As IF Times

link In Vancouver, logic has left the housing market – Canada – Macleans.ca.

But it’s not just Vancouver, it’s a phenomenom that is being experienced the world over from Vancouver to Dubai, from Shanghai to London.  These are some of the hottest spots for real estate prices in the world today.  Investment and speculation in real estate has been the surest way to building wealth for as long as the baby boom generation has known. 

In the days pre 1970, real estate price increases were fairly moderate, for the most part, in line with the cost of living.  In fact, it was a detriment in many cases to own real estate because there were costs involved; maintenance, taxes etc.  At least in the North American experience, as the baby boom demographic pushed it’s way into real estate in earnest, supply and demand for the favored areas gradually drove prices up and houses became for most people, the single largest store of wealth for this generation.  There is no doubt that valuations in real estate are correlated with the wealth of the local inhabitants, but it can cut both ways as residents in Las Vegas, Arizona and Florida have recently found.  Wealth tends to beget wealth and so prices can really climb when a local economy is hot.  Of course access to favorable financing is another significant factor as the multiplying effect of this tool excerbates demand for product and therefore prices.

People of course need a place to live, but in the areas mentioned above, the notion of buying a house as shelter is but a quaint notion.  The entire objective and major consideration for buying real estate in Vancouver, is as a means for hitching a ride on a fast moving train.  No rational person who makes a nominal salary of $75,000 per year, perhaps netting $50,000 after tax, will try to carry a mortgage on a $900,000 house.   According to a recent listing on Vancouver’s west side from an article in Canada.com:

“…At an asking price of $889,000, the Second World War bungalow in the 3100-block West 10th Avenue in Vancouver seemed like a bargain to realtor Terry Flahiff yesterday.With the average price of a detached home in Greater Vancouver nearing $921,000 last month, Flahiff’s listing could be considered a bargain…”

It’s interesting that the news headlines have just recently finished with Bernie Madoff’s collapsed ponzi scheme and have now turned their focus to the questionable products manufactured by Goldman Sachs.  Naturally, the media are chomping at this and the clamor for more regulation is now building.  Surely people must be protected they will say.  In reality, the largest ponzi scheme running, for the longest time and with the most institutionalized support is the real estate market.  While Madoff’s and Goldman’s activities  affect a directed segment of people, the promotion of real estate is directed at the mass of the population.  Everyone is programmed to believe that real estate is the surest way to riches.  That’s a difficult premise to refute given the past 40 years of experience. 

But as the people in Nevada and Florida, once the poster states for real estate speculation found out, when the music stops via interest rate upticks, the damage is devastating.  Ponzi schemes work by constantly finding new buyers to support the earlier buyers.  Eventually, you run out of those.

link Londons Latest Property Bubble – WSJ.com.

Interesting article by Brett Arends.   Interesting because of the eerie similarities to real estate in Vancouver over in this part of the world.  In classic economic theory, there is the concept of economic utility.  With regard to housing, it made sense for people to pay a mortgage if that was cheaper or more beneficial than renting a property of the same type.  Conversely, as long as rents were cheaper than paying a mortgage, it made more sense to rent than  buy.  The other important consideration is the ability of people to sustain mortgage payments for their levels of income.

While not an expert on London real estate and by no means an expert on Vancouver real estate, the main fundamentals that would support and maintain real estate prices in both cities appear questionable.  While the author of the article correctly points out that London has reaped the benefit of monies flowing from other murkier and more dangerous parts of the world, so has Vancouver.  It may not be relevant to consider only the income of the locals as a gauge of affordability.

Vancouver’s external demand comes from a number of high profile communities, most notably Asian residents and investors.  Compared to the bustling Asian cities of Hong Kong and Shanghai, the value received for what one pays in Vancouver is still a bargain.  Another constituency, not talked about and a poorly kept secret, is the bustling drug and narcotics trade in Vancouver.  Investment in real estate is a superb way to shelter ill gotten loot.  As an aside, only in Vancouver will you find, in the middle of any working day, multitudes of young, able bodied people just sitting around at cafes seemingly doing nothing.  Hmm.

Those in the real estate business express the same arguments about why prices are as buoyant as they are and why they are destined to go much higher.  They cite low interest rates, immigration from other parts of the country and of course the old chestnut, they ain’t making any more of it.  From my vantage point as a long time participant in capital markets, the only reason prices go higher is short supply and strong demand.  I won’t quibble about where those dynamics are, but an observation if I may.  One of the main reasons that people have been buying real estate is for fear of missing the next upmove in prices.  In other words, shelter is not the primary reason people are buying homes here.  The real reason is the fear of being left behind when prices move.   In Vancouver at least,  the word is WHEN not if.  

Young people and families are brainwashed with the idea that they must enter the housing market with whatever stretched resources are available to them rather than renting to save up a legitimate down payment.  Again, they are buying because they are chasing prices much like participants in the stock market.  Higher prices reinforces the idea that direction can only go one way and recent history has supported that notion.  

 We now have the phenomenom of 600 sq ft condos, billed as starter homes, selling at over $500,000 in the downtown core.  As if starters live in 600 sq ft. of space  paying a half million dollar mortgage.  As the author in the article points out, the overall cost of living also increases in the city as the cost of everything from cab fares to restaurants escalate in lockstep with the rising pool of ‘wealth’.   At some point, and I certainly don’t know when, the divergence of income and outgo stretch too far and demand falls away.  This can occur naturally, in which case, prices ebb and flow.  The scarier scenario is when an event triggers the closing of the income/outgo gap, perhaps a sudden uptick in the cost of borrowing.  Perhaps an economic road bump in Asia.  Perhaps a bad pot harvest.