Typical bull arguments…

Calling out!

I hate to call anyone out on this blog, but sometimes you can’t ignore the exceptionally misleading rants of the increasingly delusional Vancouver bull crowd.

In all fairness to ‘Mac’, he is by far the most articulate and convincing critic of this blog.  Though he describes himself as a housing bear, his comments call that into question.

Mac was the one who convinced me to explore the likelihood of a sideways market for bubbly areas like Vancouver.  You can read my conclusion here. He was also the one who drew our attention to the comments from Dr. Ian Lee, leading to this post debunking them.  Commenters like Mac force me to explore my own convictions and support them with factual evidence and not mere hunches or anecdotes.  For that I’m thankful.  In turn I hope my posts cause the housing bulls out there to question their own convictions.

I’ve often said that I have yet to hear a single convincing argument for the sustained increase in prices in Vancouver.  Typically they revolve around the Rich Asian story, or some other anecdote.  I would love it if someone could provide some concrete facts about the percentage of offshore buyers purchasing Vancouver houses.  To date all I’ve heard are anecdotes. I would love to be able to post a convincing argument on behalf of the bull crowd.  If you are able to piece something together, fire it off to me:  benrabidoux@yahoo.ca

I will post it.

Now in reference to the Vancouver bull crowd, I think some of the latest comments by our friend Mac reveal a great deal about the typical arguments used to support the likelihood of a rise in home values, or at least a sideways market.

To wit:

“The question is, how much more hot air is coming from the billions of newbie billionaires from the Far East? And what about when they start creating a middle class of just regular millionaires looking to shunt money illegally out of country and park it in Dunbar or Kits. Could it be enough to keep our 40 square miles (?) of West Side SFHs inflated? Enough to delay a correction for another decade or two?”

“Then should the advice to Vancouverites be, get in while the market is going sideways and the FED is hellbent on QE 2, 3 & 4 (according to Roubini). Find a distressed sale. Find a fixer upper. Do it responsibly, don’t get into too much debt, take a smaller place, live with less and hang on.”


Billions of billionaires?

The first tool in the arsenal of the bull (or sideways) crowd apparently is hyperbole.

Billions of new billionaires? Not sure if Mac’s done the math, but China has less than 1/6th the total number of millionaires as our neighbours to the south? There aren’t even half a million millionaires…..the notion of billions of billionaires exposes a complete ignorance to the magnitude of the numbers suggested.

So how many billionaires are there?  Well, according to Forbes, China had 64 billionaires in 2010.  Collectively, the ‘Far East’ has less than 200 billionaires in total.  If we include Russia, it’s still less than 250.  So, the notion that there are more than 1,000,000,000 new billionaires in the Far East is so ridiculous that it is laughable.

But what about the notion that there are a number of wealthy individuals looking to shelter some of their wealth by buying foreign real estate?  I have no doubt that is true.  My question is simply how many of them are actually doing this in Vancouver.  Give me a solid stat!  Further to that point, are we assuming that these wealthy Asians are also extremely dumb?  Consider this scenario of two potential investment homes:

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.

House 1 in in Vancouver.  House 2 in Seattle.  Someone explain to me how this is rational behaviour?  And if it isn’t rational behaviour, then the word for that is speculation.  Do some research to find out how real estate booms supported by blind speculation always end.

Renting in Vancouver….smart during a sideways market?

Let’s deal with the second assertion.  It may well make sense to buy in a locale that is likely to experience a sideways market, provided that price/rent ratios are at or near their historical norms.  I can buy that.

But let’s talk specifically about Vancouver.  Let’s analyze two different scenarios, one involving renting in this current market, and one involving buying.  We’ll examine both a 5 and 10 year time horizon, and we’ll look at condos in particular, as they are the overwhelmingly popular among the new homeowner crowd.

Buying:

The benchmark price of a Vancouver condo hit 390K last month.   Using the formula for average maintenance fees and property taxes described here, taxes would be roughly $1450 per year, or $120 per month.  Maintenance fees could conservatively be estimated at $250 per month (700 sq. ft x $0.35).

Assuming the buyer puts the typical 7% down, it would leave a mortgage of $363,000.  If we amortized over 30 years, at a low fixed rate of 3.5% which we’ll assume will remain at this historically low rate over the 5 year and 10 year periods (unlikely), the monthly mortgage payment would be $1625.  Once we add property taxes and maintenance fees, it rises to about $2000/month.  We’ll assume a stable property tax rate (unlikely) and a stable monthly maintenance fee over 5 and 10 years.  We could also add on to that the lost opportunity cost of the $27000 downpayment, which if invested conservatively could generate 4% per year, or another 90$ a month.  So the real cost of buying is $2090/month.

