Thursday, November 27, 2008

Ubergeek Post Update - Price Changes and Months of Inventory in GVREB

Here is a quick update on the work mohican and I did in the spring around refining mohican's work tracking price changes and months of inventory. Remember that the best fit was to track half-over-half (i.e. 6 months over 6 months) price changes to a three month moving average of months of inventory (total active listings at the end of the month divided by the sales in that month).

Here is mohican's famous scatter plot for half-over-half versus 3 month moving average MOI:

Remarkably the correlation is disturbingly accurate into the downturn. Looking forward we can see how well the model has "predicted" the next month's price movements.

By happenstance we can see the model was consistently predicting larger price drops than actually occurred, except last month when it was bang on. In any case, the model predicts the November benchmark to be 14.1% below that of May of this year, or about $611,000. Likely a bit aggressive, but there it is. I am expecting the November benchmark to come in around $650,000 with what looks like a long way to go in the southern direction.

Thanks Jesse for the update.

I wanted to weigh in here on this model because at the time when we put it together we didn't know how well it would help us predict price drops. It apparently worked exceptionally well and put us ahead of the curve when looking at the size of the potential price drops. I see no reason to expect a change now. More price drops to come.

Tuesday, November 25, 2008

Vancouver CMA CMHC Data

It has been awhile since I updated the CMHC statistics. Here you go.

This chart shows the number of units under construction (blue) from 1948 through 2008. It also shows the last 12 months of housing starts (red) and the last 12 months of completions (yellow).

With the current slowdown in the local real estate market you would think that developers would accelerate completions and hold back on starts but it turns out the opposite has been true of the past six months. I can understand not rushing to push new units into this market but why start so many?

The number of housing units under construction is at all time record highs and there is a virtual tsunami of housing units close to hitting the market. This will flood the supply situation even further than now and combined with the abysmally low sales levels we are looking at large and sustained real estate price decreases for quite some time.

Sunday, November 23, 2008

26% Price Drop in 6 Months

I received an email from a regular reader that informed me of a new home that has dropped in price 26% from peak pricing only six months ago. I looked into this alleged price drop and it checked out. Here is a link:

This is a development of 40 or so smaller townhomes in the eastern Fraser Valley - Chilliwack. The asking price for these townhomes in May 2008 was $269,900 and today they are $199,900 with an additional offer of special financing for the first 3 years. It appears the developer is getting eager and wants to quickly unload the rest of this project. I am certain there is a fair bit of margin for the developer to work with here but I suspect the bonuses for those working at the developer won't be gigantic this year.

This is the biggest recorded asking price drop that I have seen so far. It is no surprise that we are seeing the biggest and fastest price drops in the farther reaches of the Fraser Valley. This is exactly what happened in the other North American bubble markets only it is happening here faster! In fact, this is quickly approaching affordable levels, albeit in Chilliwack. But with $10,000 down and a mortgage / strata / tax payment of $1300 / month it is comparable to rent. Very accessible for a first time homebuyer with stable employment, you just better not have to commute further than Abbotsford!

Post your anecdotes of price drops here with the developer's website or MLS Listing number.

Wednesday, November 19, 2008

Likely Outcome - Price Drops to continue to 2011/2012

In the efforts to visually represent a likely outcome for local housing prices I put together the chart (above - click to enlarge). I think it is likely that the benchmark detached house in Greater Vancouver will fall no less that 40% in value from the April / May 2008 peak price. This is a likely trajectory of the fall given the current and expected economic climate. I fully expect the majority of the price correction will take place over the first 24 months so we will see prices 30% lower by the time we are just about experiencing the hangover of hosting the Winter Olympics.

Of course nobody knows for certain how large this correction will be or how fast but I think based on current data this would seem a probable outcome.

It will be a good day when the average family can afford a basic home and condos are affordable for first time buyers.

Greater Vancouver House prices shoud be no more than $500k for a decent house in a decent neighbourhood and Fraser Valley houses $350k for the same. Greater Vancouver one bedroom condos should fall to $150k and Fraser Valley $120k. By the end of this, it will as if the bubble never happened except for the shattered finances of the speculators, and highly leveraged peak buyers.

Saturday, November 15, 2008

"Boring" Canada's Financial Tips for the World

Ottawa, November 13, 2008

From Finance Canada.

The following guest column by the Honourable Jim Flaherty, Minister of Finance, appeared in today’s Financial Times. In it, Minister Flaherty outlines Canada’s five-point plan to restore stability to the international financial system.

"The financial crisis that began 14 months ago in the US has intensified and spread around the world, threatening to roll back economic progress that has been made over the past two decades. Governments have been responding in a co-ordinated fashion and will continue this work in the lead-up to the summit of the Group of 20 leading economies.

