Friday, July 31, 2009

Fixed Fee Realty?

The concept of a fee-for-service Realty agency has been thrown around a lot but the old commission-based model still seems to be the only game in town. I happened to pick up a copy of this week's Business in Vancouver newspaper and find this article on the last page:

Auto advocate does the legwork for car-buyers (subscription; if you want to read the whole thing, find a copy or pay the subscription fee)

I will quote from the article so as to make my point:
After working in auto sales for years, - something he admits he wasn't very good at -- [Rob] Fournier decided to launch Burnaby-based Cornerstone Concepts in 2007 and took it full time in February 2008

The purpose: to act as an advocate between members of the vehicle-buying public and new, used and private car dealers.

Sounds like a Realtor but for cars. Perhaps he's an... Autotor? Actually he's not. There are places around that will act as brokers shopping for a car but here Rob's business model, or at least how he spins it, is a bit different:
While similar to car brokering services, Cornerstone Concepts does not accept money from dealerships for bringing in potential buyers or making sales on vehicles, according to Fournier. "We are completely unbiased."

Fournier charges $700 for finding new cars for his clients and $850 for used cars, including taxes. His fee covers vehicles priced from about $5,000 to $90,000. The used-car fee also includes CarProof, a vehicle history reprot, a BCAA mechanical inspection as well as a BCAA membership

So he's not really like a Realtor at all. He gets a fixed fee and makes a fixed amount ensuring he can match a car with the client. The way Fournier is selling his business is that he exclusively focuses on his clients' best interests without being induced to work for a buyer-paid commission.

I don't know how Fournier's company's sales are doing but I can see a definite business case for such a service. He purports to be grossing six figures on an annualised basis. His business is operating on his clients trusting his expertise and honesty, something to be honest I see generally lacking in the real estate business.

So for all Realtors out there looking for a tangential journey in the real estate world, such a parallel client-focused fee-for-service business could generate some noise, especially in a few years when some more tentative clients start looking to buy property again. The key, of course, is experience and trust, the latter is hard to gain but very easy to lose.

Thursday, July 30, 2009

Personal Finance and Buying a Home

Something that I haven't quite got my head around is how so many (thousands per month) people can seemingly 'afford' to purchase homes in the Vancouver area considering the prices at which local homes seem to be sold at. Greater Vancouver benchmark for all dwelling types is just about $520,000 as of June 2009.

Let's look at a sample first time home buyer.

Let's imagine John and Jenny want to get started on the property ladder after getting married last year. They have saved $10,000 over the past couple years and they have about $25,000 in their RRSP accounts which they intend to use toward a property purchase under the Home Buyer's Plan. Jenny's parents have offered to help them purchase their first home as well with an extra $20,000 'loan' to be used toward a down payment that may never need to be paid back. They don't have any credit card debt but are making payments of a combined $900 per month on two car loans which have 3 years left on them. Combined down payment = $55,000.

John makes $60,000 per year working in the technology field and his job prospects are very good given his education and work experience. Jenny works in sales and her income has averaged $50,000 per year over the past two years. Although she does okay at work, her job prospects are sketchy as the company she works for has seen business drop off considerably and has laid off a few people in the last few months. Gross Annual Income = $110,000. Net Monthly Cashflow = $6,000.

They are wondering what they are able to afford (apparently they don't have a budget) so they go talk to a mortgage broker about their situation. The mortgage broker punches some numbers into the computer and comes up with a preapproval amount of $430,000. John and Jenny are amazed, they wonder what they have done to make the bank love them so much! This pre-approval emboldens them.

They call up a realtor and begin looking at homes in the $400,000 to $500,000 price range. The realtor shows them several condos and a few townhouses which meet their criteria and they settle on a nice townhouse and make an offer for $450,000 which is accepted and the deal is drawn up.

John and Jenny put $45,000 down by using the parent's money and withdrawing from their RRSP accounts under the Home Buyer's Plan. They have paid CMHC and legal fees of $9,000 which gets added to their mortgage so they owe a total of $414,000 and they have decided to amortize over 35 years (they will be 65 when it is finally paid off if they stick to the original plan with the original rate) with a 5 year term and a rate of 4.5%. They will be making principal and interest payment of $1,950 per month, they have added life insurance to the mortgage ($50) and are paying property tax monthly with their mortgage payment ($200). They now get to pay strata fees of $200 per month as well.

