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episode # 180

How to time THIS Vancouver Market with Harvard’s Teo Nicolais

Everyone has an opinion on the Vancouver Real Estate Market, but how do you sift through the diverse and far-ranging, often biased voices? Well, you go to an outside credible source at a recognizable institution, like, say, Harvard – you ‘eard of it? This week we welcome back Harvard Instructor and Founder of Nicolais LLC, Teo Nicolais, who joins Adam and Matt to give an outsider’s opinion on where our market has been, where we are currently, and, most importantly, where we are headed. A true student of real estate market cycles, Teo draws on both theory and his wealth of real estate investing experience to shed much light on a topic so often clouded by the loudest & most shocking voices.  So pahk the cah in Hahvahd Yahd & listen up ya townie!

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Episode Summary


About Teo:

Teo is a Harvard Extension School instructor and President of Nicolais, LLC. He specializes in real estate

investments. Teo believes real estate is a topic that affects everyone in the world. Because it’s one of the most entrepreneurial ventures, a lot of people are interested in it. Whether you’re investing in real estate or just living in a city, it’s important to understand how the market forces of real estate affect your life. This is what he teaches at Harvard Extension School.

On how Teo got into real estate:

Teo does what he teaches, and he teaches what he does. Everyone that’s a part of real estate should be continually investing in their education in terms of researching and understanding the market. He got into real estate by working for a large, multi-family investment company in Northern Illinois, near Chicago. Teo moved to Denver after the recession and started his company there. It’s given him the opportunity to test a lot of what is taught in academia and also bring back into academia what he has learned and been doing on his own.

Teo has been in real estate investing for a long time and has enjoyed the exploration of it. Many people get started the same way he did – with one individual property that snowballed as things moved along. It’s been a wild ride.

On the four phases of a market cycle and what they entail:

Real estate moves through a curious cycle for which we don’t always know the timing of when things will happen. The cycle is best explained through a four-phased breakdown; this is explained well by Glen Mueller, a professor at the University of Denver. He has refined a model of real estate cycles into the four phases (which goes back to the 1870s, in terms of our understanding of it). What’s amazing is the truth of it is still present today, in markets throughout the world, despite it being 150 years old. We can measure where we are in the cycle, which also tells us what is likely to happen next.

Phase 1 Recovery: This is when we’ve gone through a recession, so there is high unemployment, high vacancies, lower home prices, and lower rents. It is the bottom of economic activity. Economic demand for space and for stuff tends to grow organically, even if we’re in a recession – people are still having babies; people are still turning 18; companies begin to grow. This built-in demand slowly but surely brings us out of a recession. The recovery phase is also typically helped through government intervention such as low interest rates and other stimulus. What we measure it by is occupancy rates. Occupancy can be rented units or total inventory available for sale; in the recovery phase, the numbers are below average.

Phase 2 – Expansion: We move into the expansion phase when the delineating line of current occupancy exceeds long-run average occupancy. The significance of this is that we begin to see upward pressure on rents and prices when occupancy is high (or inventory is low). We run out of space because of this scarcity. However, we are not seeing a lot of new demand. The expansion phase will see occupancy, rents and prices go up, and the only thing that will typically change this is the addition of new supply. Towards the end of this phase is when developers respond to this by building more units. That’s when we transition to phase 3.

Phase 3 – Hypersupply: Phase 3 occurs when we see occupancy start to decrease. The increase of available homes and storefronts not being absorbed yet is what causes this. It’s important to note that throughout phases 2 and 3, current occupancy is still above long-run average occupancy. Whenever this scarcity occurs, we still see upward pressure on rents. With above average occupancy and therefore rents in this phase, builders feel it’s great and so they keep building. The problem in real estate is it takes a very long time for new product to come online – it can be three to five years between when a project is started to when it is delivered. This long gestation period is largely responsible for the boom-bust nature of the real estate cycle. In phase 3, we’re already building more units than needed, but the problem is there’s a huge pipeline of units coming online over the next few years – which is typically long beyond when the units are needed. Rents go up because occupancy is above the long-run average, but occupancy goes down to eventually get out of this phase. This would be a great time for developers to slow down, since a recession is coming. However, in all of Teo’s research and interviews with developers, he has not found one who will do so. This leads into the fourth phase.

