The report entitled THE ROLE OF SECONDARY SUITES: RENTAL HOUSING STRATEGY – STUDY 4 published by the City of Vancouver’s Community Services Group is about a year old but nonetheless contains some interesting data on the state of Vancouver’s secondary suite rental accommodations. Here are excerpts from the executive summary:

The market-rental housing stock is usually divided into two segments – the primary or conventional rental stock, consisting mainly of purpose-built rental apartments, and the secondary rental stock made up of rented houses, secondary suites, individually rented condo units, and units in multiple conversion dwellings and SROs. Over the last three decades, the secondary rental sector has played an increasingly important role in meeting rental housing demand. This increased role reflects the decline in the construction of new purpose-built rental and the redevelopment and conversion of the existing rental stock.

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Using 2009 BCA data, this report estimates that there are at least 25,000 properties with secondary suites in the city’s single-family zoned areas. The proportion of properties with suites ranges from 6% in Oakridge to 59% in Grandview-Woodlands. On the west-side as a whole, less than one in five properties have suites; on the east-side, almost one in two properties have suites. Six local areas on the east side account for three quarters of the city’s single-family zoned secondary suite properties.

It’s a fascinating report, highlighting how the concept of secondary suites is starting to percolate more and more onto the west side of the city and into the hearts and minds of city planners who realize that the term “single family home” is becoming outdated. We can look at all RS-zoned properties with secondary suites. It looks like a Vision/NPA civic election voting map LOL.

A few key facts and insights I picked up in the report:

• Data claim only 21% of homes built in the 1990s have secondary suites. (p13) Hogwash. There is something wrong with the data.
• There is some natural resistance to secondary suites on the west side because homes are generally of older vintage. That is, it’s less desirable to tear down an older structure that has been well-maintained but not suitable for suiting.
• The City is coming to terms with its dirty little secret: people are living in illegal basement suites and their permit officers purposefully turn a blind eye to properties with obvious basement suites installed but without the proper permits in place. According to the permit application data, about 20% detached properties are being fitted with legal suites, yet over 60% of new stock have basement suites. The City is well aware of this and looks poised to start the thin edge of the wedge into the dirty underbelly of the City’s basement suite accommodation.

“Council also approved a post-occupancy inspection program. Under the program, all new single-family houses are inspected a year after being approved for occupancy. Properties found with unauthorised suites are required to either apply for permits or to close the suites. Despite the changes, the proportion of single-family houses being built with approved suites has remained low.”

I commend the City of Vancouver for making this report public and shows, at least to me, they are aware of the problems illegal suites pose to the quality of life in the city, accelerated depreciation of neighbourhoods with slum housing, and (not least I’m sure) the chance for expanding their permit and inspection business unit!

Feel free to post your Vancouver secondary suite stories, good and bad, in the comments section: have you ever dealt with home inspectors overlooking secondary suites? What’s your most bizarre secondary suite experience, either as landlord, renter, or acquaintance?

A conversation I recently had with a friend about his parents has been insightful for me about another dimension of the real estate market as the population ages.

First a little background. My friend was born in Asia and immigrated to BC 20 years ago. His parents immigrated about 20 years ago and are professionals educated in Asia. When they arrived in Canada their degrees were not recognized and they spent the subsequent years eking out a living for their family. They bought and sold properties at various times and rented in between over the years, depending upon the needs of the family. Once their kids graduated university about 10 years ago they had a mostly paid-off property and an investment property with reasonable equity, both in the Vancouver area. They did not accrue much else in the way of savings.

Fast-forward to today and the parents are approaching retirement in about 5 years or so. The father has finally had his professional degree recognized and is working but not at a high salary. The mother is not working. On the property front, they sold one of their properties a year ago and are living in the other with a small mortgage, about $200K, that they plan to pay off in 5 years one way or another. They just refinanced at about 3.3% 5 year fixed. They now have about $700K cash in the bank and a mostly paid-off house worth about $500K with five years left until they plan to retire.

Now the conundrum for my friend. They are planning on retiring but do not think they have enough saved up to provide enough income to retire. They now need to put their $700K to work for them and are looking at the current investment environment. They have dabbled for brief spates in other investments but for the past 20 years they have saved most of their money through real estate. With this background in mind, they are now looking at what to invest in. Fixed income is returning little and they see other higher yielding investments as “too risky.” That is, they aren’t comfortable doing it.