At the end of 5 years, you would have an outstanding mortgage balance of 325K.  Since the property has not appreciated, you now have equity amounting to 65K.

At the end of 10 years, you would have equity of $110K, assuming no capital gains.

Not bad.

Renting:

The most recent CMHC rental report from April 2009 indicated that the average rental on a two bedroom Vancouver condo was $1150.  Let’s be generous and assume that the rent has increased to $1200 today.  If property values go sideways, rent tends to also move sideways as it maintains an equilibrium in the price/rent ratio.  Therefore we’ll use a stable $1200 per month value.

That means that the average savings per month over renting is $890.  We’ll assume that the renter is starting with the same $27K downpayment and adds $890 to it every month and manages a 4% return, which we will reduce to 3.5% after-tax.

The total after 5 years is $90,000, which easily dwarfs the $65,000 of equity of the homeowner.

After 10 years, the renter would have $166,000, easily eclipsing the $110,000 in equity by the homeowner.

Once again we find that the arguments of the housing bulls/sideways crowd hold little water when explored rationally.

Mac’s comments validate my assertion that the ‘arguments’ advanced in support of Vancouver’s miracle housing market amount to nothing more than weak anecdotes and hyperbole.  If someone has an argument to support the sustained price level in Vancouver, currently the most unaffordable city in the world, please post it here.

Cheers

Ben


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16 Responses to Typical bull arguments…

  1. James says:

    Is renting a apt in Vancouver a better investment decision over buying? : yes absolutely. No doubt about it. And rents in the long run (v. long run) determine real estate values and my own anecdotal sense is that the rental market is now offered, but certainly was v. well bid in 2006/2007.
    Are Vancouver real estate prices stretched. Yes by almost any rational measure, but that does not mean they cannot remain so. For prices to turn south there would have to be a catalyst. Some potentials : 1) China has a hard landing 2) Consumer debt
    becomes unsustainable 3) There is a double dip in the US while fiscal policy in Canada is tightened. All three are possible. There is also the possibility of two or more happening simultaneously which is a prospect one really does not want to think about but must from the point of view of rigorous risk management.

    • Certainly a catalyst like you describe would go a long ways towards inducing a price cascade. However, the notion that bubbles need catalysts to pop is a common misconception. What was the catalyst that sent the US market into its tailspin? There was no sudden catalyst. The credit crisis was caused by the declining real estate market, as was the rising unemployment. Interest rates did not rise significantly prior to the bursting. Foreclosures and delinquencies rose moderately, but nothing that would portend a crash. Housing sales simply died. Mass psychology turned. We usually go looking for the reasons why after the fact.
      Cheers

      • jesse says:

        That’s a good point. We shouldn’t be obsessed chasing down cause and effect when the cause is as simple as prices being too darn high.

  2. jesse says:

    I agree that housing is in a bubble, especially in Vancouver, however I don’t see much evidence to support rents remaining flat. Markets like San Diego are experiencing significant price corrections that started in 2005 are still seeing rents increase at the headline CPI inflation rate, give or take. Though the link is stale, piggington.com analyzes rents in the San Diego area from time to time. CMHC data for Canada, and specifically Vancouver, show year-over-year rent increases in the neighbourhood of a couple of %.

    Continued CPI inflation is actually a bit of a surprise for me; in my naivete I used to think deflation meant falling prices. Now I know it’s more complicated…

    • The CMHC rental market report for Vancouver indicates that 35% of condos are owned by landlords, rental vacancies are rising, and year-over-year rent increases are declining. I highly doubt that we would see continued rental increases in even flat market over the next few years, though your argument is true beyond the next few years.

      To be fair, the chances of renewing a 5 year mortgage at the same record low interest rates of today is virtually nil, as is the likelihood of property taxes and maintenance fees staying flat. I’ve kept values constant on both sides of the calculation.

      If you’d like me to run the same calculations but with a 2 or 3% increase in rents, I’d have to also include similar increases in taxes and fees, as well as higher mortgage rates after the initial 5 year term. I highly doubt it will change the ultimate result.

      • jesse says:

        The other way of looking at condos, instead of getting hung up on mortgage rates, is to look at it from a strict investment return perspective. That is, an investment in property — assume buy to let for simplicity of argument — should make sense regardless the method by which it is financed.

        So how should housing be valued? For condos we can simply look at cap rates and compare to investments with similar risk profiles, such as a water or gas transportation utility or other similar businesses. By that gauge properties should be netting 8% at least given the risk involved. We can convert this into a multiple of gross monthly rent to make the calculation very quick. By that simple measure, a cap rate of 8% with total expenses 20% of rent equates a price-monthly rent ratio of about 120. Vancouver is currently a wee bit higher than this.

