RealTMOR Asset Mgmt LLC and RealTMOR Apartment Mgmt LLP

www.realtmor.com

Over the last two decades real estate prices in two developed markets, Canada and Australia, have defied gravity. London, New York, Hong Kong and, to a smaller extent, Miami/Dubai real estate were popular investment options for real estate investors, including foreign buyers. But in the last two decades, many foreign buyers have focused on real estate assets in Vancouver, Toronto, Sydney and Melbourne. The main push has been led by Chinese investors, who have descended on these markets in droves, transforming the pricing there.

Why and how this happened, is an interesting analysis. China’s economic rise, investors’ desire to geographically diversify asset-ownership, use of leverage (in China and in destination countries) and propensity of Asian investors to favor real estate are among myriad reasons. But the focus in this case is on future course of action. It is clear that these cities have had a great ride and now prices have reached stratospheric valuations. In all probability it’s a decent forward assumption that these markets could witness a soft or hard landing. Real estate price corrects either through “time-correction” or “price-correction”. The former is downward meandering of prices, over time, until the longer-term price trend rectifies. Previously happened in Singapore and is currently happening in Mumbai (another market with sky-high pricing). The latter is the price correction caused by a sharp fall, in a short time, of real estate prices. This happened in USA in 2006-2008 and in SE Asia, in late 90s, during the Asian financial crisis.

A Tale of Two Countries:

The happenings in Canada and Australia is not dissimilar.

Canada: Vancouver’s real estate prices gained 300%+ from 2000-2018 while Toronto’s gained 225%+/-.

Australia: Sydney’s real estate prices gained 200%+ from 2000-2018 while Melbourne’s gained 180%+/-.

Globally, among developed economy cities, during this period such growth has been matched ONLY by Hong Kong and London (220% and 200% capital gains, respectively). Hong Kong and London are global financial and population centers (Metro London and Hong Kong have populations of 13MM and 8MM, respectively). These two cities have long traditions of being premier business centers of Europe (Brexit risk, notwithstanding) and Asia. Hong Kong is advantaged by its proximity and relationship with China and is the sought after investment/residential destination for mainland Chinese. London is a primary investment/residential destination for the world’s rich, from places like Russia, India, Gulf countries. Also, Shanghai and Mumbai have outperformed these cities during this time frame. But the dynamics of rapidly modernizing and growing economies like China and India have different trajectories and different macro-stories. They are “fast-growing markets” with a different/higher risk profile and hence justifying higher returns.

No doubt, these cities are premier cities in rich, developed countries but population-wise these cities are small and their economic impact is, at best, regional/local. The metro areas of Sydney and Melbourne have populations of 5MM and 4.5MM each. The population of Toronto metro area is 6MM but Vancouver’s (metro area) is 2.5MM. This implies local buying capacity, numbers-wise, would have its limitations. Analyzing the financial picture:

The financial/valuation information is based on my research and use of publicly available sources to corroborate information.

Canada: Rental Yields: Net annual rental yields ((Annual Rent-Annual Real Estate Expenses)/Price of Property) in Toronto and Vancouver are 2%-4%.

Mortgages: Depending on the type of loan, the best annual mortgage rates in Canada are 3%-4% (foreigners seldom get these rates). The Canadian government has raised mortgage rates periodically to counter the “heated” housing market. The government has been tightening lending standards (higher down payments, higher mortgage insurance etc.) thus making it harder to access riskier mortgages. Mortgage interest is not tax-deductible in Canada, making homeownership more expensive compared to USA.

Other Parameters: Illustration: 800 square foot condominium in Toronto/Vancouver. Average price (actual prices could be higher) assumed as $850 (Canadian)/sq ft. Thus potential price of unit over $700,000 (Canadian).

1. Price to Annual Rent (assuming monthly rent as $2,750 (Canadian)) would be over 21.0x. Standard range for this metric is 10.0x-20.0x, prospect of overvaluation closer to 20.0x.

2. Price to Income (assuming average annual income in these urban areas around $75,000 (Canadian)) would be around 9.0x. It would take an average family 9+ years’ income to buy an average dwelling. The standard for this affordability metric is 2.0x to 4.0x which indicates appropriate pricing.

Australia: Rental Yields: Net annual rental yields in Sydney and Melbourne are 2%-3%.

Mortgages: Depending on the type of loan, the best annual mortgage rates in Australia are 4%-5% (foreigners seldom get these rates). The Australian government has been tightening lending standards (higher down payments, removal of interest only loans etc.).

Other Parameters: Illustration: 800 square foot condominium in Sydney or Melbourne. Average price (actual prices could be higher) assumed as $1,000 (Aussie)/sq ft. Thus potential price of unit over $800,000 (Aussie).

1. Price to Annual Rent (assuming monthly rent as $2,700 (Aussie)) would be over 24.0x.

2. Price to Income (assuming average income in these urban areas around $70,000 (Aussie)) would be around 11.0x. It would take an average family 11 years’ income to buy an average dwelling.

Other Factors will impact forward prices in both these countries. The price of residences, for locals, have become prohibitively expensive and there is an outcry from the local population (justified or unjustified is up for debate). The governments in both countries have instituted measures to “cool” property prices. The taxes and fees for foreigners and vacant homes have been raised in Canada. Foreigners, in Australia, have new restrictions regarding leverage use, ability to purchase only “new properties” and need for approvals from investment boards. These measures, along with others, are designed to impact foreign ownership.

The other worrying fact, these markets didn’t miss a beat during the US real estate bubble burst in 2006-2008 and the subsequent down market for the next 4-5 years (during the Global financial crisis). During 2007 to 2011, when US prices were severely negative these cities logged positive returns, not affecting its northern neighbor’s property prices. During 2000-2007, Asian real estate was reeling from the Asian financial crisis, even prices in Hong Kong were negative, but Australian property prices moved along nicely. This shows that these markets have not had a real price “finding” exercise in decades. From 2000-2017, there have been no material price declines. Till recently, non-price metrics like months’ supply, construction parameters etc. have also shown beneficial trends for pricing. This would result in low volatility combining with high returns, but that doesn’t mean this is a “great, safe investment”. It could mean that these markets are now at or close to peak or experiencing a “bubble”. Chinese investment (Australian government data sources) in Australian real estate increased around 700% from 2013-2016. Correspondingly prices in Australian cities (Sydney and Melbourne) experienced double digit annual growth rates. The first price slowdown happened in 2017, the year Chinese investment halved from the previous year. This demonstrates some link between Chinese investment in Australia and the meteoric price rises.

But, 2018 has demonstrated small cracks in these markets. There have been some price declines but not large enough or sustained enough to conclude that “price-correction” is happening. There may be oversupply and overbuilding of the “luxury”/more expensive properties in these cities. Sales volume seems to be getting sluggish and for-sale properties are on the market longer. In Australia and Canada, the mortgage market has exploded, both owner occupied and investment properties, and is estimated to be 95% and 75% of GDP, respectively.

Further, the government measures seem to have an effect on foreign demand. Couple these with foreign exchange restrictions in China, turmoil in the commodity markets, risks of a global recession/ economic slowdown and perception of over-valuation of these property markets.

There are many motivations for people to buy real estate but if HNIs/ foreign investors currently invested in Sydney, Melbourne, Vancouver or Toronto have an “investment outlook” then they should seriously reconsider their situation. If the investor has bought the property many years ago and has attractive unrealized gains then monetize gains and take some “money off the table”. In my view, there is a good chance that residential property prices in these cities have the potential of “tough times going forward”. There are many other attractive markets that could be a better investment destination for these gains.