Sunday, October 3, 2010

I'm interested in reading more discussion on the future direction of Alberta's housing market

 I can see that Vancouver and Toronto may be overvalued in general terms, but Calgary or Edmonton?
Since 2000 property values have increased dramatically even taking into account a 5 to 30% (depending on market segment) drop in value from the peak. As with any boom like the one we experienced in Alberta there was initially a significant catch up component when compared to the other Canadian cities.
There are (just like in other investments) so many ways to value properties and there is always one that points to overvaluation. REIN members look at cap rates and base value on investment income. Others compare values based on the prices of recent sales for comparable properties. Some is done in excruciating detail others are happy with a CMA. Value is in the eye of the beholder and a lot is emotional and also depends on the pocket book of the potential buyers.

I have attached the Calgary Single Family Price chart from 1973 - 2010. You can interpret this charts in 2 ways the glass is half empty (pessimistic view) or the glass is half full (optimistic). In the pessimistic case you can interpret the chart as representing a bubble that hasn't crashed yet. In the 'half full' case, my most likely scenario, we had a value catch up and now we are returning to more sustainable levels of appreciation. I bet you can come up with every scenario in between and some that are a lot more bullish than the 'half full' view.

 So let's start with the bubble scenario or 'half empty' scenario. Many investment bubbles are characterized by a gradual value increase that suddenly steepens with valuations reaching unsustainable levels. Classic examples are the U.S. Real Estate 2000-2007 or the high tech bubble of 2001. After an unpredictable long or short time period, the market crashes. It crashes not back to reality but it overshoots to extreme levels of pessimism and undervaluation. Just like in March 2009, investors will realize that their pessimism is overdone and values will restore back to the original trend (possibly with some volatility). Based on this scenario, Calgary housing prices may collapse and fall back to the $300,000 - $350,000 range and from then on-ward appreciate at its historical rate (prior to the bubble of 7.3%). Right now the rate of appreciation is somewhere around 2-3%.

The scenario favoured by me is shown on the 'steady as she goes' or 'half full' scenario. My scenario is that Calgary's real estate appreciation accelerated because of a fundamental economic change. Namely commodity pricing and heavy oil. After decades of depressed commodity prices, Alberta's resource potential, in particular for heavy oil in Eastern Alberta was recognized; it became technically viable and economic attractive. This was a fundamental game changer and allowed Calgary real estate valuations to catch up with that of other North American cities of similar size. That is why we experienced not a crash as elsewhere in North America because Calgary's fast rate of appreciation was supported by fundamentals. I guess a solid Canadian banking system helped as well.

So now that we have caught up and are getting past the volatility experienced in North America overall, we will likely revert back to a more sustainable and very respectable rate of appreciation reflecting Calgary's vibrancy even during normal economic times. In that regard, 7.3% may be considered very attractive and we would do well et even today's more modest growth rates of around 2-3%.

When looking at Calgary's current income levels, in-migration and potential as an energy power-house, I think we are far removed from bubble conditions. But... as always, the world is unpredictable, just look at what a new technology such as multi-stage frac'ing has meant for the Natural Gas industry or what technological innovation has done to the profit margin of the computer manufacturers.

Even if there is a bubble in Calgary, as long as you bough before 2005 and are in a positive cash flow with a responsible level of leverage, 10 years after the bubble 'burst' you would still be ahead. If the 'Steady-as-she-goes' scenario (Glass is half full) will play out, you're hollering all the way to the bank. And at even better economics, you'll go hysterical for joy.  In my experience, optimistic realism is what makes you rich!

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