Thursday, March 3, 2011

Houses and incomes, they correlate, they always have

That's not to say that other factors, like say, rising and falling interest rates, can't also play a factor in home prices. Of course they do.

Long-time readers of HHV may remember this post from April 2009, just about the same time the mini-crash we experienced in the latter half of 2008 and early 2009 was ending, highlighting a TD Economics report that pegged Victoria average home prices to be 18% out of whack when incomes and rents were compared.

In the past couple of days, BMO has released a similar analysis of the Canadian real estate market. Ben over at Financial Insights has some commentary up. And the Financial Post is weighing in too with this piece titled: Housing crisis inevitable if prices outpace incomes.

While the economist at BMO, Sal Guatieri, was quoted, and some of the quotes were juicy purple bear kool-aid, the report can hardly be called a damning indictment of the current market conditions. But let's drink from the fountain anyway OK?
Tighter mortgage rules, which come into effect March 18, along with higher interest rates, lower affordability and elevated household debt, “should keep house prices on a tight leash,”
Emphasis mine. Did you see what bond yields did today? Astonishing (H/T Ben). That's right, if this doesn't drop in a hurry, you better prepare for fixed-term interest rate hikes in short order from the major lenders. Do I hear a full half percent in a 30 day span? Effectively dropping qualifications an additional 7%?

By March 18, when the new mortgage rule changes come into effect, if we see a coincidental interest rate hike, buyers could see their mortgage qualification amount drop substantially. But of course, this won't impact Victoria 'cuz we're on an island and we're insulated.*

Let's get back to the numbers. TD Economics had us pegged at 18% overvalued in 2009. Back then interest rates were roughly what they are today. So what's happened? Well, according to BMO, BC is now 31% overvalued. Considering the Victoria average is oh, 10%-15% higher than the BC average, we might say things are looking downright Saskatchewan-y in Victoria if you buy into the history of price to income ratios.

The margins really are ever so tight right now. I giggle like a school girl every time I hear someone talk about the current situation in comparison to the big market crash Victoria experienced in the early 1980s. They say inflation was rampant back then. They say interest rates jumped to over 20% back then. They say that there is no way interest rates can jump that high again. They say because that can't happen there's no way the same situation can play out in Victoria now.

I say they don't have a clue how interest rates effect payments, markets and qualification amounts. We don't need 20% interest rates to see a monumental reduction in affordability to 1980 crisis levels. Two or three percentage points at today's prices will create the same conditions. Looks like the bond markets are starting to get jumpy with all this risk floating around.

BMO expects interest rates to rise 2% over the next 18 months. If that expectation plays out, say good bye to 30% of your mortgage qualification amount. Best buy now before you're priced out forever.**  

* We are on an island, but that doesn't mean we're insulated, regardless, get ready to hear this meme in overdrive from the usual suspects.

** Yes, this was sarcasm. Extremely sarcastic.


jesse said...

What has always confused me is that low interest rates should mean low income growth. In other words, if wage growth and interest rates are low, the discounted cash flows don't change much compared to if wage growth and interest rates are higher.

Decreased costs of capital obviously have a marginal impact but we're talking about multi-generational assets, not something that goes away after 5 years. The impact on lowered cap costs, therefore, should be more muted than what marginal buyers are assuming.

But they're not. Which is why if you're patient you will put yourself into a much nicer house than if you buy at today's prices. It may take a large part of your youth for this to happen but life isn't fair: just ask my grandfather who lost a leg in the war.

SJ said...

Hello HHV – Ref, your comment yesterday. We moved from Victoria to the South Shore of Nova Scotia in 2006. We wanted to get into a couple of rental properties in Victoria (for retirement/investments for our kids), but by 2006, prices were too high in Victoria and we came over here. We have been building a few rental properties here – mainly duplexes, which can be sold off individually. The building costs run between $96 sq ft (laminate & tile) and $120 sq ft (hardwood and more high end finishes). Lots can run between $40,000 - $85,000 in places like Chester and Mahone Bay. The rents are pretty good at just over a $1,000 pm for each side.

There are good opportunities here, especially waterfront lots and houses - there is still a lot of undeveloped land and prices haven’t shot up, even during this latest boom. As the locals say, it just keeps plodding along.

