FEBRUARY 20, 2011
Thanks to everyone for the fantastic responses to the last post on Vancouver data. Almost 60 comments on a single post in 24 hours.....a record for this lowly blog.
"Fundamentals eventually mattered..."
I've been meaning to repost a portion of an interesting article Jesse wrote over on his blog. With Jesse having written a real zinger of a comment earlier today, I thought I might post the two of them combined. It's perhaps a fitting way to wrap up the Vancouver discussion.
First I want to highlight just one key sentence from Jesse's post from last week. Basically he discussed the work by Rich Toscano in analyzing the San Diego housing bubble. The subsequent bust has been particularly painful. This sentence speaks volumes:
"The biggest takeaway from Toscano's work is that, in San Diego -- a city with a growing population, a reasonably diverse economy, and desirable climate -- fundamentals eventually mattered. As 2010 drew to a close, San Diego's house price bubble has been summarily bookended with prices approaching fundamental values again, a process that took 5 years from their peak in 2005."
Think about the underlined portion again. Reflect on it. Yesterday I highlighted a statement made in a comment earlier in the week and then asked a (rhetorical) question:
- “(I’m) just trying to get you to kinda understand that you are really getting nowhere with all this data and a new framework is needed.”....In other words ‘it’s a new paradigm’ or ‘this time it’s different’. The old rules no longer apply. Throw out the data! My question is simple: Has there ever been an example of a bubble where this mentality was not prevalent?
The answer is a resounding 'no'. A prevailing mentality that fundamentals no longer matter is the single most crucial element to fuel any asset bubble. Absent this popular delusion, bubbles die quickly. But add this prevailing mentality, and the animal spirits of mass psychology are unleashed. It bears noting that no market escapes the limiting power of fundamental value indefinitely. Not even one dominated by the uber rich of mainland China! The fact that the average buyer in Vancouver (a handful of wealthy foreigners notwithstanding) requires continued low interest rates, a steady supply of greater fools, and increasing house prices to keep them but a flea's hair from financial ruin is all you need to know.
Crunching the numbers:
Thanks once again to Jesse for this very insightful comment.
I’ve never posted the “rich Asian” effect, mostly because I thought it was rebuked when uber rich Hong Kongese and Taiwanese immigrated to Vancouver in significant numbers in the early ’90s only to have prices drop close to rental equivalence subsequent.
Anyways, here’s my methodology. In order to gain a sense of what is happening in a specific city, it is not correct to look at certain sub-regions within the city as evidence of a strong housing market. Instead the entire region should be looked at, as its people are geographically and economically linked, as are house prices.
To get a sense of the city’s ability to sustain high prices, we can look at the sum total of all residential property market values, and compare it to the ability of the locally-derived income to carry these properties. We then determine the shortfall, if any, and ask what mechanisms can contribute to filling the gap. These include: borrowing, black market activities, direct foreign investment, and direct foreign income. We can then look at the magnitude of the cash inflows and, taking a step back, asking how realistic it is to have that shortfall covered by some or all of these activities.
So the numbers: Vancouver region population: 2,374,628 Average people per household: 2.6 Number of occupied private dwellings (est): 875,000 Average household income is about $78,000 (estimated) Median household income is about $60,000 (estimated), provided for contextual purposes only
From latest January statistics, blended from Vancouver and Fraser Valley statistics packages, we derive total housing market capitalization by dwelling type: detached = 250,000 * $840K = $250 BB attached = 260,000 * $470K = $143 BB condo = 360,000 * $360K = $158 BB total = 875,000 = $551 BB
We now derive “average homeowner capital” as: $551BB / 875,000 = $630K per household
This is an average price to average income ratio of 8. Now we have to determine how much additional income or capital not accounted for in the reported income is required to maintain this ratio. If we assume the long-term price-income trend is, say 5, that means we would be expecting an average dwelling price of $390K. This means a collective $240K per dwelling shortfall must be made up by non-reported sources. That amounts to a $210 BB collective capital injection that must occur over the next few years.
I’ll leave people to discuss the numbers above. Personally, taking a big step back, I don’t see $210BB pouring into the province through foreign investment and drug operations. To give context to the housing market capitalization, BC’s (not even Vancouver’s) “official” GDP is about $195BB.