Vancouver Real Estate – West Coast Express to Affordability?
At the end of November, Vancouver city council voted to adopt a new 10 year housing strategy. The city’s plan hopes to tackle homelessness, increase neighbourhood density, stop rampant Vancouver real estate speculation, and increase rental housing stock.
Honestly, what took so long? Housing has been too expensive since 2010, and started being referred to in the media as a crisis in 2015. After 2 years of crisis they announce a 10-year plan to solve it? With all due respect, that doesn’t sound like a strong enough crisis response.
However, I’ll give credit to the city, buried in the 10-year strategy is a 3 year plan to quickly implement some measures including:
An approach to speed up permit approval processes and,
Begin consultations for rezoning the Broadway Corridor, Nanaimo Station, and 29th Station.
It’s disappointing the city has waited until 2018 to begin the Broadway Corridor process. After the Skytrain plans were published, the city snapped up properties along Broadway and stands to benefit financially from rezoning. Perhaps the city delayed rezoning so that it could buy property at discounted prices? After all, the plans for Broadway have been public knowledge for years. The wait for rezoning has held back real estate development, driven speculation, and unnecessarily delayed the release of significant housing supply.
What are the current price forecasts for 2018?
The BC Real Estate Association expects Vancouver apartment prices will rise another 8% in 2018. This is in spite of the combined headwinds of higher mortgage rates and new mortgage stress tests that reduce the size of mortgage a household can get. As an example, below I show the impact of the factors on a household making $90,000.
What’s the long term forecast?
Now that we have a Federal and City of Vancouver housing strategy, most people want to know where Vancouver real estate prices and affordability are headed. To do so, let’s evaluate the underlying causes of the unprecedented rise in Vancouver real estate prices.
Not enough housing supply
Vancouver rental vacancy rates are at record lows. 4% to 5% vacancy is considered healthy but Vancouver and Toronto are below 1%. People seeking to buy a home find themselves in a bidding war which has led to dropping financing and inspection conditions in their offers. This would have been unimaginable in 2005!
On the other hand, Vancouver based researcher, Dr. John Rose believes the supply issue is a myth. He has looked at the census data for Vancouver back to 2001 and concluded that we have built an excess supply of 20% homes in Vancouver and that the price growth must be the result of speculation and underutilized real estate.
Foreign Buyers
In 2017 foreign buyers are estimated to purchase 4% of properties sold in Vancouver, down from 16.5% in 2016. The impact of foreign buyers has less to do with how many homes they buy, but rather with how they participate in the market. Mortgage Sandbox has interviewed several local realtors whose consensus is that foreign buyers tend to make cash offers, with no subjects, they are less budget conscious, and willing to offer significantly above asking price. Imagine making an offer to buy a home knowing a competing offer may be fifty thousand above the asking price with no subject conditions. What would you offer in this situation to get you “dream home”? These situations are leading local buyers to take risks and to stretch their finances.
Our government doesn’t track the origins of foreign buyers, however the Chinese government has acknowledged that its citizens are investing in real estate abroad, and thus has imposed restrictions on Chinese citizens preventing them from taking more than US$50,000 out to the country and making them pledge not to invest in foreign real estate.
These measures have been in place for a year now and have not had a significant effect on prices. But what if the government measures start to work?
Ridiculously low mortgage rates
Mortgage interest rates today are less than half the best available rates in 2001 and much lower than the rates in 2007. The chart below shows the range of rates available to a hypothetical “Jones Family” over the past 10 years. Rates were highest at the end of 2007, lowest at the end of 2016, and the red dot shows where we are today. Mortgage rates strongly influence the size of mortgage a bank will give the Jones, so the Jones would have qualified for more money in 2016 then they would today.
To illustrate the impact of rates, let’s look more closely at the Jones Family here both parents work and bring in a combined household income of $90,000. At a rate of 7% in 2001, the Jones qualified for a mortgage of about $260,000. In 2016, at a mortgage rate of 2.5% they qualified for $410,000. In this manner, you can see how interest rates alone can account for a $150,000 increase in condo prices.
Arguments have been made that mortgage rates will never hit 5% and I would agree they will likely never hit double digits like they did in the 1980s, but 7% is very possible. In 2001, when mortgage rates were 7%, inflation was less than 1%, and the economy grew by 1.8%. In 2016 when mortgage rates were 2.5%, inflation was 1.5%, and the economy grew by 1.5%. So, there is a good chance that mortgage rates will continue to rise.
If you believe the 5 largest Canadian banks, the Bank of Canada bank rate could rise from 0.5% at the beginning of 2017 to as high as 2.0% by the end of 2018. If we return to the Jones Family analogy and assume mortgage rates rise from 2.5% to 4.0%, then they would qualify for a mortgage of about $350,000. A 1.5% rate increase reduces how much home they can buy by $60,000.