"Few countries are as dependent on trade or as integrated into the global financial system as Canada. Yet our financial sector continues to weather the turbulence better than many other countries. This did not happen by chance. Canadians by nature are prudent and our financial system has been characterised as unexciting. Canada’s regulatory regime ensures that stability and efficiency are balanced. As a result, Canadian taxpayers have not had their money put at risk in response to this crisis. If Canada’s financial system is boring, perhaps the world needs to be more like Canada.

"Before we examine grand designs for global regulatory regimes, we need to recognise that good regulation begins at home. Effective national regulatory regimes could have prevented this crisis and must be our first line of defence against any future one. We all need to draw lessons from those systems that worked well and apply them to our national regulatory regimes.

"First, we need to regulate all pools of capital that rely on leverage. The crisis has demonstrated the devastating impact that unregulated entities can have. Transparency requirements must be the price of admission to global markets. Different financial services may have different regulatory requirements, but we need to bring them all under a regulatory umbrella.

"Second, capital and liquidity buffers need to be large enough to handle big shocks. Moreover, regulators must restrain overall use of leverage. Some have criticised high Canadian capital requirements for banks as being too conservative. But the strong balance sheets of Canada’s banks through this period speak for themselves.

"Third, it is not enough for regulation to look at individual institutions. It needs to look at the system as a whole. Risks that may appear sensible in isolation can be unsustainable from a systemic perspective. This systemic vantage point must be used to mitigate any tendency to underestimate risk when times are good. This requires co-ordination across the government, central bank and regulatory agencies.

"Fourth, we need to make market infrastructure more transparent and resilient. Non-transparent over-the-counter trades and naked short-selling reduced the stability of the system.

"This crisis has demonstrated that even countries with strong financial systems can feel the effects of inadequate regulatory regimes elsewhere. Countries may hesitate to impose new requirements on their own institutions if these measures will create a competitive disadvantage. This points to the importance of the fifth step: strengthening international co-ordination, review and surveillance to create a better second line of defence. Canada was a pioneer of the joint International Monetary Fund-World Bank financial sector assessment program. This independent review of domestic financial systems should be mandatory and public. We need to strengthen the role of international colleges of supervisors to ensure better understanding of systemic risks and to co-ordinate national actions. We need IMF surveillance with teeth. Countries must live up to their responsibilities to support global financial stability and growth. Nowhere is this more important than in correcting global imbalances through appropriate exchange rate and macroeconomic policies to support growth.

"The process of how we make decisions is equally important. In two decades of unprecedented growth, we have seen the emergence of dynamic new economic players that must be full participants at the global table. Canada took one of the largest share cuts of any country in the recent IMF reform exercise to ensure that emerging economies are better represented. This broader range of voices must be heard in other venues such as the Financial Stability Forum.
"Together, these reforms must ensure that incentives are aligned to support stability and that resilience is built into the financial system.

"The open market system did not fail in this crisis. However, some forgot Adam Smith’s maxim that the invisible hand needs to be supported by an appropriate legal and regulatory framework. We need to work together to strengthen those frameworks, and that work must begin at home."

Thursday, November 13, 2008

Canadian Banking - Up for Discussion

Video here.

TORONTO, Nov 12 (Reuters) - Canadian banks should be able to get through the financial crisis without relying on the kind of government aid that is being deployed to financial institutions in other countries, Toronto-Dominion Bank's top executive said on Wednesday. While the Canadian government just announced an increase in the size of its bank mortgage buyback program -- boosting the program to C$75 billion from C$25 billion -- the federal government is actually making money on that program, TD Bank President and Chief Executive Ed Clark said.

"This is a pretty good deal from the government's point of view," since it gets paid to buy mortgages from banks that a government agency has already guaranteed, he said. Canadian banks, with strong balance sheets and healthy mortgages on their books, are using the government buyback program to fund themselves at rates comparable with, or better than, what banks elsewhere in the world can get, he said. Clark was speaking at a financial conference in New York organized by Merrill Lynch.

"We would like to get through this crisis without government bailouts, there have been no bailouts of the Canadian banking system," Clark said. TD, which has grown substantially in the United States through acquisitions in recent years, does not have to make another U.S. purchase to fulfill its business objectives, he said. The bank acquired New Jersey-based Commerce Bancorp earlier this year, and privatized TD Banknorth in 2007.

