A friend of mine sold his 1970’s, 3 bedroom North Vancouver teardown for $1.25m.  He bought it eight years ago for $650,000.  It is located on a busy street, but has a slight city view in the winter when there are no leaves on the trees.  Property taxes cost him $5,000 per year plus an additional $3,000 annually towards insurance and repairs.  The house was generating $35,000 annually in rental income.

After subtracting property taxes and repairs, his cash-flow generated $28,000 annually (I assumed he had no mortgage), or a yield of 1.8% - hardly something to brag about.

The house had also built up $75,000 per year in additional equity.  So upon selling he realized a capital gain of $600,000, or 92%.  This is an excellent capital gain no matter what the asset.  Combining income earned and capital gains he profited $824,000 (123%) in eight years, assuming there were no extra costs. 

Prior to selling he asked my opinion if he should sell and invest the money elsewhere, or keep it and continue to rake in the capital gains.  Obviously, I told him to sell.  Look at the graph above.  There is so much similarity to other bubbles in the past.  It is amusing that people think this can continue.  But, one cannot underestimate the effect that emotion has on commonsense.  

One rule of buying a home is to never take out a mortgage greater than three-times your household income.  The sole reason is to limit you from interest rate shock.  

Monthly Payments on a 25-year, $240,000 Mortgage
Interest Rate %	2.1	5	6	7
Payment $	1,028	1,396	1,536	1,681

As most surveys over the past few months have found, the majority of borrowers will be able to handle a normalization of interest rates.  However, it is the estimated 23% of Vancouverites who cannot afford an increase in interest rates, or any expense for that matter, that is the concern.  Where do the 23% expect to get the extra $4500 per year to cover higher interest rates (assuming a return to 5% mortgage rates)?  The answer is simple; they won’t be able to.  People will either be forced into foreclosure or it will come at the cost of other expenses such as vehicles, travel, and dining out.  Either scenario will have a large impact on the local economy.

Let’s put Vancouver house prices into to the context of the stock market.  Using my friend’s house as an example, the rent he was able to earn would give the house a price-to-earnings ratio of 35-times and a dividend yield of 1.8%.  The general rule of thumb in the stock market is to never pay more than 20-times earnings and invest for a yield of no less than 3%.  Anything outside of this, one is creating opportunity costs.

Don’t get me wrong, Vancouver is a beautiful city and its real-estate demands a premium, just not the one people are currently paying.  This summer will prove to be the peak in Vancouver’s real-estate market.  There is not one city in the world that has been correction free after a run-up in prices like Vancouver experienced.  If you or someone you know wants to enter the market, it is prudent to wait on the sidelines.  If you are one of the many Vancouverites who are nearing retirement and banking on your home to fund your golden days, the next few months will be the last time to take advantage of today’s prices.  This is the time to reap your profits rather than speculate.

Other than herd mentality, there is not one reason to justify today’s prices.  All lower mainland real-estate is going to correct.  It will then recover to levels that the average income can justify under normal frenzy-free conditions.  There is no doubt in my mind Vancouver will see today’s prices again, but not for a generation.