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Is The Vancouver Real Estate Bubble Ready To Pop?

 9 min read / 

Those who have lived in Vancouver have probably heard about the housing situation in the city. One is amazed by the beauty of the Vancouver skyline and impressed by the amount of new construction sites around the downtown area and the surrounding neighbourhoods.

An Entrepreneurial Finance student was quoted as saying: “They build something new every year. They tear down some <old> building and rebuild it shinier but as functional as the old one.” The problem was not confined to UBC renovation programs but represented a habit and problem for all of Vancouver and its suburbs.

The Growing Bubble

Downtown, in the financial and commercial centre of the city, lie the most expensive areas in residential housing, due to a craze that arose in the last two-three decades. Due to the uprising prices of residential properties in the area, mostly shiny skyscrapers and luxurious mansions, many have decided to sell their own properties and buy larger ones in the – at the time – less glamorous suburb near the airport.

Now, the buyers are considering moving away from Richmond for the very same reason: increased costs of living, an upsurge in housing prices and the desire to cash-out from what could be, in the near future, the next residential housing bubble.

This reasoning is as logical as it can possibly be. Dr Kershaw, of the UBC School of Population & Public Health, and Mrs Minh, a researcher at Generation Squeeze, give their explanations on the alarming “Code Red” study concerning the looming and pressing issue of Canadian housing, with particular reference to Vancouver.

They estimated, for instance, that with CAD500,000 one could roughly afford to buy two homes in 1976, as compared to two bedrooms today, for the same amount of money. What might seem an author’s exaggeration in the eye of a naïve reader is the sad truth for young buyers (and a true fortune for older homeowners).

Salaries Vs House Prices

While housing prices have doubled in a few decades, the same cannot be stated for full-time wages, with the consequence of a shrinking purchasing power for young residents willing to settle down and take out a mortgage. Considering that in 1976 one would need five years to save for a 20% down payment on their first home purchase, it is now estimated that one would need 12 years of savings for the same amount in Canada, compared to Toronto at 15 years and Vancouver at 23 years.

Of all homes in the city of Vancouver, the authors estimate that only 3% are priced less than CAD250,000, while about 30% cost less than CAD500,000, double the cost of the average home in the mid-70s. Surprisingly, the single largest share of properties is priced above CAD813,000, namely luxury properties – outrageous considering the aforementioned diverging pattern of labour income and real estate face values.

The Domino Effect

The vast phenomenon of uncontrolled price increases does not only affect buyers purchasing their new home, but it has inherent effects on service providers within the area (hairdressers, groceries stores, wine bars, etc.) who must absorb higher leasing or renting property costs and subsequently need to raise their prices.

This effect is dangerously self-reproducing. Unfortunately, the situation does not look any better moving far away from the city centre to Metro Vancouver (Burnaby, Surrey, Coquitlam, etc.). Only 15% of the houses can be bought for less than CAD500,000 and have more than three rooms, putting young families through the wringer when dealing with the choice of where to settle down. There is only one town that allows for these two criteria to account for more than 50% of the houses: Maple Ridge, 45km (38 miles) outside of Vancouver.

Affordability pressures put at stake the wellbeing of lower-income classes and result in tangible socioeconomic distress. If one considers a worker was commuting from Richmond to Vancouver, one also needs to take into account the opportunity cost that he or she faces every day, along with fixed costs of transportation, that most probably are not covered by the employer. One can assume a typical worker earns an hourly wage of CAD15, and it takes one hour to reach the workplace. Considering two hours of transportation per day, five days a week, one month of holidays, one reaches a total amount of almost CAD7000 opportunity cost per year. When one does the maths for the maturity of a mortgage, and one will get how much it costs to decide to live in the suburbs rather than in the city. Even if one is forced to.

A Call For Help

The situation has been worsening at a high pace during the last few months, with Vancouver residents calling out the British Columbia and Federal Government for actions. Their requests seem to have finally found a place on the agenda of regulators and policymakers, who have recently released a set of actions that aim to mitigate the climbing prices.

Prices have been soaring until this summer. Have we reached the plateau?
Prices have been soaring until this summer. Have we reached the plateau?