Phase 4 – Recession: The delineation between hypersupply and recession is when the current occupancy falls below the long-run average. Suddenly, not only do we have enough units coming online but we have so many that there is an abundance of vacant units. Again, this would be a great time to stop building but the units being delivered now were started three to five years ago. So, the reason we see the recession bust and a bad experience for real estate investors is because well after there is no longer a need for more supply, new supply continues to arrive on the market (the properties in progress during phases 2 and 3 are now delivered in phase 4). This pushes prices and occupancy down; developers go bankrupt and stop building. Eventually, this leads to the bottom of the real estate market, with very low occupancy and a recession happening.

It’s only when those additional units stop coming online that we begin the process of recovery. This initiates phase 1, and the process starts all over again. This is something that’s been measured with data for over 200 years and shows the cycle continuously going. It’s typically an 18-year cycle, but that depends on what’s happening in the market.

Vancouver has supply coming online in 2020/2021; there is no recession; the vacancy rate is very low; and rents are softening a bit but are still very high. There are policy measures in place (for instance, the federal mortgage stress test makes it harder to borrow money, provincial and city regulations, and the foreign buyers’ tax).

On what Teo makes of Vancouver’s place in the cycle and the region’s market:

Vancouver is an interesting market that has radically changed. The most recent data we have is from June; when you compare June of this year to June of last year and June of 2016, it tells the story of a turning real estate market and illustrates how the market functions.

June 2016 was about the high of price appreciation in Vancouver with very rapid increases. Data from the Real Estate Board of Greater Vancouver shows around 7,800 active listings. Today, there are about 15,000 active listings – about double the amount of available homes for purchase! One of the most important factors of the real estate cycle is occupancy (inventory or total active listings). The number of sales in June 2016 was about 4,400 – over half of all available active listings sold in that month alone, which is an outstanding figure. As well, these 7,800 available homes represent one home for every 315 people, an excruciating shortage of available housing and, consequently, a 32% increase in average home prices from the previous 12 months.

June 2018 shows something different: about 12,000 active listings. Sales were much lower that month at around 2,400 units, which is only one-fifth or 20% of active listings. We started to see an accumulation of active listings which means more choice for buyers and, not surprisingly, less upward pressure on prices. There is a statistic we look at called the sales-to-active listings ratio, which is the percentage of total inventory sold in any given month. In June 2016, it was 56% (with home prices going up by 32%), and in June 2018 it was 20% (with less upward pressure on prices at 9.5%, still a very healthy level though it shows a very different market).

In June 2019, we were in a completely different market. Active properties went from about 12,000 to 15,000, so this accumulation of supply means buyers have more choice. There were only 2,100 sales last month and out of the 15,000 in total, this means only one-seventh (or 14%) sold. As a result, we’re seeing many more listings than are typical and, this time, at an annual price change of -9.5%––this abundance led to downward pressure on prices.

It’s important to note how radically 2016, 2018 and 2019 were. Many people are abandoning the Vancouver market (Teo believes that’s the cause of the decline). One of the most frequent observations Teo hears is Vancouver experiencing this incredible surge of prices at 32% in 2016 – yet, Vancouver’s economy was not expanding at 32% a year. It was healthy but not robust enough to justify that kind of price increase. In the past couple of months, people have noticed the employment and job situation has not changed, yet we’re seeing a 10% year-to-year decrease in home prices.

How does that explain what’s happening? There are many theories on this, but Teo most strongly believes it’s the impact of foreign ownership on Vancouver’s market. Josh Gordon wrote a great paper about this; it explores whether you can tie foreign ownership to the housing market. He notes that you can tie price appreciation, neighbourhood by neighbourhood, to the impact of foreign ownership. Foreign owners tend to be at the very high-end, buying up expensive mansions and condos, and many people believe this won’t affect them if they’re not buying a $4 million home, just, say, a $500,000-700,000 home.