"We can grow organically, if you take a look at the average bank in the U.S. and strip out acquisitions, it's not obvious that there's a lot of organic growth there," Clark said. But TD, Canada's second largest bank, would consider U.S. acqusitions if certain conditions were met -- that is, if a potential deal were in its existing East Coast footprint, if it were cheaper to buy than build out its branch network, and if it involved minimal asset risk.

"You're not going to see us suddenly move up the risk curve in this environment," Clark said. He also said it seems "inevitable" that a U.S. recession will spread to Canada, where the bank's loan book is more retail oriented. TD expects provisions for credit losses to rise in the next few years, but from a low base, Clark said.

Wednesday, November 05, 2008

REBGV October 2008

The formerly 'immune' greater Vancouver housing market caught a cold in May and it has turned into pneumonia as the weather has grown colder this fall.

The number of homes for sale in the area is at record levels.

The level of sales is abysmally low.

Consequently the Months of Inventory, the number of months it would take to sell all the homes currently listed for sale, is in the stratosphere.

This basically means that prices are going to keep going down, down, and down for quite some time.

And down they are falling, nearly 10% since May. Yes TEN PERCENT or $75,000 off the benchmark single family home. $75,000 is a lot of money.

This post is brought to you by the letters P and D.
PRICE DROPS. Here now, here to stay.

FVREB October 2008

One could undeniably say that real estate prices in the Lower Mainland collapsed during October 2008, which is likely to be the first of many months of drastic price reductions.

The story is rather simple.
1) Prices went up a lot
2) Nobody could afford to buy anymore
3) People still wanted to sell so active listings rose significantly

4) People still can't afford to buy and sales dropped off a cliff.

5) Consequently the months of inventory rose to unprecendented levels.

6) Prices began to moderate.
7) Prices began to fall
8) Prices began to fall quickly.

9) Prices are now lower than one year ago.

10) Prices will certainly fall much further given the supply of homes on the market. The correlation between the supply/demand scenario and price changes is rather strong.

Welcome to your real world, made in Vancouver, real estate bubble and crash.
Yours in lucid sanity,

Real Estate Board Stats

I am working on the month end stats from the local real estate boards but I have had a couple busy days planned, including today, so I won't post until later. If I get a chance during the day, I may be able to work on it.


Monday, November 03, 2008

Sauder Housing Predictions

In a previous post I outlined basic theory behind net present value (NPV) calculations as it pertains to real estate and related it to a working paper (PDF) published by Dr. Somerville and Kitson Swann at the Sauder School of Business at UBC. I have read a few online discussions popping up recently regarding this paper, brought on I am sure in part by Dr. Somerville’s many recent quotations in the local media.

The paper claims that Vancouver’s house prices would need to drop 11%, from a benchmark of $754,500, to return to “equilibrium”: $680,000. If we look into the methodology used in the paper, the cost of capital elements such as tax, depreciation, and maintenance are determined by a percentage of current house value. This is fine however, should the house value change, we must re-adjust the figures as I will now do.

The cost of capital was calculated to be, as percentages of the original price: maintenance and insurance 0.5%, depreciation 1.07%, and tax 0.5%. All of course are fixed costs that will not vary significantly with changes in land value so nominally these values are $3773, $8073, and $3773 respectively. Note the $8073 number for depreciation is way too high and should be around $2500-3000 but for now let’s leave it as is.

The REBGV just released their statistics showing the new benchmark price in Vancouver is about $696,000 so let’s re-calculate the cost of capital, assuming as before a 5.4% annual capital appreciation (which I will deal with in a bit). The new percentages are: maintenance and insurance 0.54%, depreciation 1.16%, and taxes 0.54%. The new equilibrium cost of capital is 4.27%.

Uh oh. Now we need to re-calculate a new equilibrium price with the new cost of capital. Plugging in the numbers we get a new “equilibrium” value of $652,000. That is a drop of -13.5% from the paper’s benchmark price and a further -6.3% from today’s market price. If we perpetually plug in the new “equilibrium” prices into the formula, as we now must given prices are dropping fast, the new “equilibrium” converges at $602,000. Put another way, the true “equilibrium” price, given the property’s nominal costs and expected capital appreciation, is -13.5% below today’s benchmark price and -20% below the number used in Somerville et al’s paper.

It unfortunately does not stop there. I must take exception with the purported 5.4% annual appreciation numbers cited as the long term expected average appreciation in Vancouver. While this may have been true in the past there are at least three good reasons to believe this level of appreciation is far too optimistic.

The first way that prices appreciate is by rising incomes however Vancouver’s real incomes are flat. This means that in terms of long-term affordability, dwelling prices cannot increase much faster than incomes are rising, roughly at the rate of inflation. There is little in the short term to believe that incomes will be rising faster than inflation; in aggregate with falling employment and a looming recession the opposite is far more likely to happen in the medium term.