  3. Will says:

    Great post, Ben. The key message in your post is that renting makes sense, as long as the increase in disposable income is invested instead of spent. From what I have seen on other blogs, a lot of bulls assume that renters will either waste their savings, or that renters are just poor in general, and therefore won’t have a penny left.

    Regarding rent increase: I think there is an argument to be made that rents may increase faster when purchasing a home is no longer considered a wise investment. When prices go sideways or down, more and more people will stop looking to purchase a home, but still have to live somewhere. This means that people who were previously ready to vacate their rental property when they purchased a home, will now stay put. The kids who move out of their parent’s home, the couples who split up, the immigrants, etc, will also not look at purchasing a home, and therefore demand for rent will start to creep up exponentially. This will not happen over night, but it will happen. As such, one could argue that rent prices could increase substantially, perhaps even faster than the cost of ownership goes up.

    Further to that, there are many “accidental” landlords in Canada at the moment. These are the people that bought a new home before their old one sold, and have chosen to postpone the financial hit and rent out their second home. I don’t know what the statistics are on this, but I would imagine that in the majority of scenarios these people may be relatively stretched financially. So when their taxes and mortgage payments on the rental property go up, there probably is a good chance that they will have to increase the rent simply to stay afloat. Initially this will mean that renters will simply pack their bags and move (that’s the nice thing about renting!). That leaves the landlord with two options: 1) Find a tenant who will pay the increased rent, and 2) Sell the place before the bank forecloses on one of the properties. Again, as long as there are enough landlords in a position that forces them to increase rents, tenants will have no choice but to start paying them. After all, if enough landlords are forced into #2, then the amount of available rental properties would decrease even more, thereby putting a natural upwards price pressure on rentals.

    Again, I have no stats here, and there are a fair bit of “ifs”, however, I don’t think it’s too far fetched. That being said, just because rents go up doesn’t mean that buying becomes more appealing…

  4. Don says:

    I must agree that I am a bit of a bear on housing as well but the bulls are currently correct.

    Housing is not decreasing substantially, and in fact in many cities prices are increasing on lower volume.
    Your opinion is that house prices will drop. You support your opinion with many great arguments. However, the reality is housing has not dropped, and until it does, you, me, and every other bear, are just voicing our speculative opinions.

    For us to be correct, house prices must come down. Until it does, bulls are right and bears are wrong.

  5. mac says:

    Rats! I totally missed this post and am now too tired to read it all. Alas, it’s late and time for bed. But I’m glad I’m under your skin because I am under my own skin and need the company. I wish I could be still be as bearish as you but I’ve had the displeasure of seeing my well-reasoned advice to friends result in some bad decisions for them. Yes. I guess I was persuasive as a bear. I advised a friend not to buy in Toronto in the doldrums of 2008 after he had sold. I now believe that was a mistake.

    If it makes you feel better… deep, deep inside I’m hoping you prevail. But I doubt it. There’s just too much demand over here in central Vancouver. Carry on, Frodo.

    • I’m sure you’re a good guy deep down inside. I just couldn’t pass on the chance to lambaste you after that one comment.
      I meant it when I said that I appreciate your more thoughtful comments. They do force me to re-evaluate my own position and search for the facts. Most of your comments are well thought out…..but that one was a bit of a boner…..
      Cheers

  6. mac says:

    A boner? I refuse to touch that. 🙂

    If I had more time, I’d fully rebut some of your points above but briefly my problems with your examples above are:

    1. Just because there’s no data on it doesn’t mean it ain’t happening

    2. Billions of billionaires is hyperbole, which I am guilty of. But let’s think of the millions of millionaires China will make going forward should they grow a middle class and the damage that could do to Vancouver house prices.

    2a. As per above, agreed there aren’t that many millionaires in China, still a “relatively” small number of people have greatly impacted SFH Westside prices.

    3. Good lord! Not the why don’t they buy in Seattle where the metrics are better, again! I’ll get to that another time but please, I beg you, think like a Chinese person. Where do you want to live and invest and send the kids to school? Capitol Hill or Kerrisdale? LA or Vancouver? Where’s your community? T.h.e.y. p.r.e.f.e.r. i.t. h.e.r.e.!

    4. There are a few 2-bed condos for 400K around here (not many) but $1,200 for rent made me giggle. Try $1750, if ya can get it and closer to 2K for a decent place. But no kidding it makes more sense to rent. Yet not for all of the people buying! Who could those people be? (Hint: Scroll back through Garth’s photos from his tour, especially his tour in Vancouver. Those buyers never showed up to hear his message! We have a bifurcated audience AND a bifurcated market.)

    Thanks.

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