Sunday, July 12, 2009

Bears anxious, bulls victorious and a poll

Poll first. I am trying to work out how many readers I have. Google analytics may double count some folks who use different computers to access the site, therefore please take a millisecond to click ONCE on the poll to the right.

Now to the bubble graph I posted the graph a week or so ago:

In the post I said that most bubbles follow this pattern though there are of course variations in shape and duration as the authorities try their best to keep the bubble inflated, having completely ignored it while it was being pumped up (and even taking credit for it).

I did mention that the bubble doesn't have to resolve this way but could plateau or run up again. In fact I have to admit that I do not recall any bubbles that have NOT burst in this manner. From railroads at the turn of the 20th century to the stock-market bubbles, gold, oil...every crazy run-up seems to follow this path.

For it not to follow this graph would suggest:

1) We are not in a bubble but are just moving up to fair market value

2) We still have more inflation to go in the bubble.

Clearly Vancouver RE was way underpricing on an international basis about 15 years ago. As we have moved up the ranks of the most expensive cities the same cannot be said now.

Could the bubble have further to go? Possibly. As I mentioned in one of my comments the dramatic drop in interest rates came as a result of the catastrophe that was unfolding in the US, and before the full effects were felt here. We therefore had the bounce in RE all across the country. However the effects are now being felt here with rising unemployment and bankruptcies.
If we do not get a bounce in the worldwide economy soon, we will feel it full brunt.

Our governments have already fired their bullets of low rates, increased spending and tax cuts. We have nothing left to throw at the fire.

Policy makers around the world, are doing what they have done best for years, try and prevent the cleansing action of a recession - which BTW punishes speculation and over-capacity- and by doing so have built up the mother-of-all-purges.
So I would not bank on the bull resuming, but of course I cannot completely rule it out.

In fact if you look at the graph, the time of maximum anxiety for bears is during the peaks of the bubble. Like Spring 2008 when bears where getting completely despondent, watching a US RE market melting down and ours hitting new highs.

There was a brief sense of relief and vindication from Summer 2008 to Winter 2009 and now the anxiety is back up to fever pitch as prices have stabilised and moved up. That is to be expected. This graph could chart human emotions, as much as the price of an asset.
Most bubbles end with a quick drop, a bounce and then a long drawn out downward path. We will know if that is our fate in a few months.


  1. I dont know how long is going to last, but I looked at some commercial properties for sale in BC and cap rates are below 3%. I wander who is buying, you still can get 3.5 to 4% yield in a risk free 10 year treassury. What goes through the mind of those investors that invest in a commercial property with 3% cap rate is beyond me. Further more, when you look deeper in some appartment buildings, the cap rate assumes 100% occupancy which makes the investmet riskier. But somehow people keep buying them. What do they know? I cant make sense of it at all!!!

  2. Honestly this new bubble, or spring bounce, or whatever you want to call it, hasnt given me much anxiety. I dont really plan on buying within the next 2 years regardless of what price does. I am still unsure where i would want to live, so I am moving somewhere new in september so I can compare it to where I currently live.

    The short term price changes dont worry me much. What worries me is all of these people buying places they cant afford. I like Vancouver, and I would hate to see the rampant foreclosures that have devastated parts of the states. Neighbourhoods just dry up (literally in Vegas, as the city has shut off water to some subdivisions because no one lives there anymore). I know as soon as a foreclosure ball gets rolling it will hurt other property values and gain momentum and before we know it every 5th home could be bank owned. I don't want to see this happen because I actually like this city. Sure it has its flaws, but in generally it's a pretty good place to live. If home prices do crash, I am not sure if i would want to take advantage as the city may not be the same afterwards.

  3. Anon 9:23: When you can get a variable rate at less than 2%, a 3% cap rate still has a positive spread. The whole foreclosure bugbear eats up some margins but the banks charge most foreclosure fees against the mortgage. There is little downside except the bank's own internal inefficiencies. It's interesting how isolated banks feel they are from price risk.

