The UBC Real Estate Club bridges the gap between your university and professional life, by providing an opportunity to learn outside of the classroom and to network within the Industry.

New Webmaster Needed

The UBC Real Estate Club is looking for a new webmaster for the 2006/2007 school year. If you know even a little bit of HTML and CSS, You'd be a prime candidate. Please contact [email protected]. Or, if you know someone else who would be interested, let them know about the position.

Recession Probabilies

The following table is based on Estrella and Mishkin's 1996 paper, which attempts to predict the probability of recession four quarters in the future (we've written about this before):

Table of recession probabilites

John Mauldin puts it this way in his latest newsletter:

There is today a negative spread of 2 basis points, as opposed to a positive 50 basis points less than two months ago.

It is all but a foregone conclusion that the Fed will raise rates at its March meeting. If the ten year stays where it is, we will see a negative 27 basis point spread in the middle of March, which within 90 days would suggest a mid-30% chance of recession.

If the Fed raises again in May to 5%, without the ten year moving up, we would see a 40% chance of recession as the 90 day average would soon be a negative 50 basis points.

Real Estate is Exciting Now... Has it Always Been Like This?

An August 2005 New York Times article titled In the Long Run, Sleep at Home And Invest in the Stock Market (subscription required, but UBC students can get free access from LexisNexis) compared the historical returns of stocks to those of real estate. The article is a bit of a relief, as it contrasts nicely with the anecdotal tales of quick riches and impending doom scenarios that have played alternately in real estate media coverage over the last year.

The housing boom of the last five years has made many homeowners feel like very, very smart investors.

As the value of real estate has skyrocketed, owners have become enamored of the wealth their homes are creating, with many concluding that real estate is now a safer and better investment than stocks. It turns out, though, that the last five years -- when homes in some hot markets like Manhattan and Las Vegas have outperformed stocks -- has been a highly unusual period.

In fact, by a wide margin over time, stock prices have risen more quickly than home values, even on the East and West Coasts, where home values have appreciated most.

When Marti and Ray Jacobs sold the five-bedroom colonial house in Harrington Park, N.J., where they had lived since 1970, they made what looked like a typically impressive profit. They had paid $110,000 to have the house built and sold it in July for $900,000.

But the truth is that much of the gain came from simple price inflation, the same force that has made a gallon of milk more expensive today than it was three decades ago. The Jacobses also invested tens of thousands of dollars in a new master bathroom, with marble floors, a Jacuzzi bathtub and vanity cabinets.

Add it all up, and they ended up making an inflation-adjusted profit of less than 10 percent over the 35 years.

That return does not come close to the gains of the stock market over the same period. The Standard & Poor's 500-stock index has increased almost 200 percent since 1970, even after accounting for inflation.

[...]

That does not mean real estate is a bad investment. It is often an important source of wealth for families. But its main benefit is what it has always been: you can live in the house you own.

The author discusses how availability bias has helped to persuade investors that real estate is not as risky as stocks, and also makes an important observation about leverage: it can do great things for returns in the short term, but the benefit disappears quickly as a purchaser repays a mortgage.

Eighty percent of Americans deemed real estate a safer investment than stocks in an NBC News/Wall Street Journal poll done this spring, while only 13 percent said stocks were safer.

Part of that sentiment is driven by the recent memory of the stock market collapse in 2000. Many homeowners seem to have forgotten that less than 15 years ago house prices in the Northeast and California fell, but the money they lost on technology stocks is still fresh in their minds.

[...]

Economists caution that any comparison between real estate and stocks is tricky, because real estate is typically a leveraged investment, in which a home buyer makes a down payment equal to only a fraction of a house's value and borrows to finance the rest. While it is possible to borrow money from a brokerage firm to buy stocks, most individual investors simply buy the shares outright.

When home prices are rising, the leverage from a mortgage lifts real estate returns in the short term. Someone putting down $100,000 to buy a $500,000 home can feel as if the investment doubled when told that the house is now worth $600,000.

But the power of leverage vanishes as homeowners pay off the mortgage, as the Jacobses have. Leverage also creates more short-term risk, especially for those who have stretched to afford their house.

Perhaps most interesting is the suggestion that real estate often turns out to be a good investment for individuals because its illiquidity prevents them from being as bad at investing in this asset class as they are in others:

But economists and investment advisers say that most of the value from real estate comes not from anything that can be captured by flipping it, but from the safety net it provides in bad times. Even if the market shifts downward, "you have a roof over your head," said Jonathan Miller, a real estate appraiser in Manhattan.

Beyond the shelter it provides, the biggest advantage of real estate might be that it protects people from their worst investment instincts. Most people do not sell their house out of frustration after a few months of declining values, as they might with a stock. Instead, they are almost forced to be long-run investors who do not try to time the market.

Harlan Larson, a retired manager of car dealerships near Minneapolis, still regrets having bought Northwest Airlines stock at $25 a share a few years ago. It is now trading at less than $5.

