Invisible Hand of Income (Inequality)

First off I’d like to say that this whole blogging thing is new to me and so I’m still working out the quirks.  So bear with me.

Now a lot of  commentators say that house prices are way off fundamentals, rental incomes don’t jive with the prices.  Most of the times they are using analysis based on the tradeoff between rent and mortgage payments.  The general idea is that over the long term, a “rational” individual would choose to pay less for living in an almost identical home if given the choice between rent and a mortgage payment on that place.  Ultimately, the ability to pay for rent or mortgage payments is capped by what the incomes levels are in that market.  Many claim Vancouver’s prices are not justified by the income levels.

But this is where I think the problem lies.  According to BlockTalk, in the Dunbar area, the average income level is $122,948.  Using the CHMC mortgage calculator for how much one can afford, the numbers are:

V776794

SCENARIO 1:
Monthly Income Required
: $10,245
Monthly Property Taxes: $600
Monthly Heating: $100
Financing: 3.5% fixed, 5 years, 25 year term, mortgage of $516,434, monthly payments of $2,578
Downpayment: $500,000
Maximum House Price: $1,016,434*

* According to CHMC, the first rule is that your monthly housing costs should not exceed 32% of your gross monthly household income.  Housing costs include monthly mortgage payments, taxes and heating expenses.  The house in the picture above was on the market recently for $949,000

Now what if monthly income is $15,000?  Let’s see:

SCENARIO 2:
Monthly Income Required
: $15,000
Monthly Property Taxes: $600
Monthly Heating
: $100
Financing
: 3.5% fixed, 5 years, 25 year term, mortgage of $821,198, monthly payments of $4,100
Downpayment: $195,000
Maximum House Price: $1,016,198*

In scenario 1, you could say it was a dual income couple making $61,470 each.  In scenario 2, it could be a couple making $90,000 each.  You’ll notice that there is a very significant downpayment required.  But houses like the one above are being sold.  And the bears say that this is because of the extremely low mortgage interest rates.  This is true.  Are the buyers overextending themselves?  Well these scenarios are based on the criteria set out by the CMHC on 32% debt-to-income ratios.  Is it so hard to imagine a couple (gay or straight) making $60,000 to $90,000 each?

It’s the downpayment that’s troubling.  For both scenarios, they require a downpayment from $195,000 to a whopping $500,000.  But is this necessarily unrealistic?  These houses are being sold and this is what the market can bear. Believe me, there are houses in this area that selling for much more than $949,000.

Where does the downpayment come from?  This is probably the most mysterious part.  But it doesn’t really matter because its unobservable.  It could be from inheritance, from an asset sale, from the sale of a business, or maybe it was just saved earnings!  Is it that hard to imagine our hypothetical couple saving $50,000 to $100,000 each – maybe because they’re too busy working to spend their earnings – and then topping it off with a gift from both sides of the family towards their first purchase?  Or what if these people are just stinking rich or come from very well-off families?  Why is this so hard to believe?  Maybe bears aren’t good at empathizing with bull.

This is what I perceive to be some of the problems with the bearish point of view.

  1. Averages are mediocre – The average income figures are obscuring what’s actually happening out there.  An average houshold income level of say $75,000 doesn’t really tell you what is happening at the upper end of the distribution.  Who says that the income distribution needs to look like a bell curve?  Don’t income distributions follow power laws anyways?
  2. Rich people buy in Vancouver – One of the complaints is that income levels can’t sustain the current market.  Bears believe in fundamentals, but why can’t they believe where the market clears prices correctly?  Because ultimately they can’t believe that there are so many rich people out there.  Or they might brand these people as “greater fools”.  I personally know a few Goldman Sachs employees based out of Manhattan that recently purchased very high end condos in Kits.  A common complaint is that institutional investors are not jumping into the Vancouver market.  So why are Wall Street investment bankers making such foolhardy purchases for themselves?
  3. Self-Righteousness – Bears are complaining about high prices because they’re too high.  But too high for whom?  They don’t think the prices are worth it.  But does it compute that it might be the right price for other buyers?  How can one justify buying a $250,000 car?  Because it’s worth it to them.  Some like their caramel machiatto, others like their double-double.  Go figure.  But when bears say they can’t understand the stupidity of making a purchases that breaks the laws of the price-income ratio, they are basically saying why don’t others think like I do?  Why aren’t others as “rational” as me?
  4. Affordability Self-Selection Bias – People that congegrate on the Internet to talk about the “bubbly” prices of Vancouver real estate tend to reinforce each other’s beliefs.  Finding other people who share your opinion only reinforces… well, your opinion.  Just because there are so many bears out there doesn’t mean that they’re right.  We can ponder the “wisdom of crowds” all we want, unless of course the crowds are dead wrong.
  5. History is a Guide – Many bears believe that prices will achieve some long-run historical average.  They don’t believe in paradigm shifts away from what they perceive is a solid fact of history: the price-income ratio.  But paradigm shifts do occur.  For example, consider that property rights and capitalism are in fact complete paradigm shifts that only in the past 30 or so years the rest of the world have come to realize as the best form of organization for a country today.  It might not always bethis , but then that would be a paradigm shift for the future.  We can’t be so close-minded about possibilities when using historical data.

