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.
SUPERUS nails the need for using user personas.
The company SUPERUS can teach us the importance of using USER PERSONAS in real estate development and other areas of business and investing. If you are buying or selling a home, always ask yourself (in my opinion) who would buy this house in the future and why.
What do 1bed condos in Victoria downtown rent for? What will they potentially be worth in 10 years? How much do buyers need to put down as a deposit in order to make a positive monthly yield? Some of my thoughts and guesses in the video that I hope are useful. Pls reach out if you have any questions in the comments section.
1 bed condos as of July 31, 2020
A quick video that might help real estate buyers, sellers, developers use stats to improve their decision making in the market.
I believe that it is important to try and find as much context as possible around the market at this time. Below are several ‘buckets’ of information that I try to focus on. (Only meant as a rough guide and I hope it is useful)
Pop Growth & Demographic Projections
Age demographics of current population
Historical pop growth
What User Profiles would be useful in making assumptions for future buyer behaviour for specific projects? User profiles are valuable when they provide information about your user population that can be used to design better product.
Employment Projections & Incomes of Buyer Group
What types of jobs are we losing during Covid Crisis and what percentage of these employees would buy or rent?
How fast can these employees return to work when circumstances permit?
How many jobs will be available again for ppl in the next 5-24 months?
15 year Statistical Research on Sales and Market Absorption Rate Assumptions.
This is fairly relevant and I would suggest including the nasty numbers from the Credit Crunch as it might give us a better guess on where the market might be in a few years.
My assumption is they will continue to rise in the long term given the vast shortage of skilled labour.
Construction Materials overseas could be problematic in short term?
Effects of the Step Code and changes to earthquake code etc….this will increase costs to build.
Supply Curve & Demand Curve of Victoria Core Real Estate Market
“But neither supply nor demand by itself can explain prices, which are determined by the combined effects of the two” Thomas Sowell. Economic Facts and Fallacies page 31.
What projects will finish, what projects will stall and what projects will move forward?
Credit: Civilization is built upon the back of leverage and trust.
If Lenders stop giving the majority of ppl new mortgages than we will see pull back in market action to a large degree. The questions we need to ask of Lenders is what type of borrowers will still be able to access credit for a home given the current labor disruptions?
Stress Test, in my opinion it should be repealed for a period of time. However, if Stress Test remains as is, along with prime rate staying static then unlikely we will see an increase in borrowing. “We have historically low rates which will likely continue for the foreseeable future. OSFI introduced the mortgage stress test to protect homebuyers from rising rates. There is no reason now for the mortgage stress test except as a public relations tool for the govt to show they are allegedly doing something about rising prices. Except in this new COVID-19 environment, the test will harm demand & the economy. But the federal & provincial govts would rather not intercede in the domain of municipalities that have control over supply - so we have the stress test & speculation tax, school tax, etc. Housing is politics.” Casey Edge.
“The ultimate problem for monetary authorities as they try to manipulate the supply of money in order to influence the real economy is that they cannot control the amount of money that households and corporations put into banks on deposit, nor can they easily control the willingness of banks to create money by expanding credit.” Page 394 2.5.3 CFA Programs Level 1 Economics.
In high density areas with a high rent per sft I would predict a solid median price of real estate. I don’t expect as much price movement around the median price point. Especially around Toronto, Vancouver and Victoria core areas.
Average Price will flux more given that it will include more outlier properties.
Luxury markets that are priced well above what their rental yield can support would likely be impacted more especially against the contextual backdrop of Luxury Tax, Spec Tax etc. Market was already hurting this relatively small % of the market.
“Rent, considered as the price paid for the use of land, is naturally the highest which the tenant can afford to pay in the actual circumstances of the land” Adam Smith, Chapter XI Of The Rent Of Land, page 166. WEALTH OF NATIONS
How will the Victoria market adapt to renters unable to pay in the short term and how would this impact the market?
How the local, provincial and fed levels of govt work together immediately and long term will affect things more than most ppl realize
The number one detriment to housing supply using comes from a complex and lengthy permitting process. Victoria, combining High Density financing challenges against a very anti- development city council will struggle even more unless the provincial or fed levels of govt limit the city council damage. In contrast Langford city council and low density combination would likely bounce back faster on creating more supply.
The Stress Test should be repealed. At times you want to limit credit growth but at other times you will want to see ppl re enter the economy as quickly as possible. Incomes will be hurt and artificial barrier on credit is unwise at this time in my opinion.
History and the Emergency Room Bias. We are reading about this global event from the perspective of those most affected by it. “Reading a history book, without putting its events in perspective, offers a similar bias to reading an account of life in New York seen from an emergency room at Bellevue Hospital.” Skin in the Game, page 195 Nassim N. Taleb
Inferior, Normal, Luxury Products via an Economic Lens.
In a recession Inferior Economic Products will often go up in value. So when designing product keep this point in mind. Having a larger % of studio units with no parking might be more of a consideration for some projects.
Each project will have 2 different layers of IP, NP and LP. Go through where your project fits in the broad context of the market. Are you selling IP, NP or LP compared to your competition? Next look at organizing three separate buckets for your own project.
Stock Market Context. What options does Capital have?
What are GICs and Govt Bonds Paying
What are Corp Bonds Paying
Do your 1 bed condos yield more than a 5 year A- AAA Corp Bond?
Inflation impacts on real returns and its potential effect on real estate values.
Rate of Foreclosures
Main Banks look to be fine so far.
Private MICs – how much debt do they have and is that debt secured?
Construction Financing Stalling? Equity Banks pulling out of new deals?
I already know of some projects that will be stalled due to construction financing pools wanting to wait. This is a result of groups of investors who make up the pool of capital wanting to redirect their funds elsewhere to a better risk/reward ratio.
High density project will likely be most vulnerable as they will have larger construction loans per project usually at any given time. Whereas low-density or sprawling type developments will be able roll their financing needs using a staged out development timeline.