07 August 2007

Reality Check on the Condo Craze

While the US mortgage market seems to be undergoing a reality check on the excessive quantity of soft loans (see American Home Mortgage Corp), we have a similar sort of speculative bubble slowly deflating in Alberta. A popular trends has emerged of taking existing apartment complexes, subdividing them into condos, renovating them, and then liquidating the individual units for mucho profits.

This is, of course, squeezing the existing rental supply and causing price increases. I'm watching this with interest because the trend is making it more and more difficult to rent on a fixed stipend. I've already been booted out of one apartment last October and I'll have to move again in May 2008.

Alberta is currently in the midst of a labour crunch. The bitumen and gas boom is fueling the rest of the economy, and past provincal government's failure to fund public infrastructure through the 1980s has led to a surge in government spending on public works. There are a number of new condos in my immediate vicinity that have sat, uncompleted, exposed to the elements for over a year now. Needless to rising construction costs lead directly to a higher sticker price for new condos.

This does of course beg the question as to who is buying expensive 50 - 70 m2 (500 - 700 sq. ft) apartments in buildings that are 20-50 years old? The units in my past condo sold for $80,000 - $120,000 for single bedroom units which is frankly, insane for flat, flat Edmonton. Unsurprisingly it seems people aren't buying them to live in but rather as an investment to try and flip them. This is further inflationary as not only does the original owner have to pay the subcontractors for the reno and then make a profit, but the flippers also need to make a profit unless they want to eat a big serving of crow.

The number of lawn signs indicating a newly renoed condo up for sale has been rapidly proliferating. The willingness of individuals to participate in this sort of speculation game is clearly dictated by their confidence in the market. The general failure of sub-prime loans in the USA is going to have an unpleasant knock-on effect in the Canadian marketplace after the standard lag period. The major Canadian banks are, I'm sure, quite exposed to this. They claim otherwise, but they also claimed to be unexposed to the Enron fallout and ended up losing billions. Rising interest rates make the cost of holding onto these condos an expensive proposition -- in Canada fixed-rate mortgages are uncommon. All these factors seem to be posed to make dodgy 'flipping' seem a whole lot more dangerous to the average Joe. If people stop believing that the gravy train is going to continue it stands to reason that the driving force behind the condo speculation game is gone.

As an anecdote, take the building I moved out of. There are now some five 'For Sale' signs in front of the 24-unit complex, with two more in front of an 8-unit structure across the road. There's also a brand spanking new (but unfinished for over a year) 16-unit building right across the road. The rest of the neighbourhood also has a lot of signage that never seems to move. The hard reality is that no one who can afford these units actually wants to live in them. The condo frenzy was driven by false premises and now anyone who got into the game late is going to get pwned.

For me personally, I don't think I'll see much benefit aside from a great helping of schaudenfraud. While vacancy rates will probably slowly increase, the open apartments are still going to be more expensive as a result of all the inflationary pressures. The lag in rental rates to vacancy rates will probably mean that I will finish my doctorate around when rents see some real decline.

Update: Some of the European banks are starting to fess up that they are exposed to the bad mortgages in the States. I would like my readers to take note of the talking point of 'liquidity'. Clearly, some people are terrified of any sort of comparisons with the 1930s Austrian bank failures. I am distinctly reminded of Jerome a Paris' discussion of the herd mentality of bankers, and why they hold themselves on the wrong path for so long. As long as they all make the same mistakes, everything is good, especially when the state can be relied on to bail them out.

Update 2: The Bank of Canada channels Kevin Bacon in Animal House:

Bank of Canada issues statement on provision of liquidity to support the stability and efficient function of financial markets

OTTAWA – In light of current market conditions, the Bank of Canada would like to assure financial market participants and the public that it will provide liquidity to support the stability of the Canadian financial system and the continued functioning of financial markets.

These activities are part of the Bank's normal operational duties relating to the stability and efficient function of Canada's financial system. The Bank is closely monitoring developments, and will deal with issues as they arise.

Quick print more money!


YLB said...

Question (to which I think I already know the answer).

In these condo conversions, do the developers ever upgrade the energy efficiency/insulation or maybe add DHW or PV?

Maybe incentives or regulations could actually encourage this and make this market dynamic work in favor of increased energy efficiency and productivity.

Robert McLeod said...

No, they are purely cosmetic renovations. Slapping lipstick on a pig as it were. This is one of the reasons why purchasing these over-valued units is so imprudent. Any structural issues are being plastered over (literally) in order to sell the units to citizen investors. My past place had issues with plumbing leaks causing damage to the roofs in certain units. I really doubt if any of the condo buyers knew that.

In general, I think any construction done in boom-time, Alberta is fairly suspect. Contractors are in such a rush to finish the job and move on to the next one that quality declines. In addition, anyone who can wield a hammer can get a job rather than having the best craftsmen doing the work.

There is one interesting 'EcoHouse' (LEED certified) going up a few blocks from me that incorporates a bunch of green building practices, from basics like having triple-pane windows and a bicycle room as well as roof mounted PV and hot-water. It's new construction rather than a retrofit, however, and clearly it is designed to be marketed as green in order to garner a price premium.