The Froogle Scott Chronicles: Mortgaging Our Souls In Paradise – Part 10: Reversion To The Mean

Van_house_price_1960_2012

Reversion to the mean

The most likely outcome of any bubble is a reversion to the mean — that is, a return to prices that reflect the long-run mean or average growth rate that existed prior to the bubble. As the various forces that helped inflate a bubble cease to exist (low interest rates, easy access to credit), or reverse themselves (speculative mania turns to fear), prices collapse. One or more external events may also play a role; however, bubbles always contain the seeds of their own demise. Market sentiment in its extreme form is the true creator and destroyer of bubbles.

Falling prices typically stabilize around the point where they would have been had prices followed the average growth rate rather than rapidly inflating and then collapsing. In the aftermath of a house price bubble, prices probably won’t return to where they were before the bubble — although they may temporarily overshoot to this lower level. They’ll likely return to where they would have been if there had been no bubble and they had continued increasing at the average rate of growth, a rate which is typically supported by economic fundamentals such as average household income, house-price-to-rent ratio, and the rate of inflation. We can see two historical examples of this phenomenon in the chart above — the Vancouver house price bubbles that peaked in early 1981, and in late 1994. In both cases, a half-decade later, prices had reverted to the mean.

I’m able to present a clearer picture of this pattern because I recently discovered some Vancouver house price data stretching back to 1960 (details below). Most commentators in the Vancouver RE blogosphere have been using the Real Estate Board of Greater Vancouver (REBGV) average price chart, which goes back to only 1977, at least in the publicly available version, or the Teranet house price index, which goes back to only 1990.

The current Vancouver house price bubble certainly looks epic, in both size and duration. Many people now believe that  a) the past decade has been a bubble, and  b) the top has been reached and the bubble is now beginning to collapse. If the current bubble follows the pattern of the two previous bubbles, collapsing prices should eventually revert to the mean.

What is the mean?

So, what is the mean, or average annual growth rate of Vancouver house prices, in percentage terms? Based on the data underlying the chart above, here are the numbers I’ve arrived at, which assume annual compounding. For calculating the growth rate of the current bubble, I’m excluding 2012, because it has the appearance of being the transitional year between rising prices and what could be a long period of falling prices — although no one can yet be certain.

  • 1960 to 2001, House Price Nominal:  8.33%
  • 2001 to 2011, House Price Nominal:  10.21%
  • 1960 to 2001, House Price Real:  3.62%
  • 2001 to 2011, House Price Real:  7.83%

‘Nominal’ means actual price — what someone actually paid at the time they made the purchase — and ‘real’ means actual price adjusted for inflation — that is, with the inflation component of the price in relation to a control or base year  factored out. The base year is 2002, in this case, meaning real amounts are expressed in 2002 dollars.

The distinction between nominal and real rates of growth would appear to be quite important to the analysis of Vancouver house prices. If we look at only the nominal rates of price growth, we see less than 2% separating the rate for all the years prior to the current bubble, and the rate for the bubble itself. Judging by growth rates alone, we might question whether much of a bubble exists. However, if we look at the real rates for the same time periods, we see a much different picture. The bubble rate of growth is more than double that of the years 1960 to 2001, with over 4% separating the two growth rates. That’s a major difference, especially given the effect of compounding over a number of years.

The reason for the seeming discrepancy between the nominal and real comparisons is that the period 1960 to 2001 includes the years of rampant inflation that occurred during the 1970s and early 1980s, an era when the annual inflation rate hit 14% and almost 13% in two separate peaks. That rampant inflation hasn’t been factored out of the nominal house prices for the period. By comparison, the period 2001 to 2011 has had stable and low annual inflation, around the 2% mark. For the bit of prognosticating I’m about to embark upon, I think it makes better sense to use real rates of growth, which remove the distortions caused by significantly different inflation rates, and which highlight price changes more integral to the housing market itself. Based on the data I’m presenting here, I’m going to use 3.62%, the real growth rate between 1960 and 2001, as the baseline for house price appreciation in Vancouver.

It’s worth noting that a real growth rate of 3.62% in excess of the rate of inflation is significantly greater than the 0.5% above inflation that I think Robert Shiller has demonstrated for American houses, long-term. (Feel free to correct me if I’m wrong about the details of Shiller’s finding.) In other words, even using the most conservative baseline for Vancouver house price appreciation puts us well beyond most other places in North America. That’s how Vancouver became the city with the most expensive residential real estate in Canada even before this latest bubble began to inflate in 2002.

Prognostications

There’s no guarantee that the current bubble will follow a pattern similar to the pattern of the previous two bubbles, or price bubbles generally, but if it does, this second chart shows some possible outcomes. The chart also shows that real house prices are currently 40% overvalued when compared to the 1960-to-2001 mean, and were almost 50% overvalued at the end of 2011.

Van_house_price_1960_2022_mean_reversion

  • Crash — Reversion to the mean takes 4 years, and occurs in 2015. Over the entire period, real price decreases 22.53% from $762,304 to $590,547. Nominal price decreases 17.11% from $921,625 to $763,939.
  • Current Trajectory — Reversion to the mean takes 7 years, and occurs in 2018. Over the entire period, real price decreases 13.92% from $762,304 to $656,215. Nominal price decreases 2.25% from $921,625 to $900,847.
  • Slow Grind — Reversion to the mean takes 11 years, and occurs in 2022. Over the entire period, real price decreases 0.71% from $762,304 to $756,856. Nominal price increases 22.00% from $921,625 to $1,124,654 (not a typo — read on).

These projections assume inflation remains stable over the next decade at approximately 2% a year. So a house price that remains constant in nominal terms from one year to the next has decreased in real terms by approximately 2%. In other words, the house has lost value because it hasn’t kept pace with inflation. Which partially explains the seeming anomaly of some prices decreasing only modestly, or in one case even increasing, while the bubble deflates — the modest decreases are added to by the loss against inflation, and the increase only keeps pace with the 2% annual inflation rate, whereas the mean line is increasing at 3.62% above the inflation rate. The other key factor is that the modest decreases and the increase take place over longer time periods than the decreases in the crash scenario, which gives the mean line, increasing at 3.62% annually (compounded), the chance to catch up to a more slowly deflating bubble line.