However, Gordon believes it’s very related, in what he calls “knock-off effects” and “windfall boosts”. Let’s say someone who has owned a home for 10 years or so in West Vancouver which cost them $1 million now sells to foreign buyers for $3-4 million. This Vancouverite now has a lot of extra money and can easily spend, say, $2 million in another part of Vancouver. This shows what happens at the upper end of the market significantly impacts what happens in all parts of the market. The knock-off effects or windfall boosts are at play a lot when you look at the percentage of foreign-owned units being acquired. This has led to very interesting government policies to combat the issue: the speculation and vacancy tax; the foreign buyers’ tax. These measures have been effective in reducing incentive for foreign buyers to come in and buy real estate they’re not really using but, rather, looking to shelter assets with. It has resulted in a decrease in demand for higher-end units. The mid-range, lower end units that benefited from the windfall boosts are no longer getting these boosts, and so we’re seeing an increase in inventory and an overall decrease in pricing.

On where we’re at in the market cycle now:

You should always be cautious if you hear anyone say that “this time is different in the market”––these are the scariest words speculators can say. That being said, we’re not having a supply issue at the moment. The whiplash we have is driven by a unique quirk of demand. There has been a free-fall in pricing, and the question is where this will end. The things to watch for and the statistics are hard to come by in real time. These are things such as the percentage of buyers that are non-foreign. The market ought to stabilize, in theory, when the amount of transactions from foreign buyers is minimal or non-existent. “What goes up must come down” is kind of where we’re at now; Teo believes there will be a lot of academic research over the next couple of years into how much of the run-up was due to foreign buyers and, therefore, how far we have to go before it’s extinguished.

On what the next market cycle looks like, if all our policies remain in effect:

Real estate markets collapse for two reasons, the main one being oversupply. However, right now Vancouver is experiencing a demand reduction (people around the world are watching this right now, as it’s a highly unusual situation). We look out for occupancy, measured in the rental market as the percentage of units currently occupied and measured in the for-sale market as the number of active listings. Teo would compare these to the long-run average. Generally, whenever current occupancy is greater than long-run average, we tend to see upward pressure on rents or prices, and vice versa. There is an abundance of available housing (15,000 units) and we’re seeing downward pressure on prices.

Another indicator Teo would pay close attention to in Vancouver is house price-to-income ratio. The price of real estate is ultimately driven by people’s willingness and therefore ability to make payments. Currently, the Royal Bank of Canada (RBC) has characterized Vancouver’s affordability as “dreadful”––it takes 82% of household income to afford an average home. How are people affording this? Teo believes it’s the influence of foreign buyers. There is what’s called a “decoupling” between house price-to-income ratio and home prices.

Josh Gordon noted that in Calgary we currently see a house price-to-income ratio of about 4; same with Montreal. Ottawa’s is about 3.5. Vancouver’s ratio is 11 to 12 – that’s 11 to 12 times the median family income. Most market analysts would agree this is an unsustainable level. We typically like to see that fall to at least 6––this would still be a tight market but within the realm of affordability. Over the long term, we need to look at whether prices are adjusting. Investors should think about what would happen if Vancouver were more aligned with a typical market, which is around 3 to 6.

Even with the 20% foreign buyers’ tax, in terms of the potential collapse of Vancouver’s market and considering we operate in Pacific Rim markets like San Francisco and Hong Kong, how much free-fall will it take before people say it doesn’t make sense to reach these new affordability levels, and we see a pile-on from investors or people that want to live within the Pacific Rim?

The Real Estate Board of Greater Vancouver has a great term for what’s happening right now: an “expectation gap”. This happens in markets when they move from a time of high appreciation to a time of price decreases, and many buyers are hanging out on the sidelines. Buyers hold off because they think prices will continue to fall, while sellers hold off because they think prices will rebound. Suddenly, there is a paralysis in the market where people who should have participated have opted not to. Right now, it doesn’t look too good for sellers because so much of the upward pressure was from foreign buyers, but with the effect of these policies that pressure is no longer there. Keep in mind, despite the affordability issue, Vancouver still has many people living and moving there. Millennials are increasingly moving out to the suburbs, but people are still finding Vancouver an attractive place. Yogi Berra’s famous expression applies to this: “No one goes there anymore. It’s too crowded.” Affordability is a challenge for Vancouver, just as it is for places like San Francisco, Seattle, and New York––it’s a global phenomenon right now, but people aren’t exiting Vancouver in droves because of it.