The bottom line is that the reason why prices are so “high” is because there is, amongst the buying public, a huge and large income inequality.  It’s that simple.  For what else could be driving the market to clear at these prices, given the hyper-connected infoglut of a world we live in?

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24 responses to “Invisible Hand of Income (Inequality)

  1. the median CDN bank account is less than $1200…….

    puts this posting intoperspective…..

  2. Pingback: Friday Free-for-all! | Vancouver Condo Info

  3. what a load of crap

    500 K downpayments !

    average income of dunbar gleaned form antoher realtor’s website!

    even your scenario two requires a $4100 monthly mortgage payment ! $4100

    dude you are blowing hot air. desperate realtor perhaps?

  4. This entire post is pure conjecture; come back with some data to support your ideas and they will be given a lot more consideration by all. Perhaps in a vacuum you could entertain the Vancouver paradigm shift thesis, but in the context of a nearly global meteoric rise in RE prices over the last few years it seems bubble deniers are the new flat-earthers.

  5. Average incomes are misleading. We need to look at how many people make $122-150K. According to Stats Canada, less then 5% of Vancouverites make more then 90K per year. So there does not seem to be that many people with the incomes to support these monthly payments.

    Anecdotal stories about wealthy new yorkers buying up houses in Vancouver is not much of an explanation either. According to the landcor data, very few out-of-province, never mind out-of-country, buyers exist.

    So the only explanation is that many people do have 500K in cash sitting around. Again, the stats on household savings say that there are very few of those people.

    Which leaves the people who have cash and/or income that does not get counted in the stats. But there are not that many big time dealers around.

  6. Welcome to blogging … keep it up. It’s a good (though maybe not always safe) place to explore ideas through writing.

    With your numbers, what would have to happen to incomes if the interest rate jumps to something more historically normal – 7 or 8%? Is that something your neighborhood could sustain?

  7. “Where does the downpayment come from? This is probably the most mysterious part. But it doesn’t really matter because its unobservable.”

    I can’t believe I wasted my time reading this pile of horse dung.

  8. “I personally know a few Goldman Sachs employees based out of Manhattan that recently purchased very high end condos in Kits. ”

    I can’t believe I wasted my time reading this pile of horse dung.

  9. This is your first blog! Recommendation: stop now, make this your last.

    I have never read so much absolute rubbish. There is ABSOLUTELY NO COMMON SENSE, to this blog. No point me pointing out the errors or stupid assumptions your making, every body else is doing a good enough job there.

    But let me point out something that your obviously ignorant about, BC has negative savings growing, and hugely growing debt.

    Furthermore, at the ridiculously low rate of 3%, which some can still get for mortgages, even at 1 million dollars, your interest payments are only $2,500. And people are only do just that; paying their interest, and its not being done with two incomes, most places have 3rd or 4th income sources (that is, secondary suites).

    If you really want to learn how do proper analysis, and not crap like the stuff your pumping out, look at a pro:

    http://americacanada.blogspot.com/2009/07/cmhc-and-our-government.html

    solid numbers, from solid sources, with solid analysis.

    Or is your agenda just to pump this market into the super duper bubble zone? You have to be a real-estate agent, or city councillor needing ever increasing taxes to fund your incompetent management.

    Remember this, it wasn’t too long about, just a generation ago, when it was enough for 1 wage to pay for a family of 4 or more, and a home. Think about that, one wage at $40,000 today. Traditionally, that would mean the average house price today should be $120,000. Think about that!

    When are people like you going to start seeing the reality of the situation? Do we really want Vancouver to become just a city of slums? Look at the house that you chose! Its a piece of garbage! $1,000,000 for that junk! This city is being taken over by predators.

    Note: Where are you Gordon Campbell? Or are you just on the side of all the other vultures and vampires invading this city, and this blogger is just one of your minions?