Almost certainly, the actual unwinding of this current bubble will not be as regular as any of my three posited scenarios. It will likely be a much more jagged affair, in what has traditionally been Canada’s most volatile real estate market. I’m not sure if the head-and-shoulders pattern from the stock market is truly applicable to real estate, but the two previous bubbles certainly have something resembling that shape. A quick, partial crash in the next two or three years, followed by a rebound (the right shoulder) as unwary early vultures pick up houses at what they consider bargain prices, certainly seems plausible — followed by a second leg down, perhaps less steep but longer, as that initial, relatively shallow wave of buyers exhausts itself.

One other interesting observation made possible by the second chart: from 1972 onward, Vancouver has experienced a closely spaced succession of residential real estate bubbles. For almost the entire 40-year period, a bubble has been either inflating or deflating, with only a couple of years during which the market actually closely tracked the mean. Which suggests that most Vancouverites have never known a stable real estate market in this city. They don’t know what one feels like. I haven’t studied the real estate markets of other cities so I don’t know if this is the norm or not, but I suspect in many cases it’s not. It may help explain the somewhat neurotic, love-hate relation many locals have with real estate. Like junkies, we’re either floating upward, or coming down hard.

Still too damn high

There is a crucial consideration that this technical analysis, such as it is, ignores. Even with a reversion to the most conservative long-term mean that can be extracted from the first 41 years of data, houses in Metro Vancouver will still be too damn expensive for average families. I think there might come a point when absolute or nominal prices become so overwhelmingly high that they break the model, even with a mean reversion. I wonder if Vancouver has gotten there. A growth rate of 3.62% above the rate of inflation is probably not sustainable indefinitely. Because it’s a compounding rate, that mean growth line is exponential, becoming increasingly steep. Like an aircraft, it may eventually stall.

The growth rate of Vancouver house prices has meant that when this latest bubble began inflating, it was inflating a benchmark house price in 2001 of about $350K, which was already the highest in Canada by a large measure. A reversion to the historical mean may not do it this time around. The entire housing market in the city may need a 50-year reboot that creates a new historical mean that’s a lot lower than the current one. Who knows? When the 1981 bubble collapsed, real prices were chopped in half, and nominal prices weren’t far behind. It could happen again. The worst of that earlier bubble was a quick, four-year spike and plummet, so far fewer people would have been affected than are affected now. The dimensions are so much larger this time that the results of a similar implosion truly would be spectacular.

One long boom?

A suggestion I’ve read on several occasions is that Vancouver has been in one long boom of varying intensity for several decades — certainly post-Expo 86. For perspective, I’ve taken the real growth rate for Toronto houses from 1966 to 2001, and from 1966 to 2012 — in other words, excluding and including Toronto’s own bubble — and applied them to the Vancouver chart, using Vancouver’s 1960 price as a starting point. The difference is striking. By Toronto’s standards, we’ve been in a bubble since 1972. I have my doubts that Vancouver’s real growth rate can continue to outstrip Toronto’s by a percentage point or more indefinitely. You’d think that Vancouver mean line would eventually have to lose some altitude. For that to happen, real prices would have to traverse the mean line and stay below it for prolonged periods. In other words, a true crash, and a permanent reassignment downward of the growth rate of Vancouver house prices.

Van_house_price_with_TO_mean

Plastic-folding-chair economist

In one of the early episodes of The Froogle Scott Chronicles I stated that I’m not even an armchair economist. Let me reinforce that now. I’m not even a plastic-folding-chair economist. I could well have made some blunders in my analysis. If so, I won’t resent having them pointed out by anyone with greater expertise in these matters.

Happy continued bubble watching to all…

About the data

Okay, so hold on to your shirts. The numbers for 1960 to 1973 come from an article that Ozzie Jurock published in the Calgary Herald: “Price rise history defies naysayers” (July 28, 2007). I consider the argument that Jurock puts forth in the article, regarding the financial return on houses, arithmetically far-fetched. However, I think the house price data is probably legitimate. Being the suspicious type, I compared the Jurock data to the other Vancouver house price data I could find, to make sure that it aligned reasonably, and for the years in common it does.

The numbers for 1974 to 2012 come from the Royal LePage House Price Survey, which is referenced by the Bank of Canada, and UBC’s Centre for Urban Economics and Real Estate, so I’m assuming the data is valid. I followed the BOC and CUER practice and averaged the prices for Royal LePage’s Detached Bungalow and Executive Detached Two-Storey categories, which probably approximates the REBGV’s Detached Benchmark category.  And I averaged prices for all municipalities in Royal LePage’s “British Columbia, Vancouver Area”.

The Jurock data continues to 2007, but beginning in 1974 it mixes houses and condos, so I switched to the Royal LePage data, which luckily begins in 1974 — although it is somewhat spotty in the earlier years.

This final chart shows how the various data sources align. For the REBGV Detached Average data, I harvested what I could from REBGV news releases. For years prior to 2001, I estimated prices using the REBGV Residential Average Sales Prices chart. All numbers are for December of each year.

As an additional check, I included the REBGV Detached Benchmark, and I also applied the Teranet HPI to the Detached Benchmark, using the 1996 benchmark price as a starting point. As you can see, all lines are strongly correlated, with the exception of the more recent years of the average line, skewed higher by the stratospheric prices at the top end of the market, and the more recent years of the Jurock line, which mixes houses and condos. Single family home and condo prices have increasingly diverged in recent years, so mixing in condos pulls the line lower.

In general, I find searching for Vancouver house price data on the web a frustrating experience. I’m not a conspiracy theorist, but I do get the sense the local real estate industry releases only the data they want to, and controls the vast amount of information at their disposal very carefully.