    The thing to watch in the next 5 years is when (not if) investment picks up and mortgage rates increase significantly. BC typically lags the continent in job growth coming out of a recession so imagine high rates coupled with high unemployment. That's what one calls a crappy power factor.

  4. Jesse,
    I understand that, but the positive spread get eaten away so fast when you consider at least 5 to 10% vacancy and unforeseen maintenance events. With a property you get a lot of those unforeseen maintenance events. So the spread is so small to allow for any error. My question is if those prople pay cash, they are taking a huge risk and if they get a loan from the bank, we probably have still some subprime lending still going on here, because no banker will lend to such low yield property without taking a huge risk.

  5. I'm not sure which places have a 3% cap rate however a lower cap rate is justifiable if future land density increases. Also perhaps the cap rates being calculated are for properties with low vacancy rates or attract higher quality tenants or perhaps were pro-rated in terms of rent (i.e. charging less rent leads to higher occupancy).

    In any case I don't disagree that a 3% cap rate is low even for the most extreme of properties. I don't think blindly applying a 5%-10% vacancy rate without knowing the specific property or rent charged is necessarily accurate.

  6. Vancouver does have one of the lowest apartment building cap rates in the world. There are several reasons that I could deduce:

    1) The vacancy rate has always been extremely low.
    2) There has been is a steady rise in rentals due to the above, land scarcity and increasing pop. This means that what is 3% now may be 55 in a few years.
    3) there is a lot of money coming here. From other Provinces with retirees and offshore $. These investors like to be close to their real estate investments, and so they have pushed the cap rates up on the limited supply of rental buildings
    4) Competing with 3) have been REITS, Union Pensions and Insurance companies. So the demand has been high.

    Throw in low rates and the result is rediculously low caps.

    many owners just refinance to pull out equity as the assessed value increases, so pulling out money tax-free and with very little carrying cost.

    However as has been noted, a major set-back like an elevator or roof will wipe out a year or more's income. Not to mention this major recession which will have an impact on rental rates, and vacancies etc.

  7. That should be ..'what is 3% now may be 5% in a few years'

  8. I know 3 property managers in vancouver, and from discussions with them it seems that there are many empty appartments in the buildings they manage. Some of them sit empty because it seems the owners dont want to rent them out, so nobody lives in them. Most of them, they simply cant rent them out. The feed back I get is that 5 to 10% vacancy rate is not very conservative when considering an apartment building investment and vacancies north of 10% should be considered when calculating cap rate. Also in the most properties I looked there is a big difference between the assesement price and ask price with ask price being 30 to 40% more. I got the information mostly from However if you look down south yo can get cap rates of 10 to 15% on similar properties especially in the Phoenix aera. As a foreign investor I dont see much of value here yet. I normally look at a investment property only if the gross income represents at least 10% of the asking price. It is the rule of thumb used everywhere. Anything under is high risk and almost guranteed to loose money. I have not seen anything yet that comes close to this rule in vancouver and I have been on the look for three months now. Has the cap rate on commercial properties here been always like this?
    I am not so sure, but I believe that if one considers that US real estate reached the peak in 2005 and Vancouver in 2008, there is still a long way down to go for Van RE, things will return to fundementals in the midterm, they always do.

  9. Anon, I tend to agree with your investment trigger of around 10% cap rate for condos. This is based upon looking at returns from other similar investments.

    I don't know much about commercial properties but I think their cap rates tend to be a bit higher than residential. I don't think Vancouver has seen the overbuilding in commercial that many cities in the US experienced, mostly because residential has been more lucritive, thus attracting the available construction labour, and zoning has been slanted towards residential building.

    I have heard from those more atune with the rental market that Vancouver has a residential rental vacancy rate of around 5-7% which is about what your sources claim.