However, we would love to get back to Victoria again and buy a home. We still receive PCS e-mails and keep track with what’s happening (enjoy both your blog & Garth Turner). All we usually end up saying to each other is “...And they’re still buying!!” It seems incredible to us how the prices have kept on moving, apart from that one blip between the end of ‘08/beginning of ‘09. In fact, at that time, we talked to a realtor about returning then. He told us if we waited until the Fall of ‘09, there would be lots of bargains to be had! I think he would have been right if there hadn't been all this interference by the government to get things off like a rocket again.

BTW Just wondering who are the main buyers in the Victoria market now?

Brian said...

What do you think the effect will be on houses in the lower end, say the $400,000 range? Do you see a huge price drop in these entry levels also? I currently have an oppourtunity to build a house myself on a developers land in Nanaimo. They are currently selling these smaller houses for $400,000 incl HST, but I can build it myself for about $360,000. I figure this is enough to absorb a pending price decline? My wife is "nesting," and unfortunately our tiny condo which we have been living in does not work for the baby coming and all! I tried to suggest another rental to see what happens in the next year or so, but the idea of "home ownership," is too appealing to her even though I've tried to explain that we would probably be far better off financially to wait a year or two as prices will decline, and we could also save some more money in the meantime.

I am interested to hear some others thoughts on if this would be a decent idea since we are saving a bundle building the house ourselves? We have to move anyway which is always an expense and of course our rent would increase also. We are currently paying $1000/month, and I found a 3 bedroom for $1300/month.

HouseHuntVictoria said...


Renting is still cheaper than owning.

That said, if you can afford it, are comfortable with a rising interest rate environment (meaning you can afford it when rates reset at a later date 2%-3% higher than today), can see yourself nesting for a decade or more and won't be beating yourself up if the neighbours house sells for 20% less in a few years, you'll probably be fine. But there are no guarantees in life other than:

A happy wife = a happy life.

Kevin said...

With mortgage rules tightening from 35 to 30 years and an increase in the qualifying rate from 5.19% to 6.19%, the amount buyers ( with and income of 75k) can borrow drops 16%.

HouseHuntVictoria said...


Thanks for that. There's some confusion on the qualifying rate for mortgages still. It's not the posted rate on 5 year terms, it's the discounted rate. In a lot of cases that's still in the range of 3.4%-3.8%.

HouseHuntVictoria said...


Have some haddock & chips and a bottle of Kieth's in celebration that you live on Canada's right coast paradise. I love Chester and Mahone Bay, even in winter.

Maybe I can convince Mrs HHV to turn our down payment into a retirement property?

Buyers in Vic are still a mixed bag. It's been the same forces at work here for decades: FTBer's make up about 25% of sales, out of towners make up about 15% of sales (though not all live here), the rest are the move-up and down-sizers.

We have ridiculously low inventory and sales volume for a city with 160,000 or so dwellings.

The closer to the core you get, in SFHs anyway, the tighter the market is. Gordon Head appears to be in high demand.

Just Janice said...

Paul Krugman is now joining Prof. Shiller by claiming that he should be very worried about Canada...

So two very reputable economists are now worried about Canada - but the average Canadian seems to think that it's different here and that we are immune....

Leo S said...


I don't think that's true. It is the mode of the big banks' posted rates, as explained here.

This week it is 5.44

HouseHuntVictoria said...


"The benchmark rate is the rate lenders must now use to qualify mortgage borrowers for any high-ratio insured mortgage that does not have a fixed term of five years or more."

If you take out a 5-year fixed rate mortgage, you get qualified at the rate the bank will offer you.

It's only for terms shorter than 5 years that the bank uses the benchmark qualifying rate.

The majority of mortgages are for 5-year terms. Even if they weren't, they've been given the incentive to go that way now haven't they?

MC said...

"We have ridiculously low inventory and sales volume for a city with 160,000 or so dwellings"

What about the other 200 000 or so houses?

Waiting said...

Anyone catch Global news tonight? The interview with the girl who bought in Olympic Village...she said prices were reduced around 30% and the newscaster said 'she isn't allowed to say how much she paid.' I'm guessing it wasn't much if they are keeping the actual numbers off the news.