If anyone can point me to other sources of Vancouver house price data, I’d be most appreciative. For example, I haven’t been able to find the MLS HPI and average price data going back to 1980 that Ben Rabidoux, and Kevin at Saskatoon Housing Bubble, often use for their charts.

Van_house_price_with_data_comparison

Things can go missing from the web, so I’ve replicated the data from the Jurock article below. I’m assuming other commentators may want to include it in their own analyses. The year 1991 was missing from the data, so I averaged the prices for 1990 and 1992.

Year & Avg. sales price Year & Avg. sales price Year & Avg. sales price
1960  $13,105 1961  $12,348 1962  $12,518
1963  $12,636 1964  $13,202 1965  $12,964
1966  $15,200 1967  $17,836 1968  $20,595
1969  $23,939 1970  $24,239 1971  $26,471
1972  $31,465 1973  $41,505 1974  $57,861
1975  $64,471 1976  $68,694 1977  $64,556
1978  $66,243 1979  $70,888 1980  $100,087
1981  $148,860 1982  $107,829 1983  $114,618
1984  $113,722 1985  $112,737 1986  $120,035
1987  $132,658 1988  $160,375 1989  $209,670
1990  $230,641 1991  $237,921 1992  $245,200
1993  $279,800 1994  $305,600 1995  $309,500
1996  $288,200 1997  $287,000 1998  $278,600
1999  $281,100 2000  $295,977 2001  $285,900
2002  $301,500 2003  $329,500 2004  $362,800
2005  $395,400 2006  $482,000 2007  $540,100

In further communication after writing the above article, Froogle added the following thoughts:

– The e10 data still only goes back to 1960. If we had Vancouver house price data for the entire 20th century, what sort of trend line would emerge? That the average price for a house was only $13K in 1960 would suggest that the trend line was probably considerably less steep in the first half of the century.

– Did something start to happen in 1972 that has been continuing ever since, causing at least a portion of the baseline elevation? The thing that comes most immediately to mind is that the first of the boomers began hitting the earliest of the prime house-buying years. Forty year later, the last of the boomers, people our age, are perhaps now exiting the last of the prime house-buying years.

– Even bears would have to agree that the fundamental nature of Vancouver has changed. Not an “it’s different here” argument, but rather that Vancouver has shifted from being a resource-economy-based provincial outpost to being an Asia-Pacific-facing metropolitan region of a certain magnitude. World-class or global city? No. But certainly no longer a provincial backwater, either. Which means the trend line for house price appreciation for modern-day Vancouver should probably be compared to other cities of equal stature, not to earlier-times Vancouver.
—————–

Thanks very much for all this, Froogle Scott. Here follows my discussion. – vreaa

DISCUSSION:

Reversion to which mean?

Froogle Scott has sourced earlier price data, and given us a welcome analysis and discussion of the possible targets of a price reversion. The trend-line derived from data as far back as 1960, and the comparison with the long term Toronto price trend-line are healthy food for thought. If prices do ‘revert to the mean’, to which mean do we expect them to revert?

There could be arguments for the validity of any one of the following trendlines:

1. Trend-line determined by 2001-2011 rate of price increase (7.8% p.a. real)

2. Trend-line determined by longer-term 1960-2001 rate of price increase (3.63% p.a. real).

[2.5. Something in-between 2 and 3. More about this later.]

3. Trend-line determined by nominal prices rising at the same rate as long term wage inflation; little more than 0% real growth.

Trend-line #1 is the bullish case, where the very large annual gains of the last ten years continue indefinitely. By this logic, the current ‘correction’ in Vancouver RE prices would be argued to be over. We’d say at the outset that this represents particularly wishful thinking from those ‘long housing’, that 7.8%-real p.a. increases are preposterously large, and that we will soon find out that rate is far from sustainable.

The most pertinent debate that emerges from Froogle Scott’s analysis is whether we’d expect long-term support at the longer-term 1960-2001 trend-line, at a rate of 3.63% p.a. real. Even though 3.63% p.a. real growth rate may seem low to participants who are now accustomed to the 7.8% real p.a. increases of the last decade, I think we have to question whether a long term 3.63% rate is in any way typical, normal, or sustainable.

At what rate should we expect real prices in any given city to increase over the long-term?

Shiller’s very long term analysis suggests that housing prices should revert to long term means determined by long term wage inflation; by his findings, about 0.5% real growth.

Measures like income growth, population growth, and GDP growth are likely the best indicators of expected long term RE price growth.

“In Canada, as in other countries, movements in land and house prices over long time horizons are driven primarily by changes in population and per capita income. Over shorter horizons—a decade or less—house prices may outpace population and income in some periods and lag behind them in others.” – BOC Review, Winter 2011-2012

Here are some recent indicators of what rates of growth we can expect from these drivers:

Metro Vancouver’s population increased by 9.3% over the five years between the 2006 and 2011 census, an annual compound rate of 1.79%. (source: Statistics Canada)
From 1981 to 2011, the population grew from 1,300,000 to 2,313,000, for an annual compound rate of growth of 1.94%. (source: Metro Vancouver)

Median total family income in Vancouver increased from $62.9K in 2006 to $67.1K in 2010, an annual compound rate of 1.63%. (source: Statistics Canada)
Real income per person increased by slightly less than 1% per year in the 1980’s, actually decreased in the 1990s, and rose by 1.61% per year in the 2000s. (Source: Business Council of BC)

GDP in British Columbia increased from $197.0B in 2007 to $217.8B in 2011, an annual compound rate of 2.54%. (Source: BCStats)
GDP increased at annual rates of 2.12% in the 1980’s, 2.72% in the 1990’s, and 2.36% in the 2001-2010 decade. (Source: Business Council of BC)

Froogle surmises that 3.6% real p.a. growth is “probably not sustainable indefinitely”, and I would strongly agree. Why would we expect Vancouver RE prices to continue to increase at well above the current rate of inflation, at a rate greater than population growth, income growth, or GDP growth? Why should Vancouver RE prices continuously increase at greater than the rate of a city like Toronto, decade after decade? (Note that this is not a question about absolute price levels.. Yes, we can accept that Vancouver commands a ‘mild weather/beautiful vista’ premium.. but that premium is ‘priced in’; it explains why there may be a baseline difference in prices, not why prices should increase each year at about a 35% greater rate in Vancouver vs Toronto.)

