jump to navigation

Long Term Relationship Between Calgary House Prices and Alberta Economic Activity Diverge – Irrational Exuberance? February 24, 2008

Posted by DustinRJay in Calgary real estate, long term real estate trends.
Tags: , ,

The price of houses is linked to the economic well-being of the region.  Recently, the Alberta economy has been extremely strong and Calgary house prices have increased tremendously. But the question remains, did house prices increase rationally in comparison to economic growth?

A comparison of house prices and GDP per capita show that they roughly track each other for 24 years and then sharply diverge.  This could imply that recent asset valuations of houses have been irrationally exuberant, and a more rational valuation of ~$300,000 would be approprate given the current level of economic acitivity.

 Long Term Relationship Between Calgary House Prices and Alberta Economic Activity Diverge - Irrational Exuberance? 



Financial Calculators For Making Real Estate Investment Decisions February 13, 2008

Posted by DustinRJay in Calgary real estate, rental yields.
Tags: , , , ,

I have found the following two calculators useful for making decisions regarding whether or not it is a good time to buy or sell real estate.  Some good test examples are:           

  • What is a fair market value for a house given its rent and an investment horizon of 10 years? e.g. No difference in wealth between renting and owning over a period of 10 years.  What about 30 years?  What about 5 years?
  • How much does increasing or decreasing interest rates by 2 percentage points affect the economics of buying vs. renting?
  • Develop three cases using conservative values, best guess values and upside values for owning vs. renting.  How do they compare?
  • Would a rental property have a greater return than safe investments like bonds or GIC’s?

The calculators are available at:

Rent Vs. Buy Calculator

Rent Vs. Sell Calculator


Risk Spreads – A Red Light on the Real Estate Market February 7, 2008

Posted by DustinRJay in Calgary real estate, risk spreads.
Tags: , , , , ,

Typically, when looking for a good investment opportunity, one expects a higher return than a safe investment like a bond. 

A mortgage product has risk and therefore should have a higher return than a bond.  By an analysis of the spread above the safe investment  vehichle one can determine periods of heightened risk in the credit markets.

Typically, heightened risk in the credit markets has accompanied recessions.  Also, this has proved to be one of several warning indicators for the peak in the housing market cycle.

As you can see in the following graph, large jumps in the risk spread (red zone) have typically accompanied the start of a bear market in real estate.  In addition, a recession has often followed a sharp increase in the risk spread.  Currently, the risk spread is the highest it has been since the early 1980’s bear Calgary real estate market.

This sort of analysis is useful in identifying some of the creamier investing opportunities (green zone) when the risks have been smaller.

Risk Spreads - A Red Light on the Real Estate Market

Reading Tea Leaves – Predicting Canadian Recessions Using Financial Variables February 5, 2008

Posted by DustinRJay in recession risks.
Tags: , , ,

One of the tools that the Bank of Canada uses for forecasting probability of recessions is the spread between Government of Canada 10 year bond yields and 90 day commercial paper.  This is a leading indicator of slower economic growth.  The benefit of using a tool like this, is that if recessions can be successfully predicted in advance, monetary policy can be adjusted accordingly.

The paper “Predicting Canadian Recessions Using Financial Variables: A Probit Approach” concludes to say:

“Results in the paper show that, in comparison to other financial variables, the spread between Canadian long bonds and the 90-day commercial paper rate is best at predicting recessions in Canada.”

The following graph shows that the spread has been the largest since the 1990’s recession for about a year:

Predicting Canadian Recessions Using Financial Variables

The past two recessions have marked peaks in the housing cycle in Calgary.  As carrying costs are the highest since previous housing bubbles (see this post), it is useful to estimate the probability of a recession as a tool in forecasting the peak in the current housing cycle. 

I am optimistic that Canada will avoid a recession at this point.  However, I estimate that the next period will be the slowest economic growth that has been seen in more than a decade.  I estimate that the probabilities of a Canadian recession are about the chance of flipping a coin three times and having all heads.  Currently,  Global Insight has estimated the probability of recession at 25% in Canada, with most other instutions forecasting less risk than that.

For those that are highly leveraged and unable to cope with an economic shock, there may be difficult times ahead…

Calgary Real Estate Supply & Demand January 2008 February 2, 2008

Posted by DustinRJay in supply and demand.
Tags: , , ,

A review of supply and demand is important in understanding the direction of house prices.  The following graph shows the recent trends of inventory and year over year sales.  In summary, the market has changed dramatically from last year:

  • Current inventory is more than double January 2007
  • Sales are down more than 30% year over year

New CREB President Takes The Reigns

Please feel free to post your own interpretation.

Canadian REIT Firesale – No Decoupling From US Real Estate January 29, 2008

Posted by DustinRJay in stocks.
Tags: , , ,

Both Canadian and American real estate investment trust indices have performed extremely poorly over the past three quarters.  Canadian real estate investment trusts are down roughly 25% from peaks in early 2007.  This is very similar to the performance of US real estate investment trusts.  If investors expected Canadian real estate to outperform American real estate, the indices should have diverged.