Let's have a look at John and Jenny's monthly budget.

John and Jenny's total monthly obligations are:

Mortgage - $1,950
Life Insurance - $50
Taxes - $200
Strata - $200
Car Payments - $900
Food - $600
Fuel - $400
Home and Auto Insurance - $400
Telephone/Internet/Cable - $300
Clothing/Other/Misc - $300
Entertainment/Vacations - $500
RRSP contributions - $200

Total = $6,000

This couple can have a 'reasonable' lifestyle based on these numbers but let's look a little closer. Let's test this for several common risks:

Death - The mortgage is life insured, the survivor would be financially okay so long as the life insurance remains in place.

Divorce - They are in bad financial shape if this happens. Neither one of the two could afford the townhouse if they split up and the townhouse would need to be sold quickly.

Children - They are in bad financial shape if they have kids. Not only would they have extra monthly expenses, which they don't have room for in the budget, they would also have less income for a period of time as it is typical for the mother to take some time off work after giving birth. Even if mom went back to work there are daycare costs, which are not small.

Job Loss - They are a financial disaster if one of the two loses employment of any extended period of time. They would be forced to make some significant life changes and likely sell the home.

Interest Rate Rise at Renewal
- If interest rates rise by 100-200 basis points they would be extremely rough financial shape. Unless they had an increase in income, they would likely be forced to re-amortize the mortgage and/or make other lifestyle changes. If rates increased more than 200 basis points, they would not be able to maintain their current lifestyle in any shape or form.
1) 100 basis point rise to 5.5%, maintain original amortization, payments rise to $2180 / month
2) 200 basis point rise to 6.5%, maintain original amortization, payments rise to $2420 / month
3) 300 basis point rise to 7.5%, maintain original amortization, payments rise to $2670 / month

Time - This is the most insidious risk of all and the least recognized. As a financial planner, I see many people who have put themselves into this type of scenario and they manage to muddle through life, manage to pay off a modest home by retirement and save a very modest sum of money. They retire at 65 and have a fairly low standard of living since they have no real significant savings and no pensions. If none of the above risks occured and they both managed to work a full career, get regular raises, contribute to CPP, receive OAS and have some modest RRIF withdrawals, they would make it through life without severe financial hardship but as a debt slave. The bank would have made over $400,000 from them in interest payments and they would have never saved much. They would live month to month their entire life and financial freedom would be a mere dream as they play the lottery each week hoping their number is drawn.

The reality is that the risks noted above are very real and for John and Jenny's situation to work out they need everything to work perfect, with no hitches, glitches or problems. This seems unlikely to me. It would be far better for them financially to leave themselves more room in their monthly budget so that they could:
1) Live / survive with only one income
2) Maintain mortgage amortization if interest rates rise
3) Speed up mortgage pay down by making extra payments as they receive raises if things work out well.
4) Increase their personal savings to RRSP and/or TFSA to ensure they have money for the unexpected and for retirement.

There are only two ways for John and Jenny to make the above work in a sustainable manner:
1) Continue renting and saving aggressively
2) Buy a much cheaper home and aggressively pay down the mortgage

What are your thoughts? Do you know John and Jenny? I do.

Teranet House Price Index for May 2009

JULY 2009

A monthly rise in the composite index

Canadian home prices in May were down 6.9% from a year earlier, according to the Teranet-National Bank National Composite House Price Index™. It was the sixth consecutive 12-month decline. The index is now down 8.9% from its peak of last August. However, its run of eight straight monthly declines ended in May with a 0.7% rise from April.

Teranet – National Bank National Composite House Price Index™

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Of the six constituent metropolitan-area indices, four showed monthly rises in May - Halifax (1.3%), Montreal (1.5%), Toronto (2.0%) and Ottawa (0.7%). For both Halifax and Montreal it was a third consecutive monthly increase. The Ottawa monthly rise came after six consecutive declines, the Toronto monthly rise after eight consecutive declines. Calgary and Vancouver continued to correct downward in May, each showing an 11th straight monthly decline.