On whether the vacancy rate on the rental side still being very low, while listings still going up drastically on the purchasing side, is normal:

We do see this because there is a lag between what happens in one segment of the housing market and what happens in another segment. The segments are all connected, but there is still a big difference between a $1,500 per month rental apartment and a $4 million single-family home. You need to ask what someone’s next best option is. If they’re renting right now, they’re not feeling much relief, even though single-family homes have gone down by 10% year-over-year. Their composite price is $1.5 million, so the $1,500 per month renter is unlikely to be waiting for that $1.5 million home to reduce by another 10%. However, what will affect these renters are the fewer windfall boosts that occur as expectations are being lowered. Those dollars are now at play in condos and smaller single-family homes and will relieve some pressure. There will likely be a continued disconnect between the rental market and single-family home market, but trends in these markets will eventually merge.

Though it happens rarely that markets move backward in the cycle (a “non-market or atypical shock”), the influence of foreign buyers earlier in this decade and now the effect of unwinding that influence are shocks to the market. Vancouver has a pretty healthy development market, but over the past couple of months we’ve seen some changes. MLA Realty projected there were about 14,000 new condo units planned for 2019. As a result of requirements from banks to have 60% of product presold before construction, and additional future costs such as development fees for public transit of $1,200 per unit, we’re starting to see headwinds to construction of new units. MLA Realty’s estimate is that the 14,000 new units would decrease by about 5,000 units, which is substantial (we won’t know until we see the 2019 numbers). There is a healthy construction market, but as average condo prices decrease it will give pause to developers: they are buying land and calculating costs based on one price, but then seeing another price. To illustrate this, last year around this time a developer would see about $704,000 per unit, whereas now it’s about $650,000. This is a challenge for them. It’s a good thing in terms of not oversupplying and saturating the market, but not great in terms of increasing affordability in the long-term.

On what Teo would look for, in terms of timing the market, if buying in Vancouver:

It’s important to distinguish the difference between timing the market and simply being in the market. You never really know what will happen; therefore, it’s important to make your investment strategy long-term, whatever it is. Teo would not have predicted that in June 2016, we’d see average home prices increase by 32%! But many people made this bet and made a lot of money doing so. People saw prices go up by 9.5% in 2018 and said, “time to buy”, but those people have seen the same decrease in their properties. The bottom line is appreciation is a fickle thing in real estate.

A stronger pillar to rely on is cash-flow. At the end of the day, this is what generates value in real estate. The reason things appreciate is because of temporary imbalances in supply and demand, but cash-flow is consistent. First and foremost, cash -flow can eventually lead to appreciation, and very important to investors is the fact that cash-flow can allow you to survive a down market. Even if you have a phase 4 recession and phase 1 recovery, with high vacancy and depressed values, if you have cash-flow, you can hang onto your property and eventually emerge. The challenge is not having the cash-flow to survive a downturn and ending up having to sell at a discount during a recession. This is where we see bankruptcies. Teo’s general rule of thumb is to buy property at a price that generates cash-flow he can count on, even during a recession.

On buffers and measures to be conservative (for instance, if rents go down as they have):

Many investors go to the opposite end; for instance, they try to sustain a 50% vacancy and 30% decrease in rent. Some will only sign a deal with these types of parameters. However, this almost guarantees they will never buy anything, as very few properties would cash-flow at that point. In Vancouver and many other cities, there is very good data on long-term vacancy rates. Teo would look at the average rate, incorporate that in his cash-flow forecast, and know he’ll likely see a similar trend. You could also look at just how bad the vacancy rate got, use that as the lower end, and prepare for it.

On how Teo factors in different or changing cultures and trends in his decision-making process:

More and more people are choosing rentals, which is also a global phenomenon. The million-dollar question is what millennials are doing, as they’re the biggest generation (for now). In the US, student debt is a huge problem, which makes buying a single-family home or even a condo very difficult. So, there are many millennial renters, by choice or not. Anyone looking to invest in the US should be aware of this. This generation is also delaying marriage and having kids, which makes renting a better choice, in most cases. Instead of paying to raise a family, they can live downtown or closer to a higher-paying job and various amenities in and around their homes.

The trend towards rentals includes the Lower Mainland. Burnaby is looking at implementing a 20% rental requirement in all new buildings, which is reflective of the housing demand and affordable rental housing evolution in the area. When and where this rental demand will change for millennials remains to be seen. The mentality in the 1950s and 1960s was home ownership should be the goal but, as many millennials are now seeing, there are a lot of advantages to renting (such as more mobility to move around).

