Fundamentals – “When would you buy?”

We haven’t mentioned the actual word  ‘fundamentals’ here for a while, probably because they seem so, well, passé for Vancouver. But the concept remains alive and well, if a little dormant, in the minds of the few remaining prospective buyers who see the market as bizarrely overvalued. Sometimes such folks are asked: “When would you buy?”
On a recent thread, ‘matt’ pointed us all to a 2008 NYTimes article on this very subject, a useful reminder in these frothy times. It’s worth the re-read, if just to keep oneself in touch with the reality of the extra-Vancouver universe:
‘As Home Prices Drop Low Enough, a Committed Renter Decides to Buy’, by David Leonhardt, NYTimes, 28 May 2008. A few excerpts: –

“One of the big lies of the real estate business is the idea that renting a home is tantamount to throwing money away. It’s a useful fiction for real estate agents, because they make vastly bigger commissions on house sales than rentals. But the comparison isn’t nearly so straightforward for the rest of us. Renting involves one obvious, recurring cost that can never be recouped: the monthly rent check. Buying, on the other hand, involves multiple expenses, some of which aren’t so obvious. On top of closing costs, there are repairs, property taxes, mortgage principal and mortgage interest. When you own, you also lose the ability to invest your down payment elsewhere, like the stock market.”

“Over the last several years, I’ve come to like a simple, back-of-the-envelope way to compare the costs of renting and owning. You find two similar houses, one for sale and the other for rent, and divide the sale price by the annual rent. You can call the result the rent ratio.
It’s the real estate market’s version of a price-earnings ratio — a measure of how expensive an asset is, relative to the underlying economic fundamentals. Like a P/E ratio, the rent ratio provides something of a reality check.
Throughout the 1970s, ’80s and ’90s, the average rent ratio in the US hovered between 10 and 14. [In the mid 2000’s] it broke through that historical range and hit almost 19 by the time the housing market peaked [in the US], in 2006.
And while home prices — and rent ratios — have always been higher on the coasts, they reached whole new levels recently. In the Washington area, the ratio went above 20. In Boston, New York, Los Angeles and south Florida, it topped 25. In Northern California, it approached 35, higher than it had been in any city, at any point on record.
In concrete terms, a rent ratio above 20 means that the monthly costs of ownership well exceed the cost of renting.”

“The question facing my wife and me was whether we were entering the market before the correction had gone far enough. I really didn’t know what the answer would be. So as we looked at houses, I started calculating rent ratios. In the neighbourhoods where we were looking, two-bedroom condominiums were selling for $400,000 and being rented for about $2,100 a month, which makes for a rent ratio of 16. Four-bedroom houses were selling for $700,000 and being rented for almost $4,000, which makes for a rent ratio of 15. No matter the price range, pretty much every apples-to-apples comparison produced a similar ratio. Historically, this is still a bit high.”

Using similar calculations, ‘rent ratios’ [sales_price/annual_rent] for SFHs in Vancouver are currently commonly in the 40-42 range. -vreaa

11 responses to “Fundamentals – “When would you buy?”

  1. Seems rent ratio on the North Shore of Vancouver is about 31: $950,000 tear downs on busy streets renting for $2500/mos. Is this a sign that fundamentals are askew and, based on history of RE market cycles, correction is not far off? Please.

  2. I was once told that a general rule of thumb about housing affordability requires that you don’t drain more than 30% of your net monthly income. This rule of thumb supposedly factors in costs like maintenance, insurance and other expenses like utilities. It also allows for one to save for retirement in a meaningful way.
    A median housing price in vancouver of 800k-900k with an interest rate of 5% and a downpayment of 25% implies a monthly payment of about 5000-6000 dollars a month. That further implies an annual gross income of about $350000.
    Have I got that right?

  3. 4SlicesofCheese

    I went in to CIBC to ask what I could get. I was told my debt service cannot be over 40% of my gross income. Also was told I could go over that but I would have to get some sort of other secondary approval.

  4. Awesome post.

    The “rent ratio” (which is basically the inverse of the cap rate, ignoring maintenance costs, property taxes, etc.) from the recent “Kitsilano vs Hollywood” post is 32.
    https://vreaa.wordpress.com/2011/03/15/kitsilano-versus-hollywood-hills/

    I’ve been recently looking at a rental which goes for $2600/mo. Comparables in the neighborhood are listed for $1.7m. That’s a rent ratio of 54!

  5. restuarant unemployee

    i’ll second that, awesome post.

    say someone rents 4 rooms in their $900,000 house for $800 each to homestay students – and the owner still lives in the house with his famiy (and a new mercedes) i saw that recently, looked like hell – but he had a new mercedes! lol

    i am sure it’s declared..

  6. I wouldn’t buy until mortgage rates are normalized. When we bought our first house in 1987, mortgages rates were 12%. Mortgages rates shot up to 18% by about 1989??, and then slowly dropped and continued to drop until they were below 10%. As long as the rates are as low as they are now the market is not on solid ground.

    When the housing boom occurred in 89-90, even the Asians stopped buying eventually. My guess is the Asians will lose the most amount of equity when the correction happens. Normalized mortgage rates are probably 7% to 9%. It’s still unclear if a re-occurrence of rapidly rising interest rates is going to happen.

    • restuarant unemployee

      you forgot to mention,

      as long as the rates are as low as they are now we will continue to have Keith Roy around.

      zing

      • As annoying as his ethos radiates, a little part of me respects people like Keith. I think it’s positive that people with that drive and desire to succeed exist in Vancouver. I envy him for having such a clear vision on how to obtain success. On the other hand, it’s too bad he’s a fucking moron misguided.

        I spend a bit of time daydreaming what Vancouver could be like with the same legal and banking regimes as Switzerland or the City of London. SFU and UBC groom a lot of smart people who are forced to leave to cultivate their careers.

  7. Price to rent should include highest and best use, which is part of the reason why NV teardowns have high ratios.

    I’m convinced it is best to look at condos as a good gauge of market strength. A healthy mix of owner occupiers and investors ensures P/R is meaningful.

    The obvious question is what P/R is appropriate? Look at what REITs require for a sense of what the market expects for earnings.

  8. I just thought I would share the following CBC video about the Millennium condos (the story starts 4min into the clip).

    http://www.cbc.ca/video/#/News/Canada/BC/1258521056/ID=1845649125

    Looking at the quality of the work done at the Olympic Village, I can only imagine the condos/houses in the rest of Greater Vancouver that were build during the recent housing boom and are not in the media spotlight.

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