Four of the six city indices were down from a year earlier - Vancouver (−11.8%), Calgary (−12.2%), Toronto (−6.5%) and Ottawa (−0.1%). Montreal stands apart as the only market that has yet to show a 12-month decline. Halifax has shown 12-month declines in only two months, February and March 2009.

Calgary prices have been correcting since August 2007 and are now down 15.2% from their peak of that month. The Calgary index has shown monthly declines in 18 of the 21 months posted since then, including 11 months in a row from last July through May. The 11 straight monthly declines of the Vancouver index have left it down 12.0% from peak. Toronto is 9.6% below its peak of last August. Ottawa is down 4.2% from its October peak. Halifax is almost back to its peak of last November. Montreal is already back to its peak of last September.

Teranet – National Bank House Price Index™

The historical data of the Teranet – National Bank House Price Index™ is available at

Metropolitan areaIndex level
May 2009
% change m/m% change y/yFrom peakPeak Date
Calgary148.62-2.2 %-12.2 %-15.2%August 2007
Halifax121.421.3 %1.0 %-0.4%November 2008
Montreal122.601.5 %2.3 %0.0%May 2009
Ottawa113.290.7 %-0.6 %-4.2%October 2008
Toronto106.052.0 %-6.5 %-9.6%August 2008
Vancouver132.53-0.1 %-11.8 %-12.0%June 2008
National Composite120.050.7 %-6.9 %-8.2%August 2008

The Teranet–National Bank House Price Index™ is estimated by tracking observed or registered home prices over time using data collected from public land registries. All dwellings that have been sold at least twice are considered in the calculation of the index. This is known as the repeat sales method; a complete description of the method is given at

The Teranet–National Bank House Price Index™ is an independently developed representation of average home price changes in six metropolitan areas: Ottawa, Toronto, Calgary, Vancouver, Montreal and Halifax. The national composite index is the weighted average of the six metropolitan areas. The weights are based on aggregate value of dwellings as retrieved from the 2006 Statistics Canada Census. According to that census1, the aggregate value of occupied dwellings in the metropolitan areas covered by the indices was $1.168 trillion, or 53% of the Canadian aggregate value of $2.207 trillion.

All indices have a base value of 100 in June 2005. For example, an index value of 130 means that home prices have increased 30% since June 2005.


Marc Pinsonneault
Senior Economist
Economy & Strategy Team
National Bank Financial Group

Teranet - National Bank House Price Index™ thanks the author for their special collaboration on this report.

1 Value of Dwelling for the Owner-occupied Non-farm, Non-reserve Private Dwellings of Canada.

Wednesday, July 22, 2009

Vancouver June 2009 CMHC Data

Good afternoon, it has been so nice outside, I haven't made the time to do much posting lately. CMHC released data for June on the national housing market and here are the numbers for Vancouver.

Starts were 571 for June. Down quite a bit from the heyday levels.

Completions were very high in June at 2049. It seems completions are speeding up prior to the Olympics and as resources are shifted from starting new projects to completing existing projects.

The number of completed but unabsorbed units was over 2,500 compared with last June at under 1,400.

The number of units under construction has dropped precipitously from over 27,000 units in March 2008 to 19,700 now. By all accounts, construction employment is falling rapidly with the less experienced and less skilled workers getting let go. This upcoming winter could be especially grim for construction employment prospects. We will see if that translates into further real estate market weakness.

I like to add the long perspective from time to time. Here is the CMHC data from 1958.

As an aside but still relevant, rentingsucks provided a link in the comments to a great article on CMHC that I thought was well laid out with some great data and some interesting conclusions. Here it is:

Upper Fraser Valley Real Estate - June 2009

From the Chilliwack and District Real Estate Board:

MLS® home sales activity rose to a 13-month high in May 2009 in the area served by the Chilliwack and District Real Estate Board. The supply of homes is also backing down from elevated levels.