The second way prices appreciate is by densification; that is, the anticipation of using a piece of land to produce higher future incomes. Here there is a good argument that some property prices can appreciate faster than incomes are rising if they have not fully densified yet. However some quick deduction can show that there is a limit as to how fast average densification can occur: the population growth rate (around 1.2% in Vancouver area). From a practical perspective the actual densification will occur less because new land (farmland and forest) is being turned into residential dwellings, easing the maximum densification potential.

The third, and the most striking, way prices appreciate is through a waning of inflation expectations that has resulted in perpetually lower mortgage rates over the past generation and this has, through a perpetually decreasing cost of capital, caused unusually high capital appreciation. We are at a point where inflation expectations are unlikely to decrease much more. The best scenario is for mortgage rates to stay flat; the worst is for them to increase.

Taken all three together, the maximum nominal appreciation I would expect from Vancouver detached housing going forward is around 2.5-3% annually. Condos, due to the fact there is little possibility of densifying further, will likely appreciate at inflation, say, 2%.

Coming full circle, using my newly expected capital appreciation estimates, we can further adjust the cost of capital up by 2.4% and re-calculate “equilibrium” value. Astonishingly the new price drops to $270,000. Note this is too low, mostly because the depreciation number used in the paper is too aggressive. Using a more realistic annual building depreciation of $2500 we can re-calculate “equilibrium” at approximately $400,000. You can make other assumptions – perhaps a lower mortgage rate – and arrive at equilibrium a bit higher, however it will be difficult to justify anything but a significantly reduced outlook for the long-term appreciation of property prices compared to Somerville et al’s estimates.

Edit: Commenters here and in other places in the local RE blogosphere have raised questions about depreciation as a line item in a DCF (discounted cash flows) calculation. While I agree depreciation is not a cash flow, in this case depreciation represents an expected decrease in future cash flows below headline estimates. In terms of the formula's framework, for what it is, depreciation does account for decreased future cash flows but is not explicit enough to really know what Somerville is modelling. Read the comments for an alternate approach.

Also the "densification premium" awarded to detached properties is further reduced when one accounts for capital costs associated with making land more productive. More bad news.

Value Investing in the Current Environment

From here.

Jeremy Grantham is the Chairman of the Board of Grantham Mayo Van Otterloo, who manages approximately $120-billion in assets, well known among institutional investors but relatively unknown to retail investors. Here are some highlights from both parts of Grantham’s October 2008 newsletter “Reaping the Whirlwind,” and ”Silver Linings and Lessons Learned.”

Part 1, “Reaping the Whirlwind,” published 2 weeks ago:
“At under 1,000 on the S&P 500, US stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10 prices, but even more so. History warns, though, that new lows are more likely than not.
“Fixed income has wide areas of very attractive, aberrant pricing.
“The dollar and the yen look okay for now, but the pound does not.
“Don’t worry at all about inflation. We can all save up our worries there for a couple of years from now and then really worry!
“Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows.
“As for us in asset allocation, we have made our choice: hesitant and careful buying at these prices and lower. Good luck with your decisions.”
You can read ”Reaping the Whirlwind,” in its entirety by clicking here where Grantham has published his views on the fallout from the financial crisis and the investment opportunities he sees.

Part 2, ”Silver Linings and Lessons Learned”, published early this week:
“When asked by Barron’s on October 13 if we would learn anything from this ongoing crisis, I answered, ‘We will learn an enormous amount in a very short time, quite a bit in the medium term, and absolutely nothing in the long term. That would be the historical precedent.’
“That is unfortunately likely to be the case. But over the next several years at least, there are many silver linings and valuable lessons to be learned.
“Chief among the many benefits of this crisis are unprecedented opportunities for investing in some fixed income areas where some spreads are so wide as to reflect severe market dysfunctionality.
“As of October 18, we also have moderately cheap US and global equities for the first time in 20 years. Probably quite soon, global equities too will offer exceptional opportunities after the additional pain that is likely to occur in the next year.
“We are reconciled to buying too soon, but we recognize that our fair value estimate of 975 on the S&P 500 is, from historical precedent, likely to overrun on the downside by 20% to 40%, giving a range of 585 to 780 on the S&P as a probable low.
“The world faces unavoidable declines in economic activity and profit margins, so this overrun is unlikely to be much less painful than average, although you never know your luck.”
You can read ”Silver Linings and Lessons Learned,” in its entirety by clicking here where Grantham has published his comments on lessons learned from the credit crisis, as well as his proposed strategy.

Source: Jeremy Grantham, GMO, October 2008