What Sets House Prices? – “In the long term prices are set by future earnings potential.”

“The likely scenario is rents increasing slightly above or at inflation and prices correcting over several years. In the US, prices corrected over about 7 years.” …
“To revert price-rent to the middle of the longer-term historical bound in 7 years, with nominal rental inflation of 3%, prices would need to change by -35%, or -6% year-on-year.
To achieve -6% for each of 7 years would require average MOI to be about 9.
2005-2011 MOI averaged 5.4.” …
“A higher MOI is a combination of higher inventory and lower sales. Historically, higher MOI has been a combination of both.
If prices are to correct like they did recently in the US, prepare for a prolonged period of high inventory and low sales.”

From ‘Vancouver’s Housing Market [1 Sep 2012]’ a slide-format presentation, by ‘jesse’, of ‘Housing Analysis’ and ‘@YVRHousing

Look through jesse’s entire presentation.
His short term and long term hypothesis and analysis is persuasive.
MOI is definitely a very good way of assessing price pressures in the short term, and we are grateful to jesse and others for highlighting it’s importance in recent years.
For what it is worth, I still have some unformed hunches about the relationship between MOI and price drops possibly changing under market conditions that we’ve not yet seen. Could you see data points off the correlation line under certain circumstances? Wouldn’t seller panic possibly take us off the correlation line? (Making larger price drops at lower MOIs possible?). The US chart suggests not. It’ll be interesting to see if our market’s descent produces any MOI/price relationships off that line.
Regardless, I agree regarding the long term primacy of the rent:price ratio; it’s the crux, the most important fundamental measure of a property’s value over the long term. Vancouver RE prices have to, somehow, reconcile with historic norms in this regard.
I strongly suspect this will happen almost entirely via price drops. jesse uses the example of 6% drops per annum over 7 years. We’re aware that isn’t the only scenario that he sees possible. We’d add it’s one of the only scenarios we definitely don’t expect. However the unwinding occurs, you can be sure it won’t be orderly and linear. As regular readers know, we’re particularly interested in the effects of sentiment, and anticipate that, on the way down, we’ll see at least two periods where seller panic sets in. One will likely occur at some point before we hit 2009 lows…. another when we drop below 2009 lows. During those periods price drops will accelerate. Before the trough we’ll definitely see some years with double digit drops, and may even see a year of flat or even slightly advancing prices; possibly after a bounce off the 2009 lows.
– vreaa

31 responses to “What Sets House Prices? – “In the long term prices are set by future earnings potential.”

  1. so far, Canada in total has followed the US/UK market. Question is: is YVR a Miami (-60% drop!) or a London (-15% drop) or somewhere in between?

  2. Jesse, slide 10 (normalized real rents) shows increase in rents after 2006; you’ve adjusted so that this is real purchasing power, yes? So am I right in suggesting:

    *either this graph reflects a change in the real purchasing power of people’s incomes, and the percent of people’s incomes going to rent is stable
    *this graph reflects that people’s rents are taking a greater percentage of their real incomes?

    If the second, I wonder if you have a thought on the upper affordable bound without tanking the rest of the local economy. It seems to me that some upper bound on median family income will exist, and above that bound you’ll see a fall in demand due to higher occupancy/room-share, unemployment, and out-migration. I’m seeing some of that as reason for leaving: resistance to paying more than 35% of income is causing my own social circle to leave, (households generally making greater than 75 but less than 110.)

    Because of the median household income numbers (only $35K for renter households in 2006, using MV housing data book from this spring!!) I suspect that we’re at or near an upper bound of what the rental market can sustain, and that rents are taking a greater percentage of real incomes. This means I also suspect that real rents won’t increase at or above inflation, and may even have a downside. Of course I could be totally wrong, but I think rental pressure is a factor in outmigration of non-owner-occupiers.

    • Rents as a percentage of incomes has been relatively flat, though in the last year or two has become less affordable. I leave it open to discussion on what a reasonable measure of price-rent (what to use for price, what to use for rent) should be. I chose one scenario and the numbers show 70% overvaluation; other measures are likely only to be worse.

  3. This is great to highlight theory from the macro view of trending to long term history. But don’t most things in life trend to the long term history? How about expanding on Slide 19, Bullet Point 2. As everyone who follows Ben knows, this is really what’s driving the speculative mania. Governments intervene to make “homeownership for everyone”, and now we’re at the end of it. Cue the ultimate catalysts of all, peak debt servicing combined with tightening credit. Grab your popcorn and Good luck all!

  4. Speaking of what market Vancouver might be following…. Some of the problems highlighted in this article bring to mind leaky condos here, local fast-talking developers, our own bubble popping, and young buyers plunking money down on presale units, to their (potential?) doom.


    • “Mr. Usher’s bank has not been sympathetic to the fact that he can neither live in nor sell his house, and he is required by law to make good on his mortgage. He does not know what to do.”

      We hope it’s not going to come to this for some Vancouverites, but we fear it might.

  5. jesse -> Regarding thoughts on spreading your presentation widely: I would recommend that you distill the whole thing down to about 5 slides or less, all charts with large captions, and, as prior commenter Ray mentioned, chart out the possible ‘35% over 7 years’ scenario, with real prices labelled.

    • vreaa, my target audience is more those who have some finance background, either self-taught or formal.

      I am probably not the best one to concentrate this into 5 slides but I can try. It’ll probably be a “what you really need to know about Vancouver housing in 60 seconds” type approach.

    • For those who have some finance background, your presentation is great as it stands.
      For a broader audience, the concentrated approach is almost definitely better.