The lack of convincing answers to these questions, as well as other factors concerning asset price bubbles that are mentioned below, lead me to believe that prices will go a lot lower than support determined by the 1960-2001 3.63%-real trend-line level.

It may be no coincidence that the nearby support as calculated using this 3.63%-real trend-line is also soon to be in the vicinity of the early 2009 price lows, those that resulted from the quick 15% pullback of 2008-2009. I have previously predicted there would be support at those levels for technical and psychological reasons (which technical analysis aficionados will know to be the same thing). I’d expect a temporary increase in buying interest at those prices, as it is likely that a group of prospective buyers will be expecting a floor at the 2009 lows. It wouldn’t be at all surprising to therefore get some support at those levels, and perhaps a bounce. This would result in the ‘right shoulder’ to which Froogle refers. I’d then expect that such support would fail in the months thereafter.

There are at least two other lines of argument that would suggest that price corrections are going to be more extreme than the worst-case 22.5%-drop scenario predicted by the 3.63%-growth trend line:

A. Fundamental analysis.
Prices in Vancouver have very clearly overextended from those determined by fundamental underpinnings. By price:rent and price:income ratios, Vancouver RE was two to three times overvalued at the peak. The average home price is more than 10 times the average income, where international standards judge 3.5 times average income to already represent an overpriced market. As Froogle puts it, even with a 22.5% drop, “houses in Metro Vancouver will still be too damn expensive for average families”. The thing is, no speculative mania ends with such a scenario. In fact, if anything, one would expect that the price correction will take values to levels where families can afford to buy. Long term sustainable prices should be at levels determined by rental yield, plus a modest ownership premium. Vancouver will never be cheap, but it will be a lot less expensive than two to three times fair value.

B. Sentiment.
Some people would be pretty miffed by a 22.5%-real price pullback. But ‘some’ and ‘miffed’ aren’t extreme enough words to herald the end of a decade long mania that has doubled or trebled prices. If such a modest pullback were to represent the end of the mania, that would mean that market participants would still have been rewarded with years of 3.63% per annum growth, over and above the rate of inflation. All this when fixed income rates have been very low. The point is, this would be a mere rap on the knuckles, and speculative manias always, always, end with holders being punished more than that. Manias resolve when speculation is completely ‘wrung out’, and a good proportion of participants are exhausted and disgusted. The bottom arrives with the proverbial ‘whimper’. After such a large and broad mania, sentiment will have to get particularly poor before we hit a final trough, and 22.5%-off simply won’t do the work necessary to achieve that goal.

Obviously, we can’t know with any certainty what trend-line we’ll revert to, or what the sustainable rate of price growth for Vancouver RE will end up being. Our best guesstimate is that Vancouver RE will find a long term trend-line below the 3.63%-real p.a. growth, but above the 0.5%-real predicted by Shiller. This still represents a very broad range, and consequently is not of much use in predicting price targets. Population-growth, income-growth and GDP-growth suggest that we’d quite likely reverting to a more modest 2%- to 2.5%-real long term growth in RE prices. That might not sound like much of a difference, the difference between 3.63% and 2%-2.5%, but it actually has profound effects on price targets: support determined by long-term 2%- to 2.5%-real growth would require prices to drop by about 55%- to 65%-real from current levels.

– vreaa

Postscript:

Caveats/Intricacies/Other:

(a) Whatever trend-line ends up being valid, we’d expect there to be overshoot to the downside to produce the final bear-market trough.

(b) Froogle asks in correspondence: “Did something start to happen in 1972 that has been continuing ever since, causing at least a portion of the baseline elevation?” We know that gold-bugs are going to be hopping up and down on hearing this question, eager to point out that Nixon closed the gold window in 1971. CPI began to rise at that point (see US chart below). But why should real prices start to rise at an even greater rate? The argument would be that there may have been hidden inflation for some assets. In other words, has there been a change due to ‘non-headline’ inflation of hard assets? This argument would still have to explain why prices have run so far ahead of rents.
Take a look at the 1972 effect on CPI in this US chart:
us national price index

(c) Concerning the argument that something may have changed about the way the world sees Vancouver; that Expo and the Olympics and other such forces moved Vancouver from a sleepy provincial port to a 3rd tiered city in global terms, and that such change merits RE price increases. If this were the case, why wouldn’t rents have increased at the same rate as prices, to reflect the argued increased desirability of the city?

(d) In the discussion of the 2010 ‘Fives Charts’ post at VREAA, commenter ‘Best Place On Meth’ stated: “I’m wondering if the entire past quarter century [of RE price growth] has been an aberration.” Indeed, it is even possible that the last half century could represent an aberration. Shiller would suggest that this could be the case (and would likely also point out that such periods of price distortion come and go over the centuries).
Did our bubble actually start much earlier than 2003?
Does the 2001-2012 spec mania action just represent the last two or three stages of a larger bubble blow-off, as the curve became steeper (2001) and steeper (2003) and steeper (2006; 2009-2011)?

Other articles pertaining to the trendline/price-support discussion include:

‘Five Charts: Predicting Future Vancouver Housing Prices’, VREAA, 11 Sep 2010

‘Vancouver Teranet HPI Trendline Analysis’, Jesse [YVRHousing] at Housing Analysis, 30 Mar 2012
Chart from jesse/YVRHousing’s article:
Teranet trend

67 responses to “The Froogle Scott Chronicles: Mortgaging Our Souls In Paradise – Part 10: Reversion To The Mean

  1. “I’m not even a plastic-folding-chair economist.”