The following graph is a comparison of Canadian vs. American real estate investment trust indices:

Canadian REIT Firesale - No Decoupling From US Real Estate

One possible reason for the repricing of Canadian REIT’s is that both Canadian and US real estate prices have roughly doubled since 1995 and this has raised the same concerns of overvaluation that are present in the US markets.

Carrying Costs for Calgary Houses – Highest Since the 1980’s January 27, 2008

Posted by DustinRJay in carrying costs.
Tags: , , , , , , ,

One macroeconomic factor affecting real estate is interest rates.  As interest rates go down, house prices should go up and vice versa.

Here is a summary of  conclusions that I have made regarding the graph below:

  • Historical annual carrying costs above ~$17,500 in 2007 dollars appear to be unsustainable
  • Recessions often follow peaks in the housing cycle (as is currently being exhibited in the United States)
  • Upward trending house prices from 1997 to 2005 is rational due to decreasing interest rates
  • It is unlikely for there to be interest rate relief in the magnitude necessary to bring carrying costs into sustainable territory
  • Interest rates are still relatively low in a historic sense

Carrying Costs for Calgary House Prices

Calgary Bull or Bear Real Estate Market? January 22, 2008

Posted by DustinRJay in short term real estate trends.
Tags: , , , ,

For those looking to buy or sell in the near term it is worthwhile to understand the current trend so that some forecasting or predictions can be made about the real estate market.  This is a complementary post to my Long Term Trends in Calgary Real Estate.  

The primary factor affecting the near term trends is the supply & demand balance.  The absorption rate is the (current inventory)/(sales in the last 30 days).

For example, as of yesterday:

Active listings: 3882
Sales last 30 days: 777
Absorption Rate: 3882/777 = 5.00 months

CREB defines a balanced market as anywhere between 2.0 to 3.5.  The following graph illustrates the relationship between the absorption rate and the price change per month.

 Calgary Bull or Bear Real Estate Market?

If the absorption rate was:  

Below 2.0 = 79% of the time there were price increases
Above 3.5 = 100% of the time there were price decreases

The equation that can be used to roughly predict the price increases or decreases per month is:

Price Change Per Month = -$4,594 * (Absorption Rate) +$14,141

Based on the current absorption rate of 5 months, it appears that price decreases in the near future are likely.

First Encounter with a Calgary Mortgage Broker January 20, 2008

Posted by DustinRJay in mortgages.
Tags: , ,

Buying a house is the biggest purchase that most people make in a life, and how you choose to finance it is a part of how you meet your personal and financial goals in life.

So, this weekend, I gave a local mortgage broker a call here in Calgary.  I wanted to know what index variable rate mortgages were based on and how often it changed.  Instead, he asked how much money I made and proceeded to give me a quote for the maximum mortgage I could afford with a 40 year mortgage.  Not exactly what I asked for…

If anyone knows of reputable mortgage brokers in Calgary  that have a focus on their client’s interests, or credible sources for  mortgage information with a focus on financial planning,  please feel free to post your recommendations below.

I have found the Canadian Mortgage Trends blog written by Melanie & Robert McLister to be extremely useful in keeping up to date on mortgage related news.  Bearclaw also has a good blog about 40 year mortgages the other day. 

My personal thoughts are that unless you have an income producing investment that has a greater rate of return than your mortgage rate, paying off your mortgage as quickly as possible is very good advice. By increasing the amortization period from 25 year to 40 years, the interest paid is about 75% more.

Rich Dad? Poor Dad? A New Territory for Calgary House Price to Household Income Ratios January 19, 2008

Posted by DustinRJay in house price to household income.
Tags: , ,

I was interested in how Calgary house prices historically compared against household income.  The two papers I am aware of that have been written in relation to the subject are:

  1. RBC’s “Housing Affordability” concluded that “Affordability levels in Calgary are now comparable to levels reached in the late 1980’s at the peak of the housing market bubble and this has sparked some concern about the sustainability of prices… But caution is now warranted because we anticipate a significant slowdown in the pace of resale activity, new home construction and price gains in the coming year.  Many properties have likely overshot their true value and will return to a pace of growth closer in line to the fundamentals.”
  2. Another source of research on the relationship between house prices and household income is the 3rd Annual Demographia International Housing Affordability Survey: 2007.  In it, the survey states that, “In recent decades, the Median Multiple has been remarkably similar among the nations surveyed, with median house prices generally being 3.0 or less times median household incomes where demand and supply are balanced.”

For Calgary, the median house price to household income ratio has been 2.8 as shown in the graph below:

 Rich Dad? Poor Dad? A new territory for Calgary house price to household income ratios

In general, when house prices deviate too much above or below the longterm house price to household income ratio, house prices have tended to correct. Therefore, caution may be warranted if buying, as house prices are about 75% above what people could traditionally afford.

Terrain of Calgary Real Estate Valuation – Price To Rent Ratios January 16, 2008

Posted by DustinRJay in rental yields, valuation models.
Tags: , , , ,

In the previous post, I discussed how Calgary rental yields are less than many safe investments like bonds.  I was interested in how the price to rent ratio compared in a historical perspective and what were the valuations like compared to previous real estate cycles. 

A price to rent ratio is similar to the price to earnings concept which is borrowed from the equity markets.  The idea is that house prices can be compared against the cash flow that can be generated from the property.  Ergo, the higher the house price in comparison to the rent, the poorer the value of the asset.

RBC published a report in 2005 called “House Valuations Across Major Cities.”  At the time of the report, it stated that price to earnings ratios for Calgary real estate had pushed “significantly beyond” late 1980’s levels.

The following is a graph of how price to rent ratios compare in Calgary.  As you can see, rental yields are an underlying fundamental of house prices up until 1998, when house prices started increasing exponentially, but the trend for the rent index stayed at roughly the same as inflation.

 Price to Rent Ratios - Terrain of Calgary Real Estate Valuation

The current valuations are roughly double the long term price to rent ratio.  This information dovetails with my previous blog entry wherein I came up with a rental yield of 3.1% for Calgary house prices which is less than safe investments like bonds.  A comparison against the long run price to rent ratio and the current valuations indicates that a more rational valuation would be 6.2% (slightly above low risk assets like bonds).

Therefore, caution may be warranted if buying, as house prices are roughly double traditional valuations.

Mind The Gap – Spreads Between Low Risk Investments and Calgary Rental Yields January 14, 2008

Posted by DustinRJay in rental yields.
Tags: , , ,

I thought it would be interesting to compare Calgary rental yields against a suite of safer investments.

For one to invest in real estate, one should desire a higher rate of return than other safer investments.

So, how did Calgary real estate stack up against the safer investments?  As you can see in the graph below, not very well…  In general, Calgary rental yields were less than the safer investments yields like GIC’s, savings accounts and bonds.  Low rental yields have led to high levels of condominium conversions as lessors arbitrage differences between renting and owning.

 Calgary Rental Yields

The following is a rental yield calculation for a two bedroom condo in Calgary:

December 2007 Calgary Condo Price = $304,719
Residential Tax Rate = 0.0054614
Annual Taxes = $1,664
2007 Calgary Two Bedroom Condo Rent =$1089/month
Condominium Fees = ~$150/month

Calgary Rental Yields = (1089*12-150*12-1664)/304719 = 3.15%

This compares against:

ICICI Bank Savings Account (4.25%)
ICICI Bank 1 Year GIC (4.65%)
GoC 2 Year Benchmark Bond Yield (4.25%)
GoC 3 Year Benchmark Bond Yield (4.00%)
GoC 5 Year Benchmark Bond Yield (3.75%)
GoC 7 Year Benchmark Bond Yield (5.00%)
GoC 10 Year Benchmark Bond Yield (4.00%)
GoC Long Benchmark Bond Yield (5.75%)

Rental yields would need to increase by roughly 75% in order to be competitive with other safer investments.  Considering current market conditions, a fair market value of $175,000 instead of $304,719 may be warranted for a condo (a drop of ~$130,000).

I find it unlikely that Calgary rent will increase to make rental yields competitive so much as Calgary real estate prices will continue to drop due to:

  1. Calgary has the highest rent in the nation
  2. For the first time since 1994, Alberta had negative interprovincial migration.  This was likely due to individuals arbitraging regional cost of living differences.

Long Term Trends in Calgary Real Estate January 13, 2008

Posted by DustinRJay in long term real estate trends.
Tags: , , ,

House prices have increased dramatically in the past few years.  For people looking to buy Calgary real estate in the near future, it is worthwhile to examine whether or not the current valuations are justified and what is the upside potential or downside risks.  If there is upside potential, how can one capitalize on it, and if there are downside risks how can one hedge against it?

From 1973 – 2007, house prices in Calgary have appreciated at 1.2%/year above inflation (not a hedonic regression).  However, over the last 6 years house prices have nearly doubled. 

This blog attempts to understand whether the increase has been substantiated by underlying rental yields, higher incomes, or lower carrying costs.  In addition, this blog will examine value investing approaches to quantify Calgary house prices.

The following is a summary of the peaks, troughs and recovery times for previous real estate cycles in Calgary (graph is shown below):

  • Peak: 1981 – $234,000 (~21 years to recover)
  • Trough: 1984 – $125,000
  • Peak: 1990 – $192,000 (~8 years to recover)
  • Trough: 1995 – $159,000

Calgary Inflation Adjusted House Prices 

Here are two interesting indexes to compare long term trends in Calgary real estate against:

The New York Times article states:  “Between 1628 and 1973 (the period of Eichholtz’s original study), real property values on the Herengracht — adjusted for inflation — went up a mere 0.2 percent per year, worse than the stingiest bank savings account. As Shiller wrote in his analysis of the Herengracht index, “Real home prices did roughly double, but took nearly 350 years to do so.””

 In summary, recent house appreciation in Calgary is much greater than the long term real estate trends.  For long term trends, house appreciation of 1.2%/year for Calgary seems reasonable.  Also, house prices tend to revert to mean.  Caution may be warranted if buying, as house prices are approximately $150,000 more than the long term trend.