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episode # 113

Has the Vancouver Real Estate Market Cycle Run its Course? With Teo Nicolais

Everyone knows that markets are cyclical, but how do they work and where are we at in Vancouver? Harvard Extension School Instructor Teo Nicolais sits down with Matt & Adam to detail the 4 stages of a real estate cycle and how it relates to the Vancouver real estate market. This episode is a must for those interested in real estate!

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Episode Summary


About Teo:

Teo teaches real estate, finance and investments at Harvard Extension School, within an online program with open enrolment. They get a lot of students wanting to learn about real estate and there is even a real estate investment certificate. Many are investors and entrepreneurs from around the world. Teo also invests on his own in apartments and fix and flips. He has been doing this since 2004, and so has seen one real estate cycle.

On what fundamentally drives home prices:

This is surprisingly misunderstood around the world. We have to go way back to the economist David Ricardo from 1817, who introduced Ricardo’s Law of Rent. After the Napoleonic war, the price of corn skyrocketed around Europe and England, as did land rent. So, people determined the price of corn went up because so much rent was being paid. The common saying goes, “We have to raise prices because rents are going up”. Ricardo realized it actually works in the opposite way: rents go up because the price of goods goes up. Users of land realize some benefit from using that land (for example, a store owner picks their location because they expect to make a profit, or someone lives in a city because they enjoy that city). Edward Glaeser, author of Triumph of the City, noted lower real income is a sign of a thriving city, not one that’s in trouble. Look at Vancouver home prices being an average $1.7 million, which is four times greater than that in Yellowknife; why are people paying this? They are not irrational-there is a compelling reason to live in Vancouver: it has one of the lowest unemployment rates in Canada, along with great outdoor recreation and a lifestyle that people are willing to pay for. The more desirable the area, the more prices go up, but nobody would be paying this if they didn’t want to be here.

On the distortion in this market due to Vancouver’s out of whack price-to-income ratios:

People pay a price in exchange for something. You’re not just buying the items in your home; you’re also buying access to the locale and its amenities. It’s a package deal and there is consequential value to that. You get a lot more by paying more of your income, because you can enjoy what’s around it more than you would in other locations (for instance, Yellowknife).

On his piece, How to Use Real Estate Trends to Predict the Next Housing Bubble, and the cycle in which real estate markets inescapably move:

Real estate moves through a predictable four-stage, approximate 18-year cycle that’s determined by occupancy. Rent prices are by-products of something else-they are the effect, not the cause. Occupancy drives the cycle and prices and it, along with vacancy rates, will tell you more about real estate than any other statistic. The cycle is as follows:

1. Phase 1: recovery. Coming out of a recession. High unemployment, vacant storefronts and apartments. Low economic activity. Land is essential to this. Governments step in to stimulate growth. Occupancy increases. Still downward pressure on rent – many available units. This changes at the transition between Phase 1 and 2.

2. Phase 2: expansion. More economic activity, occupancy is increasing. Now there is scarcity: fewer units available so property is being bid on and prices are increasing. If prices go up there is new supply, but in real estate there is a lag time between when units are sold and when they’re actually supplied. It takes a long time to build and can be four to six years from when the developer starts the process to completion. Competition for space pushes prices up further and encourages developers to begin new projects, again. People panic because there is no available inventory. At the end of this phase, units are being delivered and people can occupy. The number of new units coming online starts to match the demand, which brings on Phase 3.

3. Phase 3: hyper-supply. Still very high occupancy, upward pressure on prices, many people who can’t find space. But the units from Phase 2 are being delivered, and occupancy is being pushed down. When current occupancy is above long-run average occupancy, there will still be upward pressure on rent. It’s a weird phase-rents go up but occupancy goes down. At the end, the recession comes.

4. Phase 4: recession. Occupancy decreases due to supply, but here current occupancy falls below long-run average. The need for those units that were pushed out after many years isn’t the same anymore because prices aren’t as high. This doesn’t stop the machine though and is the real nightmare, as there’s little room for developers to change their plan even though the market they were building for no longer exists.