According to statistics provided by the Board, MLS® home sales numbered 262 units in May 2009, the highest level since April 2008. This is up 10 per cent from May 2008, and marks the first year-over-year increase in sales activity in 15 months.

Sales activity jumped 39 per cent in May 2009 from the previous month, which is a stronger than normal seasonal increase. As a result, seasonally adjusted sales activity climbed 18 per cent month-over-month in May 2009 (seasonal adjustment removes normal seasonal variations). This adds to monthly increases in each of the previous four months. Seasonally adjusted sales activities now stand at 84 per cent above the recent low in December 2008.

The combined dollar value of MLS® home sales in May 2009 totalled $77.9 million. This is up 3.3 per cent from May 2008.

Total MLS® sales numbered 277 units in May, an increase of 3.7 per cent from year-ago levels. The total value of all MLS® properties sold in May 2009 edged up by eight-tenths of one per cent to $83.2 million.

The MLS® average residential price for homes sold in May 2009 was $297,376. This is down six per cent year-over-year from May 2008, when the average price reached its highest level on record for the month of May. It was also the smallest price decline since December 2008.

The number of new residential listings on the Board’s MLS® system numbered 403 units in May 2009, down 37 per cent from May 2008. This is the fifth consecutive month in which new listings were down from year ago levels. The year-over-year decline in the number of new listings has exceeded 20 per cent every month since the year began.

The number of active listings continues to retreat from the peak reached in July 2008. There were 1,452 active residential listings on the Board’s MLS® system at the end of May 2009, down 24 per cent year-over-year. This is the third consecutive decline in active listings in as many months, and the largest in more than five years. The supply of homes is expected to continue trending lower as sales activity draws down inventories and new listings continues to trend lower.

“Improving consumer confidence and lower interest rates are drawing buyers to the housing market, and that has caused the MLS® housing market to firm up considerably in recent months,” said Jim Adam, President of the Chilliwack & District Real Estate Board.

Wednesday, July 15, 2009

FVREB June Stats

It completely slipped my mind until today but I neglected to post the monthly recap of the Fraser Valley Real Estate Board statistics release.

Here it is:
Active listings ended the month of June 2009 at 9300. A level well below the lofty levels of last year.
Sales were nearly at peak levels with 1982 homes changing hands during the month. I would love to hear some anecdotes of sellers and buyers to hear what is motivating them to move in the market right now.

Prices have certainly stabilized for now and increased a little with the robust activity this spring.
The correlation between Months of Inventory and price changes is extremely strong.

Thursday, July 09, 2009

Your Home and Other People's Money

One of the many arguments surrounding real estate investment, whether as a true financial investment, or as a lifestyle investment for personal residence, involves using "other people's money" to finance the purchase. That is, use leverage through mortgages and secured lines of credit to provide the necessary financing. This is often touted as a benefit of real estate investing -- lever up and a small investment of $20,000 turns into $200,000. Fancy terms are thrown around by financiers showing double-digit returns on initial capital invested. Wow. But don't sign me up just yet.

Let's look at a simple case of me with a business idea. I want to open a store selling popcorn. I think have a decent business case but, unfortunately, no money with which to carry out my fancy plans. I need to find some capital through investors. One place I can go is the bank which has boatloads of money. I can also see if some of my business contacts are willing to pony up the dough for my venture.

The thing is, when I use "other people's money" they have a funny way of wanting a cut of the returns for use of their money. The bank manager sees me and looks at my business case, offering me a loan at 10% annual interest. My business partners are willing to invest but want an equity share of the business. Some even offered to fund it and have me work as an employee. No matter how I slice it, I have to give up some of my potential returns in exchange for the use of capital.

Now we can turn to real estate and housing. When my family walks into a bank interested in applying for a mortgage, there is little difference between this and my popcorn investment. Sure popcorn is a bit more risky than housing, but for the bank, which has access to a fixed amount of capital, both are considered pretty much equally, adjusted for risk. The bank needs to maximise its returns and manage risk.

