having these tenants go to the local press. Tenants certainly played the sympathy card well, given the high level of media coverage.

I am sure readers here have an opinion on this case. It is a complex issue and I have sympathies for both sides of which I will not expand upon much. But I will say that it’s completely fair game for the tenants to have brought in the media who effectively sensationalised this story. Like it or not, a free press is, well, free to report on these stories as they see fit.

Actually, it was a decent strategic and tactical move on the part of the tenants, worthy of careful study in business schools. The landlords, while likely pissed off, should not be too surprised they are receiving such attention, as should any businessperson trying to make money through uncomfortable situations such as this one. Par for the course, guys. I doubt, though, these landlords really thought media coverage likely before they bought.

In the end, the landlords received a partial increase in rents for some of the units, to be phased in over a course of several months. But with them having an entire building of pissed off (and possibly high quality) tenants who can make the landlord's life miserable or move out and be replaced with what could well be higher maintenance and riskier tenants, I wonder if their investment is really going to be a good one in the end. It could also be that these rents were just too low.

Owner’s Equivalent Rent

A question surfacing recently on local blogs and forums has been how to properly value owner-occupied housing. The concept of “owner’s equivalent rent”, the effective rent an owner-occupier pays to carry a property, can be used to justify a property’s value. Such a concept would require setting equivalent rent based upon what other owner-occupiers pay, a slightly unsatisfying exercise for the value investor. A more palatable method would be to find equivalent investment properties and see what rents they command but this is not always easy. It begs the question: how does one ground a property’s value when there is little in the way of equivalent local rentals to do so?

A recent article in the Vancouver Sun had three local pundits involved in the real estate industry give their comments about the local real estate market. While I cannot encourage you to read it fully, I did pick up on a few items Dr. Tsur Somerville from the University of British Columbia has said about his research in how real estate markets behave with a significant portion owned by owner-occupiers.

Q: You said the investment piece is gone: Does that mean that the froth is not going to happen again? (If people aren't buying as investment properties, what would happen with price?)

Tsur Somerville: A couple of issues: No. 1, we don't actually really understand what goes on with investment real estate. When you look at research and studies, it is because home owner/occupiers are such a big piece....

Q: How big?

Tsur Somerville: Since we don't actually 100 per cent know which unit is which. But if you take the Lower Mainland and [calculate] 2.5 million people, 2.6 people per household, that's 800,000 households, 60 per cent homeownership [so] 480,000 households.

The investment piece is still very small in the overall number. It's highly concentrated in certain product types, downtown condos, certain suburban high rise buildings. Overall, it's not a big story. Going forward, we have two things we don't really understand, which is what are those people going to do?

What Dr. Somerville is commenting on is that when owner-occupiers make up a significant portion of a housing pool, it becomes more difficult to determine motivations of marginal players when existing data lump investors and owner-occupiers in one pool, especially when the “investment piece is still very small,” say, 40% of total households.

Joking aside, what I believe is implied is many people place a monetary premium on ownership and motives for buying and selling are not always strictly financial, hence the difficulty in separating true “investors” from the rest. (this blog discussed the concept of the "ownership premium" here.) The “non-investment” focus of marginal owner-occupiers therefore adds uncertainty to the behaviour of the market. He states that there is segmentation between owner-occupied and rental housing, or at least that is the perception, meaning that valuing entire neighbourhoods based upon the whims of investors not heavily involved in the market is questionable.

From a value investment perspective, to determine the net present value, we sum a property’s expected discounted net cash flows. We should also remember that undensified detached housing can justifiably carry a premium over today's rent as the property could be redeveloped in the future so as to increase its utility (as discussed here) and possibly a "gentrification" premium AKA location-location-location in some circumstances (see m-'s great post for some interesting data and analysis). Determining net present value with many equivalent properties with known rents is simple; unfortunately it is more difficult when properties have few direct comparisons. It is possible that in certain neighbourhoods the one or two rentals offering true comparables do not provide enough of a sample to truly gauge what rents would be for other properties. This can even be true for a seemingly normal property with a high finish quality where the neighbourhood's rentals are not renovated to the same degree.