Animal Spirit said...

JustJanice - good to see you back - hope that your small family is doing well now.

Devore said...

Olympic Village prices were reduced ON AVERAGE 30%, with rates ranging from 5% to 50%. Supposedly the lower end units got the smaller discounts?

Still boggles the mind how a 20-something single person can buy a half-million dollar box.

HouseHuntVictoria said...


There aren't 360,000+ dwellings in the CRD area. There's only just over that many people.

CRD Fact sheet

Just Jack said...

Is your home a property ladder or a step stool?

Choosing the right property for the potential future appreciation is key to real estate investment.

For example if you had bought a half duplex in Maplewood in October of 2005 for $305,000 you would have sold the property this week for $396,000. A gross profit of 30 percent. And you would be on the property ladder to the next rung of a detached home.

But, if you believed the press in 2005 and 2006 that said that Victoria was drawing in the retirement population from the rest of Canada, then you may have bought a condominium on Oak Bay avenue with an 18 year and over restriction for $310,000 in May 2006 and sold it today for $330,000. A gross profit of 6% and ended up on a step stool.

Marko said...

"Still boggles the mind how a 20-something single person can buy a half-million dollar box."

Your average 20-something is not buying.

You need to savvy with your money, hard working, and a bit lucky. If you are working 9-5 pm, saving only 10% of your income and investing in GICs most likely you won't end up in a half-million dollar box.

I find most of my younger buyers have much larger incomes on average than my older buyers when both are looking in the same price range. The older buyers typically have equity, younger ones have to use income to qualify.

Finally, you have to make some sacrafices if you really want to get into real esate at a young age.

Just Janice said...

My little family is doing well with the newest addition approaching 8 months, actively crawling, pulling up on things, making a range of sounds, eating all sorts of stuff and filling my days in a way I couldn't have appreciated before. My husband has a strong nesting instinct and is itching to approach the owner about purchasing...I'm hesitant and think we should hold off any such plans until January 2012 at the soonest depending on market conditions. I just feel there'd be a real risk of buying at the peak and facing negative equity while doubling our monthly cost of living. My husband worries about the risk of losing out on the 'ideal' location for us to build our forever home. It was so much easier to postpone buying when our personal finances were such that focussing on them made the most sense. Now we have a modest but feasible down payment and a combined income that makes it a real so much harder to persuade him to wait when he's been waiting now for more than two years...

End of the day, I want a happy husband - the couple hundred in negative equity (for a decade or so) might just be the price to pay for the location we want. What do the bears think of the outlook for Dallas Road (near clover point) ? I'm thinking 20% correction while the rest of Victoria rolls back 30% with outlying areas getting a 40% haircut over the next 5 years. (I see prices decompressing with the traditional relationship between Oak Bay, Fairfield, Fernwood, Saanich, Esquimalt, the West Shore and Sooke being restored somewhat). If only our little family could have a big enough windfall that I wouldn't care about the coming asset price deflation....

Marko said...

Let's say that prices on a 500k home are lower 10% in absolute terms, maybe 20% lower adjusting for inflation, in 5 years.

Right now, you have 20% down and you can borrow 400k at a five-year fixed, 3.65%, 25 years.

Are you better of renting for the next 5 years then buying, or buying now?

Just Janice said...

Marko - much better off renting. A 500k house in Victoria right now is going to rent for $2000 or less per month. No property taxes, no maintenance, low costs to move. In your scenario you'll spend about $120,000 on rent over the 5 years. But if you bought you'd spend $50,000 on lost equity, another $67,800 on interest, plus at least $12,000 on property taxes and maintenance, plus the transaction costs.... At the end of 5 years you would still owe about $346,000 and the house would be worth $450,000.

Conversely if you rent you continue to earn interest on the downpayment (even at 3% that's more that $15,000 over the 5 years), can save the $12,000 and can buy the same house 5 years down the road for $450,000 with $127,000 down payment and owe $323,000.

wally said...

Marko, interesting question. I’m game to crunch the numbers to find out. Since I have an hour to kill, and the building across the way has two units for sale with an open house starting at noon - I’m off to get the numbers. I think they're both listed for four something, but i'll get the strata fees and taxes. I’ll be back.

Marko said...