By comparison, he views the four-bedroom home he bought for $32,500 in 1965 -- or about $200,000 in today's dollars -- as a money tree. He and his wife recently listed it for $413,000. That would translate into an annual return of 1.2 percent, taking into account inflation and the cost of two new decks and an extra room.

How the US Housing Market Affects Vancouver

From Vancouver Housing Market Blog:

The US housing market is clearly starting to fall. I'm sure even our resident bulls will acknowledge this fact. (Of course, it could never happen to Vancouver . . . )

As we've often discussed here, this will affect prices in Vancouver through (at least) four channels:

  1. Exports: US demand for BC exports (like wood for houses) will decrease.
  2. Credit markets: As the risk premium gets reintroduced to credit markets, Canadian banks and bonds will be affected.
  3. US investors: Some have said that US investors have been active in the Vancouver condo market. At best they'll stop buying; at worst they'll sell Vancouver to pay off their losses elsewhere.
  4. Psychology: tear-jerker stories of families losing their houses will be all over the US media. Oprah will do shows on it. This will affect the beliefs that real estate 'always goes up'.

Updating the Yield Curve

The United States yield curve as of January 24, 2006:

24 January 2006 Yield Curve for USA

The Canadian yield curve as of January 24, 2006:

24 January 2006 Yield Curve for Canada

What Happens When the Yield Curve Inverts?

The yield curve for United States T-bills and government bonds inverted ever so slightly on December 19, 2005 (for the first time since the early months of 2000), and has stayed that way until the time of this writing. A normal yield curve is always upward sloping, since investors expect to be paid more for taking more risk as the term to maturity increases.

The curve looked like the one shown below on January 5, 2006, but check Bloomberg to see what it looks like right now, or have a look at this dynamic yield curve that matches interest rates to stocks over time.

6 January 2006 Yield Curve for USA

Depending on the shape of the yield curve, a percentage probability of future recession can be inferred, as Arturo Estrella and Frederic S. Mishkin wrote in a 1996 Federal Reserve Bank of New York publication.

In his latest newsletter, John Mauldin helps to summarize the case for the yield curve as a predictive tool and describes what it means this time around:

Professor Campbell Harvey of Duke was the one that wrote about the relationship between recessions and the yield curve, and proved that the yield curve outperformed other forecasting tools in his 1986 dissertation at the University of Chicago. He published his dissertation in 1988 in the Journal of Financial Economics. In 1989, he published a follow up piece in the Financial Analysts Journal. Estrella (we'll read more about him later) and Hardouvelis picked up on the idea and published an article in 1989 and a few more.

Harvey's prediction about the usefulness of the yield curve was right on target. In 1991, after the 1990 recession he noted that inversions of the yield curve (short-term rates greater than long term rates) have preceded the last five US recessions, suggesting that the curve can accurately forecast the turning points of the business cycle.

[...]

But [today's] level of spread has happened several times in the past 40 years and we have not had a recession follow. So why should we pay attention today?

Because for a full inverted yield curve to show up you will start seeing "signs" in the yield curve like we saw this week. These things start innocuously, usually when the economy seems to be booming, and most observers suggest we ignore them. And sometimes they are right.

But most observers suggested we ignore full-blown yield curve inversions as well. I think it was something like 50 out of 50 Blue Chip economists failed to predict the last recession even a few months out. They ignored the yield curve, all finding reasons why "this time it's different."

In a follow-on paper mentioned below, Estrella documents that each of the previous yield curve recessions since 1978 produced major academic papers telling us why this time it's different. They were all wrong.

This is certainly something to watch. In case you're curious, the yield curve for Canada also appears to sag in the middle:

6 January 2006 Yield Curve for Canada

US Housing Market in 2006: The Economist's Take

The Economist's annual publication, The World in, looks to the year ahead for the political, business, and social trends worth watching. Here is an excerpt from The World in 2006 (unfortunately, the full article is available to subscribers only):

For the past few years America's economy has consistently defied those who predicted doom. That resilience has much to do with American Consumers' seemingly indefatigable appetite for spending. Year after year they have shrugged off shocks--from the bursting of the stockmarket bubble to soaring fuel prices--and kept their wallets open. The main reason is well known. Low interest rates have fuelled a house-price bonanza against which Americans have been able to borrow more and save ever less.

That combination cannot continue indefinitely. And the chances are that the turning-point will come in 2006. Consumers will be battered from three sides in the year ahead: the cost of fuel will stay high, house prices will flatten and even fall in some regions, and inflation jitters will push interest rates up.

[...]

In the spring of 2005 the price of a typical house was more than 13% higher than a year earlier, the fastest pace of house-price inflation in over a quarter of a century. Over 80% of the increase in mortgage debt over the past couple of years has been due to households cashing out equity from their houses. After declining inexorably in recent years, the household saving rate turned negative in July.

But there are signs that this frothiness may be fading and that consumers are becoming more worried. Houses in many parts of the country are too expensive for many purchasers. The ratio of median mortgage payments to median income--a good gauge of affordability--is at its highest level since 1989, when the American property market last peaked. Inventories of unsold homes are rising and mortgage applications are slowing. Measures of consumer confidence plunged in September.