It may not seem like it, but when the mortgage specialist fills out the online form including your income, assets, liabilities, credit history, et cetera, she/he is but filling out a streamlined business plan on our behalf. We can sometimes lose sight of this with the big rosy smile on the broker's face and McMenus of financing options.

Mortgages are, in their essence, nothing more than business ventures. The most important thing to realise is that, like most business ventures, you are passing on some of the profits to the initial holders of the capital. Unless you are speculating and benefit from unsustainable capital appreciation, your returns will, on average, be less with borrowed money than they would should you have your own money to invest instead. There is nothing absolutely wrong with this -- one may forgo future savings for present day benefit and borrowing capital is often necessary for a venture to happen at all; both are usually the case with owner-occupied real estate purchases.

Using "other people's money" is not free, especially if other potential non-real estate investments are producing decent returns, such as in the late '90s. I asked a few people why they didn't invest in properties ten years ago that were netting 7-8%. The answer: there were lots of other investments doing better with a lot less overhead. In fact, mortgage rates of the day were over 7%, reflecting how competitive other businesses were for available capital. It seems the trough of money is not bottomless after all, especially when business is booming.

Disagree? Do you think you can always do better with borrowed money? Let's hear it.

Tuesday, July 07, 2009

Vancouver - Decline From Peak

Here is Vancouver's decline in house prices plotted in comparison to US cities since their respective price declines began. The Case Shiller indices track sales pairs much like the Teranet methodology and have been shown to be the most accurate house price tracking methodology.

Case Shiller data is as of April 2009 - data released June 30.
Vancouver REBGV data is as of June 2009 - data released July 3.
Vancouver Teranet data is as of April 2009 - data released June 19.

Dallas, Charlotte and Denver are 20 months into correction mode compared with Detroit, Boston, and San Diego which are over 40 months into the correction. In comparison, Vancouver is only 9 (Teranet) months or 14 months (REBGV) into its correction.

Time will tell if the latest uptick in prices has staying power but I would hazard a guess that we haven't seen the end of price declines. If we are 40 months from peak and we haven't decreased from current levels by then I will count myself as being wrong. Until then, I'll watch and wait.

Monday, July 06, 2009

Guest Post: Vancouver Housing Price Correlation Model

A recent discussion on the impact of low interest rates on local housing prices had me whipped up a quick, but significant correlation model between Vancouver housing prices and a few key factors.

The regression model is based on quarterly data, dating back to 1990. The independent variables for the regression are: Vancouver's unemployment rate, average 5-year residential mortgage rate, inter-provincial migration into BC, and international migration into BC. The result is as follows:

Adjusted R-Sq Value = 0.85

1) 1% increase in Unemployment rate translates to roughly a 10% housing price decline
2) 1% increase in 5-year mortage rate translates to a 8% housing price decline
3) every 1000 interprovincial migrants into BC increases housing prices by 1.8%, and
4) every 1000 international migrants increase housing prices by 1.7%

Significance Levels (P-Values):
Unemployment = 2.78E-19
Average 5-Year Mortgage Rate = 5.89E-13
Inter-provincial Migration = 8.02E-07
International Migration = 0.0163

Other factors like Canadian/US exchange rate & foreign investment flows are either non-factors or they are already embedded into one or a combination of the above factors. What's also interesting is that international migration has a low correlation and the least significant.

The graph below is a plot of the logarithm of the average housing prices (Source: UBC Centre for Urban Economics and Real Estate) and the regression model. The plot also tries to convey how each of the independent variables (components) are added together to yield the model price. Note that these components are arbitrary shifted so that it can be seen on the same axis. The rising yellow line since Q42008 represents a decline in the 5-year mortgage rate, and the falling dotted unemployment component since Q42008 reflects the rising unemployment rate.

Obviously, the caveats to this type of model are that correlations change over time, the causality of the variables is complex and unknown (i.e. we don't know what causes the other or which is really the independent variable), and there may be non-linear elements, such as a rise in RE price may fuel further decline in unemployment or vice-versa.