Buyers are therefore left looking at comparable sales in the same geographic location to determine value, in part because neighbourhoods and even adjacent blocks can significantly vary in price. I doubt very much rental data enters into most owner-occupiers’ heads when determining a fair price yet it is an important and almost necessary clue when determining a property’s value ex speculation. Perhaps it is a stigma associated with comparing “the renters” to “the owners”; an admission a property can be rented out at all goes against the concept of “achieving” ownership, or maybe it is just making the buying decision simple: find five comparable sales, offer about that, and Bob’s your uncle. Alas, this is not my idea of value investing.

Believe it or not, even “high quality” houses are rented out. A quick search of Craigslist turns up a few “high quality” rentals, as examples (not sure if they’re “real” or not; these props will likely disappear so maybe do your own search...):

You can calculate how much these properties would be worth as net present value and compare to their rough market values. There are not too many examples of higher quality rentals, however, and we are still left with the problem that a specific neighbourhood will likely reveal few, if any, equivalent rentals for a property for sale.

Yet even from the close to nonexistent comparables, we can still make some assumptions. In the absence of direct data we can look at high quality rentals across the entire region and compare them to lower quality rentals in their respective areas. This will give a rough indication of the premium higher quality demands in the rental market. From this we can look at a larger set of “high quality” compared to “lower quality” rentals and apply a factor to determine equivalent value for a certain “higher quality” property. The concept is simply that there are many neighbourhoods that are effectively comparable, even if separated geographically.

Using comparables from other neighbourhoods is roundabout method of determining value. The uncertainty is higher and my guess is Realtors won’t like the concept one bit; after all isn’t all real estate local? But we need something, even if it’s using deductive inference, or the market is not grounded on anything but sentiment and margins.

Many neighbourhoods have a large mix of both rental and owner-occupied properties so the problem of determining value for the value investor is less severe. For some neighbourhoods, say close to UBC for example, the concept of determining value for predominantly owner-occupied properties I am sure can seem daunting. Even in the face of such high noise, using a bit of deduction, an expanded "virtual" rental market provides us with enough of a tangible signal highlighting how much "high quality" properties are currently priced above what the rents say they are worth.

The Rental Shortage

The Tyee has had an interesting series of articles on the housing market of late and the latest in their installment is The Path to New Rental Homes: One Broker's View by guest poster David Goodman. I encourage you to read the post as it highlights some of the technicalities surrounding building rental housing in the Vancouver area. Certainly it seems, on the surface, to be a bit of a quagmire.

First he starts off by setting the scene:

During my 26 years in apartment sales, I've heard on at least 50 separate occasions developers commenting that "even if the land is thrown in for free, we cannot make the numbers work on a new rental building." As a result, the Vancouver vacancy rates stands at 0.5 per cent, the age of the average purpose-build rental is 50 years plus, and local developers attempting to produce new rental housing are likely to lose money.

So developers cannot "make the numbers work"? Sounds reasonable. But I don't really get it. The vacancy rate is low, apparently signaling low supply. I would expect rents to increase to compensate for the low vacancy rate. I wonder why rental rates aren't increasing -- maybe the vacancy rate isn't as low as he is citing? He continues:

Things changed considerably in the early 1970s when the strata condominium was introduced to the market. This new concept provided buyers, including tenants, the opportunity to purchase and own their own suite rather than pay rent. Prices paid for condominiums were soon much higher than rental apartments. As a result, land quickly increased in value to reflect the fact that building condominiums was significantly more profitable than building rental apartments. Accordingly, except for very few special situations, the construction of purpose-built rental properties ceased. This situation has not changed much since the 1970s.