    Balderdash! You’ve been hiding your light under a bushel, Froogle [to paraphrase a canonical proverb]…

    [NoteToEd: Froogle’s analysis is, frankly, far better than a certain chartered bank’s senior economist whose breakfast ‘soiree’ Nem recently attended. His advice to the inflation wary HillBilly InvestmentCommunity was to load up on more real estate {I s**t you not!}. Or as the Eeeenglish are wont to say, “Well, he would say that. Wouldn’t he.”]

  2. Well done Froogle Scott. Truly impressive.

  3. UBCghettodweller

    Well done. The frustrating thing is that we’ll need to wait about 5 years to see which models are correct.

    Being really explicit about how you’ve done things with consideration of multiple outcomes is refreshing… you know actual analysis and not just an opinion piece backed by selectively chosen numbers.

    • The “tell” will come a lot sooner than five years. If there is a sudden radical drop in prices in the next year or so, it makes the tread-water scenario almost impossible, and concomitantly increases the likelihood of the worst-case scenario.

  4. I don’t believe the long term price trend line tells us too much at all – especially in terms of forecasting the magnitude of the correction. The real long term fundamentals are incomes and rents, so I think we’d be better off to anticipate those trends rather than price trends.

    • Froogle: fantastic write-up. Well done. I do tend to agree with Cyril on one point, however, which is that markets are forward-looking, and therefore prices will be driven by future earnings (rents) and discount rates. Of course, to the extent that past rents are reflective of future rents, they may be a decent guide…

  5. @v/froogle, cpi is gimmicked to understate … there are various alternatives available (eg. shadowstats, etc.) … a couple more important but difficult to treat things … time lag between monetary inflation and when prices (per cpi) respond … role of credit as part of money supply – ergo inflation – but credit has asset-specificity, behaves like vectored money … enjoy!

  6. Dimitri Tishchenko

    Wow, what a great read. Thanks for the analysis.

  7. Very nice work. Notice how the 1965, 1987, and 2000 real lows correspond to real highs in the S&P and Dow? Are US stocks the perfect hedge?

  8. That was a really interesting read, Froogle. Long too (whew!) but worth the time. Well done.

  9. Very impressive analysis! Great read!

  10. Boy this post is opening up a can of worms. There's too much debatable historic information,i.e., correct prices, income, CPI methodology, etc. The easier way I find, is to analyze data from a lenders prospective in terms of qualifying buyers, regulations, real rates, innovative credit products, etc., and using home price ratios against other benchmarks such as commodities or other goods and services. The main reason for this method is because legislation or policy changes can quickly influence fundamental demand.

    I always analogize it this way: Let's say you're a bar owner and the legal drinking age is 19 years of age. A producer of liquor/beer and your business is limited to demand in the 19+ cohort. If the Government lowered the legal drinking age to 16, fundamental demand and business revenue would increase overnight. Now there's a new normal much different from the previous period or observation. 

    This also applies to housing. Between the Government's deregulating and central bank's continuing interest rate cuts, the demand-side of housing has continually changed since post WWII. (Who qualified then and how many households were paying a mortgage compared to today?)

    One thing is certain: today's problems is nothing like the 1980s or any of the previous bubbles. The biggest distinction between today and then is household savings and net productivity output (what one produces minus what they consume).

    • Well done Froogle. Easy to read. There are only 2 others that write with that type of analysis and ease of reading, Ben and VREAA. Farmer comes close.

      I agree with you Watchdog, government intervention, 30 years of declining interest rates and demographics are the big factors for new normals and baseline trend noncontiguous graphs. Your comments are always worth a second read – thanks!

  11. Bravo. Excellent work.
    I don’t think we can stay on that 3.62% trendline. I imagine some of it is Boomers, and some of it is moving from being a burg to being a city… Vancouver is so young. It’s an interesting idea to me that changes in scale might encourage unsustainable trendlines – I wonder about the early roots of Montreal and Toronto, for example.

    I know that some may point to this as a density issue, but cities generally are constrained, even if it’s by more city.

    • UBCghettodweller

      >I know that some may point to this as a density issue, but cities generally are constrained, even if it’s by more city.

      I think people forget this when they use the “it’s different here” argument.

      The constraint could be as simple as transit times. Yes, there is cheap housing an hour and a half drive out of the city core, but very few are willing pay the three hours out of their day just to commute. Add dwindling petroleum resources, which means at least in the short term, transit costs will climb faster than earnings, and suddenly places like Calgary and Edmonton have a barrier to sprawl that is nearly as firm as a border and water on three sides.

      • Real Estate Tsunami

        UBC, completely agree with you.
        Capacity constraints can come in many shapes and forms.

      • Yes, but in the long term what should happen is commute times get reduced by places of work shifting to a new focus e.g surrey so that businesses can attract labour that cannot afford the million dollar pricing close to the inlet. And if there is a will, faster commuter transport. In london (UK), New York, Paris you have faster and faster modes of transport to get you into the less than 1.5 hour commute into the city from various distances.

      • Electric trains are a good solution. Europe has them everywhere. So does Japan. They need not be slow.

  12. Yes, excellent Froogle. Maybe this plastic-folding-chair economist is doing a better job than the ones that report to the media. Nice work.

    • [NoteToEd: Notwithstanding his SAG membership and occasional forays into GameShowTV… Ben Stein is actually a classically trained economist… not unlike his more famous father, Herbert Stein – who, following a brief visit to Vancouver immediately prior to the 81Bust, coined the famous aphorism, “If something cannot go on forever, it will stop.” Ok. I made up the Vancouver part.]

  13. Thanks for the fun read. Looking at price vs rents indicates 65% over-valuation for condos. My 2cents 🙂

  14. Here’s a little secret Froogle. The best historic housing data available is…newspapers.

    The Vancouver Sun, Aug 3, 1967
    Home Prices Skyrocket

  15. What goes up must come down. Lest we all have to be billionaires to buy a home one day.

  16. Yellow Helicopter

    Thanks for this Froogle. I really enjoyed this read, and every part of your chronicles. Much appreciated.

  17. Good work Froogle, not only on the analysis but the writing as well. Bests most of dreck I read from the big bank employed guys everyday.