With this in mind, I took the liberty of forecasting some numbers through 2011, based on these 3 scenarios:
1) Unemployment gradually rising to 9% (1990s' levels) and the average 5-year mortgage rate constant at 2009Q1 levels of 5% (based scenario)
2) Unemployment rising to 9% and the average 5-year mortgage rate declining further to 2.5% (record low mortgage spreads)
3) Unemployment rising to 9% and the average 5-year mortgage rate rising to 8% ('00 levels)

All 3 scenarios use 2008 numbers for inter-provincial and international migration numbers. Note that the scale on the Y-axis is normal.

In 2007Q2, Vancouver housing prices appear to lose correlation held since 1990. What does this mean? Is there a factor in 2007 that we need to include? or are we just seeing irrational exuberance?

UPDATE 2009-07-07 :
The model was optimized by delaying the effects of the unemployment rate, mortgage rate and international migration by one quarter. New adjusted R-value is slightly better (0.851)

I also added another scenario (unemployment at 7% and 5-Y rate at 5%, unchanged from 2009Q2 through 2011)

REBGV Sales are the Story

The local real estate market has been goosed this spring by the super low interest rates available to your average home buyer.

Sales in the REBGV jurisdiction were very high at 4259 for the month of June.

Active Listings fell to 13,252 units.

Consequently the Months of Inventory fell to a mere 3.11 for the month of June. A dramatic fall from January's levels.

As sales have risen and inventory has fallen, prices have gone up.

The correlation between Months of Inventory and Price Changes is still very strong.

It will be very interesting to see how future price changes play out. We will see if this spring market is a temporary phenomenon like so many other spring markets around North America.
Unemployment levels, interest rates, and many other factors play a big part in the local market and it will be interesting to see which way things turn.

Saturday, July 04, 2009

Ubergeek Post Update June 2009 - Price Changes and Months of Inventory in GVREB

Here is a quick update on the work mohican and I did in spring 2008 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 (the red dot is June 2009's datum):

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.

Weak-minded fool that I am, I second-guessed myself and thought the benchmark would come in at $690K, though if I had stuck to the model I would have been closer. I am at a loss to explain the reason for how well this model has done in Vancouver. Other cities where I have tried to run similar analysis show nowhere near as tight a correlation between months of inventory and price changes. Since the causation underlying this model is not well understood the model is interesting but not much more -- it will track until it doesn't.

If you're flabbergasted by the market's recent strength, consider affordability has improved close to 30% in the past year (thanks for pointing this out, fish10). That's a Brobdingnagian shift, even with aggregate incomes coming under severe pressure.

Thursday, July 02, 2009

The "Inflation Hedge"

Much talk has ensued in past months, around the time of quantitative easing by central banks, about the concept of real estate being a so-called "inflation hedge". What is meant by this?

The concept of "hedging" is pretty straightforward: take a position in an investment that limits the possible losses when summed with another investment. Generally one gives up some return for doing this but one can prevent against an investment being wiped out. Of course in the context of real estate, there is no hedge per se. What is meant is that real estate returns generally track inflation. Therefore if you have investments that would be hit hard if inflation increased, real estate is purported to generally increase its total return in an inflationary environment and you would at least have something, all said and done.

It helps to remember, when it comes right down to it, why real estate has any value at all. Simply, real estate is a capital asset that generates income from rents. Without that income or potential income (tangible or intangible), real estate would have no inherent value. It so happens that rents generally increase with inflation so the future value of the asset would tend to increase with inflation as well, minus depreciation of course.

The problem with blindly touting real estate as an "inflation hedge" is that the cash flows eventually determine prices. If prices are out of line with cash flows, what fundamentally justifies prices increasing with inflation? Often it is taken on blind faith that real estate prices increase with inflation as a law but prices are dependent upon the cash flows -- prices do not rise in and of themselves without cash flows rising as well. Unless there is speculation.

In a speculative bubble, where yields from cash flows are poor compared to other similar investments, it is not true that prices generally appreciate with inflation. In such an environment the balance of probabilities will have prices trail inflation at least until the underlying income streams are competitive again. You would be better off investing in real return bonds or perhaps some of the countless other investments whose income streams track inflation as well, many of which may well have better risk-adjusted returns than that condo with a 4% cap rate.