Readers can probably sense where this is going. They are thinking of investing their entire savings into an investment property. They are currently looking at a local multi-unit property (8 units or so) for about $1MM, which purports to produce about $70K revenue annually. Subtract expenses and they think they can conservatively clear $25K per year on $500K after mortgage re-payments (which are low in the current rate environment). The revenue is expected to increase roughly with inflation as rents are raised over time, which suits their need for fixed income.

I talked to my friend about arguments whether or not this is a bad idea. Taking a step back, the parents are putting their entire nest egg into a single property, which seems bad. The nominal returns, however, look decent in the current environment for something they consider reasonably low risk. Part of the problem he has arguing with his parents is they can’t seem to fathom the risk they’re taking. It’s hard to explain to someone how he’ll be alright 95% of the time but 5% of the time he’ll be cleaned out. It doesn’t register; the risk seems to be entirely “under their control.”

My friend used the Mark Carney “interest rates will likely go up” argument. Their answer is that worst-case they can downsize their existing paid-off property and refinance to keep the cash flow “acceptable” with a downgrade in lifestyle.

The long and short of it is retirees like my friend’s parents are starting to do the math on retirement and the traditional mix of investments just doesn’t seem to offer the income required to fulfil their expected needs in retirement. Important points:

1. They have to resort to riskier ventures to fund retirement than has been the case in years’ past.
2. The way risk is meted out in real estate is often in chunks. Producing an expected value scenario that makes any sense to them is next to impossible: many of the aggregate risks we know exist with real estate seem remote enough to be fully discounted. The so-called “long-tail” risk is set to zero.
3. Many have put so much of their retirement savings only in real estate it’s hard to leave their comfort zone and make the switch to other investments.
4. Retirees have time on their hands to help offset ongoing investment costs in case of problems.
5. Multi-unit properties, while experiencing a boom in values, appear to produce headline returns that don’t look horrible in the current interest rate environment.

We often wonder who is buying in today’s market and chalk it up to speculators and irrational owner-occupiers. I now know one family who are doing this as a cash flow investment, i.e. not relying on the property’s future value and not planning on living in it. We may step back and call this family crazy for investing but, as the chips lie, given their comfort level with various investment types, and given their ability to handle some of the investment’s inherent risk by sacrificing some of their free time in retirement (and for my lucky friend, their children’s time), the alternatives are deemed inferior.

This is a slightly edited re-post of a piece I wrote on housing-analysis about two years ago. It is a culmination of much of the comments and logic advanced by regular wiley veterans of the local blogosphere — VHB, freako, patriotz, mohican, to name a few. True to form, it is still as true today, two years subsequent to the original post date.

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No analysis blog would be complete without a paradox and I believe there is none more relevant now than the so-called “ownership premium” that owner-occupiers place on property values. I would like to offer an alternate view of the so-called “ownership premium” that has been discussed on this blog and others in the past years.

The “ownership premium,” sometimes called the “control premium” or “consumer surplus,” is a premium that a potential buyer will pay for the right of owning (and “controlling”) a property compared to renting. Here is an example thought process of how the ownership premium concept works, from a buyer’s perspective:

jesse is renting a condominium for $1200 per month but is on a month-to-month lease. With a wife and young child, jesse does not want the uncertainty of renting month-to-month and his wife wants to customize the suite, something not always possible when renting. jesse looks at the condo for sale next door. If he were to buy it at market rate, the total costs of doing so far exceed that of continuing to rent. After factoring in all expected costs and trade-offs of his specific situation, jesse decides he is willing and able to pay a monetary premium to buy. But — and here’s the thing — he doesn’t have to.
Continue reading Ownership Premium →

I thought I’d share a situation with you that in many ways epitomizes some underlying issues with the current economy. I am involved in a volunteer organization that regularly gives out scholarships to university students. Since I was involved in the organization in the mid-90s, up until a couple of years ago, the scholarship fund has managed to sustain a reasonable, though not profligate, level of scholarship and bursary awards to students. These monies came mostly though not exclusively from interest on the principal fund. The fund was topped up each year through small transfers from the organization’s general operating budget, and through these two mechanisms has managed to have its award amounts keep pace with CPI inflation for the past 15 years.

