What makes Vancouver Real Estate expensive?
I have posted on Divestor an article of “What makes Vancouver Real Estate so expensive?“. I’m sure there are some holes in my analysis, but it was interesting to write it up and go through some variables of my mental modeling of the real estate market.
One of the reasons why it is so expensive is that people don’t translate dollars into yearly income – if you gave me a stack of money today, I could translate every dollar into an income stream of 10 cents a year with a reasonable amount of risk. So when looking at your typical Greater Vancouver detached home of $749,808, one is actually giving up a future income stream of $74,981/year to purchase that home. Assuming you don’t make any other money, that would be $58,500 after taxes in 2010. If one were to rent a place for half that amount (about $2,400) and continue investing the rest of it at 10%, there is a high degree of probability that you would be up even after factoring in missed capital gains on a home purchase.
Another more concrete question is: what is the typical person thinking when they purchase RE in Vancouver at what seem like very high prices (how do they justify their purchase)?
I know various people in my age cohort and socio-economic class buying (young professionals), and this seems to typify their mind-set:
- chance real estate will keep rising significant amount is high, chance it will depreciate is low (based largely on historical model as you note in the post, but also belief Vancouver is incredibly desirable and will keep getting more so)
- they don’t think they would be able to get a loan anywhere near as large, and then get comparable returns, for some other sort of asset.
(10% return on $500,000 = $50,000, > what most Vancouverites make in a year. Peter Schiff quipped about the U.S. housing bubble that Americans used to work so they could buy a house, but during the bubble the mindset was if one could just buy a house then one wouldn’t have to work. Significantly constantly rising house prices acts as a kind of opiate for the house-owning class – everyone in Vancouver feels good because they’re doubling their income, so they believe, just by owning a house!)
- combined with ‘nesting’ instinct – they want to have a family, and so want to own their own place
I, on the other hand, see buying RE as leveraging a massive amount of $ which therefore means large possible downside. Since I don’t understand it, I can’t consider it an investment where I understand the risks or possible gains involved. A historical chart does not really move me.
One other point is that if you were given $750,000 and was asked to generate income from it, would real estate be the first choice of most people?
You could make an argument that taxes has a role in it – if you bought a place for yourself that you otherwise could have rented for $2,000/mo, you are getting a 3.2% after-tax return; if you put it in another house and rent it out for a net profit of $2,000/mo, you are getting a 3.2% pre-tax return… I doubt people think this way.
It’s interesting how people are allowed to leverage 20:1 (5% down-payment) on real estate, while that amount of leverage in most other business ventures would be highly frowned upon.
“I doubt people think this way.”
Primarily, I think RE purchases are emotional. This is especially the case when you have couples purchasing. It’s mostly a herd-based, or nesting-based, or both, psychological instinct. Rarely do people put in the due-diligence that leveraging $750,000 (or whatever) would seem to suggest is warranted.
“while that amount of leverage in most other business ventures would be highly frowned upon”
Good point.
What about “mass reaction”? They are buying today, so they know something that I don’t….I better jump in too. Who cares if I can’t afford it, my wage should go up in the future to make up for increased interest rate.
- humm…you are assuming that people can achieve a 10% annual return on $750k. Not all of us can do that in investement. So to a lot of people, if they can get 5% a year on real estate, that beats 3% savings or the fluctutations in stocks.
- it is the ‘herd’ effect. more and more of my friends have bought places and I can feel like a loser if I haven’t.
- Yes, RE in Vancouver affordability is out of wack with income, but I just don’t see people stop immigratiing to Vancouver, not just from overseas, also from other parts of Canada.