Turn Out the Lights – The Party is Ending
– Momentum Public Relations –
Willie Nelson wrote the lyrics to the famous song; “turn out the lights, the party’s over. They say that all good things must end. Call it tonight; the party’s over and tomorrow starts the same old thing again.”
Many of us have had the experience of being in bar or nightclub at closing time. Typically, to encourage a quick and orderly exit of patrons, the staff will turn down the music and turn on the lights. With the absence of music and the presence of lights, the environment of the bar or club is much less compelling. Any imperfections are noticeable in the glare of florescent lights. The place and the people look far less attractive. The message is clear; it is time to move on.
An over-heated real estate market is a bit like a bar at closing time. As the lights come up, and the music fades, reality begins to seep into the collective consciousness. Things that seemed shiny and attractive quickly lose their luster. The fundamentals didn’t change at all. Better illumination just makes the facts clear.
In examining the current state of Vancouver real estate, it is hard to avoid drawing a “party’s over parallel”. Sure, when the lights are low, and the music is pounding it is easy to be caught up in the dance. Reality can be suspended for a period of time in a blur of lights and music and libations. Real estate values are equally subject to distortion, however, in the long term, they are not immune from the fundamental principles of business. To suggest otherwise is to ignore the lessons of history.
HOW DID THE MARKET GET TO THIS POINT?
Most of the factors that have contributed to the current real estate bubble in Vancouver have been well documented. Three of the most notable contributors include:
• An influx of offshore investors, most frequently associated with Asian money in search of asset diversification in a lower risk environment
• A “scarcity mentality”; investors rushing to purchase assets due to the profound belief that they will be unable to afford them later due to price escalation
• Inexpensive borrowing costs and low capital requirements
Vancouver’s attractive location, relatively moderate climate and natural beauty compounded by a limited supply of land and housing have caused the convergence of supply and demand over the past ten years to be less than optimal.
WHAT WILL HAPPEN NEXT?
We are already seeing the leading edge of some significant indicators that tell us that the party is over. The lights may not have come on yet, but the music has been turned down. The factors that were responsible for the run up in prices are precisely the same factors that are likely to carry prices in the opposite direction. Here are the new realities that we see emerging in 2016:
• There is a reduction in the number of offshore investors: Much of the new wealth in Asia has been diminished by reversals in the Chinese economy, and many wealthy individuals have considerably less equity and cash. Additionally, with the run up in values in Vancouver, a shrewd investor will be seeking out undervalued assets. When the advertised selling price of a home is more than 15 percent higher than a comparable home on the same street it begs the question; why? Likewise, when real estate values in any city are significantly elevated compared with similar properties in nearby cities investors tend to migrate to opportunities that offer a better value. Vancouver’s real estate market is priced at a premium compared to places like Seattle and San Francisco. Investors who may prefer Canadian assets are waiting to see if the top of the market has been reached, and the inevitable bursting of the bubble will bring pricing back into line.
• The “scarcity mentality” has reached its apex: The conventional wisdom that Vancouver real estate prices would continue to rise without a pause has given way to the expectation that 2016 will be a year of price softness. It isn’t a question of “if” – it is a question of “when” and “how much”. Consequently, buyers are beginning to migrate to the sidelines which will create a market imbalance with sellers outnumbering buyers. Demographics are also playing a role in the equation. An increasing number of baby boomers are looking to monetize the investment in their homes, but there is a shortage of Gen X and millennials who can purchase properties in Greater Vancouver if it means carrying mortgages of over a million dollars.
• Lenders are more cautious: Governments and banks have taken steps to tighten up regulations and the supply of money for higher priced real estate. The capital requirements have been increased for homes over a million dollars, and lending evaluations have become more rigorous to discourage speculation. Most first-line lenders are looking very carefully at affordability. If a prospective purchaser will be spending greater than 35 percent of their disposable income on principal, interest and taxes they can expect a rough ride from lenders. With personal debt levels for Canadian households now close to $1.64 per $1.00 of disposable income, applicants for larger mortgages can expect very close scrutiny of their borrowing ratio.
Vancouver’s real estate bubble is likely to burst in 2016. When the bubble bursts, how big will the mess be? Obviously, nobody knows the answer to that question. However, the attraction of the city, its accessibility and the limited supply of real estate will ensure that a downturn will be temporary. Once the inevitable correction has taken hold, the music will start to play, and the real estate party in Vancouver will begin again.