Okay....I have a spread sheet going back to 1988 with average annual prices for SFH.

1988 - $127,888
1989 - $150,930
1990 - $179,150
1991 - $191,775
1992 - $222,415
1993 - $246,727
1994 - $256,025
1995 - $242,012

1996 - $241,910
1997 - $248,921
1998 - $246,018
1999 - $249,930
2000 - $251,398
2001 - $259,138
2002 - $280,218
2003 - $328,005
2004 - $386,045
2005 - $463,399
2006 - $521,460
2007 - $565,904
2008 - $583,701
2009 - $580,748
2010 - $629,925
2011 YTD - $608,005

So if price are 10% lower from here in 5 years we are looking at prices being lower in 2016 compared to 2007. That is drop over a 9 year spread. Seems unlikely, but I guess you never know.

There is a stronger possibility we are looking at a 6xx,xxx average in 2016 than 5xx,xxx or 7xx,xxx. Just my take on it.

a simple man said...

and I think high 300,000s to mid 400,000s

But we are all only guessing. What I do know is that right now houses are generally too expensive for incomes.

omc said...

Just Janice,

I don't know what levels of correction we are expecting, but thinking that that area is going to do better is plain wrong. Fairfield is doing rather poorly by the sales I am seeing. Oak Bay, Fernwood and Gordon head are holding much better. I don't know many families that want to live there(that can afford to) because of the middle and high school. Don't forget the BIG negative of the basement suites. Compare that to Oak Bay; we have 3 families that are looking at Oak Bay just on this board.

If you are expecting a big correction, like you said 30%, then you can expect that area to drop 30%.

wally said...

So both open house units were the same size as my rental (700+or-). Both listed at $390,000. The only two drawbacks both suites had, no view and very small bathroom. Wedged up to toilet to close door. One unit quite damaged from renter. Still, since they’re newer I decided to balance that with my ocean, mountain and city view. Both mine and listed units have underground parking.

For the next 5 years the owned unit will cost $148,500 - excludes the small amount of principle paid to make sure it’s fair comparison with renting. Includes only a 3.5% opportunity cost on your 25% down payment. This is a very safe % return to achieve on your down pay fund while renting.

For the next 5 years my rented unit costs $53,400. So you almost save $100,000 by renting your unit ‘til 2016 assuming flat prices. Prices would have to rise about 6% per year ‘til 2016 to make it equivalent to renting, ie. make your lost $100,000 back.

Darn it, I forgot to ask if listed units allowed bbq’s, as I’d have a tough time giving that up.

HouseHuntVictoria said...

Given the current discussion I thought I'd remind readers about Roger's awesome wait or buy analysis tool (Excel SS) that makes calculating rent versus ownership costs super easy.

The biggest variable is future market value, which both sides of the discussion are only guessing at anyway (though the bears are guessing better ;-))

We've ran numbers on strata units of all stripes and I've yet to find any that make sense to buy. Renting a condo or a townhouse allows you to save huge cash right now, even if you factor in for 3-5 years of "tossing away money" on rent and estimate prices stay flat over the same term. Stratas are money sucking pits of despair given current valuations and fees.

The only properties that make any sense to purchase right now are the ones in super-high demand in Victoria (precisely because they still make financial sense): homes, with suites, priced under $500K. Many of these properties can end up being a wash with equivalent rents even using small down payments.

I'm seeing a few SFHs with suites moving, that if bought by investors with 25% down payments or more would be cash-flow positive. Arguably the cap rate is still fairly poor, but bond market returns haven't been good (though real estate investing IMO is way more risky than bonds).

The high end market is almost always cheaper to rent than own. There are some crazy good deals for wealthy renters right now in this town.

Waiting said...

What constitutes a 'wealthy' renter. Clearly not me. I'm desperately looking for something and can't find anything to rent.

DavidL said...

@ a simple man wrote: I think high 300,000s to mid 400,000s. But we are all only guessing. What I do know is that right now houses are generally too expensive for incomes.

I totally agree that this is where prices are heading. I project a "slow slide" for three years followed by a period of prolonged price stagnation.

HouseHuntVictoria said...

Sorry to bump the discussion, but you guys inspired a new post! Hope you get some value out of it.