Until late 2008 that is. At that point interest payments started to dwindle. Now, two years in, more and more higher interest investments have matured and the only option available for the cash, given the scholarship fund’s requirement to retain capital, is re-investing in (now) lower interest vehicles. This has led to the organization scrambling to solicit private sector donations to the fund to cover the shortfall, or consider reducing the number or value of awarded scholarships.

The experience of this organization is, in many ways, akin to any other business or family who is using its capital to produce income. As interest rates remain low, incomes start to dwindle and the tough choice appears: start eating into the capital to fund operations, take more risks with this capital, or find other ways of producing income such as taking on another job, accepting donations, or delaying retirement. The difference with a volunteer organization, perhaps, is there isn’t any finger to point for past mistakes. This is simply a case of trying to manage ongoing operations of a conservative fund and there’s no easy way out.

In itself, the financial issues of this scholarship fund are deflationary: more money must be sucked in, ex dwindling interest income, to maintain existing operations or operations start to come under pressure. I think, in general, this background deflationary meme is hidden from most of us still young who aren’t overly concerned with funding retirement in the near future. The longer low interest rates remain, however, the more stressed those with fixed income will feel. If interest rates don’t rise soon, funding the future will start to become a more prevalent concern, realized through reduced spending, increased risk, delaying retirement, and, to the glee of many here I’m sure, accelerated liquidation of existing assets.

In a previous post The Pope highlighted a spreadsheet looking at the City’s loan to Millennium to fund the Olympic Village construction and how much of the loan amount could be recouped should only sales revenue from this development be used. The calculations ignore interest payments, ongoing management of the whole process, land value, unpaid property taxes and strata fees amongst a handful of other (comparatively) small expenses.

The outstanding loan was $731MM. Millennium recently repaid $192MM of this amount. I’ve updated the spreadsheet to reduce the primary debt owed to the City.

The big item ignored, of course, is going ruthlessly after the collateral of the debtor, Millennium, which the City is now doing according to fearless City reporter Frances Bula:

Vancouver is taking aggressive action to secure the corporate and personal assets worldwide of the Olympic village’s private developer after acknowledging that the developer did not pay the full amount of its first $200-million loan payment to the city. …

As well, the city, which took over financing the village construction in February of 2009 after Millennium’s original lender refused to continue making payments because of cost overruns, has told Millennium that it either has to pay out the $561-million it owes the city or prove that it has a solid plan for making the loan payments that were originally scheduled.

The City is starting to put feelers into Millenium’s holdings to uncover how much additional collateral is available to repay the loan. But it’s unclear how much collateral Millennium actually has. Many of its holdings are highly mortgaged and it’s uncertain, at least to me, if the owners can face judgment against their personal holdings. Long story short, the City won’t be the only creditor represented at a bankruptcy hearing.

It may well be Millenium will go insolvent. But given how many tiered creditors Millenium has, we don’t know how quickly the City can recoup the money it is owed beyond the collateral of the OV itself.

On the plus side, the City just got $192MM from Millennium. How does that change the calculations? If Millennium does go technically insolvent before its next scheduled debt repayment, we have the following approximate shortfalls:

At $700psf, there is a $200MM shortfall; selling all the rentals and retail space reduces this to about $100MM. (Interest payments to the City’s creditors on the total balance outstanding will be on the order of $25MM for a year.)

$600psf – $250MM shortfall ($170MM if rentals/retail sold)
$500psf – $300MM shortfall ($230MM)
$400psf – $350MM shortfall ($300MM)

The question is, what will be the average price of the market units? If we do a bit of analysis based solely on rental income and assuming some “rosy” rental rates of $2.75psf/mo (500sqft flat $1500/mo) and a “rosy” 150 price-to-monthly rent ratio, we end up with a market “value” around $450psf.

I think the sales staff for the Olympic Village can do better than this. It involves, in my opinion, finding people who are willing and able to pay well above rental rates for a building with unproven infrastructure and a less-than-whole strata. But it will involve selling these condos reasonably quickly or the price will likely continue to drop.

In summary, it looks like Millennium has come up with some cash to reduce the City’s shortfall on this project. That is a good thing for ratepayers. Loss estimates are now better but still ostensibly in the neighbourhood of $250MM-$300MM, minus any additional funds Millenium coughs up. Better, but still one helluva mozza ball.