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.