On if there are exceptions to this cycle, for instance in landlocked cities:

Typically, no, but there are disruptions to the cycle. The cycle and the lag from inventory need to delivery is repeated in almost every major city. Government policy which restricts supply can also extend the cycle. Overall, the cycle still stays the same.

On what to look for and how to monitor occupancy in terms of rents and sales:
Higher occupancy=higher rent. If you’re an investor in apartments, you are looking for the vacancy rate and which way it’s moving. If it’s going down, this likely means Phase 2. The single-family home equivalent is full inventory (how many homes for sale), days on market (how long is a home for sale before contract), and a month’s inventory (if no more homes went on the market, how long the current inventory would last at the current absorption rate).

On the best time for investors to buy:

Timing the market is extraordinarily difficult, but in general you want to enter that second phase after the recession, when there is higher than average occupancy and price appreciation. There is never a bad time to be in the market, but the one mistake you can’t undo is over-paying.

On if the cycles are national or city-specific, and strategy for Vancouver investors looking at other markets:

Cycles do match up more and more across the US, Canada, and Europe. Different government policies affect this, but they’re similar. Within any given country, there is still a wide spread of where cities are within the cycle (some may be well into Phase 3, while some are just emerging from the first phase). Product types differ within the cycle: apartments may be in hyper-supply but single-family construction lags behind for two to four years, and retail lags further behind. If you can move from product type to product type, you can move to different parts of the cycle.

On analytical measures used to predict bubbles in different markets:

Two things must occur for there to be a bubble: rapid increase in prices, and prices not being supported on a fundamental level (i.e. price increase, not value increase). In Vancouver, there is a well-supported market (by the low unemployment rate and employment growth, which was 3.4% in 2017). As long as this exists, you’ll likely see more migration and there is less concern about bubbles. When there is a price increase that isn’t well supported (i.e. not many people moving in, less employment growth), it’s not sustainable. The curveball in Vancouver is how much of the price increase comes from foreign investment which can leave quickly, vs. jobs which won’t likely leave quickly.

On why so many people have Vancouver wrong in terms of where we are in the cycle:

It’s not surprising that economists get it wrong; the market proves them wrong a lot. They’re not wrong about the cycle, but maybe about where we are and how long we’ll be there; there are curveballs. The increase and decrease in occupancy and driver of rent growth is largely due to new supply-which can get offset by unexpected demand changes and government policy that restricts supply.

On if the 18-year timeline is typical and if there’s much deviation:

The first cycle is to learn the cycle; the second cycle is to make money, as you know what to expect and to not overly despair in the low times and be cautious in the good times.

On the metrics used to determine severity of a downturn:

Employment and supply. Too much supply leads to a much deeper downturn because it’s not delivered until much later in the recession cycle. Employment is overplayed-you can get a wonderful three-bedroom home in Yellowknife for $450,000, but you don’t get everything else that Vancouver offers. The most important square footage is outside of your home.

On opportunities in the US and how the market is doing:

Large cities are like Vancouver. They are well into the expansion or hyper-supply phase. The 2008 financial crisis recovery has been quick, and there is now a shortage of labour and materials to build new homes and businesses. They are optimistic about the current market and cautious about what will happen in 18 months to two years out.

On the market Teo is most excited about:

Denver is exciting. Teo grew up there. Colorado is one of the most highly-educated markets. Many millennials are moving for the lifestyle, like Vancouver. San Francisco, Seattle, Portland. They prefer the present and are looking for an enjoyable lifestyle. Teo looks for cities millennials are flocking to and will likely stay in, even if they lose their jobs.

On some of the biggest mistakes Teo has made:

Keeping his eye on the real estate cycle is key. There is a time to get in and stay in-you must watch for this. There was a lot of hesitancy coming out of the recession. Keep an eye on cash flow. You can survive the bad times as long as your property is cash-flowing.

To find out more about Teo:
Visit Teo Nicolais

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