Ahh now we get to it. The reason purpose built apartments have not been built is because building condos is more profitable. It certainly seems that, given the horrid price to rent ratio in the city, any developer would be batshit crazy to build something with cash flows unlikely to cover debt repayments and other carrying costs (except with a large downpayment of course! haha).

Over many years, the developers of condominiums would assemble single-family lots in apartment-zoned areas or seek to rezone former industrial sites. Unfortunately, we have almost exhausted the conventional source of residential development land throughout the Lower Mainland. As a result, the cost of multi-family zoned land and the resulting new condominiums have increased much further in Vancouver compared to other parts of Canada. This is one reason why we have all heard of some prime Vancouver sites selling at over $200 per square foot gross buildable at the recent peak of the market.

The old faithful "running out of land" argument. Can we be so sure about this? Maybe it seems land supply is tight because there are so many projects under construction? The population didn't suddenly explode in the past 5 years and hit the buildable land brick wall. It is entirely possible what we are witnessing is underutilisation of existing housing and speculation. If we were truly land constrained wouldn't real rents be increasing as well? Strange how they are not.

I have learned to appreciate the important real estate concept known as "highest and best use" in considering the value of real estate.

Developers and value investors share this philosophy. But the difference is what "value" means. For the developer it's a very simple and short term calculation: build within one or two years and sell, pre-sold or on spec, to someone else, likely a speculator (in one form or another). This dude either occupies it, using the full brunt of his ownership premium, keeps it dark for a flip, or rents it out at a yield a developer wouldn't touch with a ten foot barge pole. Value investors, on the other hand, look at "highest and best use" more on what cash flow is possible. It may mean re-development but only because doing so generates higher rents to compensate for the construction costs and delay in occupancy. I have no clue the thought patterns of Mr. Goodman's current clients though I would expect, given they are the "dudes" buying the bags, it's not exclusively a value play.

Purpose-built rental housing is not being built because of more profitable alternatives to the developers, namely selling it to someone else to deal with. I laugh when I realise the rental vacancy stats Mr. Goodman cites don't include small time landlords to whom his developer acquaintances sell. I am sure regulation plays some part but give me a break -- even if we remove every shred of red tape surrounding rental units it still wouldn't make sense UNTIL THE RENTS CAN COVER THE THE CARRYING COSTS.

It is laudable Mr. Goodman's suggests to streamline the ability to build purpose-built rental housing again but to think doing so will suddenly swing developers into the rental camp again is a bit too "rich" for me, at least until land values drop or rents increase to where it makes financial sense. I encourage him to keep priming the pump for such an eventuality.

Developer Turns Condos into Rentals

I came across this interesting article -- from January 2007 -- about a developer named David Franco turning an unbuilt Washington DC development from luxury condos into rentals. To quote:

"In many cities, banks have significantly scaled back loans to condominium builders. Some have demanded that developers sell half or more of the units in a building before even beginning construction.

In hopes of salvaging something from their costly plans, hundreds of developers like Franco are looking to the strong market for apartments, planning to rent their units for at least a couple of years while waiting for today's condo surplus to shrink.

After six weeks of failing to lure more than a couple dozen buyers, Franco and his partner, Jeff Blum, joined the builders of nearly 6,000 condominium units in the Washington metropolitan area who have decided in the last three months to recast their projects as rental apartment buildings."

Read the whole thing. Like a book we've already read, today we hear this:

"In the face of sales that have ground to a halt, Wall Financial Corp. has decided to scrap its 414-unit Wall Centre False Creek condominium project in favour of building rental apartments on the site, company principal Peter Wall said in an interview.

In its last quarterly financial results, Wall Financial said it had sold almost 30 per cent of the Wall Centre Creek's units, 120 in all, but that sales had come “to almost a complete stop” during the quarter."

I see. What an innovative concept! Vancouver hasn't seen any substantive purpose-built rentals for years now so sounds like a winner; a real contrarian move. Surprised nobody else has thought of that. I would love to see how Mr. Wall pitches this idea to his financial backers, or is he using his own money?