Finding Hard Value in Real Estate | Dec 15th 2013

A Tale of Two Cities

I chose to examine Vancouver and Detroit because they are at two separate sides of the spectrum. Vancouver has the highest price-to-rent ratio in North America while Detroit has the lowest. This is in part due to broad national trends as illustrated in this graph:

Internationally, Canada has amongst the highest price-to-rent ratios in the world. And while the U.S. does not have as low a price-to-rent ratio as Japan, its current trend indicates that its real estate is undervalued.

Vancouver is an extreme of an extreme. In contrast, while Detroit may have an extreme price-to-rent ratio for the US market, the US itself is not extreme within international markets.

Before I continue my examination, I must give full disclosure. I am a homeowner in the Vancouver market.

Vancouver: prestige at what cost?

Even amongst Canadian cities, Vancouver is different.

According to the IMF, here’s the price-to-rent ratio for three prominent Canadian cities:

    • Toronto: 35
    • Montreal: 35
    • Calgary: 32

    In comparison, Vancouver price-to-rent ratio is an astounding 58! More astoundingly is Vancouver’s historic price-to-ratio trends compared to those three other cities.

    What accounts for Vancouver’s extreme price-to-rent ratio?

    Part of it has to do with being a prestige city much like New York, London, and Paris are. Lots of international capital flows into Vancouver’s real estate market-to the point where Hot Asian Money (HAM) has become a familiar trope amongst Vancouver residents.

    (Realtors have actually milked the HAM mythos to drive up Vancouver housing prices-and were caught red-handed.)

    Yet prestige cannot be the sole explanation. Even in suburbs that have no international appeal, the price-to-rent ratio is still higher than 30.

    As seen in the above map, the far away suburb of Mission has a price-to-rent ratio of 40. From Mission, the commute time to Vancouver is more than 1 1/2 hours in ideal conditions (in rush hour, it’s greater). It has a very small city center compared with its population. Mission’s general “walkability” rating is low as well.

    Understanding all factors, there is only one suitable explanation for why metropolitan Vancouver’s price-to-rent ratio is high: irrational exuberance.

    Vancouver residents, accustomed to continuously high rising prices, simply cannot imagine a precipitous fall. Even worse, many potential purchasers are alarmed that they will get priced out. This in turn fuels rising speculation: “Better buy now before it’s too late!”

    So far, speculation has acted as a self-fulfilling prophecy. Housing prices in Vancouver continue to go up because that’s the expectation. But as the OECD notes, Vancouver is due for a price correction. Whether this happens soon is debatable.

    But as far as assessing hard value is concerned, Vancouver is certainly not the best real estate investment in North America.

    Detroit: is there value after bankruptcy?

    Real estate sentiment for Detroit is low. It’s easy to understand why.

    American car manufacturers - all associated with Detroit - have veered towards death and required federal bailout money to survive. The Motor City continues to be inflicted with a high crime rate and low police response times. Worst of all, Detroit is the highest profile American city to declare bankruptcy.

    Yet for all its warts, many people still want to live in Detroit.

    Detroit has major cultural significance within the American psyche.

    This is the city that brought the world Motown. It’s also renowned for its sporting achievements: Detroit is the home of the Red Wings, the Kronk Boxing Gym, and the Crescent Sailboat. Of course, Detroit also annually celebrates the North American International Auto Show-which serves to introduce production and concept cars alike.

    In addition, few cities have as stunning a skyline as Detroit’s. Its waterfront shows neogothic architecture blending with Art Deco skyscrapers.

    Even as Detroit lacks in real estate prestige, it still has large cultural resonance - and this explains why 681,000 people still live there even as infrastructure is at post-apocalyptic levels.

    As a place to live, Detroit is still in demand.

    A quick perusal of Craigslist confirms that a 2 bedroom apartment in downtown Detroit may fetch $1200 per month. Interestingly, this is only a few hundred dollars less than a 2 bedroom apartment in downtown Vancouver.

    Yet though many people want to rent property in Detroit, few want to own property there. A 2 bedroom apartment on Detroit’s downtown waterfront can be bought for $149,000.

    Property in downtown Detroit may have a price-to-rent ratio of between 8-12. Taken as a whole, however, Detroit’s general price-to-rent ratio is 6.6. Here’s how Detroit compares to other American metropolitan areas:

    If one were to utilize Detroit residential real estate for rental income, a home pays for itself within a decade. Put in more stark terms, an amortization period of more than 10 years is literal pocket change on a per month basis!

    Detroit may have problems with crime, infrastructure, and city finances, but its real estate is incredibly undervalued.

    Is real estate really a good investment?

    Even as Detroit is undervalued, I do not see a massive land grab for it.

    This is due to a factor I previously alluded to: much of real estate’s value is psychic:

      • What is a city’s crime rate?
      • What is its walkability?
      • Does owning property there create social prestige?

      These factors are hard to pin down with an exact dollar amount, but even so there is one uncomfortable statistic: since the 19th century, real estate in general has only grown on a per annum basis by 2%. If you’re looking for gains, a better tool in your investment arsenal is the stock market.

      (Owners who have held their homes for 50 years may feel that their home equity has grown by exponential rates, but how does it compare with the general rate of inflation?)

      Nevertheless, just like the stocks and bonds, there are overvalued and undervalued real estate markets. When considering a real estate investment, there are many tools at your disposal-but none so important as price-to-rent ratio.

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