By Mark Hannah, Managing Director, Real Estate
It’s Vancouver’s hottest topic, housing prices. Has our twenty-year-long housing bubble finally burst? Was it done-in by government taxation policies, tougher lending requirements or just a tired market? We will examine the cause and effects and at the same time take a look at a vibrant aspect of the real estate market that is so often overlooked by investors.
Building a Bubble
Conventional wisdom tells us that Vancouver’s red-hot residential real estate market has been on a long bull run dating back to the recovery following the global financial crisis of 2008. However, even the Great Recession seemed to merely cause a pause in the price appreciation which the city had already been experiencing for quite some years prior. Data indicates that average detached home values in Greater Vancouver increased by a whopping 95% from 1999 to 2009.1 That appreciation has of course been further compounded by the incredible growth experienced by the Vancouver residential market for condos, townhouses and single family homes in the intervening years. Since 2009, during the recent run-up in pricing, the average detached value had increased by a further 140% to the peak in 2017.2 This equates to a 13% annual increase in house prices over an eight-year period. Even with the recent house price correction, the net price increase is still 120% over ten years or about 8.5% annually. Considering this, it is no surprise that the residential real estate market has experienced an overdue correction.
In addition to Vancouver being one of the world’s most desirable cities to live in, there are several key components to creating a resilient real estate bubble:
1. Restrained supply. One factor limiting the number of new homes (both detached and condos) has been the inconsistent and bureaucratic approval processes to deliver sufficient permits to allow for the development of additional supply. This constraint consistently prevents demand from being fully satisfied.
2. Lower interest rates. We experienced historically low rates which added fuel to the already strong market and helped affordability with lower priced debt for all buyer categories. The lower interest rates contributed to lower debt payments, and this coupled with less stringent lending practices allowed buyers to rationalize larger purchases.
Unfortunately, There’s a Leak
Negative press on the state of the Vancouver residential market has been dominating the headlines; the reality is that it will probably do so for the next 12-18 months.
To date in 2019, average home prices have declined significantly in the Lower Mainland with the West Vancouver housing market being hit the hardest. Prices have dropped more than 16% over the past 12 months since May 2018.3
Worse still, you needn’t look too far to see high-end luxury homes being sold for less than half of the original asking price. In May, CBC reported that over $89 billion in home equity has evaporated over the past year in Greater Vancouver.
In late 2017 and early 2018 early warning signs of a market correction started to poke through when several economic factors started to change: The Bank of Canada raised interest rates, there was significant increase in land prices, and construction costs rose due to inflation and U.S. tariffs on building materials.
In addition to these economic factors, government at all three levels (Federal, Provincial and Municipal) attempted an uncoordinated effort to suppress the sky-high residential market with the stated goal of providing affordable housing.
These efforts came in the forms of the Mortgage Stress Test, the Foreign Purchaser Tax, a higher Property Transfer Tax, the Speculation and Vacancy Tax, and a cap on Annual Rental Increases for rental accommodation. All combined, the impact of these taxes has caused significant stress on homeowners.
In addition, sensational stories in the media detailing the laundering of money gained from illicit activity and foreign capital through local casinos, luxury automobile sales, and of course real estate, have also impacted sentiment. It is no wonder why many developers have begun to put new proposed projects on hold.
Not all the news is bad for Greater Vancouver as there are several positive stories that investors should not be overlooked. Chief among them is that during 2017 to 2019, approximately 30%4 (as shown in the pie charts below) of all the real estate transactions in Greater Vancouver took place in the commercial sector – a sector which has remained resilient despite the sell-off across its residential peer.
For example, both the Greater Vancouver Office market and the Industrial market are performing well and have some of the lowest vacancy rates of all North American markets. The Industrial market is at a record-low vacancy rate of 1.5% and continues to record strong annual absorption,5 while the Office market is also at a record low vacancy rate of 4.5% with near-record annual absorption.6
Vancouver companies are expanding and evolving, requiring more space. In previous decades, forestry, mining and financial companies were the primary drivers of demand for office accommodation. However, in the last several years, British Columbia’s forestry and mining companies have been replaced by tech companies, many of which many are new entrants to this market from the U.S. such as Amazon, Facebook, Google, Microsoft and WeWork.
This is in addition to some great local homegrown tech companies who have also experienced large growth. The TAMI (technology, advertising, media, and information) sector of tenancies, specifically technology, is now the dominant user of space in many major North American markets, and Vancouver is no exception.They are creating large employment growth resulting in demand for not only office space, but residential accommodation, both rental and ownership. Again, these variables produced, on average, a 16% increase7 in downtown office rental rates from 2017 to 2019. These variables combined have caused an average increase of 15% in the past year and 27% during the past two years, as well.8
Our Strategic Plays
Nicola Wealth Real Estate follows trends very carefully to identify where future opportunities may exist.
1. Build-to-Own. In our Nicola Canadian Real Estate LP and Nicola U.S. Real Estate LP, for example, in addition to acquiring existing income-producing assets, we have also adopted a strategy of “build-to-own” for residential rental apartment buildings, which is considered by many real estate experts as the safest asset class. One of our current “build-to-own” projects is the complete transformation of the iconic Harbour Towers Hotel building in Victoria, B.C. into 219 sophisticated rental residences.
2. Build-to-Sell. In our Nicola Value Add Real Estate LP, we have adopted a “build-to-sell” strategy for apartment buildings in key markets. This includes Vancouver where investor demand remains strong and the risk is considered low. We do have a small percentage of our Nicola Value Add Real Estate LP in residential condo development in Vancouver and selected U.S. markets. However, this represents a small component of our overall limited partership. One example project within this limited partnership which incorporates the “build-to-sell” strategy includes our project with PC Urban in Port Moody.
3. Small Bay Industrial and Condominiums. Another key strategy we have implemented that has been very successful is the small bay industrial strata/condo product. This is particularly evident in the Vancouver market where demand is very strong from small business owners who desire to own their real estate to house their company. This product type represents a large percentage of the Nicola Value Add Real Estate LP.
4. A Pivot. In addition, we have targeted “re-positioning” opportunities for certain commercial assets where we can benefit from short-term holding income while we execute the re-purposing strategy. When evaluating “ground up” development opportunities with no holding income, we place a strong emphasis on securing near-shovel ready sites and minimizing the entitlement approval process.
While investors experience a softening in Vancouver’s housing market, all is not lost in the real estate market as a whole. We remain optimistic that the city’s residential domain will emerge through this difficult period, as it has before.
Nicola Wealth’s core philosophy revolves around cash flow and diversification, and that extends to our real estate investing as well. Our team is highly selective and pursues the right opportunities that fit our criteria. We are well diversified across the commercial, industrial, and multi-family spaces, by geography, tenancy, lease expiry and a multitude of other factors. Additionally, we are always seeking new ways to create value for our clients, which includes the development of new mandates to take advantage of the current real estate environment.
During periods of volatility like what we are experiencing, whether it is in investment portfolios or real estate portfolios, we ensure our selection of assets is carefully constructed and prepared to withstand the vagaries of the marketplace.
This presentation contains the current opinions of the presenter and such opinions are subject to change without notice. This material is distributed for informational purposes only and is not intended to provide legal, accounting, tax or specific investment advice. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. This investment is generally intended for tax residents of Canada who are accredited investors. Some residency restrictions may apply. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities’ commissions. All investments contain risk and may gain or lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances.