By David Wolf of Merrill Lynch
We’ve seen a handful of more hopeful signs in the Canadian housing market of late. Demand appeared to rebound in February after an awful January, with resale activity reviving somewhat – Toronto, Calgary and Vancouver reported monthly sales increases of 54%, 51% and 94%, respectively, each well in excess of the usual seasonal bounce, suggesting a nationwide pop when those data are released later this month. And the needed supply adjustment is unfolding even faster than we’d expected – housing starts have fallen 46% over the past year, with more than a third of that drop coming just in the past two months. This decline in starts (along with project cancellations) has finally begun to bring down the bloated supply pipeline – the number of units under construction across Canada is now falling on a y/y basis for the first time since 1996.
While these are positive developments, to be sure, this looks to us far more like the ‘end of the beginning’ than the ‘beginning of the end’ of Canada’s housing bust. That is, we believe we’re transitioning from acute weakness to chronic downward grind, not imminent stabilization and recovery.
First, these sorts of near-term ‘pops’ in demand are common through sustained housing market downturns, apparently reflecting spasms of hope that the market has ‘finally fallen far enough’. Through Canada’s bust of the early 1990s, existing home sales actually troughed fairly early on in May 1990, and posted their biggest monthly gain ever in February 1991 – but prices did not put in a definitive bottom for another five years. Through the current US bust, existing home sales have in fact tried to trough twice – bouncing between September 2006 and February
2007, and again between April and September last year. But far from stabilizing, US house prices appear to have re-accelerated downward of late.
To be confident in a durable rebound in housing demand in Canada, we must be able to project a sustained improvement in consumer fundamentals, the most important of which is employment. We cannot do that – our base case projection sees the unemployment rate rising above 9% in early 2010 from its current 7.2%.
Second, the supply adjustment still looks to have a long way to go. In the US, housing under construction peaked in January 2006 at 53% above the long-term average and 27% above the late 1980s peak; three years later, the adjustment is still ongoing. In Canada, units under construction peaked just last June, and despite the adjustment since, January’s level was still 85% above the longer-term average and 46% above the late 1980s peak (see Chart 3). Moreover, two-thirds of that pipeline is multiples (largely condos), the highest proportion since 1973; those longer-lived projects will still be rolling onto the market for years to come.
Housing busts almost inevitably take a long time to play out, because supply lags badly and sellers tend to be loath to mark prices down enough to clear the market. We do not expect the current Canadian cycle to be any exception.
Thursday, March 26, 2009
Teranet House Price Index - March 2009 - Monthly Report
A national downtrend, less pronounced in Montreal
Canadian home prices in January were down 2.4% from a year earlier, according to the Teranet–National Bank National Composite House Price Index™. As the chart below shows, this reading extends and deepens the home-price disinflation that began last February. It confirms that in early 2009, after more than five years of seller’s-market conditions, Canadian housing as a whole was a buyer’s market. January was also the fifth straight month in which the composite index was down from the month before, extending the first run of consecutive monthly declines since March 2007. The composite index is now down 5.5% from its peak of last August.
Of the six constituent city indices, three were down from a year earlier: Calgary (−8.2%), Vancouver (−4.2%) and Toronto (−2.4%). Two others were still up from a year earlier but by much less than last month: Ottawa (2.1%) and Halifax (1.2%). The sixth city, Montreal, also showed deceleration but maintained a respectable 12-month increase of 4.1%.
In another indication of the recent downtrend, each of the six city indices was down from its all-time high of last year (or 2007 for Calgary). However, they have not been moving in lockstep. The Calgary index was down from the month before in 14 of the last 17 months, with seven straight declines from last July through January. January was also a seventh consecutive month of decline for Vancouver. For Toronto it was the fifth, for Ottawa the third and for Halifax the second (the fourth in five months). Montreal’s index peaked in September, fell for three months in a row, then edged up 0.1% in January.
The historical data of the Teranet–National Bank House Price Index™ is available at http://www.housepriceindex.ca/.
Calgary -11.4% from peak
Halifax -3.5% from peak
Montreal -0.4% from peak
Ottawa -3.6% from peak
Toronto -6.1% from peak
Vancouver -8.3% from peak
National Composite -5.5% from peak.
