Vancouver's Housing Market
jesse (@YVRHousing)�http://housing-analysis.blogspot.ca
01-SEP-2012
Synopsis
This presentation will outline some of the analysis I have done, with aid of other bloggers, on Vancouver's housing market.
Discussion surrounds arguing what sets house prices in the short and long terms.
What sets house prices?
The answer in the short and long terms are not necessarily the same.
Conjecture 1: In the short term house prices are aligned with supply and demand.
Supply = For-sale inventory (Inventory)
Demand = Sales
The ratio of supply and demand is "months of inventory" or MOI.
Let's look at the last seven years of inventory, sales, MOI, and prices...
Real Estate Board of Greater Vancouver For-Sale Inventory
Real Estate Board of Greater Vancouver Sales
Real Estate Board of Greater Vancouver Months of Inventory
Vancouver Teranet House Price Index
MOI (supply-demand) is highly negatively correlated to price changes:
CORR= -0.91
What sets house prices?
Conjecture 2: In the long term prices are set by the present value of risk-adjusted future earnings potential.
Price = House prices
Earnings = Rents net of operating expenses
For housing the price-earnings ratio (P/E) is simplified to the price-rent ratio. This ratio will revert to its historical long-run average1.
Let's look at the last 20 years of apartment rents, prices and the price-rent ratio2...
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1 http://www.frbsf.org/publications/economics/letter/2004/el2004-27.html
2 Apartment rents are used to eliminate density premiums. See my reasoning here.
Greater Vancouver Apartment Real Rents
Greater Vancouver Apartment Price-Rent Ratio
(Price-rent ratio is currently ~70% above the 1990s average )
Can we validate these two conjectures?
Conjecture 1: In the short term house prices are aligned with supply and demand.
US MOI and price changes:
Source: http://calculatedriskblog.com
Can we validate these two conjectures?
Conjecture 2: In the long term prices are set by the present value of risk-adjusted future earnings potential.
US price-rent ratio:
�Source: http://calculatedriskblog.com
Short Term Transitioning to Long Term
Thesis:
The long term (price-rent) will eventually dominate
The short term (inventory-sales), as well as rents, must therefore adjust to transition the price-rent ratio to its long-term average
This can happen in a few ways...
Photo source: Vancouver Archives
How the price-rent ratio could correct (1/2)
Two plausible endpoints
Prices flatline and rents increase
�Prices drop and rents flatline
How the price-rent ratio could correct (2/2)
The likely scenario is rents increasing slightly above or at inflation and prices correcting over several years. In the US, prices corrected over about seven years.
Say Vancouver prices are to correct in seven years, what would have to happen to supply-demand over that period?
Let's run some numbers...
Sales, Inventory, and Price Drops (1/2)
To revert price-rent to the middle of the longer-term historical bound in 7 years, with nominal rental inflation of 3%, prices would need to change by -35%, or -6% year-on-year.
To achieve -6% for each of 7 years would require average MOI to be about 9.
2005-2011 MOI averaged 5.4.
Sales, Inventory and Price Drops (2/2)
A higher MOI means higher inventory and/or lower sales. Historically, higher MOI has been a combination of both.
If prices are to correct like they did recently in the US, prepare for a prolonged period of high inventory and low sales.
There's much more
Short term supply and demand are influenced, and caused by, at various degrees by interrelated factors including:�
These matter but... they are catalysts. They determine the path for prices but not the destination. The price-rent ratio is key.
Fin
For more information
Blog: http://housing-analysis.blogspot.ca
(check out the links)
Twitter: @YVRHousing
(check out who I follow and my past tweets)
Disclosure: I am not directly affiliated with a financial or real estate organization. My family owns housing in the Vancouver area. I currently reside in Vancouver. I prefer to remain anonymous. May this presentation stand on its own merit.