    Some properties will stay filled close to 100% of the time because the rents charged are below market. This is on purpose because landlords can pick and choose tenants who will be less hassle. Their rationale, whether correct or not, is that a stable reliable tenant paying slightly less than market rent is preferable to a riskier tenant who may go into arrears or trash the building.

    Anyways, it sounds like you "figured it out". Probably because you have some perspective outside the city limits! ;)

  10. Fish10, scarcity in rental accommodation would tend to increase cap rates. That rents have not substantially increased in the latest boom means there is more than enough housing available for the population.

    I know of very few REITs and other large scale investors active in the Vancouver area who did not buy many years ago. The vast majority of rental accommodation, especially the recent stock, is being handled by smaller time landlords and investors. That's a sure sign of a bubble.

    The fact that people are competing over a limited supply of housing stock and are willing to pay more than market price would tend to push up prices is of course true. That's the definition of a bubble. It does not justify low cap rates but merely explains them. People not looking at cash flows and instead betting on future price rises is the definition of speculation. I think we agree it's not rational when observing from outside the crucible.

  11. We do agree Jesse. The reasons I listed are the drivers. However it is not rational to buy an investment which requires significant intermittant up-keep on such razo-thin margins.

    It reminds of reading about RE in Japan in the late 80's, when invstors were buying Cap rates of 1%. Crazy. Then a year later they would sell it for 25% more and the next guy would be bringing in a fraction of 1%.

    That went on until the music stopped and RE entered a two decade (on-going) slump.

    From Wiki:

    Prices were highest in Tokyo's Ginza district in 1989, with choice properties fetching over 100 million yen (approximately $1 million US dollars) per square meter ($93,000 per square foot). Prices were only marginally less in other large business districts of Tokyo. By 2004, prime "A" property in Tokyo's financial districts had slumped to less than 1 percent of its peak, and Tokyo's residential homes were less than a tenth of their peak, but still managed to be listed as the most expensive in the world until being surpassed in the late 2000s by Moscow and other upstarts. Tens of trillions of dollars worth were wiped out with the combined collapse of the Tokyo stock and real estate markets. Only in 2007 had property prices begun to rise; however, they began to fall in late 2008 due to the financial crisis.

  12. David: "If home prices do crash, I am not sure if i would want to take advantage as the city may not be the same afterwards."

    --> I actually hope that the city will be different: not nearly so self-inflated and pretentious. I'm hoping that with foreclosures and banruptcies, you might actually be able to have a conversation with someone about something other than self-aggrandizing aquisitions or "lifestyle". When the narcissism finally ends, we might find that we actually have time for human relations again. Woudn't that be a good thing? We might find that we actully have common interests other than looking in the mirror and admiring ourselves for our ever-so-prescient real-estate investments.
    Honestly, I can't wait to for everyone to regain a sense of proportion in their lives, and build some actual human relationships. These plastic lives that surround me have been getting to me for years ...

  13. Anon if you are trying to tell us that RE is overpriced in Vancouver you are preaching to the choir.

    And Fish 93K per square foot? I suppose Vancouver isnt so bad after all.

  14. anon 556 (cant you guys pick names?)

    No one I know is pretentious about real estate investments because I am 22 so most of my friends cant afford and wouldnt want real estate right now. I am with them, but I am here to gain some knowledge for the future and I find it interesting.

    I am just worried because bad times bring out the worst in people. Drugs are already a pretty big industry here and I would hate to see people turn to gang life because they have no other choice. Also you think the homeless situation is bad now? A bunch of foreclosures is not going to help things. I am not saying it will be a disaster, but I like it when all of my friends can find jobs, and I know a few who work in construction.

    A nice slow decline would be much preferred over a sharp drop with thousands of people losing their homes.

  15. Anon and Dave. Actually both of you may be right. In a major economic downfall, we will see hardship and misery and increased crime. However we could also see folks rejecting the consume-at-any-cost mantra that we have been following for the last few decades.

    they would, hopefully, help each other get through the tough times and look for meaning in life other than from possessions.

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