Thursday, February 4, 2016

You Gotta Be Here

Source: Kenn Leonhardt

In 2010, Vancouver BC hosted the Winter Olympics and the city ran catchy marketing slogans including “The Best Place on Earth” and “You Gotta be Here.”

Vancouver has supernatural scenery with the ocean and mountains in the backdrop. We have world-class ski resorts just 30 mins away from the city core and enjoy a very moderate climate.

We also have some of the most expensive real estate on earth. In fact, last month the average detached house in Greater Vancouver has surpassed $1.8 million!

Source: REBGV

As you can see from this graph, prices of detached homes have gone parabolic in the past year. The locals here are dangerously in love with real estate and it seems it’s the only market they ever talk about. You got to be here to witness it.

According to the annual Demographia housing study, Vancouver real estate is regarded as the 3rd most expensive in the world (based on average housing prices divided by average local incomes).

Source: Demographia

Our housing valuations (Price/Income and Price/Rent ratios) are now over 3 standard deviations from their historical norms. Yes, I know. Something that’s expensive can become even more expensive and that’s why I’m a trend follower instead of a value investor.

So what's the point I'm trying to make?

I want to show you (especially if you’re a local) something that may surprise you. I want to show you that as hot and exciting as Vancouver real estate might look, boring old bonds would have made a better investment over the past 40 years.

Going back to the price graph above, a single detached home went from about $80K to $1.8M in 39 years. That’s an annual price growth of 8.3%. If you count rental income, then the total return would be closer to about 10%.

Over the same period, an Aggregate Bond Index such as AGG (which mostly contains AAA-rated government bonds with an average 5-year maturity) grew at a total return of 8%. OK, not quite as high but consider these important things:

  • Bonds are low-cost. They don’t have the enormous costs of property tax, insurance, maintenance and repairs. Just property tax alone in Vancouver would be $34K/year on the average $1.8M house.
  • Bonds are more liquid. To sell a home in Vancouver, realtor fees alone would be $60K on the average $1.8M average house. To sell a bond ETF, it would cost you $10 and it would be instant and painless.
  • Bonds are less volatile
  • Bond indices are more diversified

When you factor in the high costs of owning a home, we can say that the total return for a detached home is closer to 9% annually. I’d much rather take the 8% that bonds gave and have the benefit of lower volatility, better diversification and better liquidity. (Actually, I’d much rather take the 18% that GEM has produced over that same period but I’m making another point here).

Despite all these points, no one ever talks about bonds. That would just be a buzz kill at cocktail parties and nobody wants that!

I’d like to end with a quick discussion on interest rates. Here’s a chart for the 10-year US Treasury Yield going back over 100 years:


The stellar growth in both bonds and Vancouver real estate for the past 30 years was on the back of falling interest rates. In fact, if you look at pre-1982 and post, you can see how rising and falling interest rate environments have affected bonds: 

Going forward, we no longer have that tailwind of falling rates. Instead, over the next 20 years we may see something more like the 50s and 60s. This would mean a low-return environment for bonds and real estate.

And when you also factor the current stretched valuation of Vancouver real estate, I wouldn’t be surprised to see a couple lost decades in this market.

But I promise not to mention any of this at a party.

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