By : Marc Pinsonneault, Senior Economist Economic & Strategy Team, National Bank Financial Group
Canadian home prices in January were down 2.4% from a year earlier, according to the Teranet–National Bank National Composite House Price Index™. As the chart below shows, this reading extends and deepens the home-price disinflation that began last February. It confirms that in early 2009, after more than five years of seller’s-market conditions, Canadian housing as a whole was a buyer’s market. January was also the fifth straight month in which the composite index was down from the month before, extending the first run of consecutive monthly declines since March 2007. The composite index is now down 5.5% from its peak of last August.
Of the six constituent city indices, three were down from a year earlier: Calgary (−8.2%), Vancouver (−4.2%) and Toronto (−2.4%). Two others were still up from a year earlier but by much less than last month: Ottawa (2.1%) and Halifax (1.2%). The sixth city, Montreal, also showed deceleration but maintained a respectable 12-month increase of 4.1%.
In another indication of the recent downtrend, each of the six city indices was down from its all-time high of last year (or 2007 for Calgary). However, they have not been moving in lockstep. The Calgary index was down from the month before in 14 of the last 17 months, with seven straight declines from last July through January. January was also a seventh consecutive month of decline for Vancouver. For Toronto it was the fifth, for Ottawa the third and for Halifax the second (the fourth in five months). Montreal’s index peaked in September, fell for three months in a row, then edged up 0.1% in January.
The historical data of the Teranet–National Bank House Price Index™ is available at http://www.housepriceindex.ca/.
Calgary -11.4% from peak
Halifax -3.5% from peak
Montreal -0.4% from peak
Ottawa -3.6% from peak
Toronto -6.1% from peak
Vancouver -8.3% from peak
National Composite -5.5% from peak.
By : Marc Pinsonneault, Senior Economist Economic & Strategy Team, National Bank Financial Group
February 2009 CMHC Data
Good day,
CMHC released statistics for February 2009 last week and I have finally had a few minutes to look over them and put together some charts.
Starts were 701.
Completions were 1241.
Units under construction fell to 25,097. We still have a long way to go down here.
The number of completed yet unsold units is skyrocketing and currently stands at 2391. Contrast that with one year ago at 1384. Despite the best efforts of the developer's marketing firms, new units just ain't sellin'. It could be that they are unaffordable for the average person and that there are very few greater fools left.
Monday, March 23, 2009
How much is your time worth?
I really do want to know because my time is not free given there is not enough of it. So when I look at an investment, be it real estate, stocks, or a business venture, how should I account for my time?
Let’s take a simple example of a couple looking to diversify and add some real estate to their investment portfolio. They talk it over, look at the success and failure stories, think a bit about the responsibilities, and decide to look for an investment property, planning to manage it themselves. After 2 months of searching, driving to open houses and viewings, discussing over dinner, running the numbers, many offers, negotiations, inspections, mortgage approval, negotiation, and signing, and eventual closing proceedings, they purchase a condo with prospects of a cash flow positive rental income.
After countless hours of work they now have a property to rent out. Now comes the easy bit. Rental listings, fielding calls of interest, shortlisting applicants, background checks, interviews, viewings, and the eventual contract signing and logistics of occupancy.
Now the checks roll in. They go to the bank and deposit the cheques. Then there’s the property tax payments, regular reading of strata minutes, (hopefully few) maintenance calls, possibly handling of complaints of neighbours (if they’re really unlucky), and the added complexity to their income taxes.
Then there’s handling termination of occupancy, walkthroughs, and negotiation of damage deposit refund. See paragraph 3.
Every few years there will be some semblance of major repairs. Now there are the contractor interviews, planning, negotiation, reviewing and signing of contracts, oversight, and audit of the work; if they’re lucky not much more than this. Or they can go it themselves and do the plans, buy the materials, work weekends, and hopefully not spend crazy amounts of time doing it.
When they eventually sell this property there are outlays including interviewing Realtors, signing the contract, negotiating, giving tenants notice, employing a lawyer/notary, and the eventual property transfer itself. Never mind the tangible commissions and other taxes and fees.
But still, the property, at least as the cash flow statement indicates, is profitable. But what if we simply look at this investment if we assume we are running a business? Here all costs, including the initial investigation, contract negotiations, operations, accounting, and capital outlays, all must be budgeted for as if employees are paid to perform these tasks. The costs conveniently forgotten on the cash flow statement of a small-time investor start adding up.
I hear countless stories about a property being “cash flow positive” looking at the basic cash outlays: rent coming in, mortgage, maintenance, and taxes going out. Yet if we start including other costs, assuming others were fairly paid for doing this work, all of a sudden, given one’s time has value, the “cash flow positive” investment is anything but. Often I hear the justifications for all this; “sweat equity” is a favourite of mine, putting some intangible return on time spent, but an even better one is that renovation and real estate is really a hobby, a pastime whose efforts would be done for free anyways. Right. To be fair I hear the same for other types of investments too. Investments take time to manage, though some take more time than others.
It is well worth asking how corporate investors, who cannot hide all the "other" costs of managing investments on their balance sheets, make a decent return in the first place. If or when purpose-built rentals become feasible in Vancouver again, what type of yield will be required?
Let’s take a simple example of a couple looking to diversify and add some real estate to their investment portfolio. They talk it over, look at the success and failure stories, think a bit about the responsibilities, and decide to look for an investment property, planning to manage it themselves. After 2 months of searching, driving to open houses and viewings, discussing over dinner, running the numbers, many offers, negotiations, inspections, mortgage approval, negotiation, and signing, and eventual closing proceedings, they purchase a condo with prospects of a cash flow positive rental income.
After countless hours of work they now have a property to rent out. Now comes the easy bit. Rental listings, fielding calls of interest, shortlisting applicants, background checks, interviews, viewings, and the eventual contract signing and logistics of occupancy.
Now the checks roll in. They go to the bank and deposit the cheques. Then there’s the property tax payments, regular reading of strata minutes, (hopefully few) maintenance calls, possibly handling of complaints of neighbours (if they’re really unlucky), and the added complexity to their income taxes.
Then there’s handling termination of occupancy, walkthroughs, and negotiation of damage deposit refund. See paragraph 3.
Every few years there will be some semblance of major repairs. Now there are the contractor interviews, planning, negotiation, reviewing and signing of contracts, oversight, and audit of the work; if they’re lucky not much more than this. Or they can go it themselves and do the plans, buy the materials, work weekends, and hopefully not spend crazy amounts of time doing it.
When they eventually sell this property there are outlays including interviewing Realtors, signing the contract, negotiating, giving tenants notice, employing a lawyer/notary, and the eventual property transfer itself. Never mind the tangible commissions and other taxes and fees.
But still, the property, at least as the cash flow statement indicates, is profitable. But what if we simply look at this investment if we assume we are running a business? Here all costs, including the initial investigation, contract negotiations, operations, accounting, and capital outlays, all must be budgeted for as if employees are paid to perform these tasks. The costs conveniently forgotten on the cash flow statement of a small-time investor start adding up.
I hear countless stories about a property being “cash flow positive” looking at the basic cash outlays: rent coming in, mortgage, maintenance, and taxes going out. Yet if we start including other costs, assuming others were fairly paid for doing this work, all of a sudden, given one’s time has value, the “cash flow positive” investment is anything but. Often I hear the justifications for all this; “sweat equity” is a favourite of mine, putting some intangible return on time spent, but an even better one is that renovation and real estate is really a hobby, a pastime whose efforts would be done for free anyways. Right. To be fair I hear the same for other types of investments too. Investments take time to manage, though some take more time than others.
It is well worth asking how corporate investors, who cannot hide all the "other" costs of managing investments on their balance sheets, make a decent return in the first place. If or when purpose-built rentals become feasible in Vancouver again, what type of yield will be required?
Tuesday, March 17, 2009
Owner’s Equivalent Rent
A question surfacing recently on local blogs and forums has been how to properly value owner-occupied housing. The concept of “owner’s equivalent rent”, the effective rent an owner-occupier pays to carry a property, can be used to justify a property’s value. Such a concept would require setting equivalent rent based upon what other owner-occupiers pay, a slightly unsatisfying exercise for the value investor. A more palatable method would be to find equivalent investment properties and see what rents they command but this is not always easy. It begs the question: how does one ground a property’s value when there is little in the way of equivalent local rentals to do so?
A recent article in the Vancouver Sun had three local pundits involved in the real estate industry give their comments about the local real estate market. While I cannot encourage you to read it fully, I did pick up on a few items Dr. Tsur Somerville from the University of British Columbia has said about his research in how real estate markets behave with a significant portion owned by owner-occupiers.