    What *%#@!& up city this turning into. Thank you Gordon Campbell, thank you crazy blogger. With people like you around, who needs the four horsemen of the apocalypse, we do a good enough job on our own to bringing hell here.

    Oh yeah, and we’re the No. 1 livable city in the world: yeah right, I’ll remember that when I hear another shooting, see another homeless person, pay for another over priced grocery bill, take a ride on the over priced and tuna packed sky train, wait for another 4 buses to get me to the airport and have to pay twice cause 90 minutes is not enough, stew on the roads cause we have the most poorly designed road system in the world for a city of 2 million people!, and now I hear that Translink want to us to pay tolls on very single bridge in Metro Vancouver, cause they couldn’t fund the stupid olympic games that we should never had.

    Give me a break!

  10. The real reason for the affordability of houses in Vancouver is the drug trade. Huge profits from this business are laundered through real estate purchases. As long as there are addicts Vancouver will flourish…of course we will have to deal with the shootings, wacked out druggies, etc.

  11. Bullsmakegreatburgers

    How about a positive comment?

    I am positive that you know nothing about finance or economics.

  12. Best place on meth

    “Paradigm Shift”?

    Is that the new line the real estate cheerleaders are trotting out these days? Did Rennie come up with that bit of Newspeak for you guys?

    When will you pumpers get it? This is a bubble and ALL bubbles blow up eventually.
    It’s really not too complicated to understand.

    What a silly little blog you have here.

  13. Let’s assume this is all 100% true. Then…we still have a big problem — how will the housing prices rise with these kinds of numbers? Lets say…we expect housing to rise 10% a year. That means…I would need 10% more downpayment (550K?) and 10% more income. What’s ironic..is that we will be paying 10%+ more taxes too! (aka Olympics Tax) So, personally…the numbers may be right but it can’t be sustained. 2% growth (or basically..inflation) is all the market can sustain for those numbers.

    The other conjecture I would add is…are couples going to work 25 years straight and pour all their savings on a house? What about kids — raising families isn’t cheap. Raising two kids is like buying another house. lol!

    Any way…good luck on your blog… I hope your wrong since I want to buy a decent home in Burnaby and still raise my kids with a modest income.

  14. “I personally know a few Goldman Sachs employees based out of Manhattan that recently purchased very high end condos in Kits.”

    Proof thatit is the criminal element buying up Vancouver real estate.

  15. These comments – likely from people who link from the delusional bear sites in Vancouver, Victoria, Edmonton and elsewhere – prove the author’s point:

    Bears read what they want to read. Hear what they want to hear. Believe what they want to read. When the facts contradict their faith, they question the data.

    Most are undeclared, closeted Marxists: they think the market is evil and anyone who operates in it to be morally bereft.

    Sucks to be you, bears.

  16. I see the bear blogger ‘Whisperer’ has profiled your blog on his site (http://whispersfromtheedgeoftherainforest.blogspot.com/2009/08/yang-for-your-ying.html)

  17. Interesting point of view. Its not mine though. All the same, it adds to the discussion in a valuable way.

    As for the nasty comments. If they are mostly true to their words, you won’t hear from them again. If they continue being rude and nasty, either delete them or warn them and then delete
    them. It makes for much more pleasant reading for the rest of us as well.
    Thanks and keep up the discussion.

  18. Without getting into the numbers breakdown there are some more simple bearish factors at work. In most markets, when a peak has been made (let’s say last March/April) and the market pulls back, in a true bull market prices will then continue to make new highs. What should be alarming to the average bull is that volumes are high again but new highs are not being made. There is no other word for that than “bearish”. That’s how bubbles deflate, they stop making new highs even when the news is still good. All of the good news stories are priced in already. One is betting that future good news will be even better than the bullish predictions that are widely believed and priced in.
    “It takes a lot of buying for a market to go up. It simply takes a lack of buying for a market to go down” – Reminicences of a Stock Operator.

  19. What should be alarming to the average bull is that volumes are high again but new highs are not being made. There is no other word for that than “bearish”. That’s how bubbles deflate, they stop making new highs even when the news is still good. All of the good news stories are priced in already.

    thank you for your insightful comments.
    everything is priced for absolute perfection in a very imperfect world…. ‘nuf said.

  20. what a load of crap. Keep dreaming the days of Van RE are numbered. Crash is coming not far from now.

    You’re sounding desperate, man!

  21. Pingback: How Canada’s Income Disparity Is Raising Home Prices For Rich, Poor Alike | canadian blogs

  22. Pingback: Canada Income Inequality: How A Growing Earnings Gap Is Raising Home Prices … - GRANITE WORLD – GRANITE WORLD

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