All posts by patriotz

It feels so normal here

Another warm sunny day in Ottawa. Here’s what I get for having given up on the “best place on earth”:

– more cultural activities
– people who are polite and say hi to you on the street
– neighbourhoods that feel like neighbourhoods
– ethnic diversity but not segregation
– no homeless people outside of downtown
– breakins are regarded as newsworthy
– much better job opportunities

I can break the RE market into three sectors:

– Gatineau, Quebec
Prices that are actually reasonable. $200K gets you this in the English-speaking community of Aylmer:

– Generic Ottawa
Overpriced but if you really want to buy, you won’t become a debt slave. $300K gets you this in Silicon Valley North:

– Trendy Ottawa
Definite bubble territory, but still more for your money than Vancouver. This $1.2 mil house in the Glebe likely would not rent for more than $3500/month:

Compare with this rental:

Or you can rent, there’s lot of quality stock, the landlords aren’t psychos and people don’t treat you like a leper.

Enjoy the rain.

In came the waves

The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops

So begins the Economist’s landmark article on the global RE bubble from June 2005. It’s now available for free viewing after years behind the pay wall.

This is the classic analysis of the housing bubble IMHO and the one that made me bearish on RE. Its arguments are my arguments.

“The most compelling evidence that home prices are over-valued in many countries is the diverging relationship between house prices and rents. The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier.”

And there you have it. It’s possible to ascertain whether housing is over-valued because it’s an investment, whether or not its owners think of it as one, or what they mean by an “investment” in the first place. Eventually market forces and marginal pricing must prevail and that means that prices must fall back to a level justified by rental value.

Do read the article if you haven’t already, and try adding Vancouver (or other major Canadian markets, or just the Canadian average) to the graphs. How do we look compared to the US and other countries in 2005?

So what’s the total return for a Vancouver house?

Total return is a way of objectively comparing returns on different assets. The concept is simple – you buy an asset for $X, use all income when received to buy more at the current market price, sell it all for $Y, and your total return is Y/X. Annualized % is (Y/X)^(1/n)-1 where n is the number of years.

For example, you buy a 5 year compounding GIC at 3%, after 5 years it’s worth 1.03^5 = 1.16. Total return is 1.16 or 3% annualized (note not 16%/5).

When you have an asset with varying yield or price it gets more complicated. For stocks people like S&P calculate the total return for us. But for houses you have to do it yourself. What I decided to do is calculate the total return for a benchmark Vancouver house from 1985Q4 to 2010Q4, a 25 year period which saw the biggest price increase ever in Vancouver (or in most other places for that matter). Reinvestment of income is conceptually a bit of a problem as you can’t buy a “slice” of a house but that’s the way I’ll compute it because total return always does it that way.

My assumptions:
– quarterly prices as per UBC/Sauder. start 1985Q4: 160,100; end 2010Q4: 772,600
– starting rent $1500/month
– starting taxes $1800/year
– starting maintenance/insurance $1800/year
– rent, taxes, maint/insurance rise with CPI which increased by 86% over the period

And at the end you have 2.29 “houses” which you sell for a total of $1,769,254. Total return is 11.04 over 25 years which is 10.1% annually.

And what did the TSX 60 return over the same period? 9.5% annually.

The “Running out of Land” Club

You often hear of high price/rent for SFH in the City of Vancouver being justified because of the scarcity of land. I thought I would do a comparison with the City of San Francisco, which is slightly larger than the CoV and has a population of about 800,000. But the really big difference is that it comprises a little over 1/10 of the metro population compared with 1/4 for the CoV. So you’d expect San Francisco to have a higher scarcity premium. Well no.

Take a look at this listing for the West Portal neighbourhood in San Francisco’s west side for $1,075,000:

And here’s the same house for rent for $5200/mo:

The rest of the neighbourhood:

Price/rent for this property would be 207.

What about the comparable numbers for, say, Dunbar? Maybe $1.5 million and $3500/month? That’s a price/rent of 428.

Now you might say yes but property taxes are higher in SF. That’s true so let’s see how much higher.

This property is assessed at $402,019 and has property taxes of $4,836 /year. That’s because of California’s looney property tax system which taxes at the most recent sale price, not market value. If you bought the house for $1,075,000 you’d pay $1,075,000/$402,019 * $4,836 = $12,931/year.

Total property taxes in CoV are 4.21377 mills, so a $1.5 million property would pay $6320/year.

Calculate price/(rent-property tax) and you get 261 in SF versus 504 in Vancouver.

And I didn’t factor in mortgage interest and property tax deductibility and the ability to lock in low rates long term in the US.

You’d pay more for just a lot in Vancouver than the whole house in San Francisco. What sense does that make? In which city is land really more scarce? What do the rents tell you?

My $370,909 Dream Home

I’m getting settled into my new home, a newly renovated duplex in a great neighbourhood near recreation and transit. It’s got all the features I’ve been looking for – 3 bedrooms, 1 1/2 bathrooms, stainless steel appliances, fireplace, garage, you name it.

But the best thing about it is the price. I got it for a one-time payment of $370,909 – including all future taxes and maintenance.

Now wait a minute you say, nobody can get a deal like that. Well here’s how. I figure I get an after tax cash yield of about 5.5% on my investments. If I set aside $370,909 worth of my investments, I get $1700/month, which is what I pay for rent. My name is on my brokerage statement rather than on the deed, but I get the same shelter.

So what if I bought a similar property? I’d have to pay taxes, maintenance and insurance. Say these total $5K/year. Again using the 5.5% yield I’d have to set aside $90,909 more of my investments to pay these. So I figure the property would be a decent buy at $280,000.

Which gives a price/rent of 165. I’m quite willing to wait for that to buy – in the meantime I’m doing just fine.


(hat tip to M-)