Q: You said the investment piece is gone: Does that mean that the froth is not going to happen again? (If people aren't buying as investment properties, what would happen with price?)
Tsur Somerville: A couple of issues: No. 1, we don't actually really understand what goes on with investment real estate. When you look at research and studies, it is because home owner/occupiers are such a big piece....
Q: How big?
Tsur Somerville: Since we don't actually 100 per cent know which unit is which. But if you take the Lower Mainland and [calculate] 2.5 million people, 2.6 people per household, that's 800,000 households, 60 per cent homeownership [so] 480,000 households.
The investment piece is still very small in the overall number. It's highly concentrated in certain product types, downtown condos, certain suburban high rise buildings. Overall, it's not a big story. Going forward, we have two things we don't really understand, which is what are those people going to do?
What Dr. Somerville is commenting on is that when owner-occupiers make up a significant portion of a housing pool, it becomes more difficult to determine motivations of marginal players when existing data lump investors and owner-occupiers in one pool, especially when the “investment piece is still very small,” say, 40% of total households.
Joking aside, what I believe is implied is many people place a monetary premium on ownership and motives for buying and selling are not always strictly financial, hence the difficulty in separating true “investors” from the rest. (this blog discussed the concept of the "ownership premium" here.) The “non-investment” focus of marginal owner-occupiers therefore adds uncertainty to the behaviour of the market. He states that there is segmentation between owner-occupied and rental housing, or at least that is the perception, meaning that valuing entire neighbourhoods based upon the whims of investors not heavily involved in the market is questionable.
From a value investment perspective, to determine the net present value, we sum a property’s expected discounted net cash flows. We should also remember that undensified detached housing can justifiably carry a premium over today's rent as the property could be redeveloped in the future so as to increase its utility (as discussed here) and possibly a "gentrification" premium AKA location-location-location in some circumstances (see m-'s great post for some interesting data and analysis). Determining net present value with many equivalent properties with known rents is simple; unfortunately it is more difficult when properties have few direct comparisons. It is possible that in certain neighbourhoods the one or two rentals offering true comparables do not provide enough of a sample to truly gauge what rents would be for other properties. This can even be true for a seemingly normal property with a high finish quality where the neighbourhood's rentals are not renovated to the same degree.
Buyers are therefore left looking at comparable sales in the same geographic location to determine value, in part because neighbourhoods and even adjacent blocks can significantly vary in price. I doubt very much rental data enters into most owner-occupiers’ heads when determining a fair price yet it is an important and almost necessary clue when determining a property’s value ex speculation. Perhaps it is a stigma associated with comparing “the renters” to “the owners”; an admission a property can be rented out at all goes against the concept of “achieving” ownership, or maybe it is just making the buying decision simple: find five comparable sales, offer about that, and Bob’s your uncle. Alas, this is not my idea of value investing.
Believe it or not, even “high quality” houses are rented out. A quick search of Craigslist turns up a few “high quality” rentals, as examples (not sure if they’re “real” or not; these props will likely disappear so maybe do your own search...):
You can calculate how much these properties would be worth as net present value and compare to their rough market values. There are not too many examples of higher quality rentals, however, and we are still left with the problem that a specific neighbourhood will likely reveal few, if any, equivalent rentals for a property for sale.
Yet even from the close to nonexistent comparables, we can still make some assumptions. In the absence of direct data we can look at high quality rentals across the entire region and compare them to lower quality rentals in their respective areas. This will give a rough indication of the premium higher quality demands in the rental market. From this we can look at a larger set of “high quality” compared to “lower quality” rentals and apply a factor to determine equivalent value for a certain “higher quality” property. The concept is simply that there are many neighbourhoods that are effectively comparable, even if separated geographically.
Using comparables from other neighbourhoods is roundabout method of determining value. The uncertainty is higher and my guess is Realtors won’t like the concept one bit; after all isn’t all real estate local? But we need something, even if it’s using deductive inference, or the market is not grounded on anything but sentiment and margins.
Many neighbourhoods have a large mix of both rental and owner-occupied properties so the problem of determining value for the value investor is less severe. For some neighbourhoods, say close to UBC for example, the concept of determining value for predominantly owner-occupied properties I am sure can seem daunting. Even in the face of such high noise, using a bit of deduction, an expanded "virtual" rental market provides us with enough of a tangible signal highlighting how much "high quality" properties are currently priced above what the rents say they are worth.
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