Full Disclosure Finance

By Justin

Over the past 8-10 months every magazine and television channel has been discussing the fact that US Real Estate prices are tanking. This trend is well covered in the macro sense but up in the Great White North we get few specifics.

I wanted to do a little comparison between 2 areas that I have some experience with, New Haven, CT and Kitchener-Waterloo, ON. It will also highlight that all of Canada is not tied to US performance, contrary to opinions of many people I have met. On the plane or in the airport, when the topic of Canadian Real Estate comes up, people automatically seem to think that our entire market will collapse because of the US situation.

Teachable Moment: Don’t believe people’s opinions on topics like this. Instead, take time to look at published information and data from trusted sources. For Canadians, the CMHC, Royal Lepage, and individual city’s sites offer quality stuff.

In addition to getting good data, you also need to know which data is critical for understanding an area’s potential to support a strong real estate market. Taken from pg 39 of Don Campbell’s book Real Estate Investing in Canada, the 12 key fundamentals that affect real estate values are:

Passive Factors (out of your control):

1. Mortgage Interest Rates

2. Increase in Average Incomes

3. Increased In-migration and Demand

4. The Ripple Effect

5. Local, Regional, and Provincial (State) Political Climate

6. Transportation Expansion

7. Areas in Transition

Active Factors (in your control):

8. Creating Highest and Best Use

9. Buy Wholesale, Sell Retail

10. Quality Marketing

11. Renovations and Sweat Equity

12. Speculation

I was curious how New Haven was doing because I visited there a few summers ago and found some interesting areas. I could have picked many other US cities I like, Boston / Cambridge, Phoenix / Scottsdale, Portland (Maine), and pretty much all of North Carolina and Florida. After a little searching on New Haven, I found the following chart that summarized the real estate market fairly well.

In the chart you can see prices have dropped over 10% from Q3/07 to Q4/07. This doesn’t even cover Q1/08, which data should be coming in for any day now. This decrease is substantial and should get some attention. However, I can’t take my eyes off the massive drop in the number of units sold. In one quarter homes sales dropped from 370 to 75!!! This is an 80% drop!!

Wow, now I realize the real crunch for property owners. A city with a population of 124,000 only had 75 properties change hands in 4 months! The real estate agents must be scared. This would seem to be a great buyers market because there must be a huge inventory of homes, condos, and investment properties. I would be curious to see what has happened to rents during this collapse of home sales in New Haven.

But let’s look a little deeper into the New Haven market using some of the 12 fundamentals.

Mortgage Interest Rates:

They have been low when compared to historical values over the past 30 years. The interest-only mortgages and other unique products also assisted in reducing borrowing costs and therefore stimulating home buying.

Increase in Average Income:

Estimated median household income in 2005: $30,603 (it was $29,604 in 2000)

New Haven	$30,603
Connecticut:	$60,941

Estimated median house/condo value in 2005: $188,200 (it was $109,200 in 2000)

New Haven	$188,200
Connecticut:	$271,500

Besides being around half of the state average, New Haven’s median income has essentially remained stagnant from 2000-2005, while house prices were increasing 72%. Does this make sense to you?

Increased In-migration and Demand:

The population of New Haven increased by 0.3% from 2000-2006. The addition of 375 people is hardly enough to justify a 72% increase in property values.

I can keep going through these fundamentals, but I think you already know the answer. The last 4 passive factors become more central when looking to predict an area’s future behaviour and we can skip them for this analysis.

Conclusion: New Haven’s fundamentals didn’t justify the increase in home values and they were bound to go back to reality. I realize that this may seem obvious now after looking at the fundamentals, but I truly believe I wouldn’t have been able to justify a BUY and HOLD investment in this market. It would have just been speculating and I don’t have the capital or risk tolerance to be doing that.

So let’s move on to Kitchener-Waterloo, where there is a large pool of skilled labour, a diverse mix of manufacturers and innovative tech companies, and great universities.

Here’s a summary of their real estate market:

As you can see there are a few differences from the New Haven chart, not sure if you can detect the sarcasm here or not…

For KW from 2000-2005 prices rose approximately 41%. This is good stuff for sure, but not as good as New Haven’s 72%.

As you can see the increase in number of MLS sales has also increased steadily.

Let’s look at the fundamentals now:

Mortgage Interest Rates:

Canadian rates are in a similar position to the US, low compared to historic levels. The difference in Canada is that interest only mortgages and subprime borrowing is around 5% of the market compared to 20% in the US. I got this info from the Real Estate Investment Network’s site, where they have a great speech by CIBC economist Benjamin Tal.

The climate is good enough to stimulate buyers, but not at a pace like the US.

Increase in Average Income:

Along with the median family income in KW being above the provincial and national average, unlike New Haven, it also rose about 10% from 2000-2004. This is a solid indicator of a region’s health, assuming inflation is also low.

Increased In-migration and Demand:

Just looking at the population increase for KW from 2001-2006 gives a good indicator of what is happening. A total of 25,201 people were added to the KW population for growth of 8.1%, almost 70 times the growth of New Haven over a similar period!

Conclusion: This case is also open and shut. Solid population and wage increases along with low interest rates bode well for KW.

If you had to pick the sustainable market, would it be New Haven or KW? You guessed it, even though KW’s house price increase was only 57% of New Haven’s performance, their underlying factors lean vastly in favour of KW for the long term.

So there you are, a specific analysis of the fundamentals for two real estate markets allowed us to understand their behaviour. Go ahead and apply these fundamentals to other US cities. If the cities have great fundamentals and prices are still dropping it may be a great time to buy. Just be sure to do your homework!