The ‘Hot Asian Money’ fallacy

I can’t help but chuckle at the increasingly far-out reasons the media is coming up with to justify home prices in Canada.  One that has been gaining traction over the past couple months is the inflow of ‘Hot Asian Money’.  The theory goes that foreign investors, predominantly from mainland China, will continue to invest in Canadian real estate, thus keeping prices at a high plateau.

It’s an interesting theory and as with most fallacies contains an element of truth.  I believe there will be an impact from foreign ownership on certain cities, particularly Vancouver and Toronto.  But the question is just how much of an impact it will actually have.

This piece appeared in the Grope and Flail yesterday.  The title is “Asian investors keep GTA flush with rental units”.

Similarly, this piece and this one suggested that Asian demand for Vancouver properties is creating a market for ‘real estate tourism’.  And these two videos show that the notion of Hot Asian Money buoying property values has permeated our always critically thinking media.

Let’s start with the Vancouver housing market and let’s try to reason through this rationally.  Imagine that you are a potential investor looking for an investment property.  I’ll present you with two options:

House #1:  A single family residence in a city with a population of approximately 600K and a metro population of approximately 2.1 mil.  Average home prices in the city slightly under $1,000,000. Median income is 42K giving a home price /median single income of 23.8 to 1.  Favorable geography to inhibit expansion, thereby making land more valuable.

House #2:  A single family residence in a city with a population of approximately 600K and a metro population of 4.2 mil located approximately 100 miles south of house #1.  Average home prices in the city are about 370K.  Median income is 44K giving a home price to median single income of 8.4 to 1.  Similar geography and climate.

Which would you as a rich, intelligent investor prefer to purchase?  I think the better buy is pretty obvious.

House #1 is typical of a house in Vancouver, while house #2 typifies one in Seattle.  Granted there are land-use differences, some geographic differences, and differences in immigration laws that may favour Vancouver, but do these differences (and I believe they are fairly minor) merit a doubling of house prices in Vancouver?

In fact, using the same valuations discussed in one of our primers, Demographia International calculated that Vancouver ranks as the most unaffordable city in the world!  So if we’re relying on rich Asians to prop up our housing market then I guess we’re hoping for an inexhaustible pool of really dumb rich Asians who won’t ever compare the ridiculous valuations in Vancouver to other cities.    I doubt that there are scads of wealthy (dumb) immigrants willing to pay ridiculous valuations for an ‘investment’, particularly as they realize that sales and prices are starting to crumble in Vancouver.  I’m not sure how many of them would be interested in catching a falling knife.  And if they are interested, where have they been?  We’ve had the worst couple months for sales in over a decade.

However, let’s take a macro picture for a moment.  We’ll assume that the wealthy Chinese mainland investor story is completely accurate.  Will they stop the bubble from popping?

Let me go out on a limb for a moment and say that there are only two international property bubbles that eclipse the Canadian bubble:  The Chinese bubble, which I will show you is the MOTHER of all bubbles, and the Australian bubble, which is imploding as we speak and should roughly pace the Canadian housing bubble in timeline.

So let’s look at that amazing property bubble in China.  China’s economic policy is very simple: Grow the economy and keep people employed, or face a legion of young, unemployed, single men (remember the one child policy and its unintended consequences on demographics?).  So the government of the People’s Republic has no choice in the face of inevitable social unrest but to embark on massive building campaigns aimed at keeping young men employed, happy, and out of trouble.  Never mind that this approach has led to the building of entire empty cities (you have to check out this video…..it is eerie!).  Or consider the case of the world’s largest shopping mall, which is sitting basically empty (fast forward to 11:00).  Or consider that a recent report concludes that there are enough vacant homes in China to house half of the US population (this article also provides some interesting insights into the sociological reasons for this).

Now if you’re looking at all this and saying, ‘Wow, that’s unsustainable and can’t go on forever’ then let me congratulate you on your impressive grasp on the obvious.  When this fiasco comes to its ugly end(and there are signs that it is unravelling as we speak), let’s just say that there will be far fewer ‘rich Chinese investors’ looking to speculate on our overpriced real estate.

As far as Asian buyers propping up the Toronto condo market, I think that is just plain ridiculous.  Toronto condos and the Vancouver market in general are the two markets that I would be confident predicting a 50% peak-to-trough decline in the coming bust.  There’s not much that I can imagine that will prevent a significant meltdown in condo values in the GTA.

Toronto has a love affair with condos.  So much so that developers have projected such demand into the indefinite future.   Toronto is North America’s new condo capital: Last year, developers completed about 16,000 units, twice as many as in New York (a city with 4 times the population) and three times as many as Vancouver.  As of right now, according to CMHC, there are over 34,000 units near completion in the GTA.

Given that immigration to the city is projected to be 65,000 total individuals this year, this pace of condo development massively outpaces demand.  Yet, so far the units have been absorbed.  So who’s buying?  ‘Investors’!  This piece from the Globe suggests that 40% of condos sold in Toronto are sold to ‘investors’.   I’ll admit that 40% seems a bit of a stretch, but I can’t find numbers to confirm or deny it.  Even if it is 20%, that would still be a scary scenario as every ‘investor’ in a Toronto condo is nothing more than a speculator at this point.

Consider this:  For the low average price of 307,000 you too could own an average Toronto condo.  The average rent for such a condo is roughly $1400 per month.