On the markets Teo is most excited about and the phase in which they’re currently at:

Apartments in most American cities are towards the end of phase 2 (expansion) or the beginning of phase 3 (hypersupply). They see a more typical display of the real estate cycle than we do in Vancouver (because of the demand issue), where demand has been more or less constant and rising, and what’s turning the cycle isn’t change in demand but change in supply. In Denver in 2010, the whole metropolitan area had 400 units built. Now, they build this same quantity every 11 days. It’s a staggering change in new construction volume. This has resulted in downward pressure on rents over the past nine months, which people are stunned to hear. Denver is further along and in the middle to end of the hypersupply phase. What continues to surprise everyone watching this market is that people continue to move there. The units are getting filled up. Teo is looking to understand why this is and which statistics and indicators he can look at in other markets.

By far, the most important indicator is employment growth. Jobs are what attract people to a city and allow them to pay for housing. Many other urban centres continue to see this growth, such as Austin. People are getting worried about California, but that state has many people turning 18 and needing rental housing. Seattle and Portland continue to struggle with affordability, but this is because they’re desirable markets with good jobs, where many people want to live. Teo worries about the challenges in addressing the affordable housing issue; it’s one of the most important issues facing major US cities. Some cities are pursuing helpful policies, but others are not.

On advice for people well aware of the market cycle who still desire to keep their money moving:

What all investors should focus on is cash-flow, number one, but also risk-adjusted return, which a lot of people overlook. This is the returns you’re getting based on the risk you’re taking. The best way to reduce risk is to understand the product and market in which you’re investing. This is how to avoid overpaying for a property. So, Teo invests in markets that he’s very familiar with, such as Denver (though there are many great markets outside of these places). If Teo isn’t very familiar with a market, he may achieve good returns, but he would be taking a lot of risk to get them. He sticks with markets he knows the best, even if the returns are lower than other markets. A higher risk-adjusted return is what’s important.

Warren Buffett’s number one rule of investments is don’t lose money. The better tuned in you are to your market, the more likely you’ll find and capitalize on deals. The less familiar you are with other markets, the more likely you’ll miss deals and go for those that investors with better knowledge have passed on.

On whether Vancouver will be more expensive or less expensive in 10 years:

Teo prefaces his answer with the caveat that the future is unknown, and markets are good at embarrassing people who make predictions! That being said, there is a global force at work of more and more people moving to urban centres. Edward Glaeser, an economist and Harvard professor, recently wrote a book called Triumph of the City which states that cities are the ultimate economic engine. Teo agrees with this. By bringing people together, we create synergies (aside from health and climate reasons, there are economic reasons). So, other things being equal, we will continue to see cities attract people and therefore create economic activity that brings value to real estate. Teo does not have concerns about Vancouver and hopes that in the next couple of years the foreign ownership situation will be worked out and the market will return to a more normal, perhaps predictable, level. Until then, inventory may or may not accumulate, depending on what happens with buyers.

Final questions:

  1. If Teo could give his 18-year-old self one piece of advice today, it would be:
    Find a mentor and work your heart out for them. You will learn so much more by finding a master of your craft than in any other way. Teo had a wonderful mentor named Brian Cunat, a real estate entrepreneur and a master at his craft. He chats with him on a regular basis and visited him last month. His real estate empire is in Illinois and it started from nothing.
  2. Something Teo purchased for under $500 that’s positively impacted his life:
    A timer app for his phone (called Toggl, though there are many other great ones). It’s allowed him to quickly and easily track what he’s spending his time on. As Brian, his mentor, taught him, time is the one resource you can never replenish; everyone needs to consider how they’re spending time and not letting it escape. Teo has found that actively measuring time is a great way to do this; it’s brought awareness to show what he’s actually spending time on vs. what he thought he was doing. This information is priceless.

To find out more about Teo, see his courses at These courses are open enrollment for anyone to take. Harvard has a real estate investment certificate program, for which Teo teaches three of the four courses. They also offer a degree program (bachelor’s and master’s). All Teo’s classes are taught online (which can be attended live in order to participate or, afterwards, recordings can be viewed on your own schedule).

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