Irrational exuberance in Gastown

AACI | Vice President, The Regional Group of Companies Inc.
  • Apr. 27, 2016

John ClarkAgain and again, people make the same kind of investment error.

We saw it in Holland during the 1600s, when rampant market speculation drove the prices for the most sought after tulip bulbs to six times the average annual salary. It happened again in the 1700s with the crash of the South Sea Company, which knocked the wind out of the British economy. Then there was the Panama Canal Bubble, the stock market crash of 1929, the dot-com bust of 2000.

I could go on, but you get the point – “irrational exuberance” wasn’t unique to the 1990s. It’s human nature to buy into hype and the promise of a quick buck when common sense should tell you that a market is overvalued and ripe for a punishing correction.

I see it happening again in the Canadian housing market.

Terror grips Vancouver

Now I know what you’re saying – the dangers of a “housing bubble” in Canada appear to have been overstated in the past year by various market watchers and doomsayers. Weakness in one area of the country has been balanced out by easing to more stable and reasonable conditions in others.

But some markets do remain in redline territory.

I was flying back from a business trip to Vancouver last week and sharing elbow space with a lady from North Vancouver who works in communications.

“People in Vancouver are frightened of the market,” she told me. “They’re frightened by the threat of a crash.”

As well they should be. Current market prices simply can’t be supported by the average income of residents.

The ‘3-1’ rule of thumb has been smashed flat

The old rule of thumb for affordability is that the price of a home should not be more than three times your gross household income.

Take a guess at the ratio running these days in Vancouver. It’s not three to one, it’s about 11 to one. Toronto isn’t far behind, at about eight to one. Ottawa, meanwhile, is a much more reasonable 3.5 to one. (These stats come from data compiled last fall by the Globe and Mail from Statistics Canada and the Canadian Real Estate Association.)

I live in an old central neighbourhood of Ottawa called Westboro, that’s located about four kilometres from downtown. If I wanted to move to Vancouver to a comparable home in a comparable location, I would likely have to pay about $2 million on top of what I would get from selling my Ottawa home.

If I was considering a move because of a job offer, my new employer would have to give me one outlandish signing bonus to seal the deal. Even if I was some hotshot executive expected to generate tens of millions of new revenue for the company, I’m sure a rational employer wouldn’t make such an offer.

A bubble primed to burst

Vancouver residents have two choices – beggar themselves with a crippling mortgage that will weigh on them for the rest of the lives, or head further out to the ’burbs where prices are more moderate, but then waste more of their day on the commute.

An overheated market like Vancouver is being driven by the top 25 per cent of income earners. There are also a lot of boomers who bought their homes decades ago and expect to cash in big time if they sell and retire to a community with more reasonable real estate prices.

But the majority of Gen Xers and millennials who follow simply won’t be able to pick up the slack. An inflated market with a rapidly shrinking pool of qualified buyers is a bubble that will burst. This is only a matter of time. It’s like a tsunami wave – no matter how wild and high the wave gets for short periods, water will always find its level again.

That lady on the airplane expects that Vancouver will become a resort community – few people who work in the city will actually live there, and they may not work there either. This will have an added negative impact on the local economy, if the working population is instead doing most of its spending out in distant bedroom communities.

Too little, too late?

Federal agencies have already been taking action to cool such overheated markets. The Canada Mortgage and Housing Corporation has twice raised premiums on high loan-to-value mortgages where the buyer puts down less than 20 per cent of the purchase price. The new federal government has changed the minimum down payment requirements on homes valued at $500,000 or more. But these efforts haven’t had much impact so far on cities like Vancouver.

It remains to be seen how and when a market like Vancouver will finally run out of steam and achieve a more stable equilibrium. But run out of steam it will and the transition from one state to the other will surely be a messy one.

To discuss this or any other valuation topic in the context of your property, please contact me at [email protected]. I am also interested in your feedback and suggestions for future articles.

John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

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John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

Read more

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