Assuming the investor put down the required 20%, it would leave a total mortgage amount of approximately 245,000.  At the low rental financing rate of 3% financed over 35 years, the mortgage payments would be $960.  Add in condo fees and property taxes, and subtract the lost opportunity costs from the 20% down payment and you’d essentially be looking at subsidizing someone to live in your own unit.  No rational investor would do that.  So clearly they are expecting capital appreciation.  In real estate investing, someone who buys a property with the hopes of selling it at a higher price to a greater fool is known as a speculator.  The problem with speculators is that since they are expecting capital appreciation, when it becomes evident that there will be no capital appreciation in the foreseeable future and they are likely looking at a capital loss, they often sell ‘en masse’ leading to a price cascade.  Furthermore, as markets continue to weaken, those investors will disappeared.  New projects, which typically require at least 70% of pre sale volume to obtain financing, would stall, leading to rising unemployment in a city that is currently wrestling with 10% unemployment.

Judge for yourself.  Come to your own conclusion.  I think it’s pretty clear that I’ve come to the conclusion that the ‘rich Asian investor’ story, while perhaps holding a grain of truth, will not be nearly enough to save our two most bloated housing markets.

Cheers

B

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18 Responses to The ‘Hot Asian Money’ fallacy

  1. vreaa says:

    Thanks, Ben.

    We continue to believe that the ‘hot asian money’ has a very modest direct effect on the Vancouver market, but had a fairly large effect indirectly in that it is one of the fallacies that have caused local speculators (= all local buyers) to gorge on RE.

  2. Tom says:

    What your saying makes sense, and I agree we’re in a bubble, but if the wealthy Asians are not driving this market, then who is?

  3. Mike says:

    It was primarily low interest rates and changes to CMHC that drove this bubble. Our house price problem is internal, pretty much country wide, and very Canadian in its causes. There’s no land shortage, or housing shortage, or rich external investment environment starving supply, this is actually quite a simple rollercoaster ride that a lot of countries took their populations on (including Canada) that we couldn’t see the downside of while we were all seated in the ride and excited by how high we were all climbing. CMHC stepped in huge when we started a scary rapid descent in 2008 (giving money to anybody), but now has run out of steam putting us squarly in that awkward transition from going up, to going down… Spend a little time to educating yourself (a couple of good starter links below), and get a grasp on the new reality. There were a lot of winners in this game over the last 5 years, and there are now about to be a lot of losers.
    http://canadabubble.com/bubble-article-list/1305-primer-4-cmhc-the-enabler-to-canadas-housing-addiction.html
    http://www.greaterfool.ca/ (the site is rebuilding, which is too bad. It was decimated by a hacker attack, but had fantastic dialogue going on here, and mainly factual and smart open discussions which I am sure will build up again)

  4. ulsterman says:

    I agree Tom. I’ve followed these blogs for 4-5 years and everone keeps saying “drug money is a myth”, “asian money in a myth”, “Median incomes only 42k” etc etc. OK then, if that’s the case then who IS buying the average homes here in the LM?

  5. ulcerman says:

    ulsterman… obviously, it’s people like you! Local suckers who buy into a bubble… thinking it will never pop… you don’t need “rich” or “dirty” money when there’s cheap money to be had at the local RBC…

  6. Anonymous says:

    “they often sell on mass”

    En masse; french for “as a group”.

  7. sinking@canadabubble says:

    I know a group of students, whose families are still in China, supposing visa students, just graduated from the university, have no jobs, have no hope of even getting a professional job. They all bought a condo. They are not even employed once. I don’t know if they need mortgage. if they need, obviously they have enough $ in their bank account, to qualify for one.

    These cases are so typical. Their parents want to move their capital elsewhere, because that’s safer than any bank saving in China. Also, unless they are actively involved in the RE flipping in China in the last few years, how they accumulated these wealth is questionable. So their RE buying rationale is partly laundry, partly as having saving a/c in the swiss bank. RE in vancouver, is definitely less risky than anything they can buy/invest in China, maybe except gold in very secure safe at home.

    and unlike other RE investor, these fresh grad student RE owner don’t flip. but don’t be surprised that they do ‘accumulate.’

    I don’t know if these data are accessible: is there a way to see the registered owner of all RE transactions? it’s pretty easy to spot from the last name who’s Chinese & Korean, and who’s the rest. Anyone can compile these data, if accessible?

  8. sinking@canadabubble says:

    comparison: vancouver vs seattle

    question: is there a place outside china that chinese can survive and live happily forever, without having to speak the local official language???

  9. vancouverit says:

    Your logic is impeccable. But what I see in Van is the fact that Asians actually behave in herds. Not only in RE, but in everyday life. In other words, an single Chinese always takes the way where all of them go.
    Irrational.

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  11. to play devil's advocate for a moment says:

    There could be rich Chinese buying inflated real estate in Vancouver, but it might not be for investment purposes so much as money-laundering purposes. The Chinese government and many well-connected businesses are notoriously corrupt and the ill-gotten gains have to be put somewhere. It’s possible that in Canada it’s easier to get around money-laundering regulations by finding a crooked lawyer to do all the transactions and in such a scenario overly-inflated values might be a positive.

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  17. Sam says:

    I found your article very informative. I wonder why you haven’t touched on the enormity of the money laundering in real estate, especially in the Toronto area. I believe it is a problem that government/regulators are turning a blind eye. Ontario now being a major hub of the drug trade. I believe this reflects in the mass overbuilding, and anxiousness by the development community. I’m not able to grasp how a new immigrant family can afford a $550k (plus tax, maintenance) 2 bedroom condo in the GTA. This is the reasoning given by development to many city councils in Ontario. That immigration is fueling condo /new home sales. with the price steadily going up. With what outside law enforcement has stated (Italian authorities) that Ontario has a minimum of $65billion dollar money laundering infusion per year. That certainly would make one wonder, where it is being used. This could explain Ontario’s unrealistic steady rise of housing prices despite all indicators of a flattening of economic growth.

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