As well, starting in January the government will require lenders apply a 2% stress test when home buyers get approved for a mortgage (i.e., home buyers need to qualify for 2% above the actual mortgage rate they have negotiated). Returning to the example above, assuming 5 years mortgage rates at the end of 2018 are 4.0%, a home buyer would qualify against a stress test rate of 6%. Now the Jones can only qualify for a mortgage of $290,000. The addition of the stress test reduces their purchasing power by another $60,000.
If we assume anyone buying a home needs a mortgage and we know that their home buying budget could drop $60,000 to $120,000 between 2016 and the end of 2018, what should we forecast home prices will be at the end of 2018?
Best investment
Many people have argued that Vancouver Home Prices are driven by the “commoditization” of real estate; Vancouver real estate is a global investment which is why the home prices are not connected to local incomes. As well, if the home is your principal residence it receives favourable tax treatment.
The hypothesis is that over the long run, real estate is attractive because it provides:
Tax free capital gains
A physical asset
Low risk and high return
1. Tax free capital gains
For people who don’t mind moving every couple of years, flipping houses can be very lucrative particularly in Canada. In the U.S. mortgage interest is tax deductible, but in Canada capital gains on your primary residence is tax exempt. Some people fail to pay the capital gains tax when they sell a home, even if it wasn’t their primary residence. This makes home ownership more attractive than other investment options. Buying a home is like a tax-free saving account with no limit.
2. A physical asset
Unlike investing in companies whose assets are dependent on constant innovation and market share like Apple and Wal-Mart, real estate is an investment in physical asset tied to land. An investment in a company can lose its entire value with a bankruptcy or government bail out. For example Lehman Brothers, Sears, and Toys R Us were considered “too big to fail” but ultimately failed. Yes, your home values may go up or down but the property itself is not going to disappear.
3. Low risk and high return
Vancouver real estate prices have generally risen steadily since the 1990s when Canada was spared the global turmoil of the financial crisis that saw real estate prices in many countries around the world cut in half. If the Jones had bought a condo in 2015 for $470 thousand, they could sell it today for $645 thousand. That’s an investment return of 15% annually. If they had only put in a $70 thousand down payment, then their equity today would be over $245 thousand.
Mortgage Sandbox recently posted an article about the “low risk and high return” myth. In efficient markets, there is no such thing as a low risk investment with consistently high returns. If there were such an investment, then everyone would buy it and bid up the prices until the investment returns were equivalent to other low risk investments.
Looking at the chart above, people buying Vancouver real estate today are expecting it will be as safe as a Savings Account, but with returns equivalent to “Small Cap” stocks.
There is a real risk that buyers today could be close to the top of the cycle. Many experts believe that Vancouver real estate is in bubble territory regardless of the supply and demand conditions and await the inevitable crash. They conclude that prices are simply too high when compared to Canadian incomes and have surpassed the maximum share of average take home pay that a household can devote to housing. Some notable bubble proponents are Union Bank Suisse (UBS), Moody’s Credit Rating Agency, CMHC, the U.S. Federal Reserve and Steve Eisman, who is famous for managing a fund that made over a billion dollars due to the 2007 U.S. housing crisis. If you want to replicate the “Big Short” Steve Eisman says CIBC is the bank most exposed to risk in the event of a housing correction.
Government intervention
The City of Vancouver has placed restrictions on short term rentals, imposed an empty home tax and is contemplating restrictions on foreign ownership.
The Province has imposed a property transfer tax on foreign home buyers and is planning to announce further measures with its budget in February 2018. They are particularly concerned about real estate speculation spilling into Victoria and other B.C. cities affecting affordability and the sustainability of those communities.
The Federal government has changed mortgage rules several times in the past few years trying to rein in speculation. They shortened insured mortgages to a maximum of 25 years (at one point 40 years was an option), added stress tests to both insured and uninsured mortgages, and made it more difficult for lenders to be competitive financing rentals and offering mortgage refinances.
Census data has showed that in some the most expensive neighbourhoods in Metro Vancouver a high number of households have declared income below the poverty line. This has led tax authorities to begin auditing households that are asset rich but aren’t declaring an income that would support their lifestyles.
What you need to know
What do we think? We believe home is a place to live and is separate from your investment strategy. If you feel you need to own your home in order to be happy then buy a home that doesn't put too much pressure on your finances.
If you want an investment talk to an investment advisor and consider diversification.
With rates rising, the government intent on pushing prices down, income growth flat, and home prices breaking records every year, we believe there is a real risk of Vancouver home prices dropping rather than continuing to rise.
What do we think? We believe home is a place to live and is separate from your investment strategy. If you feel you need to own your home in order to be happy then buy a home that doesn't put too much pressure on your finances.
If you want an investment talk to an investment advisor and consider diversification.
With rates rising, the government intent on pushing prices down, income growth flat, and home prices breaking records every year, we believe there is a real risk of Vancouver home prices dropping rather than continuing to rise.
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