I often get asked about why real estate prices are so high in Victoria relative to an average middle class income. This is a very difficult question to answer in one conversation. However, if we look at neighborhoods in Victoria that have high density demographics (ppl living closes together) we start to discover some key reasons in my opinion. In future blogs, I will look at many reasons for this market effect; rent per sft, population growth, demographic bulge, construction costs etc... However, for this short post, PART ONE, I have tried to key into what are likely the main reasons for the current lack of real estate supply in the Victoria downtown core market.
Building UP (Condos, Apartments) required more construction financing than building OUT (sprawl, single family home subdivisions, townhouses). A developer of a low density project can roll the construction financing from home to home. Basically, you can build a home, sell it and then start the next one. For a condo building you cannot sell the home until the entire structure is completed. This limits your ability to stage out developments and increases your construction financing requirements and risks. Therefore, the return on investment (ROI) will need to be higher or the capital will flee to safer investment opportunities.
The market structure for multi-family residential downtown concrete development I would define as an Oligopoly. (CFA Institute 2012, 160, 180) The barriers to entry are high and the up-front costs alongside political risks & bureaucratic processes make this segment of the market out of economic reach for most developers. There are few sellers and the main companies in the market are currently Cox Developments, Concert Properties, Chard Developments, Alpha Developments and Bosa. The market area would be the downtown area of Victoria, Oak Bay, James Bay and Vic West. An Oligopoly market structure may lead to pricing strategies such as the “Cournot assumption” where “each firm determines its profit-maximizing production level by assuming that the other firms’ output will not change”. (CFA Institute 2012, 181-182) This makes intuitive sense given the time required to build new product and the supply/demand dynamics. What occurs in the market is basically a development holding steady on it’s prices whenever financially possible as the end user will absorb any extra costs that are placed onto the supply curve. So for example if the Step Code increases the cost of a condo unit by 30,000 CAD, a developer will wait to sell that product at the increase in price versus taking a loss.
Over the past five years, there has been a notable increase in real estate demand (a shifting to the right of the demand curve) and a sustained shrinking of available new supply for the core. We need to improve the efficiency of the permitting process to keep up with future growth and attract smaller firms to compete in the market. Anti-development sentiment and red tape creep have increased risk to developments and make adding new supply difficult if not impossible for most market players. Potential rent controls will also impact our industry and I would encourage Victoria and the BC Government to study the effects of rent control in other high-density communities such as San Francisco or Dublin. (Moranis 2017) (The Economist 2017) (Murphy 2017) But, the main reason for lack of housing supply rental or strata based, is likely due to the combination of a broken city council permitting process and the increased risks that high density developments take on in the form of construction financing exposure.