  18. Real Estate Tsunami

    I think the consensus on this blog is that RE in Vancouver is overvalued between 40 and 60% and that the bubble is deflating.
    What is still debatable is the value of the “escape velocity” of the bubble.
    Meaning how many years it will take for prices to revert to the mean.
    Value of 1 = 1 year, Value of 10 = 10 years.

    • UBCghettodweller

      Having seen Alberta go through more than one boom-bust cycle as a resident there, I’m wondering how Vancouverites would deal with property prices tanking 40% in under two years.

      • Kill all baby boomers

        How did albertans deal with it?

      • [NoteToEd: Albertans? The ‘dirty secret’ is that most of them… are from somewhere else… Where do you think I enjoyed the WonderYears after that brief post-natal stint in MotownSouth?]

      • Real Estate Tsunami

        Thanks UBC,
        I’ll put you down as saying the Vancouver RE bubble will revert to its mean during the next 2 years.
        Anyone else dare to place their bet!

      • UBCghettodweller

        Oh, actually my model a slide of ~10% inflation adjusted prices over the next four or five years. Mostly because I’ve noticed enough irrationality in Vancouverites that I reckon they’d rather be underwater and totally drowning than sell their properties in this city. It really is the only place I’ve ever lived in Canada where people can’t fathom living anywhere else and not hating every minute of it, even if it’s a rental property in the same city… The market lied to itself all the way up, why not all the way down?

        Don’t get me wrong, I really like many aspects of Vancouver. Hell, I might even want to live here long term later in my life. I just see the same delusions here I as I saw in Alberta when it came to the bottomless pot of gold that the petroleum industry supposedly is (was?) Only that it’s square footage rather than barrels of crude and Btus.

        And yes Nem, try to find a born-‘n-raised Albertan in Alberta these days. They’re about as rare as a hen’s tooth.

      • UBCghettodweller

        That would be ~10% each year for several years until a bottom is hit, not ~10% from peak to bottom.

    • NoteToEd: Gord wrote his homage while DancingTheBooms… and playing his guts out in NewWest HonkeyTonks along the shores of the MightyFraser. A long way from Rosedale, non?

      http://tinyurl.com/b27q4ts

      PS – he was so happy with Liona B.

      • …”Gordon Lightfoot doesn’t much like his house. It’s a generic monster home in the posh enclave of Toronto’s Bridle Path, and barely older than his car, a 2001 Chevy Malibu, of which he speaks more fondly. (“It runs like a top. Just got a new set of brakes put on.”) His second wife, Elizabeth Moon, pushed him to move out of the city centre and sell his old Rosedale mansion, which had turrets and ghosts, and guests that included the young Bob Dylan. “I loved that house,” says Lightfoot. “But I was asked to move and I moved. I got outvoted.” Lightfoot and Moon separated in 2003, then divorced last year, ending a two-decade marriage that produced two of his six children. “I would have stayed married,” he says. “I would have seen it right through to the end. Making a change like that at my age requires a lot of thought.”….

    • Prices always revert ‘through’ the mean, not to the mean.

  19. pfffft! … seemed appropriate … http://tinyurl.com/b3lktvo

  20. “Feel free to correct me if I’m wrong about the details of Shiller’s finding”

    Tom Lawler did some analysis on long-term biases in Case-Shiller:
    http://www.calculatedriskblog.com/2012/12/lawler-on-upward-trend-in-real-house.html

    Further if we acknowledge that Vancouver is increasing in density, we can plausibly add an additional growth rate offset on top of this. Not to say prices are close to fundamental value, but to think that prices in Vancouver are going to revert to wage growth is perhaps slightly optimistic.

    I stick with condos for my analysis as growth rates above rents are unlikely to be sustained.

  21. Great work! Thanks very much for all the effort that went in.

    Regarding 1972, this was about the time boomers entered their prime home buying years. Rarely if ever has a generation been so enamored with a single asset class as boomers with RE. Even now I hear over and over from boomers that RE only goes up. Nowadays they often apend “long term” but they still think RE is the path to riches. And, for them, they are mostly correct – they have driven an extended supercycle of higher house prices. But what will happen now they’ve entered their downsizing years? I believe this generational effect has been comprehensively analyzed by Ben and others and is uniformly found to be negative.

    Still, Tsur/Cam/Bob/Helmut all say it’s a great time to buy so they must be basing that on something more than faith and naked self-interest right? Right?!

    • In countries around the world, house prices peaked as the dependency ratio troughed. The change in the 1970s was massive (from over 0.7 to under 0.5). The change in the 2000s was about 0.48 to 0.45, but this ignores the income shift to the boomers.

      http://worthwhile.typepad.com/.a/6a00d83451688169e201538ebf6fb7970b-800wi

      I think our society has made a colossal investment error, by spending (or foregoing savings) for boomer retirement. I expect them to sell out their children and this country completely to save their hides.

      The last time the dependency ratio increased Canada allowed unprecedented immigration. I expect them to throw open the doors to anyone and everyone. Maybe admit 3-5 million people per year. They will pack this country until you don’t want to live here anymore.

  22. Really enjoyed the post/article. I appreciated the writer’s analysis from many perspectives.

    “Still too damn high” There’s a couple of scenarios conjured (wonderings, I’m no expert but the post and comments helped me frame some opinions)… The speculation factor could continue in select areas with fewer and fewer locals involved. Locals may continue to speculate further out into the burbs, but in urban areas, speculation has seemed forced upon locals to the benefit of Canadian and international investors. Some locals have done well. Since Expo, Vancouver promotes like a tulip bulb market, funky, fashionable, earthy. Vancouver gets a nod as a B-rated speculative market with tendency to the upside. It’s recreational property in a western parliamentary democracy with resources backed by a huge trading partner. It’s technologically advanced with many natural and social amenities. The population seems polite and welcoming.