  6. House prices?… If it isn’t future earnings (even when brought forward with a little levereage)… Surely it’s the land value, right?… In a Utilitarian sense. As for you Consequentialists, ‘there be’ an UnwholesomeSurprise waiting for you tomorrow morning[ish]…


    [NoteToEd: A ‘SurpriseTeaser’… FullDetails… In the ‘morrow. Very much in the, “You can’t make this stuff up.” category… Hence, a deeply philosophical question… of interest to Existentialists and PoliticalEconomists everywhere. In the absence of a spectator, does a Realtor™’s signage flapping in the wind… make a noise? Discuss. This clip, by the way, was shot last year… and the ‘site’ revisited today… NotPretty]…

    • Nice footage. Moody. Ominous.

      • “What is the purpose of houses? It is to protect us from the wind and cold of winter, the heat and rain of summer, and to keep out robbers and thieves. Once these ends have been secured, that is all. Whatever does not contribute to these ends should be eliminated.” — Mozi, Mozi (5th century BCE) Ch 20

      • “Whatever does not contribute to these ends should be eliminated”

        Or at least not be subsidized by the state. Nor should we decry those who live in meagre conditions and save their money for other pursuits.

      • Great Mozi quote. Will incorporate into future headline piece.

      • The ony reason I have yet to regard and ‘remark’ upon your presentation, ‘O IllustriousDr.J… is that I, in my deepest Heart ‘O Hearts, dread pondering yet another Graphical and/or QuantitativePresentation ‘TruthTooFar’.. I spend far too much time as it is immersed in QualittativeReality. FYI, that’s a respect thang.

        Well, at least we have Road13’s new Rosé…

        OK. I have no time to explicate this evening, DearReaders… Urgent tasks and other responsiblities preclude a lengthy disquisition tonight… TimeZones are a bitch… ThisMonkey ain’t always -8GMT.

        Now, those of you with either a Medical or Forensic background will instantly interpret the following pictorial [yesterday’s ContemporaneousCompanion to the Archival RoadToPerdition clip] for what it is… One object was not disturbed. One other was moved 2-3 inches… the others were were moved from their original locations less than 24 inches distant for a more pleasing composition [cinematic license, IlustriousEd – I’m allowed, or so I was once told]… In the overall scheme of things… Not that surprising… but I see these things rather too often amidst the flotsam and jetsam of failed Realtordom™. After a while… it gets to you.


        OK… well, to conclude on a lighter noter… how does Nem encounter these things…

        It’s all in the helmet really…


      • “What helmet?”, you say… The prototype for these…


  7. I don’t think what I’m about to post/query about is strictly OT, since it’s about what sets house prices!

    I’m trying to do some more research on what kind of weird flipping continues to go on in my neighbourhood.

    Latest find: 2540 West 45h Ave. Large newer build by local developer; was on the market for some months last winter; realtor practically begging for offers. He said it was for sale then because the developer had bought another house in Point Grey and moved into it. It was eventually sold in March 2012, and it looks like the last asking price listed was $3,338,000.

    It is now for sale again, with an asking price of $3,480,000. The listing realtor is someone named Jack Yu of Sunstar. Sunstar says on its website that, among other things, it specializes in “investor properties.” (Also mentions it caters to, among others, “overshore [sic] clients.”)

    I’m wondering if one interesting thing we could do on this blog is monitor what happens to these flips. Obviously, because the MLS is guarding important world secrets, we plebes can’t know exactly what the place sold for in March. But it’s interesting to know how fast it reappeared on the market. I wonder how long it will sit now? If it’s anything like other newer builds near this intersection — there are about a dozen I can think of within a few blocks that have been on the market for ages — it might linger for a while.

  8. hmm … I believe Michael Hudson is correct:

    “An asset is worth whatever a bank will lend against it”


    • Thanks for the post. Painful to read. My heart goes out to all the victims of the cheap money and RE speculation.

    • Morgan’s ‘Bubble and Beyond’ book cover is a bit of a disappointment. The trajectory is Parabolic, not linear, and the correction is below the point where the parabolic incline begins, not where he shows it. Sorry for splitting hairs, but this is important when many of us are here to gain insight into the timing of this market.

  9. that unit was sold on march 8, 2012 for $3,100,000, wonder what kind of moron would buy that for 3 millions

    • Thanks, morgan, leo, and outrigger!

      Typo in my post — listing realtor for that property is Jack Fu, not Jack Yu.

      • numbers and charts and graphs, oh my … where are the accordion charts? … i pity da fu! … (was that wrong?) … pffft! … http://tinyurl.com/9pcpffk

      • There are times… When ‘Nem’ misses the GreatGame/his former persona… I digress. Sorry. Epte…. but, that was the logical choice. DeatReaders, the Shayler denouement will probably require some additional Rosé. It’s so depressing.

  10. What happens if present value of discounted cash flows is the wrong conjecture? We need to consider the strong assumptions that actually going into using some kind of market-proxied discount rate and equilibrium concepts to give us a handy guide using pv. Otherwise, it’s clear as mud. Just sayin’…

  11. Epte, I revisited 2540 West 45th today and this is just mind boggling. The place was sold in Jan 21, 02 for $538K, then in 10years, the owner/developer was able to put in $2.5million dollars of value into the place and sold it for a whooping $3.1million. What can possibly worth $2.5millions?? A state of the art hydroponics grow op or a meth lab run by Walter White the Heisenberg himself?? How can someone get a $3millon mortgage, that is like $18K a month!!

    The only best case scenario here is that some Chinese speculator paid the developer $3.1million of their dirty laundered money in March 2012 for this place, and as the market crash, we can only hope the same Chinese criminal would lose a crap load of money as the house price come tumbling down.

    • Outrigger, I would imagine that the developer (he’s Caucasian btw) bought a “tear-down” at this address in 2002. He certainly built a very fancy house on the property, and must have reaped a huge profit when the market took off fueled by cheap credit from the Canadian government.

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