[...]

If house prices merely flatten, consumer spending will be hit. If they fall, it could be hit hard. And the effects of a housing slowdown would ripple further, slowing residential investment and hitting employment. Thanks to the boom in construction, residential investment now counts for 6% of GDP, its largest share since 1955. All told, around four out of ten jobs created in the past couple years are related to the housing boom. The lesson of other countries that have seen their property markets cool, such as Australia and Britain, is that the impact on consumption can be pretty dramatic.

The Economist's unapologetically bold demeanor means that their yearly soothsaying is frequently wrong (or the timing is badly off), but it's always an interesting read. You can get a taste from The World in homepage, where a few articles are available for free.

Resumé Book

We are now accepting resumés for the password-protected Employers section of our website. Employers will be given access to browse through your resumés.

If you would like your resumé posted, please send it (2 pages max) in .doc format (Microsoft Word) to [email protected]. Upon receipt, your resumé will be converted to PDF format for viewing, and scanned to make sure no formatting errors have occurred.

Edited to add: Please note that we do not proofread resumés. They will be checked quickly for any formatting errors resulting from the conversion between .doc and PDF, but other than that, we will post whatever you send.

Using Debt to Unlock Equity

Vancouver Housing Market Blog, a consistently bearish opinion on local home prices, points to Saturday's Vancouver Sun Article on British Columbians' propensity to use debt to unlock equity in rising home prices. The Sun interviewed Benjamin Tal, a senior economist with CIBC World Markets:

B.C.'s explosive real estate market and its concurrent rise in property values has [sic] also led to increasing debt loads. As home equity rises, people spend more, Tal said. It's called the "housing wealth effect."

For every $1 increase in house value, a homeowner generally spends an additional five cents. But that five cents is not actual money in our pockets, Tal said, so it must come from somewhere else, like increased debt. In the last three years, that five cents per dollar accounted for $25 billion in increased spending, Tal said.

If BC residents have been living better in recent years, it would be useful to know what is the contribution from debt compared with income gains.

In a post in late June 2005, Vancouver Housing Market Blog plotted disposable income in BC against a falling saving rate from 1981 to 2004. The results are surprising, since inflation adjusted disposable income seems not to have changed dramatically, moving within a band of about $2,500, while there is a determined downward trend in the saving rate over the same 23 year period.

Ben Bernanke and Housing Markets

All indications are that Ben Bernanke will be the next chairman of the Federal Reserve, starting February 1, 2006. He is unlikely to stray far from the policies developed during the Greenspan years, which may be why his nomination was well received by analysts and markets alike, as the Economist notes.

So where does Bernanke see American housing markets going, and what does he consider the Fed's responsibility to be toward asset prices and the welfare of the overall economy?

The Washington Post reports that "Bernanke does not think the national housing boom is a bubble that is about to burst," although he makes no similar statement about local markets. He has also made clear his view that the Fed's role is not to identify and correct potential asset price bubbles. From the Post:

...he has argued for many years that the Fed should respond to rising or falling prices for stocks, real estate or other assets only if they are affecting inflation or economic growth in an undesirable way. Thus, he would advocate cutting interest rates if a reversal in the housing market sharply dampened consumer spending, triggering job losses or a fall in inflation to very low levels.

For a more detailed account of Bernanke's philosophy, see his remarks on asset-price bubbles and monetary policy, where he talks about the difficulty of identifying bubbles, as well as the dangers of corrective options such as "leaning on bubbles" or aggressively popping them.

The Next Recession

John Mauldin considers what might cause the next recession in America. He talks about energy prices, housing markets, and the impending handover of the US Federal Reserve to Alan Greenspan's successor (as yet unannounced).

Mauldin's commentary quotes the Center for Economic and Policy Research, describing the tradeoff between maintaining low inflation and keeping the economy afloat:

...The immediate path forward looks very shaky as the economy is ever more dependent on the housing boom and debt. If wage growth does not begin to pick up, it will be difficult for this cycle to continue much further. However, if wage growth does pick up, then inflation will accelerate, pushing up interest rates, which will burst the housing bubble.

Mauldin's focus is on the US, but his analysis certainly has implications for Canada, and for Canadian real estate markets.

The Economist Gets to the Point

The newspaper describes the world's housing market as "the biggest bubble in history."

The most compelling evidence that home prices are over-valued in many countries is the diverging relationship between house prices and rents.

[...]

Investors are prepared to buy houses they will rent out at a loss, just because they think prices will keep rising -- the very definition of a financial bubble.

Tsur Somerville on Vancouver Housing Prices

The Vancouver Sun has an article comparing Vancouver's current housing prices to those of Sydney, Australia, where prices rose quickly for several years before plummeting in late 2003.

Over the past three years...prices have risen faster in Vancouver than the Canadian average, behind only Montreal and Toronto. But Vancouver's housing boom only really got going in 2002 -- lagging the rest of the country by a couple of years. If you look at prices over the past five years, rather than the past three, prices have actually risen slower in Vancouver than the national average, trailing every major city except Calgary and Halifax.