    There’s a point where local lifestyle and incomes don’t compensate for the high expense. It’s not the best place on earth, so prices appear to reflect speculative possibility and the loss of Canadian dollar value particularly in this region of Canada. I think regions of Canada play off each other with varying asset values, likewise the banks move capital around our diverse economies. I agree with the article, we should compare prices to similar sized cities with similar income streams. Here, goods and services seem priced to support property values. All other services are ancillary to real estate and locals dig for any revenue to compete. I don’t see similar economic booms in other industries, wages or consumer spending, just high prices, markups and costs. The real estate buy-in is so high, locals I know are leveraged to the max. Many of my friends don’t have savings accounts or RRSPs. With savings interest less than inflation, there’s no point. Now I hear there’s a new savings tool, TSPs?, which make it easier to withdraw emergency cash. For people I know, everything goes into the house and they believe the house is the only chance to preserve wealth and maybe grow it. Everything else depreciates including cash. They believe the Lower Mainland is special, yet remain tied to their crappy house and don’t participate in many ‘popular’ activities. They sit at home, plan room renovations and feel like market makers. They are operating on a balance between payables and receivables until one day they time it right and cash out.

    I think we’re mirroring what was happening in California before 2008 and buying an address. Taking some gains might be wise for those leveraged multiple times. I don’t see carrying costs met until rents increase, and that needs more productivity in other sectors. Til then, wannabe investors I know are trying to eke out a return in a made up RE market. They are trying to combine investing with living expenses. Similar in the stock market today: Even though US productivity numbers show a slump last quarter, the Dow went up because it’s the only game, worthy or not. I’m surprised home buyers aren’t offering derivative schemes to friends and family, “Pay for my new roof on spec”.

    Just thoughts. Great read Mr. Scott and VREAA.

    • UBCghettodweller

      >They believe the Lower Mainland is special, yet remain tied to their crappy house and don’t participate in many ‘popular’ activities.

      For all the talk of skiing and beach in the same day, I have yet to meet a single “native” Vancouverite who has done this in their lifetime.

      Before I leave Vancouver in the next couple of years I’m going to do this and out-vancouver the Vancouverites I know.

      • Yellow Helicopter

        Ha, I do actually do this quite often- but only because I love our local mountains and spring-skiing, and live by English Bay (renting) so often grab a beach towel and head down there with a book in the afternoon.
        Think this is one of the luxuries of renting- I’m not instead stuck doing home renos or in Home Depot!

      • Done already. Quote heard on top of hollyburn. “Was out sailing yesterday, and today I am up skiing and snow shoeing. What an amazing city.”

      • Real Estate Tsunami

        UBC, I did ski and golf once in one day.
        Neither one of them was satisfactory.
        The snow was all slush and the grass was all mush.

  23. Tamara Taggert bullish newspiece sighted!

  24. Thanks Frugal! Awesome effort and analysis.

  25. Real Estate Tsunami

    Thanks Frugal,
    Awesome effort, long report, but short of any recommendations.
    Please be more specific.

  26. A statistical test of mean reversion for the prices in the table suggests a relatively low speed of mean reversion and a fairly high growth rate. One might conclude that price drops are slow and relatively shallow against what appears to be a very high mean growth rate. For the data, mean reversion requires a high growth rate since there must be an equal number of occasions when prices are pulled back up toward the mean.

    Assume Vancouver RE prices follow the mean-reverting process:

    dS = a *(L – S) dt + sigma * S * dz
    S is the price, a is the speed of mean reversion, L is the mean price, dS is the change in price, sigma is the volatility, and dz is the wiener increment/random influence.

    If a in the equation above (speed of mean reversion) is large then prices quickly and suddenly adjust back toward L. This doesn’t appear to be the case unless one cherry picks L such that prices only revert downard to the “mean”.

    If L is a fundamental price, then RE prices are obviously not mean-reverting for Vancouver as prices have always been above fundamental value. Historical Vancouver RE prices appear to show some value well beyond traditional fundamental value and the most likely price process is a simple random walk with a very strong growth rate.

  27. Great post. I share froogles seemingly simple explenation of the 3.62% starting in the early 70’s being attributed to baby boomers. However, the counter argument would point to other cities with lower than 3.62% and say there are baby boomers there as well. I haven’t seen any statistics on population moving into the geographical areas with the highest increase in property values that is broken down by age. There may just be a strong correlation there. We’ve seen many articles pointing to the baby boomers and the impact they will have on property values as they downsize or exit the market completely, but nothing that really quantifies it. Perhaps this analysis does just that?

    • Add 5% of the total Canadian population to predominantly Vancouver and Toronto over the past 5 years and . . . voila! Combine this with lax lending and mortgage rules, ultra low rates, immigration that targets wealthy RE investors and global liquidity expansion to guarantee a housing and asset price bubble. I don’t believe that this is a time for fundamentals that have applied historically.

  28. I’m really pleased with the level of discussion here, folks. It’s exactly what I’d hoped for — that others would take what I’ve presented and go farther with it, and suggest additional avenues for inquiry and methods of analysis. I think the overall quality of participation is one of the things that makes VREAA a great blog.

    We’re getting into some interesting territory here — ‘zooming out’ from the current 10-year bubble period and looking at the longer time horizon. At the end of Part 3 of The Froogle Scott Chronicles (4 Feb 2010) I chewed over the difference between ‘a boom’ and ‘a bubble’, and wondered whether Vancouver was experiencing both simultaneously. “I don’t think any of us really knows whether Vancouver is experiencing a boom, a bubble, or a boom become a bubble.” Despite being chewed over by the commenter “Anonymous”, I think the ‘boom become a bubble’ theory has some merit. If we look at the second and third charts above, you could argue that the 3.62% real growth rate line represents the boom, and on top of it ride the three closely spaced bubbles. I think it’s highly likely that the current bubble is a) a bubble, and b) going to come to an end. But the larger, perhaps more interesting ‘zoom-out’ question is whether the half-century boom also comes to an end. Maybe not immediately, but in the foreseeable future. If so, then the work on fundamentals that vreaa, jesse, Ben R., Kevin, and others have done becomes highly pertinent. I’d love to see bloggers dig even deeper into this long-time-horizon area. Anyone up for creating a hundred-year, Case-Shiller-like chart for Vancouver? I’m tempted to try, but like most of us, I have a day job.

