Spot The Speculator #2 - Renovators As Speculators - “That’s what things cost now. The cost of everything is through the roof. But look at what you’re sitting on. A property that’s probably going to be worth a million dollars in a few years. That’s the reality of Vancouver now, and the reality of construction and real estate.”

In the last episode of the Froogle Scott Chronicles ['Part 7: Renovation Nervosa Continued', VREAA, 20 May 2010], we hear of a remarkable exchange that took place between Froogle and his general contractor, moments before they signed an agreement to commence work on Froogle’s home. -

“We talk about the cost, and he agrees that it’s expensive. “That’s what things cost now. The cost of everything is through the roof. Skilled trades are through the roof. But look at what you’re sitting on. You’re sitting on a property that’s probably going to be a million dollars in a few years. That’s the reality of Vancouver now, and the reality of construction and real estate. If you can’t make eighty to a hundred a year in Vancouver right now you’re a loser.” I’m assuming he means eighty to a hundred a year in construction or real estate. Neither my wife nor I make eighty thousand a year, so if he’s speaking more generally, he either assumes we make more money than we do, or the remark is just indiscreet.”

[Note that the contractor is implying that it is worth spending what seems to be too much money simply because the market is going to continue to make homes worth more and more. -vreaa]

Froogle Scott has now forwarded to VREAA some germane comments that relate to this very process. He did so in response to the recent anecdote that described a local couple who had bought and reno’ed an Eastside house that they were now selling ['Spot The Speculator #1 - Speculation Disguised As Normal Behaviour', VREAA, 26 Jun 2010]. Here are his thoughts on the speculation inherent in many renovations:

“I think you can add major renovations and homeowner custom building to the list of seemingly normal behaviours that have a hidden speculative component. I suspect the renovation and building mania that has swept through numerous older and established neighbourhoods in the City of Vancouver, and elsewhere in Metro Vancouver, has been largely driven by the same belief that RE prices would continue that rich rate of annual increase. And I’m not referring primarily to flippers, but rather to homeowners, like my wife and I, and the couple in the Sun article, who intend to live in their renovated or custom-built homes for years. You are much more likely to spend big on renovating a place or building a dream home if  a) you believe the money you spend today will eventually be returned to you, perhaps with a premium, when you do finally sell,  b) the increasing market value of your home puts a large home equity line of credit at your disposal, and  c) you see lots of examples of other people undertaking major renovation and building projects in your neighbourhood.

This dynamic has been at work on Vancouver homeowners, perhaps without some of us being fully aware. After all, most of us want a nice place in which to live, and have aspirations for what that place should be. But have those aspirations, and the pace at which we can achieve them, inflated along with the annual property assessment? How many people would spend $200K or $300K of borrowed money renovating their home, or $500K or more building a custom home (in addition to lot price), if house prices were flat for years, or slowly grinding lower? I wonder what the renovation and custom build business is like in some of those US cities that have seen massive price drops?

There seems to have been a self-feeding quality to the Vancouver RE bubble (all bubbles, I imagine) that powered at least some of the unusual price growth, which if not exponential, has certainly had far too steep an increase to be sustainable. Because of that self-feeding quality the bubble is perhaps inherently unstable. In some respects, the growth of the bubble has been enabled by the growth of the bubble. It hasn’t been based on a commensurate growth of fundamentals such as wages, or rents, or GDP.

It’s a bit of a chicken and egg argument about how a bubble first gets seeded and starts to inflate, but to return to major renovations or custom building dream homes, here’s a self-feeding sequence for consideration.

1. As houses prices start to rise you get less for your money. Many first-time buyers are forced to settle for older, smaller, somewhat dilapidated houses that they plan to renovate over time. The “dump,” that Fricker refers to in the article. Or the place my wife and I bought in 2003.

2. Not content to live in a dump forever, you start looking at ways to renovate, and what it might cost. At the same time, you’re surprised by the big jumps on your annual property assessment, and start to consider the following, probably deeply flawed, bit of personal financial voodoo: assessment price – mortgage amount = the amount of money you feel safe borrowing to renovate. Because, you reason, you could always sell post-renovation and recoup your investment.

3. The bank offers you a HELOC with an attractive rate of interest based on the steeply increasing assessed value of your dump.

4. You pull the trigger on a major renovation financed using the HELOC.

5. At some point you decide to enter the move-up market, or the custom-build market, by using your renovated home as leverage. You put the renovated home on the market for a price that reflects the general price appreciation in the years you’ve lived in the place, plus the amount you spent on the renovation, plus whatever else your realtor thinks you can wring out of an overhyped market. In the case of the couple in the article, $270K > $899K. (Not to pick on them. All Vancouver homeowners are currently forced to maximize return if they want to make a move within the city, because what they take with one hand they’ll have to fork over with the other.)

6. Someone buys at your bubble price of $899K, or more if there’s a bidding war for a nicely renovated character home in an established neighbourhood. You pay a bubble price for a move-up home, or a lot and a custom-built home.

And so it goes, or so it has gone. I happen to agree with those who think the end of the bubble is upon us.

What gets lost in all of this escalation is that nobody really _needs_ a majorly renovated home, or a dream home. For decades many people in Vancouver lived quite reasonable lives in modest homes that they maintained and slowly improved over many years — sometimes themselves, sometimes by hiring builders or tradespeople. $50K would have been considered a lot of money to spend on a reno. More than the median household income in Metro Vancouver in 1991 ($42K, Stats Can). Now $50K gets you a renovated kitchen. But in 2006 that median household income in Vancouver was still only $55K and won’t be much different today. So has a significant reno/custom build contribution to the bubble been made possible by the bubble itself, and the huge increase in leverage it put into the average homeowner’s hands? And is there something inherently unstable about this situation?

I’d suggest that the bubble hasn’t just been about hugely increased prices for existing housing stock. It’s also been about increased prices encouraging significant upgrading of the housing stock which in turn has been an important contributing factor to ongoing price escalation. A supercharger effect.”