Friday, March 20, 2015

The Vancouver Housing market and foreign money

There are few things are the fueling Vancouver housing market. One factor, that has gotten a press recently is the amount of foreign money coming in. The problem is it has been next to impossible to pin down just how much money is flowing in and just who it is that is buying. Most of the evidence is anecdotal -- official figures being few and far between. Further complicating matters is there are a large number of high worth individuals, many of them investor class immigrants, who are not foreigners at all, but Canadian citizens who work elsewhere and pay taxes elsewhere. Whatever the case, given the huge gap between medium income levels and housing prices, particularly detached housing prices, it is fair to assume that the role of outside money is playing a big role.  The gap between housing prices and median incomes levels is second only to Hong Kong.

A second factor is interest rates. Lower interest rates have greatly increased people's ability to take on a larger mortgage. A few examples should drive home the point. The monthly payment on a $500,000 mortgage at 5% with a 25 year interest period is $2,908.03. The monthly payments on a $615,000 loan at 3% is $2910.46 The monthly payment on a $650,000 mortgage at 5% is $3780.44. The monthly payment on a $800,000 mortgage at 3% is $3785.97. Now, the maximum period that one can lock in for in Canada is 10 years. As a result, we tend to think of these results and transitory and so forget that what matters is not the purchase price but the amount of interest paid, plus the down payment plus the principle. Someone with a $325,000 10 year fixed rate, 10 year interest period, mortgage at 3% is going to pay less than someone with a $300,000 mortgage at 5%.

The third thing, that is not getting much play at all, is this. All that foreign money following in is not simply vanishing. Foreigners, however you want to define them, are not buying off other foreigners. They are buying from locals -- more often than not local baby bombers looking to downsize. These newly displaced locals are not retiring and moving full time to Mexico. They are staying in town and so still need a place to live. Flush with cash, these lucky locals have helped inflate and now sustain the condo market. Of course, many of these same people have passed some of their wind fall to their offspring. This in turn has made it possible for the lucky sons of daughters of these baby bombers to enter into the market they would otherwise be priced out of. According to a survey by mortgage insurer Genworth, 40% of first time home buyers used family money in purchasing a home. Finally, the huge spike in housing prices over the last 15 years has greatly increased the ability of those still in their homes to purchase a secondary property or to "right size". With regard to the former, the amount of collateral they have to offer up has gone though the proverbial roof. With regard to the later the huge increase in equity on the house they already live in provides them with the ability to afford price of a new home that is incongruent with their income level.

This leads me back to foreign money. In so far as the amount of foreign money flowing into the market represents a windfall for a portion of the local population, housing prices are somewhat sustainable. The money is still in the local economy and a chunk is ready to be reinvested in the local housing market. However, eventually that is going to come to an end. Even if foreign money keeps flowing in and even if the secular stagnation thesis proves right and low interest rates become the new long term norm by the time the next generation goes to downsize they will be no position to inject their earnings back into the economy and the local into the housing market. Most if not all of the spread will go into paying off debts, most notably the mortgage they took out buying the place they are selling.