    I think this latest bubble/price conflagration is likely the result of a perfect (fire)storm of factors coming together. The last half-century in Vancouver could be something similar, but of a lower, slower burning intensity. The key item would be the ongoing transformation of Vancouver from what it once was to what it has become and continues to become. Does Vancouver stabilize at some point, or for a number of decades into the future, no doubt with a variety of ups and downs, does it keep going the way it’s been going? That’s a difficult one to answer.

    Real Estate Tsunami wondered about “recommendations”. Only one really: It’s a fire — avoid getting burned. Hanging out here, and on other good RE blogs, and learning stuff, as I’ve done for the past five years or more, and thinking hard about things, is a great way of developing an internal smoke detector, or what Ernest Hemingway called an internal BS detector.

    Thanks again, all, for your responses.

  29. Real wage growth is sometimes positive, which would make real price increases affordable. Rather than extrapolating historical real wage growth, better to forecast it as an input.

  30. 1976-2000 real median Vancouver wages = -0.5% per year
    2000-2010 real median Vancouver wages = -0.2% per year

    This explains why real rents also have negative growth. Due to increasing income inequality the averages (not medians) have fared better: -0.1% and 0.9% respectively.

    To smooth out the signal I looked at 6-year compounded real median wages. There were only two episodes of above 1% real wage growth on that measure: 1989-91 and 2006-08. Interesting. Reversion to the mean.

  31. Real Estate Tsunami

    Any analysis of the dynamics driving RE in Vancouver that does not take into account the impact of offshore investors is IMHO meaningless.

    • This analysis does take into account offshore investors. They’re one component of the buyers contributing to the price action we’re discussing.

    • The flow of foreign money into Vancouver RE, primarily from China, but also from elsewhere, has definitely contributed to the current bubble, and probably to the previous one in the first half of the 90s, during the uncertainty surrounding the handover of Hong Kong. However, because of the lack of data — at least publicly available data — it’s difficult to quantify how large the effect has been, or what proportion is direct versus indirect.

      Foreign investment and immigration, and the nature of the immigration (i.e., ‘targeting higher net worth individuals’), is part of what I refer to above as “the ongoing transformation of Vancouver from what it once was to what it has become and continues to become.” Foreign money could be considered the ‘X factor’ in the economics of Vancouver residential real estate. I don’t think anyone really knows what lies ahead. Do rich people continue to leave increasingly polluted Chinese cities, seeking ‘enviro-refuges’ like Vancouver? Does China begin to clean up its industry, as London did many decades ago, and liberalize its society, so that people feel less desire to leave? Do the three levels of Canadian government, under pressure from the local citizenry, enact laws that dampen the effect that offshore money can have on local house and condo prices?

      In general, Canada wants and needs immigration. Who’s going to pay for all those aging boomer hip and knee replacements, and keep the public pension plans topped up? But some simple and sensible regulation around the purchasing of residential real estate could be helpful. Many countries have such regulation in place. Allowing anyone in the world to come to your city and buy as many houses and condos as they like, someone who is not the least bit dependent on the local economy (there go your fundamentals), seems problematic to me. Although I’d also say the same thing about allowing a Canadian citizen to amass a large number of residential properties. It comes down to discouraging a necessity for the many (shelter) from being treated as an asset class and arena for speculation by the few.

      • With respect to the “direct vs indirect” effects of offshore money on Vancouver, I find it difficult to make a differentiation. Like any market, prices are set on the margin irrespective of the type of buyer and based on their willingness (and capability) to pay. I suppose it’s debatable whether the belief that offshore (hot) money has the highest willingness to pay is correct or not but there’s enough anecdotal evidence to suggest that it is reasonably close to the truth.

        With respect to investment and immigration, you raise some good points about why offshore money has a higher willingess to pay. Pollution, the lack of a social safety net, extreme income disparity, government control, little freedom of expression, and an extremely competitive society are all factors as is the plain and simple desire for wealth. As a friend who has been working throughout Asia for the past 10 years said to me when we were talking about the housing prices, “you have no idea what people are willing to pay to get out of Asia for the things that we Canadians take for granted everyday”.

        With respect to foreign ownership restrictions, I would imagine that the prospect is a Vancouver homeowner’s worst nightmare – local incomes would have to support home prices!

        It’s a touchy topic but there is increasingly more debate on whether Canada needs immigration as it did 50 years ago. A recent CBC report suggested that 60% of Canada’s new immigrants require some form of government support. There’s also plenty of evidence that immigration has not created jobs for local Canadians – outside of the RE industry, that is.

        If I were to hazard a guess, I imagine that Vancouver will continue on it’s 40 year old trend with bumps along the way as increasingly tied to the health of Asia’s economies. The rest of Canada is less relevant to Vancouver now just as Vancouver is less relevant to the rest of Canada.

      • Your last thoughts about necessity for many vs arena for speculation by the few is spot on. I’ve been saying this for years but not nearly this succinctly. Thank you for summing it up so nicely.

        There’s always going to be income disparity but those fortunate enough to have sufficient disposable income to speculate shouldn’t mess up basic necessities just cuz it might help them get even more disposable income. Speculation does this. Those that are so rich that they’ll pay pretty whatever is asked cuz haggling or looking for better isn’t “worth it” do too by skewing housing (/asset) prices upward.

        I’ve come to terms with the fact that I’ll never be rich. I can live with that. But stresses on my finances due to RE pricing here has pushed my retirement out by years – if I ever get to retire, actually. That sucks.

        BTW: This was quite an article. It will take a few reads to digest but I’ll try 🙂

  32. Thanks for your thoughts, W. I think one role of government is to balance out income inequity, by regulating how much power can be exerted by those with wealth. I feel that Canadian governments at all levels have been getting away from that important function in recent decades. It all comes down to the kind of country we want to live in.

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