Economy

Vancouver's bubbly housing

The housing bubble will exact a heavy price both individually and society wide when it finally bursts

by Reed Eurchuk

A classic early bird gets the worm scene: by 5 am on April 23, the first prospective buyers began lining up for a chance to view condos for sale at the new Infinity Towers development in Surrey. About three hours into the sale there were offers made on 300 of the 345 units, totaling about $79 million. By the end of the day only ten units remained unsold.

Vancouver remains in the grips of real estate mania. In mid-May, the BC Real Estate Association issued a news release that stated in the first quarter of 2005, consumers purchased $10.23 billion worth of housing in the province, up 7.2% from the period in 2004, itself a banner year. In 2004, consumers spent $27.8 billion on residential real estate, shattering the previous record (set in 2003) by more than $3.6 billion, or 15%.

The prices for individual units have climbed along with the total volume of trade. The Royal Lepage web site claims a standard two-story house in East Vancouver costs $435,000 as of January 2005, a rise of $159,000, or 58 percent from its January 2001 price. The rise is even more extreme on the west side, where Royal Lepage claims a two story home now costs $900,000 on average, a rise of $425,000 or 89 percent over the four years 2001—2005. And the situation is not unique to Vancouver. Across North America, but especially in key trendy cities, real estate prices have taken off wildly.

No wonder so many see parallels between the current housing market and the hi-tech market just prior to its crash in 2001. In fact, one of the prophets of that crash, Yale economist Robert Shiller, whose book, Irrational Exuberance, was published just before the tech bubble burst, recently stated on Report on Business Television, that "This is the biggest national bubble that the US has seen in over a century." This is "not a sustainable situation," claimed Shiller. Then he directed his attention to Vancouver. The bubble was especially extended in "glamour cities and glamour vacation areas," he warned, and, "Vancouver is the most bubbly city in the world."

The local dailies, which reap hundreds of thousands of dollars annually from housing ads while at the same time shamelessly shilling for the industry, did not run the dire warning. It was not newsworthy. The Globe and Mail did cover it.

The unaffordability of housing comes out clearly when you crunch the numbers. Assuming a 20 percent down payment and a six percent interest rate, that $435,000 eastside house would cost you just under $2,000 per month, including property taxes and insurance. Making the same assumptions, a luxury west side condo would cost $2,920 per month. Remember, these figures relate only to payment on the interest of the loan, plus taxes and insurance; not a penny of these numbers would go to the principal on the loan. Furthermore, these figures will go up dramatically as interest rates rise, as the Bank of Canada recently forewarned us they will. Plug in a 7.5 percent interest rate, and watch the numbers grow exponentially: now the eastside house would cost $2,425 per month, in interest, taxes and insurance alone.

The Economist's survey of global housing prices in wealthy countries (March 2005) found "the costs associated with home ownership have risen so high, and the benefits accruing, in terms of rents and rising property value so slight or precarious, that, in many countries it is now cheaper to rent than to buy.”

The housing market presents us with individual and collective dangers. The dismal prospects of a life measured out in onerous mortgage payments ("only 328 more monthly payments to go!"), puts flesh to Chekhov's observation, “The art of keeping slaves is being progressively refined." But beyond the assumption of a lifetime of work implied when we accept the bit and saddle of outrageous housing prices, ballooning housing costs bode poorly for the economy as a whole.

Especially since 2001, the housing market has provided much of the impetus behind consumer spending. Why? Because more and more, the housing market has been a key motor of the economy as a whole. With the bursting of the tech bubble in 2000, much of that speculative money went to the housing market. Respected University of California economic historian Robert Brenner writes that between 2000 and 2003, “while shares (including mutual funds) earned by households plunged in value from $12.2 trillion to $7.15 trillion," or by 44%, "residential real estate owned by households rose in value from $10.4 trillion to $13.9 trillion." And this rise in wealth in the form of housing has been a primary motor driving the much vaunted "consumer driven" recovery since 2001.

How? While income has stagnated or even fallen (a current Statscan report has median employment income down across the country—2.7% in Vancouver), homeowners across North America have been withdrawing money from their housing equity. With housing values increasing at rapid rates, banks are only too happy to refinance mortgages or provide home equity loans. Homeowners have been refinancing in record numbers but, according to business journalist John Rubino, "instead of refinancing the same-size mortgage, home owners borrowed the maximum against the new, appreciated value of their homes, paid off the old mortgage, and pocketed the difference." More and more cash from refinances went toward renovations or new SUVs or vacations. Brenner writes that in 2001, 2002 and the first half of 2003, mortgage refinancing "hit all-time records . . . at $1.2 trillion, $1.6 trillion and $3 trillion respectively.” While the figures are specific to the US, the phenomena, as anyone who has a radio or TV knows, is not.

At the highest level, the ramifications of a continent-wide real estate bust could impact the whole economy. Gone are the days when your local bank held your mortgage loan to maturity. According to John Rubino now there is a large "secondary market for mortgages, in which banks, after originating loans . . . sell them off to investors.” Through a process called “securitization,” a number of mortgages are bundled together and sold in a market to huge investors. These securities can then be traded like any bond. ''Because the market . . . is global," writes Rubino, "Wall Street's bond traders, and banks, and other mortgage originators have discovered they can write and package pretty much unlimited quantities of mortgages and sell them off at a nice profit." This "creates a kind of financial perpetual motion machine." And as at your local casino, “round and round she goes where she stops nobody knows.”

In Canada, insurance companies, trust companies, loan companies, caisse populaire and Chartered banks are able to issue National Housing Act Mortgage Back Securities (NHA MBS). An article in Realty Times in February 2003 stated that in the first nine months of 2002, more than $16.4 billion in NHA MBS was issued—more than three times the amount issued during the comparable period of 2001. The Canadian market parallels the phenomena in the US.

At the same time, employment in construction has emerged as a key growth area in the labour market. Looking at the forest of construction cranes rising above the downtown area, it seems at times that construction is Vancouver's main industry. Business in Vancouver magazine recently provided a list of the “Fifty biggest construction projects" in BC. Of the top ten, seven are in Vancouver or its immediate vicinity, for a total worth of $7.65 billion. Of these seven projects, five are primarily residential projects (the other two are tourism related, which says a lot about Vancouver's economy).

With these three key areas of the economy —consumer spending, the construction industry and a speculative, casino like financial market—even a slow downturn in the housing market will reverberate across the economy. Vancouver stands to be hit especially hard.