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That Hissing Sound – Vancouver Edition
Back in 2005, as the US housing bubble started to pop, Paul Krugman wrote That Hissing Sound.
This is the way the bubble ends: not with a pop, but with a hiss.
Housing prices move much more slowly than stock prices. There are no Black Mondays, when prices fall 23 percent in a day. In fact, prices often keep rising for a while even after a housing boom goes bust.
So the news that the U.S. housing bubble is over won’t come in the form of plunging prices; it will come in the form of falling sales and rising inventory, as sellers try to get prices that buyers are no longer willing to pay. And the process may already have started.
It appears as though the process has now started in Vancouver. From the latest monthly report from the Real Estate Board of Greater Vancouver:
- Residential property sales were 2,853 in May – a 15.5% decline compared to May 2011.
- May sales were the lowest since 2001 and 21.1% below the 10-year May sales average.
- New listings totalled 6,927 in May 2012 – a 16.8% increase compared to May 2011.
- Last month’s new listing total was 15.3% above the 10-year average for listings in May.
- At 17,835, the total number of homes listed for sale increased 21% from this time last year.
Sales have stalled and inventory is rising. To make things worse, yesterday the Canadian government made major changes to mortgage rules.
- Mortgage amortizations were reduced from 30 years to 25.
- Refinancing limit reduced from 85% of home’s value to 80%.
- Gross Debt Service ratio reduced from 44% to 39%.
- Government insured mortgages now limited to homes purchased for under $1,000,000.
- Minimum down payment of 20% for homes priced above $1,000,000.
- Cash-back and stated-income (liar) loans eliminated.
- HELOC maximum reduced from 80% to 65%.
Also, consider that these mortgage rule changes are coming at a time of record low affordability. From RBC’s latest Housing Trends and Affordability report:
Any time the government tightens mortgage rules, it can have a negative effect on home prices. Coming at the same time as the market appears to be turning and with affordability at record lows, it will probably speed up the decline and could turn that hiss into a pop.
Vancouver Housing Valuations
Writing about the San Diego housing market, Rich Toscano at Piggington’s Econo-Almanac has a great explanation of the historical relationships between house prices, incomes and rents.
Longtime readers know that I consider the price ratios to be absolutely fundamental to determining whether housing is fairly valued. It makes intuitive sense that home prices would tend to track incomes and rents: incomes, because they determine how much money people have available to pay for housing; and rents, because rent prices reflect how much San Diegans are willing and able to pay to put roofs over their heads when there is no speculative or investment element involved. The historical record bears out this intuitive logic, as San Diego’s home price-to-income and price-to-rent ratios have tended to be strongly mean-reverting over time.
He includes the following two graphs showing how San Diego’s ratios are now back to normal levels after the bursting of the housing bubble.
Here are the ratios for Vancouver:
The San Diego ratios were calculated with slightly different data, so the absolute numbers aren’t the same as Vancouver’s. However, today’s deviation from historical averages in Vancouver are comparable with the situation in San Diego in 2005.
So what is the likely future for home prices in Vancouver? Unless Vancouver is different, historical price-to-rent and price-to-income ratios will return at some point. Absent a significant jump in incomes and rents, the only way these ratios can get back to normal levels is with a very significant drop in prices. If this was to occur over the next couple of years, it would take a 40-50% fall. Like this:
North American Economics 