Despite the fact that prices seem to have endured some cooling effect after the introduction of recent regulations, the scarce availability of properties on sale at the moment is still keeping the price high. How long, though? One cannot know if this equilibrium is sustainable and the house of cards might just fall at the first uncertainty.
Worst case scenario, homeowners will lose a consistent amount of their recently acquired property value and possibly default on their mortgages. The risk is all but unrealistic, given that Bank of Canada estimated that the share of borrowers with an LTI (loan-to-income) above 450% had increased considerably year-over-year.

The Eastern Factor

It is common knowledge that the majority of real estate investors are Chinese, who became the main promoters of investments in the city with relevant inflows of money from mainland China. Given the important economic and social role that the whole Asian community plays in Vancouver (the local China Town is the second largest in North America after San Francisco’s, for instance), it is no such wonder that there are tight business relationships between Canada and China. These relationships are of crucial importance not only for Vancouver but for Canada as a whole, they will get stronger in the future as negotiations with the EU regarding CETA come to a halt.

A thorough report by Macleans, however, suggests that in the past five years, the flow of money coming from Chinese investors has consistently increased, reaching toxic levels and risking the destruction the internal market for residential properties. Although this might not be the only explanation for the phenomena, it is a fact that existing tax loopholes and former immigration laws have permitted and fostered investments from outside Canada during the last decades, thus inflating prices to above-normal levels and ultimately frustrating middle-class residents, who are being priced out of the market.

Growing Foreign Interest

The formerly existing Immigrant Investor Program, which was created in 1986 and suspended in 2012, granted residency to foreign citizens willing to invest CAD800,000 in the country, a considerably low amount for wealthy foreigners willing to park money offshore at a low price. Interestingly, a similar program is still running in Québec with a higher threshold, meaning that after complying with the holding period and time of investments regulations, foreigners would still be able to obtain Canadian citizenship and continue to invest in other provinces as well.

Very few investors, in fact, seem to remain in the Eastern province, but prefer to move to closer-metropolis Toronto or settle down in Vancouver, given the proximity to the home country and stronger cultural resemblance. The common habit of buying and selling real estate after a quick appreciation has been reinforced by the downward trend the Canadian dollar has been lately experiencing against the Chinese currency, allowing foreign investors to offer ridiculously high prices for existing properties and invest high amounts of money for new construction sites.

CAD$ is trending down against YUAN, considering that the latter is fixed to the higher performing American $.
CAD$ is trending down against YUAN, considering that the latter is fixed to the higher performing American $.

The well-known habit of leaving entire buildings and properties empty for long periods throughout the year has worsened the situation also for home renters. Empty and under-utilised housing could represent a key source of supply and, as it is suggested in a Vancouver City Council report, it could help improve the dramatic low rental vacancy rate for the city (0,6% in 2015, with healthy rates ranging between 3 and 5%). The report’s findings suggest that around 5% of housing units in Vancouver were unoccupied for more than a year in 2014. As economic pressure on low-income earners intensifies, the introduction of a tax on unoccupied properties is under discussion, with the aim of stimulating the turnover of housing.

Vacancy Rate for Rental Properties in Vancouver
Vacancy Rate for Rental Properties in Vancouver

It is true, nonetheless, that the Vancouver (and Canadian) economy has largely benefitted from an increased demand in the housing-related sectors, from realtors and construction companies to interior designers, accounting for the largest share of the city’ and provincial GDP. From this point of view, the problem is now not what the influx of capital from mainland Chine has caused in the previous decades to reach this trembling equilibrium, but what will happen now that the Provincial and Federal government have suddenly decided to open their eyes. They are now reacting impulsively with a new tax designed precisely to discourage foreign home-owners.

How To Deflate The Bubble

The introduction of an additional 15% tax on property transfers on foreign entities (“foreign nationals, corporations, taxable trustees and transferees that are not Canadian citizens or permanent residents”, as the Property Transfer Tax Act defines), based on the fair market value of the asset, resulted in an upsurge of deal closings before the starting date of the measure. It is unclear yet how realtors will act in the next months.

Despite the fact that long-term results need to be seen, initial forecasts and data suggest that initial cracks in the system are beginning to emerge. Considering the historical solidity of the Canadian banking system, it will be crucial to carefully design the next steps to deflate the bubble. This should avoid worse consequences that could be brought either by an unexpected slowdown in Chinese economy (and fewer investments from wealthy foreigners) or in a diminished British Columbia attractiveness for outside investors.

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